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Monday, August 25, 2008

The Socialization of Mortgages

As the crisis in Fannie Mae and Freddie Mac deepens, more and more "experts" will come out of the woodworks to offer their opinions. Because the mortgage ciris was ultimately the result of a speculative market, an argument could be made that the market failed the system. All speculative markets are inherently a failure of the market system. Anytime there is a failure of the market system there will be those that suggest that it is time to revolutionize from the market system into something socialized. That's what we attempted to do in 1933.

The Home Owners' Loan Corporation (HOLC) or Home Owner's Refinancing Act,
was a New Deal agency established in 1933 under President Franklin D. Roosevelt. Its purpose was to refinance homes to prevent foreclosure. It was used to extend loans from shorter loans to fully amortized, longer term loans (typically 20-25 years). Through its work it granted long term mortgages to over a million people facing the loss of their homes. The HOLC stopped lending circa 1935, once all the available capital had been spent. HOLC was only applicable to nonfarm homes, worth less than $20,000. HOLC also assisted mortgage lenders by refinancing problematic loans and increasing the institutions liquidity. When the HOLC ended its operations and liquidated assets, HOLC turned a small profit Crossney and Bartelt 2005 Urban Geography article. Crossney and Bartelt 2006 Housing Policy Debate.

HOLC is oft-cited as the originators of mortgage redlining. Recent research has suggested that the institution itself did not redline or discriminate on the basis of borrowers' race and ethnicity. The racist attitudes and language found in the appraisal sheets and Residential Security Maps created by the HOLC likely reflected private sector bias and racial antipathy.

It is what some will propose to end this crisis.

The bubble in real estate, like the bubble in the stock market, transformed our culture into an expectation that everyone could be a mover and shaker in capitalism. And cable-TV business shows promoted that dangerous way of thinking. Yet the truth is that unchecked financial innovation works poorly in asset markets.

The solution, suggests Shiller, is to make policy changes that will "inhibit the development of bubbles, stabilize the housing and larger financial markets, and provide greater financial security to households and businesses." He proposes a Home Owners' Loan Corp., as established during the New Deal in 1933, that would make credit available to home buyers, especially if Fannie Mae and Freddie Mac are crippled. The HOLC could accept mortgages as collateral for loans to mortgage lenders.

Now, frankly, socializing mortgages fails to recognize the current problems now in our mortgage system. The system is now quasi socialized because both Fannie and Freddie are extensions of the government as Government Sponsored Entities. This creates an inherent moral hazard because as an extension of the government the companies are too vital to fail. The reason both took on more risk than they needed to is because they both knew the government would to there if their risks blew up. By socializing the entire industry, the entire industry is too vital to fail.

Second, to truly socialize mortgages, this would create the largest bureaucracy in the government. For this new Homeowner's Loan Corp to have any effect on the overall mortgage market, we would be creating a bureaucracy of unimaginable size. Not only would an extra bureaucracy create more government expenses but it would increase corruption.

The bottom line is that whatever free market failings caused the mortgage crisis it is the same free market that must fix them.

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