Against Government-Subsidized 30-Year Mortgages

I don’t think that those who disagree with me are dumb.  It is often that the person in question is bright, but has presuppositions that disagree with mine.  I am for the most part a libertarian.  Thus I don’t often agree with liberals, or the pro-big-business wing of the Republican party.  Most of the time, I also favor regulation of financial companies, because when too many of them borrow short and lend long, something horrible happens to the economy as a whole.

That is the main reason why I think government encouragement of 30-year mortgages should end.  It increases leverage in the economy, and makes it more susceptible to crises.  Societies that have a lot of debt tend to be more fragile.  We forget how certain we were that Fannie and Freddie could never fail.  I was one of the few people that argued the opposite at  (Sadly, those posts are lost.)  F&F assumed that there would never be a sustained period where housing prices would fall across the US as a whole.  When prices began to fall, their business model was destroyed, because they were levered very high.

30-year mortgages allow some to buy houses that they should not buy.  If you have to have a 30-year mortgage instead of a 15-year mortgage, you are buying too much house for your income.  We spend too much money as a society on housing, and we take on too much debt as a result, leading to fragile financial systems.  Debt-based systems are fragile relative to equity-based systems.

If there are to be 30-year mortgages, let them be purely private, like Alt-A, Jumbo, and Subprime loans.  Don’t let the government place any guarantee on them.  If we have to guarantee mortgages, do it from 15 years and shorter.  Reduce the amount of leverage in the economy as a whole.  Make the system stronger, against those who think that encouraging borrowing is a free lunch.

What is the cost to my proposal?  Fewer people buy houses, and fewer houses get built.  Good.  We are over-housed already.  Far better that investment should go to production rather than consumption in the US (opposite in China).  We already subsidize mortgage lending through the tax code, which we should eliminate.  Why should we favor one class of borrowing over another?

Let the apartment REITs house people.  They borrow over a wide maturity spectrum, and do not rely on long-term finance.  Loss of government guarantees on 30-year mortgages will not affect them.

Now, I am responding to this article of Mike Konczal.  Here is one thing that he said:

The second [reason] is that providing macroeconomic stability is a legitimate and important function of the government. After the crash, the government had to step in, prevent a banking crisis and run the entire mortgage market after private capital disappeared. As such, the government holds the tail risk of the mortgage market imploding already; why not make this insurance explicit, while also regulating and pricing it?

Sorry, that’s not the way it works.  The Fed provided too much liquidity, and F&F provided too much lending up to 2007.  Now we suffer the bust from having over-stimulated housing demand.  The government rarely makes things more stable; they are pro-cyclical, and make things less stable.  That’s the way politicians are, because no one will oppose a boom.

We need to move to a less-levered system, where debt is discouraged, to create a system that is not fragile.  After two failures due to high debt levels (current and the 1930s), we should learn that high levels of debt lead to economic failure, and move to a system where interest in not tax-deductible, but dividends are.  This will lower debt levels, and our economy will become more stable.



  • Crocodile Chuck says:

    David, I don’t understand this. Most mortgages here in Australia have an (actual) duration of 5-6 years (families re-fi-ing, or purchasing another house) -even if the term written was 25 years (maximum here). And no one I know has ever just made the minimum monthly payment-they pre pay early. Last, why don’t US banks offer a product with variable interest rates-then they could shed the need to hedge and early repayment risk?

  • Helical_Investor says:

    I don’t disagree, but shifting the bar from backstopping a 30 year mortgage to a 15 year is still support of government-subsidized program. It does not have to be all or nothing. The ability to shift that threshold in terms of down payment rates, credit worthiness, duration, tax benefits, or other properties can form the basis for counter-cyclical housing policies. I also agree there is no political will for such a thing. It would require the statement “We spend too much money as a society on housing” to be less subjective and itself benchmarked in some way (%GPD, %income, % of population???), so that the market, and businesses that operate within it, could anticipate when mortgage support might be more forthcoming or withdrawn. The devil is always in the details.

  • Johnnydenver says:

    Do you have any recommended reading that explores what it would be like if dividends were tax deductible instead of interest? I have talked about this on more than one occasion, but have not read much on the topic. Curious if you have anything worth reading.

  • Greg says:

    @crockodile chuck — The US already has ARMs (adjustable rate mortgages) and 3-1 or 5-1 programs (fixed for 3yrs or 5yrs, then adjustable for the remainder).

    US 30yr fixed loans have an effective duration around 7-8 years, very similar to what you describe.

