Apr212015

Mortgage lending standards should not be relaxed further

Lending industry and realtor lobbyists argue lending standards are too tight and should be loosened up. They are wrong on both counts.

realtor_and_platoReal estate industry lobbyists appeal to lawmakers for policies the real estate industry believes will promote more transactions at higher prices. Most often this myopic lobbying causes unintended long-term detrimental impacts on the housing market.

In 2004 every realtor wish was granted: lending standards were loosened to the point of complete abandonment, and restrictions on the amount prospective buyers could borrow were also removed through teaser rates, liar loans, and negative amortization. In the short term, realtors reaped the benefits as transaction volumes escalated even as prices rose higher and higher.

Rather than being the culmination of all their dreams, the direct result of granting the wishes of realtors resulted in a massive housing bubble and painful, equity-crushing housing bust that lowered home ownership rates to 20-year lows, and caused an 80% reduction in new home construction — a condition the industry has not recovered from.realtor_know_nothing

Do realtors acknowledge the failing of the policies they advocate? Of course not. Rather than learn an important lesson from this disaster, real estate lobbyists continue to pepper the press with complaints about how tight mortgage standards are today with hopes that policymakers will lower standards at the FHA and GSEs to promote more transactions by making bad loans to people who won’t repay them. In short, they learned nothing; lobbyists still promote short-term goals at the expense of long-term stability. And the worst part is they are completely wrong about mortgage standards being tight today.

Tight Lending And Other Urban Legends

Logan Mohtashami, Posted on April 9, 2015panic

As many of my readers may be aware, my mantra since 2010 has been that “We simply don’t have enough qualified home buyers in American, once you take away the cash buyers, to have a real economic recovery in housing “. While some may be tired of this refrain, there remain a number of highly respected housing “gurus” who continue to profess that it is unfairly tight lending standards, not the lack of qualified buyers that are suppressing a housing recovery. The difference is not academic.

Back in January of 2014, I wrote Bold California housing market predictions for 2014. In that post I made the following prediction, “I believe the consensus will be wrong, and sales volumes will decline, house prices may rise, but sales volumes in 2014 will be lower than 2013. The biggest demand cohort in 2013 was investors, many paying all-cash. With house prices 20% higher or more, these investors will not be nearly as active in 2014. In fact, I predict one of the big housing stories of 2014 will be just how dramatically and abruptly these investors pull back.”

Logan and I saw the same circumstances back then as we do today. The owner-occupant cohort is not yet ready to support a fully-functioning housing market, particularly at price levels near the peak of the housing bubble.cant_pay_oc

Would-be home purchasers are unable, to qualify for a mortgage due to the following factors:

They lack adequate monthly income. A lot of the jobs created, post-recession, are low paying jobs that don’t provide adequate income to support a mortgage payment. More liberal lending standards will not correct this.

They lack liquid assets. The down payment (even just 3% for some loans) and closing cost for a home purchase exceeds many American’s available liquid assets.

• There is no financial bubble. The formal definition of a financial bubble is an economic cycle characterized by a surge in asset prices above the fundamental value of the asset. The housing bubble created excess demand based on poor lending standards. When the bubble popped, that excess demand disappeared. Not all the demand was fake in that cycle, however. In fact a good portion of it was real. It would be a drastic mistake to attempt to manipulate lending standards in an effort to recreate that extra fake demand. If historically low interest rates cannot generate home ownership demand, then we need to accept that a percentage of our adult population is simply not in a financial position to take on mortgage debt.

excessive_debtObviously, lenders don’t want to accept this fact. Lenders and loanowners want to get out from under the bad bubble-era loans they made, and the only way they will do that is to reflate the old housing bubble, which they are.

Demographics are not favorable in this cycle, but in time they will be. Household formation has been very soft. People are staying single or getting married older. This translates into lower housing ownership demand as most people will wait to marry before considering a home purchase. Fewer dual income households so fewer households that can afford a mortgage payment. These factors have driven strong demand in the rental market.

(See: Why aren’t Millennials buying homes?)everyone-qualifies-low-bar

Still think tight lending  is preventing a housing recovery? A quick review of the requirements for some of mortgage loans available may surprise you.

No money for a down payment? Is zero down too tight?

VA (Veterans Administration) loans require no down payment, a minimum FICO score of 620 and allow up to 60% debt to income ratio. I don’t think anyone could call this tight.

Poor credit score? Is a FICO score of 560 too high? FHA (Federal Housing Authority) loans require a FICO score of 560 to 620. (Scores of 650 are considered “fair and below 600 are considered poor or high risk). Other requirements include at least 3.5% down, and a maximum debt to income ratio of 43%. In some cases they will accept up to 50% debt to income ratio.

High debt to income ratio? Is 50% debt to income ratio too stringent? GSE (Government Sponsored Enterprise) loans allow for 43% to up to 50% debt to income ratio in geographical areas where housing is particularly expensive. A minimum FICO score of 620 and a 3 % down payment is also required. …

If lending standards really are that loose, why aren’t lenders underwriting more loans?

Perhaps the borrower pool is weak as Logan contends….

mortgage-brokers-life

All housing analysts, I would surmise, would like to see a more robust housing market. Where we disagree is what should be done to encourage a healthy market. I believe we have a moral obligation as a society to reject attempts to engineer conditions that encourage people to put themselves in economic peril. We did that before, it was a disaster and we must learn from our past mistakes.

I have to believe that those who are saying lending is too tight are either not aware of the actual requirements and have absolutely no lending experience or have some other agenda that is preventing them from acknowledging the obvious. Gotta wonder. Frankly, I also gotta wonder why we keep listening to them.

Long ago political lobbyists learned they could control public perception by dominating the conversation, so they bombard a compliant financial media with self-serving stories and commentary. realtors want to frame the issue as one of tight lending standards because they believe looser lending standards will make them more money. realtors lack the self-reflection or understanding of how loosening lending standards ultimately leads to bubbles and a radical decline in their incomes; therefore, they lobby for short-term goals despite the long-term detriment.

happy_ending_realtor

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