Sep162010

Did We Replace Welfare with Home Ownership and HELOC Abuse?

Why did the home ownership rate go up?

Many people have speculated as to why the home ownership rate rose from a stable 64% to an unstable 69% beginning in 1996.

subprime-mortgage-portion-of-market

 

Many political operatives have tried to tie this to one piece of legislation or another, and the article I am featuring today does the same. I am going to add a crazy idea to that mix. To be honest, I don’t believe political decisions and government policies had much to do with the growth in home ownership. Lax lending standards and lowered down payment requirements added buyers to the pool by converting good renters into bad loan owners.

 

If you want to blame any particular policy for this, I would look to Alan Greenspan’s refusal to regulate credit default swaps as a good candidate. The reason lending standards got so lax is because lenders believed they had transferred the risk to someone else, most often AIG. Since this risk was grossly mispriced, lending standards continued to fall and the mispricing of risk was hidden by the rampant appreciation the influx of new, unqualified buyers created. When it all blew up, we had a major financial crisis.

The delivery mechanism that put unqualified buyers into homes was not the GSEs, so it was not government policy that increased the home ownership rate: it was private subprime lenders. The data on this point is difficult to refute (see below). Republicans have tried to blame Barney Frank which is a joke considering he had no power while all this was going on. Democrats try to blame the Republicans because they were in charge, but that isn’t right either because it was caused by private companies — not the GSEs — and not by any government programs.

 

Notice how well the increase in home ownership rates tracks the increase in subprime lending. Correlation is not always causation, but in this case, how can you deny it. We know that many subprime borrowers were put into homes that previously could not get one. We also know these are the borrowers who have largely been foreclosed on to date as the alt-A and prime borrowers have been allowed to squat.

Subprime was private lending. I have no doubt that policy makers where happy to see this industry grow, but it was not a government policy that made this happen, and it certainly was not caused by the GSEs. Keep that in mind when you read these bogus political “explanations” of what went on. Most of them are factually challenged, and all of them miss the bigger picture connection between the activities in the private sector, credit default swaps, and the mispricing of risk that caused money to flow into the market and increase the home ownership rate and inflate a massive housing bubble.

 

Subprime 2.0 Is Coming Soon to a Suburb Near You

By Edward Pinto – Sep 7, 2010 6:00 PM PT

On the second anniversary of the bailouts of Fannie Mae and Freddie Mac, it’s now obvious that weak lending standards, serving the political interest of affordable housing for all, were the main reason for the nation’s mortgage meltdown.

Actually, no, that is not obvious. Serving political interests of affordable housing was not the culprit.

But the government just can’t permit lending to anyone and everyone; it must insist on prudent judgment about who will repay and who will default. Not only will borrowers who lack a down payment, steady income, employment and a good credit history probably get into trouble — surprise! — but too much irresponsible lending also creates artificial demand for houses, driving prices into the stratosphere and, as we have just experienced, puts all homeowners at risk.

The same mistake occurred in 1929, when any investor could buy stocks on margin with as little as 10 percent down. Small wonder that after the crash the U.S. government instituted a margin requirement of 50 percent down.

Congress should apply the same principle to housing purchases, increasing the amount a buyer must put down and other safeguards to assure prudent lending. Congress refuses to do this. Why? Giving citizens cheap, easy housing is a great way to win votes, no matter what horrific repercussions ensue.

That is certainly part of the problem, but the main reason is because any increase in the down payment requirements would cause the already diminished buyer pool to shrink further.

Who’s Following Whom?

Consider the prevailing narrative that holds a greed-driven private sector responsible for the 2008 financial crisis. A secondary narrative points to a greed-driven Fannie Mae and Freddie Mac abandoning their credit standards in an effort to follow the lead of Wall Street.

If these explanations fail to convince, a third blames a combination of deregulation and insufficient regulation, again driven by greed, as rulemakers were asleep at their posts.

Yes, the first two narratives are only partially true, and the third one hits the nail on the head as I outlined above.

What is missing is the central role played by an affordable housing policy built upon the misguided concept of loosened underwriting — a policy created by Congress and implemented for 15 years by the Department of Housing and Urban Development and banking regulators.

The reason that is missing from the narrative is because affordable housing policy did not create the problem. The affordable housing policies did not cause money to go into subprime. Now if we had seen a dramatic increase in the number of GSE loans and an increase in their market share, I might give some creedance to his supposition; however, that is not what happened. The GSEs were losing market share to subprime lenders, and it wasn’t until 2005 that the GSEs became more aggressive about buying subprime loans.

 

From 1993 onward, regulators worked with weakened lending policies as mandated by Congress. These policies systematically dismantled a housing-finance system based on the common sense principles of adequate down payments, good credit, and an ability to handle the mortgage debt.

No Money Down

Substituted was a scam of liberalized lending standards that turned out to be no standards at all. In 1990, one in 200 home-purchase loans (all government insured) had a down payment of less than or equal to 3 percent. By 2003, one in seven home buyers had such a low down payment, and by 2006 about one in three put no money down.

