This chapter develops a framework to clarify the roles of the private and public sectors in expanding formal housing finance markets. It examines the reasons for government intervention in housing and housing finance markets and the types of regulatory and subsidy interventions that may improve market outcomes for different market segments. It is a propitious time to focus on the role of government in the housing finance sector in developing and transition countries. The past period of macroeconomic stability, sound economic growth, and lower interest rates in a growing number of developing countries offered opportunities for governments to begin to address legal and structural issues that hindered the expansion of the sector and that have proven to make it less vulnerable to upheavals in international credit markets. 2 Improved macroeconomic conditions increased private sector interest in expanding the scale and extent of mortgage and consumer lending for housing and in accessing domestic and foreign capital market funds for the housing sector in countries such as Mexico, Colombia, Chile, Malaysia and Korea. Much progress has been made by many governments in strengthening the legal infrastructure for housing finance. Improvements include better land titling and property registration systems, transferability of titles, and stronger enforceability of contracts, including foreclosure procedures and reforms in judicial systems biased in favor of the underdog.

But there is still a long way to go; mortgage loans and other types of housing finance products remain accessible only to a small proportion of the population in most developing and transition economies. Often not more than 10 or 20 percent of housing transactions involve credit (Angel 2001). High real interest rates or the lingering volatility of inflation continue to limit long-term lending in several countries (e.g., Brazil, Turkey, Indonesia), while recent increases in commodity prices add inflationary pressure on rates and house prices. Private lenders are reluctant to expand into underserved markets that are considered riskier, because mechanisms to deal with those risks are inadequate. Households below the 70th or 60th percentile of the income distribution or those employed in the informal sector rarely have access to mortgage finance. Also, major structural problems remain in many countries, often due to the large role of government-owned housing finance institutions. Central banks and finance ministries are under pressure to commercialize or privatize the many state-supported or state-owned housing finance systems and to curb deep institutional and non-transparent subsidies. These have often led to unanticipated liabilities to the state while hindering private entry into the sector. Structural reforms have proved difficult, however, because subsidized housing finance institutions fear loss of their privileges. 4This fear is reinforced by the lingering perception by governments and housing ministries in particular that the state is more efficient in allocating scarce housing credit to large segments of society. Indeed, the risk that governments will unexpectedly change the rules and regulations governing private lenders.