Mortgage-Style Bubblenomics | Feb 13th at 11:45am
Should securitization continue to be basis of the American mortgage system? The background question to this panel that no one is talking about is whether widespread, systematic use of privately-originated mortgage-backed securities is better than having Fannie and Freddie dominate the market.
Peter Engberg Jensen, chief of a Danish bank, is describing the European mode of securitization, which requires taking on only people who have high downpayments, for originators to keep some “skin in the game” to make sure the security is fair to investors and to structure payments in a way that prices risk more effectively. I’m a little unclear if this system is required by the originating banks, by the investors or by law. The result is a much more stable system, but allows less investors to profit off of the mortgage market—potentially bad or potentially good, depending how you look at it.
Either way, the private model of originating mortgage backed securities in the U.S. will require a period of extended house price appreciation or at least some signs of health in the banking sector to get started again. Private money will only be attracted back when there is some sign that investors can make money out of housing again.
The model we have now is one where the government-sponsored enterprises (“GSEs” in banker and wonk speak)—Fannie and Freddie— are the major originators of mortgages. This is the situation we are likely to be in for the next year or more. This is good for people buying houses in downturns, when capital is scared away, but can crowd out needed private investment when the market is hot. The reality is that we will continue to need a mixed system- the GSEs will be the only players in downturns like this one, and private money will jump in the market when it’s hot. The question is how to manage the transitions between the two without suffering a major meltdown on the way down and without encouraging reckless speculation on the way up.
In a shameless plug, I’m looking forward to reading my friend Alyssa Katz’s book Our Lot: How Real Estate Came to Own Us, which describes how this balance got out of wack in the run-up to the crisis. One of the things she tells me the book describes is that the GSEs’ dominance of the prime mortgage market led private investors hungry for exposure to the mortgage market to seek out other ways to profit, which led them to subprime and jumbo (roughly mortgages over $400k) mortgages that the GSEs ostensibly couldn’t touch.
For those that haven’t heard it, my seat neighbor reminds me about the “Giant Pool of Money” episode of This American Life, which explains securitization and the mortgage meltdown in a way that is clear and engaging.
Michael Freedman-Schnapp is a candidate for a Masters in Urban Planning at NYU's Wagner School for Public Service. He is the Senior Policy Associate for the New York Industrial Retention Network, where he works on keeping blue-collar jobs in New York City and encouraging the growth of the local green economy.
