Government as Mortgage Lender

May 4, 1998

"Since government regulation has not been successful in eliminating deceptive practices from the mortgage market, wouldn't it make sense to have the government lend directly to consumers?"

As ineffective as governments often are in regulating private activities, as lenders they are far worse.

In the first two decades after World War II, the sentiment you express was widely shared, especially throughout the developing world. The result was the creation of about 50 "housing banks" in the same number of countries. These were government-owned entities that made home loans directly to consumers. At various times over the years I have had occasion to visit and consult with institutions of this type in Iran, Ethiopia, Indonesia, Pakistan, Portugal, Thailand, Brazil, and Fiji.

With one exception, these housing banks have been a disaster. Some have been terminated while others are looking to privatize. Just last summer I was in Fiji helping to develop a privatization blueprint for the troubled housing bank of that country.

One of the major problems of the housing banks has been high default rates. In some cases, half or more of the borrowers don't repay their loans. Instead of administering "revolving" loan funds, where loan repayments plus interest provide the funds for new loans, the housing banks have needed continuing cash infusions by government. Which is a major reason why governments have become disillusioned.

Chronically high default rates reflect poor loan selection practices, and poor collection practices after the loans are made. With private lenders, the dominant criteria used to determine whether or not to make a loan is the likelihood of repayment. With government lenders, politics and favoritism are often involved in a major way. This is especially likely when loan rates are below the market and therefore a bargain, which is often the case.

Because they charge market rates, loan selection by the Fiji housing bank is not subject to politicking. However, the bank does not consider an applicant's past credit record in determining whether or not to make a loan. They view such judgments as subjective and judgmental, and therefore subject to second-guessing by politicians and the media. They make loan decisions on the basis of objective measures of "ability to pay", and ignore evidence bearing on the "willingness to pay". As a consequence, private banks who turn down loan applicants because of bad credit histories refer the applicants to the housing bank.

Housing banks also do very poorly at loan collections. In many cases, their loan collections systems are so poor that borrowers who stop paying do not receive a delinquent notice for 6 months or longer, by which time it may be too late to remedy the situation. In dealing with delinquent borrowers, furthermore, housing bank officials usually shrink from exercising the ultimate sanction, which is to take away their house. It isn't their money, so why should they take the political heat? As a consequence, borrowers learn that they can get away with not paying, and word gets around. In many cases, the distinction between a loan and a government grant becomes blurred.

The Housing Bank of Thailand is usually viewed as the exception because it has been well-managed, its loan default rates have been comparable to those of private banks, and it has grown without need for continuing investment by government. The secret of its success has been that it has operated in essentially the same manner as a private bank, the only major difference being that dividends have been paid to the government rather than to private shareholders. It has been able to do this because of strong leadership in the early years when the culture of the bank was forming, and because the government granted it virtually complete autonomy. A singular success story based on emulation of the private sector does not support the case for government lending.

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