The U.S. housing finance system presents a conundrum for the scholar of regulation because it defies description using the traditional regulatory vocabulary of command-and-control, taxation, subsidies, cap-and-trade permits, and litigation. Instead, since the New Deal the housing finance market has been regulated primarily by government participation in the market through a panoply of institutions. The government’s participation in the market has shaped the nature of the products offered in the market. We term this form of regulation “public option” regulation. This article presents a case study of this “public option” as a regulatory mode. It explains the public option’s rise as a governmental gap-filling response to market failures. The public option, however, took on a life of its own as the federal government undertook financial innovations that the private market had eschewed, in particular the development of the “American mortgage”-a long-term, fixed-rate fully amortizing mortgage. These innovations were trend-setting and set the tone for entire housing finance market, serving as functional regulation. This history suggests that an awareness of the public option regulatory mode in housing finance is in fact critical to its long-term success, and that the public option is a well-pedigreed regulatory mode that has historically been associated with stable housing finance markets.
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