Government in mortgages: One major problem

The more common arguments against government involvement in mortgages is that it gives government the power to create winners and losers, sets up rules that benefit the rule-makers, and reduces competition in what otherwise should be a free market. But it also shows the ineptitude of govenrment to predict and plan the way a freer market would. And it illustrates why we don’t want to be in the business of predicting the market for the purpose of centralized economic planning.

When governments get involved in things like mortgages, the public is accepting the risk of the failure of the mortgage. And it puts the public in a position of not only risk, but also a duty to protect the investment. With the recent hurricane Harvey and Texas and all the flooding, it’s another reminder that natural disasters are a major risk in real estate. That means we have to look at government-backed mortgages.

Over 80% of the homes affected by the flood do not carry flood insurance. I don’t have the satistics on how many of those  homes carry government-backed mortgages but my guess is nearly all of them. And that is because investors have a safe investment in government-backed mortgages.

Mortgage lenders these days are mostly big banks. They are otherwise known as Wall Street. They make the banking and financial rules through their representatives in Congress. The creation of Fannie Mae and Freddie Mae and the general role that the government plays in backing mortgages that meet the government guidelines has eliminated the risk for investors in mortgages. One of the big original arguments for the existence Fannie Mae and Freddie Mac was to help level the playing field, to give investors and incentive to lend where they otherwise may not have. For example, low income housing.

So government agencies got into the business of creating guidelines for which mortgages they would secure and which ones they would not, because it gave itself power to create these rules. This is where they pick winners and losers. Those lending institutions and investors that decided that the government gave them some good investment opportunities were the ones who took the opportunity to lend on these government-backed programs. And the investors and lending institutions that did this got a pretty good deal because they were able to get a return on an investment with very little or no risk. In essence, the government was removing the risk for the benefit of investors through the purchase of the mortgage notes. But the government agencies doing this have not been very good at creating guidelines for the government investment in these mortgages to be sustainable.
This is what is happening today. Today as I write this, Hurricane Harvey has created flooding in Texas where homes are actually underwater. Those 80% of homes that I referred to above that do not have flood insurance, are now a liability because those homeowners that are uninsured are most likely going to default. Had they been in government planned FEMA designated flood zones, the government would have required flood insurance. But the government did not plan this properly, having failed to account for the risk of flood in that affected Texas market. And that is where homeowners, the public sector and investors will experience major financial loss. Except the home owners and investors are able to walk away from the loss quite a bit more easily than the government because of the government- backing of the loans.

The government will never be able to account for all of the risks in the market. Our government is not designed to be good at investments and assuming these types of risks. That is why it should not be up to the government to account for all of the risks in the market. Leave that to people who assume that risk for themselves.