It is hard to see how a private guarantor could credibly provide full insurance because of its inability to diversify against severe common, or macro, risk. The presence of a government guarantee, as opposed to a private guarantee, resolves the credit risk asymmetric information problem associated with MBSs that do not yet have their constituent mortgages fully specified. With this asymmetric information problem resolved, the TBA market provides liquidity, hedging, and price discovery to the mortgage market.
Thanks to Nick Timiraos for the pointer.
What Stock is advocating, and what seems to have the support of the Obama Administration and many in Congress, is a completely new business process in the mortgage industry, with a government guarantee of mortgage securities as the critical element. As you read this, I am appearing on a panel of experts who take a different point of view.
In my contribution two years ago to a Mercatus center collection of alternative proposals, I stressed the danger of trying to stand up a completely new set of institutional arrangements in the mortgage industry. I was worried that implementation could prove troublesome. That argument might not have seemed so powerful then, but maybe in light of healthcare.gov it might get more attention now.
In my presentation to the panel, I will say that a government mortgage guarantee is like the ethanol mandate. Whatever the alleged public policy justification, it is really a special-interest handout. See Your Mortgage, Their Rent. Of course, just as with the ethanol mandate, it will be very hard to stop and, once in place, impossible to kill.
I am so pessimistic about the politics of housing finance reform that I think that the best hope would be to try to create a restrictive charter for the new government guarantee agency. Make it illegal for the agency to guarantee cash-out refinances, second mortgages, investor loans, home-equity loans, negative-amortization loans, and ARMs. Limit the agency to owner-occupied mortgages, for purchase or rate-lowering refis, with fixed rates for 15 or 30 years. Getting that would be a huge victory, and it would not detract from any legitimate public policy goals, but I doubt that it is achievable. Wall Street and the housing lobby are going to have their way with the public, and we’re going to end up having to bend over and submit.