Will GSE Modifications Destroy the 30-Year Mortgage?

By Stevie Duffin Updated on 3/4/2013

By Daniel Duffield

At present, one of the most discussed topics has been the government sequester that threatens to bring about various budget cuts that could have a significant effect on the American economy. While the extent of this damage is debatable, government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac would be severely affected by the sequester, potentially having lasting consequences on the current mortgage market in which 9 of 10 mortgages are currently backed by the federal government.

According to a think tank gathered by Senate Majority Leaders Howard Baker, Tom Daschle, Bob Dole, and George Mitchell, the solution to this looming problem would be to gradually reduce Fannie Mae and Freddie Mac’s involvement in the mortgage market by selling off the assets of these enterprises to the private sector in accordance with economic upturn. To replace these organizations, the government would ideally establish a guarantor of mortgage loans that is a public entity, similar to the way Ginnie Mae functions in the guarantees of FHA and VA loans. Rather than purchasing up mortgage-backed securities (MBS), this new guarantor would provide insurance against default for these mortgages, levying a fee for this service. The BPC framework would additionally mandate that issuers of MBS to buy private insurance, such that the government agency would only need to intervene in the event of a significant market downturn, similar to that of 2008.

This proposed system would be more reliable than the current one, since the government guarantees would be represented in the budget. Moreover, any government losses would be funded in advance by guarantees from banks issuing these mortgages.

In general, this issue begs the question, “Why is the government involved in the housing market at all?” especially considering that many attribute the mortgage market meltdown to over-involvement of Fannie and Freddie who assumed too much risk in the past. Accordingly, many Republicans have suggested the privatization of the entire housing finance system, which they believe would guard taxpayers from needing to fund another mortgage industry bailout.

Unfortunately, carrying out this plan would eliminate the 30-year fixed-rate mortgage (FRM) as it has previously existed in the American mortgage market. Without government support, these types of mortgages would become an endangered species within the mortgage industry, as history has shown during the savings and loan crisis of the 1980’s, in which long-term FRMs were scarce due to their risk. Since interest rates on FRMs do not change with the market, banks would be unable to gather the profits of a higher rate on borrowers who secured long-term fixed-rate mortgages, making financing these loans less advantageous and less profitable.

Many Americans may be surprised to discover that 30-year fixed-rate mortgages are rare outside of the U.S., mainly for the reasons described above. Banks simply do not want to engage in long-term commitments with borrowers in cases where interest rates could rise and profits would be uncollected. In Canada, the most popular loan product is the five-year fixed-rate mortgage, which are loans that amortize over twenty-five years but have uncapped interest rate adjustments every five years.

While Americans may find this system somewhat strange, favoring the stability of FRM mortgage payments, banks do not like to issue long-term loans that sacrifice potential interest payments. However, though the Canadian system seems risky to American borrowers, Canadians have become accustomed to and accepted such loan products, with no complaint. As a result, borrowers may not find themselves lamenting the death of the 30-year FRM quite as much as one would expect. In conclusion, Americans will have to assess whether the price of government intervention is worth the cost of revamping the American mortgage industry in the absence of a 30-year mortgage program with fixed-rate interest.