April, 3rd 2013

Rebuilding the housing bubble?

– Liz Mair

I occasionally comment on Twitter that I'm concerned that rather than really addressing underlying problems in the American economy, leaders are sweeping them under the carpet and are inadvertently rebuilding the housing bubble because it's simply easier than the alternative.

I know this sounds tinfoil hat-ish to some folks. But I can't help but immediately feel again that there is some of this going on, intentionally or not, when I read things like this, from the Washington Post:

The Obama administration is engaged in a broad push to make more home loans available to people with weaker credit, an effort that officials say will help power the economic recovery but that skeptics say could open the door to the risky lending that caused the housing crash in the first place.

President Obama’s economic advisers and outside experts say the nation’s much-celebrated housing rebound is leaving too many people behind, including young people looking to buy their first homes and individuals with credit records weakened by the recession.

In response, administration officials say they are working to get banks to lend to a wider range of borrowers by taking advantage of taxpayer-backed programs — including those offered by the Federal Housing Administration — that insure home loans against default.

Housing officials are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default.


Obama pledged in his State of the Union address to do more to make sure more Americans can enjoy the benefits of the housing recovery, but critics say encouraging banks to lend as broadly as the administration hopes will sow the seeds of another housing disaster and endanger taxpayer dollars.

“If that were to come to pass, that would open the floodgates to highly excessive risk and would send us right back on the same path we were just trying to recover from,” said Ed Pinto, a resident fellow at the American Enterprise Institute and former top executive at mortgage giant Fannie Mae.

Administration officials say they are looking only to allay unnecessary hesi­ta­tion among banks and encourage safe lending to borrowers who have the financial wherewithal to pay.


“If the only people who can get a loan have near-perfect credit and are putting down 25 percent, you’re leaving out of the market an entire population of creditworthy folks, which constrains demand and slows the recovery,” said Jim Parrott, who until January was the senior adviser on housing for the White House’s National Economic Council.

One reason, according to policymakers, is that as young people move out of their parents’ homes and start their own households, they will be forced to rent rather than buy, meaning less construction and housing activity. Given housing’s role in building up a family’s wealth, that could have long-lasting consequences.


Deciding which borrowers get loans might seem like something that should be left up to the private market. But since the financial crisis in 2008, the government has shaped most of the housing market, insuring between 80 percent and 90 percent of all new loans, according to the industry publication Inside Mortgage Finance. It has done so primarily through the Federal Housing Administration, which is part of the executive branch, and taxpayer-backed mortgage giants Fannie Mae and Freddie Mac, run by an independent regulator.

The FHA historically has been dedicated to making homeownership affordable for people of moderate means. Under FHA terms, a borrower can get a home loan with a credit score as low as 500 or a down payment as small as 3.5 percent. If borrowers with FHA loans default on their payments, taxpayers are on the line — a guarantee that should provide confidence to banks to lend.

But banks are largely rejecting the lower end of the scale, and the average credit score on FHA loans has stood at about 700. After years of intensifying investigations into wrongdoing in mortgage lending, banks are concerned that they will be held responsible if borrowers cannot pay. Under some circumstances, the FHA can retract its insurance or take other legal action to penalize banks when loans default.

“The financial risk of just one mistake has just become so high that lenders are playing it very, very safe, and many qualified borrowers are paying the price,” said David Stevens, Obama’s former FHA commissioner and now the chief executive of the Mortgage Bankers Association.

The FHA, in coordination with the White House, is working to develop new policies to make clear to banks that they will not lose their guarantees or face other legal action if loans that conform to the program’s standards later default. Officials hope the FHA’s actions will then spur Fannie and Freddie to do the same.


The FHA is also urging lenders to take what officials call “compensating factors” into account and use more subjective judgment when deciding whether to make a loan — such as looking at a borrower’s overall savings.

“My view is that there are lots of creditworthy borrowers that are below 720 or 700 — all the way down the credit-score spectrum,” Galante said. “It’s important you look at the totality of that borrower’s ability to pay.”

