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How would this transition affect prospective home buyers?
If I'm right and there's not this huge increase in interest rates, the market would be able to transition very easily to a world without Freddie and Fannie. The world is in a precarious position right now, that's why it has to be a five-year [time frame]. But if we get to the point and we find out that the world wants 300 basis points, [that] would mean a 4.5 percent mortgage would then be 7.5 percent. On the other side, it could be as low as 30 basis points.
Once we get out of this hole we're in, if it turns out it the world wants 300 basis points, interest rates would go up. In the short run, consumers would be taken aback, but if you look over history, even under President Clinton rates were about 7.5 percent.
The difference between the Clinton administration, which was 7.5 percent, and today, which is 4.5 percent, that's the impact of the housing bubble. Once we get back to normal conditions, 7.5 percent will be perfectly fine.
What needs to change about the mortgage system to improve the housing market?
This is all going to be trial and error. We must understand that the GSEs pump $8 trillion into the housing finance system. It's hard to close the door after you let the horse out of the barn. We're going to have to feel our way around this.
Right now, we are the only country in the world with 95 percent 30-year, fixed-rate mortgages. Other countries actually like to have a mix: adjustable rates, shorter-term mortgages, and they have lower default rates.
We've become so addicted to the government involvement in the housing market that the 30-year fixed mortgage has almost become an entitlement because it protects the consumer from interest rate increases. But somebody has to bear that interest rate risk when interest rates go up, and eventually they will. If interest rates pop up, whoever holds mortgage-backed securities is going to take a beating. So if we transfer [that risk], the borrowers no longer have that risk.
If you're protecting the borrowers of the 30-year fixed, which sounds admirable, just bear in mind that pension funds are probably going to get hammered if interest rates go up or any other investor in the mortgage market.
Let's go for a broader base of mortgages like ARMs, shorter-term mortgages, the Canadian rollover. The advantage of having consumers with an ARM bear some risk is that they're much more careful if they know that interest rates might double in three years. They're going to be more careful about how much house they buy. Having consumers bear some risk is actually a good thing.
That's the problem with the FHA's 3-percent-down program and Fannie and Freddie buying mostly fixed-rate. Consumers are not exposed to the risk that they create for other people. They do not have enough skin in the game. Three percent down is like the skin off of your fingertips.