Volker: Mortgage Market Still Dysfunctional

From Dow Jones:
Paul Volcker, chairman of President Barack Obama's Economic Recovery Advisory Board and former Federal Reserve Chairman, said the U.S. mortgage market, money market funds and rating agencies are issues that still need to be addressed in the wake of the global economic crisis.

He was speaking at an International Economic Alliance event in New York.

The mortgage market is the "biggest single thing to work on now," said Volcker, adding that it is dysfunctional due to its dependence on the government. He also discussed money market funds, whose place in the financial system ballooned in the lead-up to the crisis, but are free of capital requirements. Volcker added he is not pleased with how the rating agencies have been dealt with.
The reason the issue of what to do with Fannie and Freddie was not resolved is because no politically expedient solution exists. Either continue to spend hundreds of billions supporting these insolvent institutions or put them through bankruptcy/break them up into smaller institutions. Most taxpayers do not want to continue propping up these institutions forever. But if you allow them to fail, it would surely hit the mortgage market hard because these two government wards buy or guarantee 90% of all mortgages right now. In effect Fannie and Freddie are the mortgage market. The only reason banks are making any loans at all right now is because they can always resell them to Fannie and Freddie. There will not be a sizable private mortgage market for a long time because insolvent financial institutions are continuing to delever their balance sheets.

Some people suggest that Fannie and Freddie should be broken up into smaller regional units. This idea, while it may be politically viable still represents a taxpayer backed subsidy for the housing market and further distorts the mortgage market. Government intervention is what got us into our problems in the first place. You remember the bogus but politically popular idea of saying that anyone with a pulse deserved a home. It is simply not true. A home is not a right, it is a privilege for those who can afford one.

Personally, I think the only solution is to completely dismantle Fannie and Freddie by allowing them to go into run-off. This would undoubtedly cause mortgage rates to increase (absent more Fed money printing) and cause temporary dislocations in the mortgage market. But these effects could be mitigated by having Fannie and Freddie gradually lower their presence in the mortgage market. For example, the process could take 5 years where the two government wards reduce their participation by 20% per year. The timing is of course up for debate but with mortgage rates at historic lows, refis will make the timeline rather short as prepayments remain higg. Critics of the Keynesian persuasion argue that this policy would reduce home ownership and make it harder for Americans to obtain financing. I agree and these are good things. I don’t want any more housing bubbles. I would also require that potential home buyers put down 20-30% down. If you cannot afford that amount then you should be renting rather than buying a home. We need to have homeowners who can really afford their homes.

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