Do We Need the 30-Year Fixed-Rate Mortgage?
That question is the title of a recent worker paper by Mercatus Center economists Michael Lea and Anthony Sanders, and I think the simple answer is "No."
The authors present evidence that the 30-year fixed-rate mortgage (FRM) is really a creation of U.S. government policy, and certainly wouldn't dominate the mortgage market without direct government support and intervention. The authors write:
Later in the paper, they write:
"David Min, of the Center for American Progress, has written “the 30-year fixed-rate mortgage remains the gold standard for mortgages throughout the world, offering superior stability for both homeowners and financial systems.” If this is true why is the U.S. one of only two countries in the world with this instrument (only U.S. and Denmark have long-term, fixed-rate, no-penalty prepayable mortgages.)? And why is the U.S. the country most afflicted with a housing bust? Given the catastrophic condition of Fannie Mae and Freddie Mac, it is clear that the 30-year fixed-rate mortgage is outright dangerous and not a gold standard. Perhaps his musing should be rewritten to say “the 30-year fixed-rate mortgage remains the fool’s gold standard for mortgages throughout the United States, offering superior stability for some homeowners and potential catastrophe for U.S. and global financial systems.”
What would the U.S. mortgage market look like without "government life-support" for the FRM?
"What would emerge as “standard” U.S.-mortgage instrument without the government support of the FRM? We think a rollover mortgage similar to that offered in Canada and several European countries is the likely candidate. This instrument offers short- to medium-term payment stability to borrowers. Borrowers can manage interest-rate risk by adjusting the fixed-rate term upon renewal. Min’s assertion that borrowers would be unable to refinance is not borne out by modern international experience. Borrowers could hedge the interest rate risk by locking in a forward rate in advance of renewal. German lenders offer
forward rates up to five years—certainly U.S. lenders with a deep derivative market could do the same. Alternatively, they can adjust the degree of risk by varying the length of the fixed-rate period.
A complete and robust housing-finance system should offer borrowers a menu of mortgage options—ranging from short-term ARMs for those borrowers who can handle payment change, to long-term FRMs for those borrowers who value payment stability. To assert that the FRM is the preferred alternative for most borrowers is naïve. Many borrowers have shorter-term time horizons and can handle some interest-rate risk. Min’s assertion that the switch to shorter duration instruments would lead to massive defaults if and when interest rates increase is not supported by international experience."
Related: In a recent post on the Enterprise Blog, AEI's Alex Pollock wrote about "The Dark Side of the 30-Year Fixed-Rate Mortgage," and I followed with "The Dark Side of the 30-Year Fixed-Rate Mortgage, Part II." Like the Mercatus authors, I also point to Canada's system of 5-year mortgages, and note that Canada didn't have a single bank failure during our S&L crisis when 3,000 American banks failed (partly due to FRMs) and didn't have a single bank failure during our recent financial crisis.