Before delving more deeply into this, let me first get a little bit of light "I-told-you-so" out of the way regarding measures advocated by Obama and other Democrats, generally, that some of us said at the time were interventions in the private market and actions regarding the lending market that would indeed help guard against another financial crisis, but with the tradeoff cost that banks would become thoroughly unwilling to lend to borrowers with less than a perfect credit score and a boatload of cash to use as a downpayment.

Surprise! The intervention in the market and action vis a vis lenders worked: They're not lending to people who look at all iffy anymore because they don't want to get hammered if (or maybe even when) the iffy borrowers default and the taxpayer doesn't pick up the tab!

But now, to the real meat of the matter: What are we talking about doing here, why, and what are the potential effects of it going to be.

Clearly, the Obama administration has come to the view that, contrary to what they had perhaps thought previously, banks taking a very conservative approach to lending is a problem, and banks need to get riskier (although I'm sure they'd quibble about the degree of risk involved).

So, they are returning to some of the core "realizations" that drove the policy moves to make it easier for people to get mortgages to buy houses back before and during the bubble-- those policy moves (e.g., the Community Reinvestment Act) having helped ultimately to build that bubble. These realizations include:

- construction is a big chunk of our economy, and if we don't constantly make it super-easy to get credit, there won't be buyers around to buy new houses, and if that's the case, we'll have a crappy construction sector and a bunch of blue-collar, non-college-educated males unemployed, and the economy won't look so healthy, either;

- if you make it harder or riskier for banks to lend, they tend to try to find ways of reducing their risk and/or hassle. That means less lending to unestablished twenty-somethings (even if they have great credit ratings) and, predictably, less lending to a whole swath of middle and lower income people who, while nowhere near as risky as a no-income no-job no-assets  borrower like the kind that was able to get a mortgage on a big, expensive house a few years ago, still aren't anywhere near as safe a bet as the guy who's already owned (and paid the mortgage on) two houses, makes $250k a year, and can front a 25% downpayment;

- that in turn tends to mean (gasp!) the borrowers most able to get credit are rich, white people who are probably already pretty financially secure and not dependent on getting on the housing ladder to achieve financial security (in part because in many cases, they're already on the housing ladder and have already achieved a fair degree of financial security);

- (and I'm conjecturing here) it's basically impossible for the vast majority of people to get ahead and build any wealth or savings in a country where wages have been pretty flat because all potential increases have been being plugged by employers into ever-pricier health insurance plans (with the health care cost inflation rate being higher than the overall inflation rate), and where a lot of people can't save because they have exorbitant amounts of student debt to pay off. So, hey, let's make people rich anyway, by making sure everyone "owns" a house and stimulating the hell out of the real estate market (a.k.a., growing the bubble), so that people can comfort themselves by looking at the surveyor's estimate of their house's value after a bout of crying induced by seeing only a couple of thousand dollars in savings (if that) after years of work. (Hey, also, let's solve the problem of parents not being able to afford $100k to send their kid to some crappy college to get a BA in "media studies" or somesuch by ensuring they can borrow more easily to fund the four years of study put into getting the "media studies" degree).

The reality, folks, is that America without risky lending is a bitch for a lot of people.

They don't start off ahead, and they have much more minimal chances of getting ahead than what most of us grow up believing.

The Obama administration has noticed. And they likely know that fixing that situation is hard; moving back towards where we came from, even with all the attendant risks of people losing their houses, going bankrupt, shareholders losing value, people watching their pensions and investments go up in smoke, banking institutions crumbling, and taxpayers footing a big, fat bill, to prevent worse, might-- just might-- be easier, at least in the short term.

That doesn't make it better, of course, or smarter, thinking long-term. But it is more immediately pain-free, and at least allows the illusion that is sadly as it stands just that for a fair chunk of people-- an illusion-- of being able to achieve the American Dream to continue.

Hence my suspicion, between stories like this and the Fed keeping interest rates crazily low, that we're going to pursue policy that moves us towards rebuilding the bubble at least a bit, like it or not. And personally, I remain skeptical of the wisdom of such moves, though I certainly understand the motivations. [intro]



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