Fed chief: Reduce U.S. role in housing

  • Article by: CHRIS SERRES , Star Tribune
  • Updated: April 5, 2011 - 8:50 PM

Minneapolis' Kocherlakota said the market relies too much on government guarantees.

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Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank.

Photo: Glen Stubbe, Star Tribune

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Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Tuesday that the federal government needs to reduce its support of the housing market and explore ways to encourage people to build equity in their homes.

In a speech at a housing forum in Minneapolis, Kocherlakota argued that the U.S. housing market's reliance on government guarantees from mortgage giants Fannie Mae and Freddie Mac is "not a sound long-term strategy." He also criticized the long-standing federal tax deduction for mortgage interest payments, saying it encourages people to take on debt rather than build equity in their homes.

"Over time, our country needs a mortgage market that returns to greater reliance on private risk-taking and private risk assessment, along with the enhanced regulatory oversight that is already in place," Kocherlakota said.

Kocherlakota's comments come as Republican lawmakers in Washington prepare to introduce legislative proposals that would gradually reduce the role of Fannie Mae and Freddie Mac, which buy mortgages from lenders and package them into securities for sale to investors. The mortgage giants were placed into government conservatorship in September 2008 after they nearly failed from losses on subprime mortgages.

There have been repeated calls to wind down the government's role in Fannie and Freddie, but lawmakers have been reluctant to act while the housing market remains in a state of turmoil. Many economists believe a speedy withdrawal of government support of the housing market could cause home sales and prices to drop even further, slowing the economic recovery and potentially pushing up the cost of a taxpayer bailout of Fannie and Freddie.

Since Fannie and Freddie were taken over by the U.S. government, the giant entities have received $156 billion in support from taxpayers. Total losses could top $360 billion through 2013, according to government estimates.

"Everyone knows we need to reduce government involvement, but we need to tread carefully because we are so dependent on these government-controlled entities," said Scott Anderson, a senior economist at Wells Fargo Securities.

In his remarks, Kocherlakota, a first-time voting member of the policy-setting Federal Open Market Committee, didn't specifically address legislative proposals to reform Fannie and Freddie. However, he expressed discomfort with the level of government support in the housing market, suggesting that policymakers should explore ways to bring more private capital into the mortgage market.

After housing prices declined sharply in 2007, many investors stopped buying loans backed by mortgages, even those of sterling quality. Fannie and Freddie became a vital backstop, preventing a complete meltdown of the housing market by purchasing loans that banks did not want to keep on their books, some experts argue.

About 90 percent of all mortgages originated over the past two years are guaranteed by Fannie Mae, Freddie Mac and other government-controlled agencies, Kocherlakota said Tuesday. "This heavy reliance on government guarantees is not a sound long-term strategy," he said.

Today, Fannie and Freddie own or guarantee 30 million home mortgages, about half of all mortgages in the United States.

Kocherlakota spoke during a workshop hosted by the Federal Reserve Bank and sponsored by the Minnesota Homeownership Center, which gathered stakeholders from various parts of the housing industry to discuss ways to close the homeownership gap between whites and minorities.

Kocherlakota also argued that policymakers should rethink the government's role in other areas of housing finance. He said the mortgage-interest tax deduction and other programs encourage people to take on "large amounts of debt," rather than invest in their houses.

"If we truly want to encourage homeownership, we should contemplate programs that provide incentives for individuals to save and become equity holders in their homes -- and, by extension, in their communities," Kocherlakota said.

The mortgage interest deduction has become a source of controversy in recent months, as concerns about the federal debt intensify.

In December, the co-chairmen of the White House's deficit-reduction commission proposed paring the mortgage-interest deduction as part of a series of proposals to rein in the federal government's swelling debt.

Star Tribune staff writer Jim Buchta contributed to this report. Chris Serres • 612-673-4308

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