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A key issue in the upcoming debate over housing finance reform will be the importance of the 30-year fixed-rate mortgage, the pillar of the modern U.S. housing finance system.

Many conservatives argue for a withdrawal of all government support from the mortgage finance system. One nearly certain outcome of this course of action would be the elimination of the 30-year fixed-rate loan as a mortgage financing option for the vast majority of Americans.

There are three major arguments in favor of continuing to emphasize the 30-year fixed-rate loan in the United States.

• First, the 30-year fixed-rate mortgage provides cost certainty to borrowers, which means they default far less on these loans than for other products, particularly during periods of high interest rate volatility. 
• Second, the 30-year fixed-rate mortgage leads to greater stability in the financial markets because it places the interest rate risk with more sophisticated financial institutions and investors who can plan for and hedge against interest rate fluctuations, rather than with unsophisticated households who have no such capacity to deal with this risk and who are already saddled with an enormous amount of financial burden and economic uncertainty.
• Third, the 30-year fixed-rate mortgage leads to greater stability in the economy because short-term mortgages are much more sensitive to interest rate fluctuations and thus much more likely to trigger a bubble-bust cycle in the housing markets. Indeed, there may be reason to believe that a primary cause of the recent housing bubble-and-bust cycle was the rapid growth of short-duration mortgages during the 2000s, which caused U.S. home prices to become more sensitive to the low interest rate environment created by Alan Greenspan’s Federal Reserve.

For more: http://www.americanprogress.org/issues/ideas/2010/11/112210.html