The Wall Street Journal
By: Arkadi Kuhlmann
April 11, 2011
By allowing borrowers to write off the interest on their mortgages, the IRS is incentivizing homeowners to drag out their payments for years. There's a better way.
If the financial crisis revealed anything about homeownership in this country, it's that "ownership" is too often a misnomer.
Since the crisis began, more than five million homeowners--people who thought they'd achieved the American Dream--have seen their houses reclaimed by lenders. Thirteen million more will be forced out by 2015. That's hardly the kind of security one associates with owning.
Government-backed financial institutions like Fannie Mae and Freddie Mac prop up a system in which homeowners can spend decades paying their mortgages, often with little money down. They go years without building significant equity in their homes, rendering them little more than glorified renters.
Not surprisingly, the idea that the government should get out of the mortgage business has lately taken hold in Washington. Sen. John McCain (R., Ariz.) and House Republican Conference Chairman Jeb Hensarling (R., Texas) recently introduced bills that would wind down government sponsorship of Fannie Mae and Freddie Mac within the next five years. In February, the Obama administration submitted to Congress its plan for backing out of Freddie and Fannie.
The idea of a country with no government-backed mortgages is frightening to some Americans. But shifting more mortgages to private banks, particularly smaller ones that are more likely to maintain relationships with their borrowers, does come with certain benefits. It could stabilize the home market and prevent another collapse like the one we're still recovering from.
The mission for Fannie and Freddie has long been to make it easier for Americans to own their homes. But a side effect of that mission was making it too easy for banks to shrug off troubled mortgages.
For example, in 2008, at the height of the financial crisis, Congress raised the maximum size of a home loan that Fannie and Freddie could purchase to $730,000 (where it still stands today). The idea was to keep the mortgage market moving. Banks and other mortgage originators could now sell off many of their larger loans to Fannie and Freddie, allowing them to worry less about risk and keep lending.
Meanwhile, Fannie and Freddie turned many of the loans into securities and sold them to investors. We know how that turned out.
But when banks have an incentive to keep loans on their own books, they are more likely to impose stricter standards on their borrowers. They are also more likely to work with borrowers to help them fulfill their obligations. The result is homeowners acquiring more equity in their homes, and fewer defaulted mortgages.
This is not merely a hypothetical. Low-income home buyers who borrowed from a local lender between 2005 and 2008 had markedly lower rates of default and delinquency than those who used more distant banks or mortgage companies, according to research from Ohio State University Prof. Stephanie Moulton.
The government enables tardy mortgage payments in other ways, too. By allowing borrowers to deduct the interest on their mortgages from their taxes, the U.S. gives homeowners an incentive to drag out their payments for years.
Must the U.S. government remove itself entirely from the mortgage market--or take away every family's favorite tax deduction--to fix it? Not necessarily. Congress could as easily create an incentive for consumers to pay down their mortgages by letting them deduct payments on principal, rather than on interest.
A successful model exists to our north. In Canada, the interest on mortgages is not tax deductible, which gives homeowners good reason to pay down their principal as quickly as possible. Canadian banks also hold about 75% of their loans on their books, which encourages more prudent lending. Thanks to such policies, just 1% of Canadian mortgages are currently in foreclosure or delinquent, compared to about 14% of American mortgages. The Canadian real estate market has already rebounded above pre-recession levels.
Getting government out of the mortgage business would mean significant upheaval in the ways homes are paid for in America, so if it's going to happen it must happen slowly and carefully. But by forcing banks and consumers to put more skin in the game, Congress could help head off the next housing crisis. The best thing we can do for America's homeowners now is to make sure they own as much of their homes as they can.
Mr. Kuhlmann is president and CEO of ING DIRECT USA.