Tighter Lending Standards and the Housing Market

Yesterday's WSJ seemed to lay the blame for the lack of zip in the housing market at the feet of banks, as well as Fannie Mae and Freddie Mac for being too tight with standards for lending. It is argued by some interviewed that this is an overreaction to the excesses of the last decade. In fairness, they also interviewed experts who thought the tightened standards were appropriate. Fannie and Freddie come in for blame because loans that don't meet their standards will not be purchased by the quasi-governmental organizations. The whole article just goes back and forth on the minutia of the arguments, so I am not recommending reading it.

Here is what I do know. Fannie and Freddie are political creatures of the federal government. Their lending standards are therefore set by politics, not market conditions. Surely there will be pressure for them to loosen their standards by those politicians for whom this will be expedient. This is why Fannie and Freddie need to be broken up into smaller entities and divorced from their status as Government Sponsored Entities. (I can't find that term in the constitution.) The new companies, by competing on how well they assess the riskiness of loans, will find the correct equilibrium for the housing market. Further, these companies could seek out innovative ways to hold banks and other loan originators liable for bad loans that were due to lack of due diligence. This seems like a great way to inject true free market principles to re-vitalize the housing market.

What will the new default rate be? I have no idea, I just know it will be more likely to be beneficial to the economy as a whole. Further, without the taxpayers on the hook for losses, it will cause the system to work out the correct risk level and prevent another expensive bailout.