Rethinking home loans without regulation means a repeat of crisis

Update:  Thursday, August 9. Today Fannie Mae announced a quarterly profit of $10 billion and projected profits for the foreseeable future. When this dividend is paid, Fannie will have repaid approximately $105 billion of $116 billion it received from taxpayer bailout.

The latest quarterly gain followed a record $58.7 billion net income in the first quarter, when Fannie capitalized on tax benefits it had saved from its losses on loans during the crisis. It paid a first-quarter dividend of $59.4 billion to the Treasury.

In a major policy speech yesterday President Obama announced plans to reshape federal rules for 30-year fixed mortgages. The idea is to preserve the policy goal of getting American workers and their families into affordable home loans, but in practice this has played out with troubling consequences.

Obama’s speech comes on the heels of news that Freddie Mac, the country’s largest home loan lending institution along with Fannie Mae, reported a $5 billion net profit in the second quarter, compared with $3 billion from the same period last year. The earnings will offset all losses from mortgage defaults, which continue to be a problem for the housing sector, banks, and consumers.

The federal bail out Freddie Mac and Fannie Mae during the financial crisis in 2008 amounted to $187 billion, but since a housing recovery started percolating last year both institutions have again become profitable. Roughly, they have paid back roughly $136 billion of government loans, which is helping to make the budget deficit this year the smallest since Obama took office.

In his speech yesterday the President proposed overhauling the home loan system, including the elimination of Freddie Mac and Fannie Mae from the mortgage guarantee business. Obama claimed taxpayers should not be in the position of “holding the bag” for the risky business strategies of such giant financial institutions. However, President Obama did not clarify the rationale of the goal to preserve the 30-year home loan, a financial instrument that does not appear in other industrialized countries.

One problem with the long-term strategy of home ownership is that the size and cost of owning property has increased while income has stagnated for those working individuals and families who need such long-term loans. Another problem is that banks and lending institutions still have no regulations that prohibit them from using mortgage guarantees in risky financial investments, including derivatives trading, which led to the sub-prime mortgage crisis and, by extension, the financial collapse of the economy. The preservation of this policy goal under the same economic circumstances therefore means a future catastrophe for lenders and borrowers alike. Why finance a 30-year home loan on a mortgage that consumers cannot afford, when it remains a risky investment strategy?