Prudent credits standards averted nearly 1,000,000 future foreclosures

Lenders wisely stopped from granting loans to nearly 1,000,000 unqualified borrowers over the last 6 years.

done_making_paymentsMany people blame the last housing bubble on lenders and subprime borrowers. Lenders abdicated their responsibility to vet their borrowers’ qualifications, and not surprisingly, many unqualified borrowers entered the buyer pool and ultimately defaulted on their mortgages, leading to millions of foreclosures.

The disaster was exacerbated by the proliferation of Option ARM loans that both inflated house prices and masked the problems with borrower’s ability to repay with teaser rates and negatively amortizing payments. When these loans caused all borrowers (not just subprime) to implode, crashing house prices took down the economy and millions of qualified and unqualified borrowers along with it.

When so many borrowers defaulted, lenders lost faith in all borrowers and in all their loan programs. As a result, America endured a massive credit crunch.

Banks make money by making loans and collecting interest, so they needed to loan something to someone or go completely out of business (which many did). In times of turmoil, lenders retreat to what they know works: 30-year fixed-rate mortgages with carefully documented borrower qualifications — as they should.

Credit cycles from periods of extreme tightness to periods of extreme looseness with credit crunches often bridging the gaps between. Credit standards climb slowly and fall quickly.foreclosure_massacre

Competition drives the credit cycle. Lenders who fail to loosen their standards lose business to more aggressive lenders. Without regulatory boundaries, competition drives lenders to offer increasingly unstable loan products to increasingly unstable borrowers, which makes the highs and lows of the cycle more pronounced.

Dodd-Frank attempted to address this problem, but any regulatory boundary, no matter how well intentioned or well implemented, will run afoul of those who want to push the envelope and generate more business. Donald Trump signaled a willingness to remove the regulations that keep lenders from making bad loans to unqualified borrowers. Let’s hope he doesn’t follow through on that one.

Overly tight credit killed 1.1 million mortgages in 2015

Laurie Goodman, November 21, 2016

Industry advocates earn their keep by telling stories. They spin a narrative that emphasizes the best features of their policy initiatives of industry performance while downplaying any negative aspects. Laurie Goodman is an industry advocate, and she intentionally ignores the positive aspects of prudent lending standards.

It was so hard to get a mortgage in 2015 that lenders failed to make about 1.1 million mortgages that they would have made if reasonable lending standards had been in place.

lose_houseHer advocacy is a bit over the top. First, lending standards are not “overly tight.” They are prudently tight to avoid defaults. It’s not hard at all to get a mortgage. Anyone with a decent credit score, a minimal down payment, and documented income can get a loan. Current lending standards are “reasonable.” If they were unreasonably tight, some lender somewhere would loosen those standards to gain market share on the competition. Since this isn’t happening, we can deduce her opinion on standards is nonsense.

From 2009 to 2014, lenders failed to make about 5.2 million mortgages thanks to overly tight credit. In total, lenders would have issued 6.3 million additional mortgages between 2009 and 2015 if lending standards had been more reasonable.

The GSEs will take loans with FICO scores down to 620. The FHA will go down to 560. Below these levels, default rates exceed 15%. It costs too much in loan losses to make up the small increase in marginal business, so lenders won’t go any lower.

So assuming her calculations are correct and that lenders didn’t make 6.3 million loans over the last 6 years to unqualified borrowers, we can safely assume that at least 15% of those borrowers would have defaulted and become can-kicked loan modifications or foreclosures. That’s 945,000 delinquencies.

We should celebrate that prudent loan standards prevented nearly 1,000,000 foreclosures!

Since the 2008 housing crisis, borrowers with less than stellar credit have found it hard to obtain a mortgage. Accordingly, the number of mortgages taken out to buy a home declined from 4.6 million in 2001 to 3.5 million in 2015. The reasons for this exceptionally tight credit include

  • the “overlays,” or additional restrictions lenders put on borrowing because of concerns that they will be forced to repurchase failed loans from the government-sponsored enterprises or Federal Housing Administration (FHA);

Lenders should fear that they will lose money on bad loans. Back when lenders carried these loans on their own balance sheets, they were prudent with their standards because they carried the risk of loss. Once we detached origination from owning the loan, the incentive for lenders is to originate like crazy and hope hapless investors foolishly buy the garbage before it goes bad.take_tepee

  • the high cost of servicing delinquent loans; and

The high cost of servicing delinquent loans is another great deterrent for making bad loans. Why would we want this to be any different?

  • the concern about potential litigation for imperfect loans.

If lenders underwrite copious quantities of shitty loans, shouldn’t they have their noses rubbed in it?

While the tight credit box persists to the frustration of borrowers, lenders, and policymakers, there has been modest progress. The  (Federal Housing Finance Agency) has taken many steps to address overlays, and the FHA (Federal Housing Administration) has taken some, but far fewer, steps. Nevertheless, this latest figure supports the urgency of continuing regulatory and other reforms that will make mortgages more accessible to all creditworthy borrowers.

No, actually it doesn’t. The fact that these constraints on lending prevented 1,000,000 foreclosures is a strong reason to support the existing framework and oppose regulatory “reform” intended to remove the protections in the system.