MORTGAGE LENDING: “LET’S TAKE IT NICE AND EASY, IT’S GONNA BE SO EASY…”

10/22/14

Two developments on the mortgage regulatory front warrant serious consideration and spawn one insightful observation and draw two conclusions.

Federal Housing Finance Agency Director Mel Watt announced yesterday that Fannie Mae and Freddie Mac will guarantee mortgages with down payments as low as 3%.  Previously, though there were exceptions, Fannie and Freddie required 20% down payments on mortgages they guaranteed.

At the same time, the Dodd-Frank requirement that banks retain 5% of the risk in the mortgage loans they originate and sell to investors or require a 20% down payment on such loans was watered down.  Under the new rules, banks can avoid retaining risk in the mortgages they originate and sell by merely “verifying a borrower’s ability to repay” and ensuring that their debt levels remain below certain predetermined thresholds.

Both moves are part of a general thrust toward easing home lending requirements and are seen as a response to a continued sluggish housing market that is characterized by home sales’ being down 2% from last year and still below pre-recession levels of seven years ago.

One can make one observation and draw two conclusions from these regulatory developments.

First, the observation:  At the expense of sounding like a heretic in the church of new age financial innovation, when you have put down only 3% of the value of “your” home, you don’t own the home; your lenders do.  Many have pointed out that only a slight change in housing prices would wipe out one’s equity under such a structure, and that is true.  But even more fundamentally, one doesn’t have to be as atavistic as yours truly to realize that you don’t own anything when you have borrowed just about its entire purchase prices.

Now, the first conclusion.  Wall Street must have gotten to the regulators.  Mortgage backed securities issuance is down 50% year to date from last year.   This of course hurts the trading profits of banks and other Wall Street institutions.   The regulators and their political masters are following their usual “Yes, sir, you’re right sir, what else can I do to make your life easier, sir?” approach to Wall Street and to anybody else capable of writing brobdingnagian “campaign” checks and providing other sources of lucre to our selfless public servants.  That the taxpayers and others not within the vortex of Washington may wind up with the bill for such service is inconsequential to the political class.

Finally, the second conclusion.  Regulators have to have concluded that our Potemkin housing market, and maybe our Potemkin economy, cannot survive without massive debt extension and creation.  That a large chunk of such debt may be unserviceable, and thus will have to be picked up by the taxpayers is, again, inconsequential to the political class or to the special interests it services.

REPLACING FANNIE AND FREDDIE: “I’LL BE HERE WHEN THE MORNIN’ COMES; I’LL BE RIGHT HERE AND I AIN’T GONNA RUN…”

8/6/13

President Obama reportedly will propose today a revamped system of guaranteeing residential mortgage loans in this country.   The previous system, in which Fannie Mae and Freddie Mac, strange hybrids of private profit, public risk, and federal patronage, guaranteed mortgage loans with the implicit guarantee of the taxpayers, has obviously been a failure.  Mr. Obama proposes replacing them with private sector guarantors backstopped by a government guarantee, which sounds strangely like, well, Fannie Mae and Freddie Mac.

The Republicans are not quite clear on what they would replace Fannie and Freddie with but are paying their usual lip service to the private sector.   But a purely private mortgage loan guarantee system is a pipe dream.  Why?  Because there is no substantial market for the types of loans that have supported real estate in this country for just about as long as most people can remember—long term (usually 30 year), fixed rate loans with no call protection for the lender—without federal guarantees.  As long as we insist that borrowers are entitled to loans that feature almost incredibly juicy terms to them and just as incredibly lousy terms to the lenders, the government has to play a big role in the mortgage lending.

The obvious answer, it seems, to avoiding a repeat of the Fannie/Freddie debacle is to move away from the 30 year fixed rate loan model on which the real estate market has been built.   Remove the guarantees and let lenders make loans that make sense from an investment perspective, loans that they would be willing to hold on their books rather than sell to a government backed entity.   Variable rates would clearly be a big part of such a mix, but the cleverness and innovation of the free markets would make all sorts of loans, probably including equity participation loans, available to consumers.  But the 30 year fixed rate loan, ridiculously skewed in favor of the borrower, would probably become a museum piece.

Such a logical transition will probably never take place, even though it works in most other advanced economies.   The real estate industry would scream bloody murder.   Homeowners, largely at the inducement of the real estate industry, would complain that the value of their homes, previously inflated by government guarantees, would be hurt.  Potential home buyers would whine that their entitlement…the 30 year fixed rate loan…had been taken away from them.   And so Fannie and Freddie, or, more likely, something very much like them with a different name, will be around more or less forever.

Long ago, we decided, for whatever reason, that we would heavily subsidize homeownership, and thus investment in residential real estate, in this country.   The largest components of that subsidy are the deductibility of mortgage loan interest and the 30 year fixed rate loan made possible through the intercession of the government.  Neither makes much sense, but neither will be going anywhere soon.  As usual, politics trumps finance, economics, and common sense…and we live with the consequences.

DO WE ALL LIVE IN GOVERNMENT SUPPORTED HOUSING?

6/10/13

This morning’s (i.e., Monday, 6/10/13’s, page A2) Wall Street Journal contained an article by Nick Timiraos discussing the bull and bear cases for the housing market.  The bulls argue that demographics, primarily increasing household formation and falling inventories of housing units, and affordability should spur something of a housing boom.  The bears argue that the end of the one-time boosts to consumption that came about as a result of the broad introduction of two-income households and the democratization of credit should hobble housing.  The bears argue further that home financing will be harder to come by as banks tighten standards and first time home buyers are hobbled by student debt.

Given my normal predispositions, I tend to favor the bear case.   There is still too much household debt in the economy (See, inter alia, my 4/23/13 post THE ATTACK OF THE McMANSIONS FOR SALE:  A SECULAR BRAKE ON THE HOUSING MARKET for some statistics.) and incomes are not growing at a pace that will alleviate the burden of servicing that debt.  Banks, and investors, are understandably reluctant to lend to people who can’t pay back their debts.

Therein lies the problem currently plaguing the prospects for reinvigoration of the housing market, to wit, banks are reluctant to lend to less than creditworthy buyers and so the government, though Fannie Mae, Freddie Mac, or the FHA, still guarantees the overwhelming majority of mortgage loans made in this country.  The last I saw, the percentage of new home loans that are guaranteed by the U.S. government was about 90% and I suspect the number still hovers somewhere in that unprecedented, until the credit debacle of 2008-09, level.

Add the government being the ultimate guarantor of just about all new housing loans to Ben Bernanke’s War on the Elderly, i.e., the Fed policy of keeping interest rates low across the curve, that itself is designed in large part to support housing and you have a housing market that is nearly completely dependent on government support.  We talk about a stock market that is being propped up by Fed policy; the housing market is at least as dependent on Fed manipulation of interest rates to make housing “affordable.”

Add to that the argument I made in the aforementioned 4/23/13 post and yours truly finds little reason to be sanguine about the housing market.