After the collapse of lending caused by skyrocketing delinquency rates which ultimately brought down the housing market, lending was taken over by the US government. The FHA, which was an existing government program, saw its share of mortgage origination balloon from 4% to 25%. The government sponsored entities of Fannie Mae and Freddie Mac were taken into conservatorship by the Department of Treasury and injected with about $150 billion to keep them solvent. With takeover of the GSEs and the increase in FHA lending, the government insured the loans on as much as 98% of the housing market. The current footprint is still well over 90%.
Most of the parties involved with supervision of the GSEs and FHA agree that the government footprint in lending should be reduced. However, any proposals to accomplish this end is always greeted with the same shrill cries about increasing costs or reducing eligibility. Lenders have morphed from companies with large portfolios of loans to an origination model where they underwrite the loan to government standards then sell them in the secondary market. This new origination model requires little capital to operate because they don’t have to keep any of the loans they originate on their own balance sheets. These new players vehemently oppose a new requirement in the Dodd-Frank law that mandates they keep 5% of the origination value of loans on their books that do not conform to the new “qualified mortgage” standard. It’s primarily these groups who operate on the origination-to-sell model that are lobbying to relax the Dodd-Frank standards.
Pending mortgage regulations could lock today’s tight lending standards in place and result in nearly 20% fewer mortgages being issued in the coming years, restraining home sales and construction, according to a new study.
What these studies don’t understand — likely through the willful ignorance of the report sponsor — is that tight standards are exactly what we want and need. First, we don’t want the taxpayer taking on risk. Taxpayer-backed loans should be of the highest standard with the least amount of risk. It provides a stable base we can fall back to in times of crisis. This conservative standard does not inhibit private lenders from taking risks on looser underwriting standard. It merely requires those lenders to keep 5% of that risk on their own books to keep skin in the game. I think this is a great requirement. Realistically, it probably doesn’t go far enough. The idea that conservative underwriting standards will inhibit future lending is sensationalist nonsense. It will merely shift the burden of risk from the US taxpayer to private lenders, which is where it should be.
The report from the American Action Forum, a center-right think tank, provides an estimate of the potential impact of three important mortgage regulations set to take effect next year:
- Higher bank capital standards under the Basel III agreement
- The “qualified mortgage” rule regulating ability-to-repay standards, which is part of the Dodd-Frank financial-overhaul law
- The “qualified residential mortgage” rule setting standards governing loans that are issued as securities, also part of Dodd-Frank.
Together, the new rules “will raise the cost of borrowing for millions of home buyers and tighten access to credit beyond pre-boom standards, a period of much more responsible lending than in the lead-up to the housing crisis,” says the AAF paper.
Yes, it will. These regulations should be embraced by everyone who cares about seeing their tax dollars kept safe from dodgy loan originators.
Of course, regulators have yet to finalize the “qualified mortgage” and “qualified residential mortgage” rules. As a proxy for where those rules might land, the report roughly assumes that today’s tighter lending standards won’t return to those that prevailed before the housing boom as a result of the impending regulation.
“It would make permanent the current, tighter standards,” says Douglas Holtz-Eakin, the president of the AAF. While he says he won’t pretend that his estimate is “perfect,” he says it is a “sensible” forecast.
Again, this will only effect those who operate on the origination-to-sell model. Private lenders who operate on the traditional model will not be negatively impacted because they often hold these loans on their books anyway.
Mr. Holtz-Eakin and his co-authors attempt to quantify the potential impact of the regulations by comparing today’s mortgage lending standards with those that prevailed in 2001, which they use as a “baseline” for more normal lending standards.
Banks have tightened up their standards over the past three years—and kept them tight—largely to address the threat of mortgage “put-backs” from investors, from lawsuits, and from the higher costs associated with handling delinquent mortgages.
The paper concludes that if lending standards that are in place today don’t moderate to the 2001 baseline level, there would be roughly 14% to 20% fewer loans originated over the coming three years. That decline, they estimate, would reduce total home sales by 9% to 13%, depending on the ability of all-cash buyers to pick up any slack.
Nonsense. The tightening standards will create opportunity for private lending to reenter the market.
The decline in home sales, in turn, would reduce housing starts by 1.01 million through 2015 and GDP growth by 1.1 percentage points.
“The issue is, if we want to have tighter standards for mortgage origination—as a safety-and-soundness issue for banks, or as a matter of not having people get in trouble on their loans—you have to cut back on what you originate,” said Mr. Holtz-Eakin.
In other words, if you don’t give loans to anyone who can fog a mirror, you will make fewer loans. No kidding? Perhaps that’s why owner-occupant demand is so much lower than it was six years ago.
While no one is arguing for a return to the lax standards that prevailed during the housing bubble, Mr. Holtz-Eakin said he’s surprised that more policy makers haven’t focused on the potential impact on the housing market should regulation enshrine banks’ current defensive position when it comes to making mortgages.
Consumer advocates say they are cautiously optimistic that the Dodd-Frank rules can ensure stronger consumer protection without limiting new lending. “If Dodd-Frank is done right, we should see somewhat expanded lending from what we have right now,” said Julia Gordon, housing policy director at the Center for American Progress, a liberal think tank. “It’s important to raise these concerns, but it’s also important to be specific, and not just anti-regulation.”
I used to be anti-regulation. I saw the lingering effects of over-regulation during the 1970s, and when Ronald Reagan rolled many of these back, I thought it was a good idea. Then I witnessed the housing bubble. Deregulation can be taken too far, and the Conservative movement of the late 90s and 00s proved that. We did away with Glass-Steagall and many other Depression Era protections that served us for 80 years. We knew better. In less than a decade we blew up our financial system and created the Great Recession. Unfortunately, we haven’t gone far enough to prevent a recurrence. I hope our children don’t end up in an even larger mess.
The former owner of today’s featured property paid $106,000 back in 1988. In 2002 he had only a $86,850 first mortgage, but in 2003 he refinanced with a $220,000 first mortgage and imploded. He stuck American First Credit Union with his final refinance for $235,000. They let him squat for two years, then they sat on the property for a year themselves before finally releasing it to the market.
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Proprietary OC Housing News home purchase analysis
$264,900 …….. Asking Price
$106,000 ………. Purchase Price
12/29/1988 ………. Purchase Date
$158,900 ………. Gross Gain (Loss)
($8,480) ………… Commissions and Costs at 8%
$150,420 ………. Net Gain (Loss)
149.9% ………. Gross Percent Change
141.9% ………. Net Percent Change
3.9% ………… Annual Appreciation
Cost of Home Ownership
$264,900 …….. Asking Price
$9,272 ………… 3.5% Down FHA Financing
3.47% …………. Mortgage Interest Rate
30 ……………… Number of Years
$255,629 …….. Mortgage
$73,498 ………. Income Requirement
$1,144 ………… Monthly Mortgage Payment
$230 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$66 ………… Homeowners Insurance at 0.3%
$266 ………… Private Mortgage Insurance
$193 ………… Homeowners Association Fees
$1,899 ………. Monthly Cash Outlays
($170) ………. Tax Savings
($404) ………. Equity Hidden in Payment
$10 ………….. Lost Income to Down Payment
$53 ………….. Maintenance and Replacement Reserves
$1,388 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$4,149 ………… Furnishing and Move In at 1% + $1,500
$4,149 ………… Closing Costs at 1% + $1,500
$2,556 ………… Interest Points
$9,272 ………… Down Payment
$20,126 ………. Total Cash Costs
$21,200 ………. Emergency Cash Reserves
$41,326 ………. Total Savings Needed