Government guarantees of mortgage-related assets should be explicit, not implicit, Federal Reserve Vice Chairman Stanley Fischer said in remarks today.
Fischer noted that the implicit government guarantee of mortgage-related assets contributed to the underpricing of risk leading up to the financial crisis, and that because mortgage-backed securities were seen as having an implicit government guarantee, “investors did not fully internalize the consequence of defaults, and so risk was mispriced in the MBS market.… Taken together, the government guarantee and resulting lower mortgage rates likely boosted both mortgage credit extended and the rise in house prices in the run-up to the crisis.”
While government involvement in the mortgage market can promote the social benefits of homeownership, those benefits have both a direct and indirect cost, Fischer said — directly through the beneficial tax treatment of homeownership and indirectly through government assumption of risk. “To that extent, government support, where present, should be explicit rather than implicit, and the costs should be balanced against the benefits, including greater liquidity in housing finance engendered through a uniform, guaranteed instrument.”
In addition to having an explicit guarantee, Fischer highlighted additional steps that could be taken to bring greater stability to the housing market, including implementing macroprudential policies to minimize the severity of future housing crises; ensuring a well-capitalized banking system; and having clear and workable rules for mortgage modifications.