Housing Finance System? Easy, Until It Crashes

Suppose you were advising policymakers in an emerging market country on how to set up a housing finance system. First, you tell them that people don't have to save much, if any, cash for a down payment, and they don't need to prove they can afford the monthly payments, either. If house prices rise, lend them more!

If the borrower cannot subsequently pay, let him walk away with no recourse to his income or assets, and qualify him again for another loan in a few years.

Concerned with payment shock when interest rates rise? Then prevent his interest rate from ever rising for 30 years, but lower it every time interest rates decline, with no penalty.

Does this system sound too unsafe for private bank lending? Tell them they can pass over their banking system and just sell all the loans. Call this silver bullet "securitization," a wondrous U.S. innovation.

Tell them they just need to set up a government-sponsored housing bank to buy most of the loans others originate, particularly those with fixed interest rates. This "housing bank" will drive down the spreads available to private deposit-funded lenders. But they don't need to budget the cost because they can just call it private. That's a really good deal because the housing bank can then kick back virtually unlimited amounts of funds to them for political activities. It's all free. Everybody wins!

Of course such a system is likely to blow up every few decades. But the beauty of it is that when it does blow up, you can blame predatory lenders, Wall Street greed and the short-sellers.

Then you can bail it out under the table. Big commercial banks and Wall Street will even pay for it if you threaten them enough with more regulation and fees.

Sound familiar?