{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Yet we run the real risk that the current condition

Info icon This preview shows pages 103–105. Sign up to view the full content.

View Full Document Right Arrow Icon
Yet, we run the real risk that the current condition of the housing markets might in the end lead to a government decision that does not resist the temptation of using the GSEs for one more function: propping up the housing market in a crisis rather than contributing to one. We outlined the many roles that the GSEs have played: as a tool for promoting homeownership, as a tool to fight income inequality, as a tool to fight foreclosures, and even as a monetary policy tool. By combining all of these functions, the GSEs were unfit to conduct any one of their functions well. And they became gigantic and complex institutions that were too- big-to-fail. The securities that they issued or backed represented the largest fixed income market in the world at the time (now the Treasury market is slightly larger). Any substantial loss of value would do considerable harm to their largest holders: the financial sector and other countries. This reality adds further pressure to the federal government to continue to prop up the housing market. We argue that this is an unsustainable and undesirable state of affairs. A viable long-term solution must radically overhaul the housing finance system in the United States and build it back from the ground up.
Image of page 103

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
102 The goal of reforming the housing finance is to ensure an efficient mortgage market, both in primary (origination) as well as in secondary mortgage markets. If the origination quality of the mortgages in MBS pools is poor, secondary markets can suffer from severe information problems. Conversely, if secondary markets are illiquid or systematically under- price risk, they provide incentives to mortgage lenders to originate poor quality loans. Hence, by an “efficient” mortgage market, we have in mind a housing finance system that: (i) does not engender moral hazard issues in mortgage origination and securitization; (ii) corrects any market failures if they exist; notable in this case is the externality from undertaking too much credit and interest rate risk as this risk is inherently systemic in nature; (iii) maintains a level-playing field between the different financial players in the mortgage market to limit a concentrated build-up of systemic risk; and, (iv) features market pricing of risks as well as charging for implicit or explicit government guarantees. Based on Chapters 1-5 of this book, there should be little doubt that the current mortgage finance system falls far short of these goals. In particular, moral hazard is rampant as financial institutions – the GSEs, other large and complex financial firms, and FDIC deposit institutions- load up on mortgage risk knowing that they are insulated from its full consequences. Indeed, economists Nadezhda Malysheva and John Walter at the Federal Reserve Bank of Richmond find that 58% of all liabilities of the financial sector now come under a safety net. Because this safety net either is not priced or is underpriced, large distortions occur, such as subsidized financing of financial firms and the loss of market discipline. Somewhat perversely, the problem
Image of page 104
Image of page 105
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern