Mortgage mess gets a small fix

Can the housing market function without government guarantees for jumbo mortgages? This fall, on Long Island and in other high-cost areas, Uncle Sam will take a useful step toward finding out.

Starting Oct. 1, the maximum size of home loans eligible for guarantee by Fannie Mae, Freddie Mac and the Federal Housing Administration will fall to $625,500. This is hardly a giant leap; for many years Fannie and Freddie had a limit of just $417,000. Congress boosted this to $729,750 in 2008 in an effort to support the nation's sagging housing market.

The lower limit makes sense, though it might cause a little pain for some. By backing larger loans, Washington is putting all taxpayers at risk for the mortgages of a relatively well-to-do few. Besides, it's high time to wean buyers, sellers and lenders away from dependency on the federal government, which now guarantees 90 percent of new mortgages.

In an ideal world, the maximum loan backed by Fannie and Freddie would be reduced over a 5- or 10-year period to zero, at which point we could consign these two big government mortgage companies to oblivion. Both are ugly poster children for the risks of government-guaranteed mortgages. They've already cost taxpayers $138 billion to make good on mortgages guaranteed when Fannie and Freddie were private enterprises, generating private profits at public risk.

Shrinking Washington's footprint in the mortgage business, however gradually, has big advantages. For one thing, it would take taxpayers off the hook when mortgages go sour. A lack of government guarantees would make banks and investors more careful about whom they lend money. And it would spare one unlucky class of taxpayers -- renters -- from providing additional subsidies to homeowners, who already benefit from the tax-deductibility of mortgage interest and property taxes.

But let's not kid ourselves. Such a move would raise the cost of borrowing. The lower ceiling coming in October, for example, will probably cost home buyers affected by the change an extra 3/8ths of a percentage point on their mortgages. And by making financing more expensive, it will probably lower the price of expensive homes a bit.

Getting rid of most government guarantees might even make America's cherished 30-year fixed-rate mortgages -- complete with a free prepayment option that enables refinancing when rates drop -- into an endangered species. These loans exist in few other nations and without government backing aren't appealing to lenders.

For these reasons, getting Uncle Sam out of the mortgage business may not be politically feasible even if it is advisable. There are already bipartisan proposals, including one co-sponsored by Rep. Carolyn McCarthy (D-Mineola), to retain federal mortgage guarantees.

We'd be better off without them. In Canada, the home ownership rate is about the same as ours even though it doesn't have government-guaranteed, prepayable 30-year mortgages or a tax deduction for mortgage interest. Not coincidentally, Canada's banking system sailed through the financial crisis. Ours nearly capsized.