Imagine you have hundreds of millions of dollars in disposable income. (Congratulations!) You’re looking to find a safe place to keep it, and maybe earn a decent yield. Along comes a prospectus for a new product, to invest in the MBS Ice Cream Corporation. It comes from the same people who pitched you on MBS Ice Cream a few years ago, only they lied to you about the quality of their rancid ice cream, did nothing as the company imploded, and paid you back just pennies on the dollar when you sued them. Now, they want to sell you on this investment again, without any meaningful changes to the ice cream.
You used to be able to invest in Freddie & Fannie’s Sorbet, Inc., which the government backed with a guarantee. But that doesn’t exist anymore, so your alternative, if you’re a frozen dessert mogul, is MBS, where you'll have to take the losses yourself. You can take out insurance on the investment, but last time you did that the insurer couldn’t handle all the claims after MBS’s failure, and they went out of business.
I’m guessing that, given you’re a smart investor, you’d ask the government for some kind of subsidy, a little grease, to get you into MBS Ice Cream. Otherwise you’d be completely out of your mind to purchase it. And it seems pretty illogical for the government to have to pay you, a multi-million-dollar investor, to invest in an ice cream company. What’s so important about a robust ice cream manufacturing market that we have to bribe investors to fund it?
That’s basically the impulse behind President Obama’s plan, released yesterday, to subsidize the purchase of private-label mortgage-backed securities (MBS), the most corrosive financial product in the U.S. economy over the past 80 years. Obama, like many in Washington, is concerned about the massive $4.2 trillion portfolios of government-sponsored mortgage purchasers Fannie Mae and Freddie Mac, and the subsequent taxpayer risk if the market stumbles.
But the solution isn’t to restart the private-label market. MBS issuers abused investors in myriad ways during the housing bubble, and even afterward. That’s the primary reason why, since 2008, the private market for MBS has been effectively shuttered; private-label MBS represents 1 percent of all mortgage security issues, down from 37 percent in 2006. Investors have voted with their feet here, running to the security of Fannie and Freddie's government guarantee, or chasing risk elsewhere, rather than remaining the sucker buying toxic mortgage bonds.
Despite this, both President Obama and the bipartisan Senate coalition, led by Bob Corker and Mark Warner whose plan Obama endorsed yesterday, assume an eager private MBS market will replace the $4.2 trillion in the portfolio of government-sponsored entities Fannie Mae and Freddie Mac. The boosters of these plans claim that explicitly insuring private capital against losses will lure investors back. First of all, that would make the system no different than Fannie and Freddie, just under a different name. Second, the same people promising this guarantee say no taxpayer dollars will get spent in the process; it will all come out of insurance fees paid by investors. So someone will have to take that transfer of risk, and it's sure to be the investors (or private mortgage insurers, who mostly went out of business during the crisis and won't be able to handle the risk in a severe downturn, at which point it falls to the investor again).
All of these options attempt to preserve something that maybe should not be preserved. The secondary mortgage market exists, we’re told, to provide liquidity for mortgage lenders, thereby increasing homeownership rates and maintaining the 30-year fixed-rate mortgage. But this doesn’t logically follow: As economist Dean Baker points out, jumbo mortgages, which cannot be purchased by Fannie and Freddie, still exist, albeit at a slightly higher interest rate (and really, it’s slight, we’re talking between 0.25-0.50 percent). Is it worth it the risks to the nation’s economy to subsidize the mortgage market so heavily to bring down the price of mortgages a half a percentage point?
I would argue no. The idea of homeownership is unhelpfully viewed as part of the “American dream,” which nudges people into dumping most of their savings into a highly volatile asset. They are given all sorts of enticements toward this, like the 30-year fixed mortgage and the mortgage interest deduction, which are massively expensive and mostly regressive, transferring wealth upwards. Even with these illusions of security and thrift, homeowners have found themselves on the wrong end of massive abuse at the hands of lenders. The psychological imperative of owning a home plays into this illusion as much as the material benefits, and it promotes bubbles, as an endlessly increasing price of housing is favored as an economic engine, with government policies put toward edging that forward. Just as investors are set up to be gamed, so are homeowners.
If you really want private finance to sit at the center of the mortgage industry, you have to police the markets to discourage misconduct, and you have to give banks the ability to lend with their own funds and hold those loans on their books, rather than continue to perpetuate the broken originate-to-distribute model. There are ways to do this that protect both lenders and borrowers, and reverse the current situation, where the profit motive increases risk for everyone in the system. And as for the cries that homeownership would fall out of reach to many Americans, that’s really not a bad thing in the final analysis.
Americans “like their cheap mortgages,” we are told. I’ll bet they like having a job even more. New research from the Peterson Institute for International Economics shows a healthy correlation between rises in the homeownership rate and rises in the unemployment rate, because business entrepreneurship suffers and sprawl increases, and investment plows into home equity rather than more productive purposes. Furthermore, the Organization for Economic Cooperation and Development finds no correlation between high rates of homeownership and satisfaction with the quality of housing.
Despite calling homeownership a “cornerstone of American life,” the President did include a brief pitch for affordable rental housing. You have to ask whether there isn’t far more security and flexibility in renting, as long as elites take away the weird shame associated with it. One way to help stabilize rental markets would be to look into the mass purchases of foreclosed housing by Wall Street hedge funds, and their plans to securitize the rental revenue into bonds, creating the same opportunities for corruption. Local laws against slumlords and moderating annual rental increases would go a long way here. And they could promote the same kind of stability and community aspects that everyone seems to like about homeownership. After all, the people who need subsidies for housing are at the low-end, not the upper classes.
The last thing we need in the midst of the biggest financial collapse in decades, driven by an unsustainable run-up in housing prices, is to reconfigure the same market with a bunch of different names. If you have to throw a bunch of money in subsidies at a market just to get it to exist, you might want to question whether it should.
David Dayen is a contributing writer to Salon.
Lede image via Shutterstock.