Why America needs a public option for mortgages

Eight years ago, Fannie Mae and Freddie Mac were supposed to be on their death bed.

Hit hard by the 2008 housing crisis, they were placed into receivership by the U.S. government, and everyone agreed they needed to be wound down. "There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form," said Treasury Secretary Hank Paulson at the time.

Yet today, Fannie Mae and Freddie Mac are still alive and kicking. They issued $974 billion in mortgage-backed securities in 2016 — up 18 percent from the year before — and Fannie Mae recently guaranteed $1 billion in debt by Blackstone-owned Invitation Homes. Which begs the question: To make home ownership widely available, is the government just stuck with this flawed mortgage-financing system?

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Not necessarily. What's needed is a different way of thinking about mortgages. And the Home Owners Loan Corporation (HOLC) — a short-lived creation of Franklin Roosevelt's New Deal — could show the way.

It and Fannie Mae were actually created around the same time — 1933 and 1938, respectively. But their purposes were crucially different.

Fannie Mae buys home loans created by private lenders, repackages them into new financial instruments (like mortgage-backed securities), and sells them back to the private markets. In exchange for a fee, it also guarantees investors that they'll get paid even if the homeowners fail to repay their mortgages. Fannie Mae started as a fully government-owned entity, but was transformed over time into a for-profit, shareholder-owned company. It's just that the federal government still owns most of the shares, and requires Fannie Mae to make certain efforts to promote low- and moderate-income mortgages specifically. Freddie Mac was created in 1970 to add additional liquidity; today, it more or less mimics Fannie Mae's duties and structure.

The point of Fannie and Freddie was to promote homeownership by making more mortgages attractive to private lenders. Unfortunately, it also meant the two entities would be on the hook if there was ever a housing market collapse. Which is why they had to be bailed out after 2008.

The New Deal's Home Owners Loan Corporation did things differently. It also bought mortgages created by private lenders, by offering to give the banks U.S. treasury bonds in exchange, but then it refinanced those loans — effectively replacing them with mortgages it created. Over the course of its brief existence, the HOLC granted over one million mortgages and lent a total of $3.5 billion. Equivalent figures for today, adjusted for population growth and inflation, would be 2.5 million mortgages and $750 billion in lending. Moreover, the HOLC's efforts effectively created the 30-year mortgage, establishing it as the mainstay it remains today.

It was a phenomenal undertaking at the time. But what would be required today is far less intimidating: Princeton economist Alan Blinder estimated a modern HOLC would need to refinance around two million mortgages, and lend as much as $400 billion — and that was back in 2008, when things were much worse.

Unfortunately, the Great Depression was a brutal collapse, and even a fully public mortgage lender can't work miracles. The HOLC operated under certain rules, and some people are too poor to be able to sustain a mortgage under any circumstances. The HOLC had to deny about a million homeowner applications, and 20 percent of the mortgages it did provide still defaulted. So a modern version of the program wouldn't be a cure-all: We'd still need to repair the job market and raise everyone's incomes, and direct cash aid to help people with housing would still need to increase.

But what the HOLC did do was rationalize and clean up the government's efforts to promote homeownership, and cut out the middleman of private finance.

It was still technically "bailed out" by the government, because it financed itself by either borrowing from private financial markets or from the Treasury Department. So it was backstopped by the federal government's power to borrow and print money. But that was the point: The HOLC's unique service to the mortgage market was to be able to operate at a loss, without concern for profit (though it nonetheless made a small one). You could think of it as a public option for home loans. By contrast, when Fannie Mae and Freddie Mac get bailed out, it's a failure of their design.

The HOLC's clarity of purpose also allowed it to be far more merciful to borrowers: It offered homeowners low interest rates, lenient terms, and principal write-downs. It even provided struggling homeowners with debt counseling, family meetings, and help with their budgets. It did not leave decisions about mortgage terms or foreclosure to the tender mercies of private lenders and financial firms, the way Fannie Mae and Freddie Mac do. Instead, the HOLC dealt with homeowners directly.

Lastly, because it didn't just repackage mortgages and sell them back to the financial industry, the HOLC didn't entangle itself with the private financial markets. So it wasn't vulnerable to their instability, or at risk of adding to it. In fact, should the U.S. ever resurrect the HOLC, it could take that separation even further and mandate that the HOLC can only borrow from the federal government.

Proposals for a modern HOLC are already making the rounds. Blinder endorsed the idea, and spelled out some provisos and rules for how to improve it. The think tank Demos put forward a proposal as well. In particular, Demos would like a modern HOLC to more aggressively use its ability to operate at a loss, and offer lower-income homebuyers more lenient terms and bigger reductions in their principal, should it buy their initial mortgage from a private lender.

There was even a bill introduced in 2008: H.R.5649, the "Home Owners' Loan Corporation for the 21st Century Act." It just didn't go anywhere.

The way we provide mortgages in America is characterized by one of the great obsessive flaws of modern economic policymaking: We always assume solutions are better when private markets take the lead, instead of government just doing the task itself. The result is often programs that are overly complex, expensive, inefficient, unstable, and that allow big-time financiers and corporations to skim off the top. It's a testament to this backwards thinking that Fannie Mae and Freddie Mac still live on, while the HOLC stopped offering mortgages after just three years of its existence, shuttering permanently in 1951.

Perhaps it's time to correct the error.