Thursday, March 17, 2011

Mike Lea and Tony Sanders diss the 30 year fixed rate mortgage

They do so in a paper.  I think Mike and Tony are smart guys.  But I think their reasoning is flawed here..

They basically argue that Fannie and Freddie were responsible for the 30-year fixed rate mortgage, and that they have been a catastrophe, and that therefore the 30-year fixed rate mortgage was a catastrophe.  But had FF done two things--stuck to prime 30-year fixed rate mortgages and matched the duration of their liabilities to the duration of their assets by using callable debt--they almost certainly would not have imploded.

FF imploded because they invested in AAA tranches of low quality mortgages (which were originated and securitized in the private sector) and Alt-A mortgages, and because they had to roll over too much short-term debt in 2008.

Lea and Sanders also argue that there is "nothing special about housing finance."  I am not sure I agree.  It is the one method households have to take on large amounts of leverage, and households are not in the position to hedge risk (not that our financial institutions proved to be particularly good at hedging).  

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