How Government Guarantees in Housing Finance Promote Stability
David Min, How Government Guarantees in Housing Finance Promote Stability, 50 Harv. J. Legis. 437 (2013).
In the aftermath of the financial crisis, major reforms of the U.S. housing finance system are likely. One of the key issues facing policy makers in this area is whether and to what extent the federal government should maintain its current role in the residential mortgage markets. Since the New Deal, the federal government has guaranteed the primary sources of housing finance in the United States — bank and thrift deposits, and the obligations of the mortgage securitization conduits Fannie Mae, Freddie Mac, and Ginnie Mae.
The prevailing view of government guarantees is that they increase financial instability because they encourage excessive risk-taking and reduce market discipline. But this perspective fails to explain why such guarantees have been closely correlated with stability in the housing finance system through our nation’s history.
Incorporating historical and economic analyses, this Article challenges the conventional wisdom around government guarantees in U.S. housing finance, and argues that these guarantees actually help to promote stability in several important ways: they prevent banking panics, they limit the formation of credit bubbles, and they promote the origination of consumer-friendly loans that are less likely to default. The Article concludes with the new and counterintuitive proposition that the positive stabilizing effects of U.S. mortgage guarantees far outweigh their destabilizing effects, which is why guarantees have been so closely tied to financial stability.