    I think David left out a few details about FNMA and FHLMC. Both companies used to be government agencies, and were “privatized” (sort of) during the Lyndon Johnson administration. The “IPO” revenue from selling FNMA / FHLMC to the public allowed LBJ to falsely claim he had a balanced budget. The one time revenue from the sale was used to offset perennial overspending for his great society and Vietnam war expansion. In short, both FNMA and FHLMC were born of accounting fraud.

    From their IPO in the late 1960s until the middle 1990s, both GSEs acted primarily as mortgage insurers. They guaranteed mortgage principal (for a fee that was fixed / did not always reflect true risks). But the system was so stacked in their favor that their legislated profits could easily absorb the expected losses and still leave plenty for dividends to shareholders.

    In the 1990s, Congressman Barney Frank managed to convince then President Clinton to appoint Franklin Raines as FNMA’s CEO. Whatever his merits might have been, Raines was and is a politician, not a banker. He was absolutely clueless about managing any sort of financial risk. Raines was later fired after it was discovered that FNMA had massive accounting fraud under Raines’ watch. In addition, the government commission investigating the fraud also found that FNMA had ***NO IDEA*** what their prepayment or interest rate risks were. None, zip, ziltch. A politician pretending to be a banker can’t manage risk of an ARM or a fixed rate loan. A politician had no business running FNMA. (FHLMC was a smaller company, but essentially mimicked everything FNMA did).

    Under Raines’ leadership, FNMA started buying and holding billions of dollars worth of mortgages on their own account, financed with corporate debt as well as the repo market. FNMA was quickly transformed from a quiet mortgage insurer into the largest and most levered hedge fund in the world at the time (today, the Fed is bigger and more levered). FNMA was levered more than 50x (approaching 100x at times), and they still had no way to measure their interest rate or prepayment risks, never mind the credit risks that they just assumed away.

    Of course, Raines (and Barney Franks) were pushing for more subsidized housing loans for poor people — who couldn’t really afford to buy a house. Lending money to people who cannot afford the loan is a guaranteed loss, no matter what the interest rate or the term.

    It was during the investigation into FNMA/Raines’ fraud that Barney Frank made has absurd assertion, on the floor of the US Congress, that FNMA was not bankrupt and even if it went bankrupt the US taxpayer would not be on the hook for the losses. More lies, more fraud.

    Despite lots of hand waving and obfuscation tactics, FNMA’s management after Raines was fired knew they had a very serious problem in 2005 or 2006.

    FNMA went all over Wall Street trying to buy gamma. Pretty sure they contacted every single firm, but they definitely hit all the primary dealers and many large banks / hedge funds.

    FNMA was desperate to buy gamma — receiver and payor swaptions in huge notional amounts. Wall Street wanted to sell, but no bank could afford to take on the exposure FNMA was trying to offset. A group of traders at my former employer tried to estimate FNMA’s total gamma needs versus how much gamma the entire street could sell — and it was very obvious that FNMA’s gamma needs exceeded what every bank in the US could fit on their aggregate balance sheets. There was no way to hedge that much exposure. Not even if every single bank / hedge fund maxed out their aggregate balance sheets for FNMA (never mind FHLMC and FHA and GNMA and all the whole loans).

    Somebody suggested that FNMA start issuing callable debt — the bond owner is long a bond, short a call (or a strip of calls). That means FNMA was short its debt (already), but long those embedded calls. It was a very expensive and desperate way for FNMA to buy some gamma to hedge interest rate risk.

    Prepay risk and credit risk were never addressed, at least in part because FNMA had only started to develop the required risk measurement tools. Like many government entities, big computer projects at FNMA tend to go over budget and way over schedule.

    FNMA was born of accounting fraud. Over the years, it was abused more and more as a transfer system from wealthy borrowers to poorer borrowers and eventually to people who could not repay the loans under any circumstances. Then a political crony was put in the CEO office, and he turned a mortgage insurer into a giant MBS hedge fund with no risk management department at all.

    All this was revealed to Congress by then Treasury Secretary John Snow — who tried to put some controls on FNMA, and limit the damage to the economy. Snow was essentially shown the door for his efforts. Congress knew in 2003, at the latest, that FNMA was a runaway train.

    Buying votes in the next election was more important than protecting the economy. Please try to act surprised here.

    US taxpayers all witnessed Barney Frank lying his teeth out on the floor of Congress — and we let him get away with it for years. We watched Clinton put a political hack in charge. We watched “W” Bush throw John Snow under the bus lest his middle east wars get sidelined.

    We the People sat around with our thumbs you-know-where while our government did everything possible to screw things up.

    We the People wanted the quick and easy money, and our corrupt officials were only too happy to play our greed against us.

    Them the corrupt are still playing to We the People’s short sighted greed today.

  • Crocodile Chuck says:


    Thanks v much for your lucid, detailed post.
    Appreciated. :)