Refi Madness: Use Fannie and Freddie to Solve the Housing Crisis

Glenn Hubbard, Harvard-trained economist, former Bush administration official, dean of the Columbia Business School, is a mild-mannered, buttoned-down guy. But his proposal to bolster the housing market and provide some stimulus to America’s long-suffering homeowners is a bit radical.

In a recent New York Times op-ed article, Hubbard and Columbia Business senior vice dean Chris Mayer urged a simple solution: Fannie Mae and Freddie Mac, the government-controlled housing giants, should just refinance homowners at today’s low interest rates.

Hubbard joined Aaron and me to discuss this proposal, as well as other prescriptions he lays out for reforming America’s housing finance system in his new book, Seeds of Destruction: Why the Path to Economic Ruin Runs Through Washington, and How to Reclaim American Prosperity, co-authored with Peter Navarro.

Hubbard noted that the government and the Federal Reserve have already made significant efforts to shore up housing. “The Fed’s purchase of mortgage-backed securities really helped the housing market a lot,” by helping to narrow the spread between Treasuries and mortgages, Hubbard said. But falling house prices have made it difficult for people with under water mortgages to take advantage of lower rates. “Even with low interest rates, it’s hard to see a lot of refinancings because loan to value ratios are high,” he says.

A Sensible, Low-Cost Solution
His suggestion is that Fannie and Freddie could simply refinance existing mortgages at lower rates, at no additional cost to taxpayers. With Fannie Mae and Freddie Mac under U.S. conservatorship, the taxpayers already guarantee most mortgages through them. Hubbard believes this refi boom would ultimately save taxpayers money, since borrowers would be more likely to stay current on new mortgages with lower interest rates.

“More to the point for stimulus, this would be the equivalent of a $50 billion to $60 billion per year long-term tax cut for middle-income families, with no cost to the Treasury,” he says. “It seems pretty sensible.”

A bonus: this plan wouldn’t require passing legislation through a gridlocked Congress.

Of course, there are obstacles. Even at today’s much lower volumes, the home-lending system is having difficulty processing mortgage documents efficiently. Many critics are calling for Fannie and Freddie to reduce their scope of activities, not to increase them. And then there’s the question of moral hazard: Wouldn’t this just be another example of taxpayers bailing out borrowers who made what turned out to be poor decisions?

Not so much, says Hubbard. Many of the borrowers who now have loan-to-value (LTV) ratios that preclude them from refinancing are in the situation not because they borrowed so much to buy a home, but because the property supporting the mortgage has declined in value by 30 percent. “The whole thrust is to keep people in their homes and provide a tax cut that they would have gotten if their LTVs weren’t so high,” said Hubbard.

More Housing Solutions
In Seeds of Destruction, Hubbard and co-author Peter Navarro offer some other provocative thoughts on how to reform housing finance and avoid another debacle. Among the suggestions:

Both homeowners and lenders should be required to have some “skin in the game” on mortgages.

Prohibitions or restrictions on funky lending practices such as interest-only and adjustable-rate products, especially if they’re going to be securitized.

Greater disclosure on the information that goes into creating credit ratings for mortgage-backed products.

Perhaps most controversially, Hubbard calls for a rethinking of the home mortgage deduction, which allows homeowners to deduct interest on loans up to $1 million from their taxable income. The home mortgage deduction is an inefficient and expensive means of subsidizing housing and benefits higher-income Americans disproportionately.

“I’m not saying repeal it this afternoon, but we should take a hard look at our subsidies for housing and ask if they really make sense,” he tells Aaron and me in the accompanying clip.

If there’s a need to subsidize homeownership for lower and middle-income Americans, policy should focus subsidies on those sectors, Hubbard says. “But the very expensive subsidy system we have now really helped get us in trouble.”

Watch the interview on Yahoo Tech Ticker.