The Federal Government Should No Longer Subsidize 30-Year Fixed-Rate Mortgages

President Obama is set to outline his plan for reforming the federal role in the home mortgage market today. Here's one of his requirements:

An acceptable measure also must specify the government’s role and liabilities for Fannie Mae and Freddie Mac, the officials said, and — unlike legislation in the Republican-controlled House — must ensure Americans’ continued access to a 30-year mortgage at a fixed interest rate.

Dean Baker is unimpressed:

In fact, government backing is not necessary for 30-year mortgages, as is shown by the existence of the 30-year jumbo mortgages which are too large to be eligible for government guarantees. The interest rate on these mortgages is typically 0.25-0.50 percentage points higher than the interest rate on conforming loans that can be purchased by Fannie Mae and Freddie Mac.

So the story here is not really about the existence of 30-year mortgages, but rather the price. The program being pushed by President Obama effectively subsdizes mortgage interest rates by subsidizing mortgage backed securities. If the goal to make homeownership more affordable for moderate income people, this is an extremely inefficient way of doing so.

Under the Obama administration's proposal the vast majority of the subsidy would go to higher income homeowners since there will be a bigger subsidy for people who take out bigger mortgages.

A few years ago I think I would have believed that the 30-year fixed-rate mortgage was worth saving. But I now suspect I was just being a slave to path dependence. I grew up with the 30-year fixed-rate mortgage as the "standard" mortgage, so it naturally seemed worth saving. But other countries get along fine without it, and as Baker points out, the jumbo mortgage market gets along fine without any federal guarantees. You can still get a jumbo 30-year fixed, but you'll have to pay a bit more for the security.

The same would likely happen in the conforming market if federal guarantees were ended: 30-year fixed loans would continue to be available, but they'd cost a bit more than ARMs. And even if they did go away completely, it's not clear what harm would be done. As with so many other things, we'd just have to get used to living in a world where pretty much everything is indexed to inflation.

Speaking for myself, I'd get the feds out of the business of deciding which kinds of mortgages should be available. This is something where the market works perfectly adequately. Instead, federal regulations should be all about minimizing fraud, maximizing transparency, and setting rules necessary to keep the broad mortgage market stable (down payment minimums, HELOC regulation, balloon payments, ability to pay, etc.). That's where the real bang for the buck lies.