In his housing speech yesterday, President Obama described his determination to reform the housing finance sector in a way that preserves the 30-year fixed rate mortgage as the backbone of American homeownership. What he didn’t do was say why he wants to do that. My view is that this is a badly overrated policy goal that should not become a fixed point of analysis.
The thing about the 30-year fixed rate mortgage is that it’s a bit of an odd duck. In normal economic times when nominal house prices tend to be flat or rising, you’re normally able to take advantage of any fall in interest rates by refinancing. But if interest rates rise, the bank can’t take advantage of you by raising interest rates. That’s an attractive proposition for a borrower, but it’s not really obvious why a bank would want to offer this product. The answer turns out to be that Fannie Mae and Freddie Mac offer a public subsidy that encourages banks to offer “standard” 30-year fixed rate mortgages. Since the subsidy is available, that often makes this the best product for borrower and lender alike and so it’s what we’re used to.
When assessing forward-looking policy options, there are basically two stylized facts to keep in mind. One is that if you look at other developed countries you generally don’t see the American-style 30-year fixed rate mortgage. Instead you either have short-term loans that need to be periodically refinanced at new interest rates, or else something more like an Adjustable Rate Mortgage. The other is that if you want to get a really big mortgage in the United States (unwisely, the cutoff point varies from market to market as a matter of policy), you need a “jumbo” loan that Fannie and Freddie don’t subsidize. These jumbo mortgages generally are available as classic American 30-year fixed rate mortgages, but the interest rate is generally 0.25–0.50 percentage points higher than on a conforming loan.
From these two stylized facts you can draw two conclusions. One is that absent a specific government subsidy for the fixed rate mortgage it would vanish and we would become more like Canada. The other would be to say that the jumbo loan market shows that there’s enough path dependency in the marketplace than the fixed rate mortgage would persist, just at slightly higher cost. But neither line of analysis seems to me to support the idea that there’s some urgent need for the government to subsidize 30-year fixed rate mortgages. If you cross the border into Canada it’s not like people are living in yurts. It works fine. But since homebuyers have to carry a bit more interest rate risk, they seem to purchase slightly smaller houses. Alternatively if you imagine a jumbo loan scenerio where the 30-year fixed rate mortgage lives but with systematically higher interest rates, you’d find that people would have to respond by purchasing slightly smaller houses. And it’s not a coincidence that Americans live in the biggest houses in the world.
But is getting people to live in marginally larger houses than they otherwise would an important policy goal? I don’t really see why. Recall that this subsidization doesn’t conjure up any physical or financial resources that wouldn’t otherwise exist. Absent the subsidy our somewhat smaller houses might contain somewhat nicer furniture. Who cares? Making this a fixed point of a policy framework seems like status quo bias at its worst.