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What the Fannie Mae and Freddie Mac Proposals Mean for Mortgage Costs

I hope to have more to say about the administration's mortgage proposals, but for now here is a quick take on how this might affect borrowing costs.

There are three alternative plans in the administration's proposal. The first would still provide insurance for some mortgages, but the role of Fannie and Freddie would be substantially reduced. The second and third proposals would only provide relief during crises when the mortgage market is threatened with failure, and are therefore likely to have the larger consequences than the first proposal.

All of these proposals reduce the amount of insurance on mortgage loans, and hence would be expected to cause an increase in mortgage interest rates to compensate for the increase in risk.

However, there are some countervailing forces that will help to limit how much rates rise. First, there is also a proposal to gradually increase the down payment required to purchase a home to 10 percent. This will make it harder for many borrowers to obtain loans, and the resulting fall in borrowing activity will put downward pressure on mortgage rates. The down payment is still a big hurdle for borrowers, so even though this may lower rates relative to where they would have been, it will still be harder to get credit. More generally, lenders are likely to tighten up the requirements to get a loan, and while that will further reduce activity in mortgage markets and help to limit the rise in rates, credit overall will still be harder to get. So we shouldn't think of this as necessarily better for borrowers, even though it does tend to limit the amount mortgage rates will rise.

Thus, mortgage costs are expected to go up as interest rates rise due to the withdrawal of government insurance, and because of increased down payments and other requirements. How much will interest rates rise? That is difficult to say at this point, especially since we don't know the actual policy that will result. But with both sides of the political aisle in agreement that the role of Fannie and Freddie needs to be reduced, we can expect borrowers to face much higher costs in the future.

However, as Congress begins to hear complaints from middle class households priced out of home ownership, and as we forget how bad things were (as we always seem to do), I also expect that new programs offering help to some home buyers will be put in place. So, the long-run impact is likely to be less than the more immediate effects over the next several years.

But this does bring up a question. If we take Fannie and Freddie and all of their accumulated experience out of mortgage markets, and then replace them with something else down the road after complaints about home affordability reach politicians, will we be better off? Will a new institution perform better than what we have now? It's not at all clear to me that it will, and for that reason I believe Fannie and Freddie need to maintain some presence in mortgage markets, though it needs to be a much more limited role than they play now.

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