The US Congress is finally inching toward an overhaul of the US housing finance system. If they do it right, US mortgages should continue to be an appealing investment opportunity not only for US investors but also for Europeans.

US housing reform is important. But getting reform right is more important than getting it done. To us, that means ensuring the US government retains a clearly defined role in the mortgage market.

Three Benefits for European Investors Today

For European investors, this policy challenge may seem like a distant affair. Yet the US mortgage market offers access to accelerating US economic growth and a robust jobs market that can provide several benefits to investors today:

1) Credit quality—On a euro-hedged basis, a diversified portfolio investing in different types of US mortgage-backed securities (MBS) should be able to provide yields similar to the euro high-yield market but with a better average credit quality.

2) Attractive yields with lower duration—Certain segments of the mortgage market (outside the traditional agency MBS) such as Credit Risk Transfer (CRT) are very attractive. CRTs currently offer yields between 2.5% and 6%. Yields vary depending on the subordination/credit risk, with low duration risk as these notes are floating rates.

3) Diversified risks—Investing in US mortgages provides exposure to a different pool of risks—with portfolio diversification benefits versus other asset classes such as equity and high-yield corporates.

From a wider perspective, US agency mortgages offer several advantages for global investors: liquidity, the agency bonds’ yield pickup over Treasuries and the government guarantee. We believe that if government involvement were eliminated, many of these buyers would likely disappear.

Should the US Government Guarantee Mortgages?

US policymakers have been trying to reform housing finance for nearly a decade, and shrinking the government’s footprint is a priority for many of them. In fact, one of the several proposals that have surfaced in recent years envisions no government involvement in the US mortgage market at all.

It’s not hard to see why. When the US housing bubble burst in 2008, US government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac suffered massive losses, forcing the government to take over both and the US taxpayers to foot the bill. Who wouldn’t want to avoid a repeat performance?

An Explicit Government Guarantee and a Cushion for US Taxpayers

We agree that the system needs reform and that taxpayers should be partly insulated against future losses. But a housing market entirely without government involvement is unrealistic. Housing is crucially important to the health of the US economy, and it’s hard to imagine any government sitting on its hands in a future crisis. That’s why we think the government should explicitly guarantee securities issued by Fannie and Freddie or their successors.

That’s not to say taxpayers should bear the risk alone. Investors, too, should be on the hook if loans default. Fortunately, the GSEs have already made considerable progress on this with the introduction of CRTs, which require private investors to absorb a share of the losses when there are defaults.

We think there’s room to expand this approach and would support reform that requires a significant private capital cushion before the government guarantee kicks in. It’s also important that the guarantee be appropriately priced. We suggest this premium be deposited in a government-established mortgage insurance fund to help set a fair price.

Keeping What Works

But what’s most critical, in our view, is that reform preserve the parts of the current system that work. For example, agency mortgage-backed securities issued by Fannie and Freddie make up one of the largest and most liquid fixed-income markets in the world. Global investors provide more than $5 trillion in mortgage financing, which helps to keep credit available and allows borrowers to lock in rates when they purchase or refinance a home.

How would US mortgages be financed instead? Probably in the same way as before the advent of securitization: banks would make mortgage loans and hold them. Without the GSEs to buy mortgages and repackage them into securities, credit would be constrained. That would result in higher mortgage rates and likely shut many potential borrowers out of the market.

Another likely casualty of taking the government out of the equation? The 30-year fixed-rate mortgage. This loan is the go-to form of financing for most US borrowers, making it the backbone of the US mortgage market. But it’s not clear it would survive without a government guarantee, because investors might balk at assuming all the duration and default risk. The loan’s disappearance would be highly disruptive to the housing market and would likely reduce home sales and home prices.

Whatever shape reform takes, we think building on the invaluable expertise and infrastructure of the GSEs is essential. That’s why we think a new system should either retain the GSEs under their existing charters or re-charter them into similar entities.

A durable housing finance system is critically important to the US economy. We’re excited about the prospect of reform—which can help underpin advantages for European investors too.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.