Again, this problem was not driven by the public sector or the GSEs (which were not public sector at the time). This was a private sector problem that was not caused by government policy.

These policies led millions of Americans to buy homes with little or no money down, impaired credit and insufficient income. As a result, our economy has been brought down and the taxpayers have had to foot the bill for bailout after bailout.

The taxpayers didn’t have to bailout anyone. Our leaders thought it was the proper course of action to give our money to the idiots that created this mess, and despite the common belief this was necessary, I remain unconvinced.

Congress and U.S. President Barack Obama’s administration refuse to learn the lesson that is painfully aware to American taxpayers, and they have made it clear that they have no intention of fixing broken underwriting.

That much is true. They need every available buyer to help clean up this mess.

Let’s start with the latest pieces of evidence. The Dodd- Frank Bill, signed in July 2010 by the president, omitted both an adequate down payment and a good credit history from the list of criteria indicating a lower risk of default as regulators sought to define a qualified residential mortgage.

‘Prudent Underwriting’

This was no oversight. Republican Senator Robert Corker and others proposed an amendment that would have added both a minimum down-payment requirement and consideration of credit history along with the establishment by regulators of a “prudent underwriting” standard. This amendment was defeated.

In early September 2010, Fannie and Freddie’s regulator, the Federal Housing Finance Agency, following requirements set out in 2008 by Congress, finalized affordable housing mandates that are likely to prove more risky than those that led to Fannie and Freddie’s taxpayer bailout. As required by Congress, these new goals almost exclusively relate to very low- and low- income borrowers. Meeting these goals will necessitate a return to dangerous minimal down-payment lending, along with other imprudent lending standards.

Of course, FHFA Director Edward DeMarco notes that Fannie and Freddie aren’t to undertake risky lending to meet these goals. As has already been noted, Congress doesn’t consider low down payments and poor credit as indicative of risky lending. How convenient.

It is troubling that our financial reform didn’t reform much. That Republican amendment was a good one. Unfortunately, Democrats feel they need warm bodies to take on bad loans, so now the US government is replacing subprime.

Return to Subprime

The Federal Housing Administration, in its actuarial study released late last year, projected that it will return to an average FICO credit score of 635 by 2013. This signals the FHA’s intention to return to subprime lending. Once again, Dodd-Frank supports this policy change.

The FHA, the Veterans Affairs Department and the Agriculture Department’s grip on the home-purchase market increases month by month. They now guarantee more than half of all home-purchase loans. However, skin in the game isn’t a requirement. For example, the FHA’s average down payment is just 4 percent. Even this meager amount disappears after adjusting for seller concessions and financed insurance premiums.

On Christmas Eve in 2009, the Treasury Department announced new terms to the bailouts of Fannie and Freddie. Starting on Jan. 1, 2013, the terms of the bailout agreement provide for a continuing obligation to provide about $274 billion in capital to Fannie and Freddie. This amount is in addition to the unlimited sums that are available between now and Dec. 31, 2012. As a result, one or both of these entities can now continue indefinitely as zombie institutions under conservatorship.

As a society, we have to go back to at least 20 percent down, with limited exceptions. Credit histories need to be solid. Documentation has to be iron-clad. Lender capital levels need to be raised.

Yes, that is exactly what we must do. Can you imagine how prices would crater if we did? Perhaps we could phase it in, but it seems more likely that we will not move in that direction at all.

Here’s my proposal to bring Congress’s penchant for imprudent lending to a quick end: All congressional pension assets should be invested in funds backed solely by the high- risk loans mandated by federal housing legislation. I have a feeling that things would change fast.

That is hilarious!

(Edward Pinto, a mortgage-finance consultant, was executive vice president and chief credit officer at Fannie Mae from 1987 to 1989. The opinions expressed are his own.)

To contact the writer of this column: Edward Pinto at [email protected]

Despite my disagreement with many of his contentions in the article, I support his conclusions that we need to return to sane underwriting standards even if that caused prices to fall further. Do we really want a housing market completely controlled and financed by the US government?

Did We Replace Welfare with Home Ownership and HELOC Abuse?

Here is my bogus correlation to politics for your amusement. Democrat Bill Clinton promised to “end welfare as we know it.” Newt Gingerich as part of the Republican Contract With America agreed. Together they passed the Personal Responsibility and Work Opportunity Act of 1996. Since poor people could no longer count on the government for ongoing support payments, they needed a new source of spending money. The government eager to avoid civil disorder came up with an idea: make all these people home owners to make them feel vested in the community, and give them home equity they can convert to spending money to make up for the lost welfare money.

This legislation does correspond to the beginning of the housing bubble, and the cause and effect is plausible. Also, during the bubble rally, there were certainly many poor subprime borrowers who got to take a ride on the HELOC gravy train. I don’t happen to think this correlation is causation, but it is something to think about. It is certainly more plausible than most of the nonsense coming out of the Right-wing narratives I have read.