Home > Mortgages > Will Abandoning Mortgage Reforms Bring On a New Housing Crisis?

Comments 0 Comments

Here we go again. I laughed, I cried and I felt like it was 2006 all over again while reading the financial press this week cheerlead administration steps designed to “ease mortgage credit.”  What’s really happening is, in an incredible gift to banks and investors, Fannie Mae and Freddie Mac have now officially completed their horror-movie-like rise from the dead. Expect to see Housing Bubble 2 in neighborhood theaters near you very soon, with investors laughing all the way to the bank.

Mel Watt, the new director of the Federal Housing Finance Agency, gave his first public speech on Monday, and made clear that the notion of winding down Freddie and Fannie was dead. In fact, he called for increasing their role in greasing housing sales. Headline after headline expressed relief that it’ll be easier to get mortgages, and what a great thing that is for the economy.  The same lack of curiosity by financial journalists that helped create the housing mess — if banking regulators say it, it must be true! — has reared its ugly head again.

Let’s go through what really happened. It’s not all bad, just mostly bad.

Easier Credit

Citing fear that would-be homeowners are stuck on the sidelines because credit is too tight, Watt called for a series of measures that would encourage banks to lend, and make things easier for those with less-than-perfect credit. There’s a lot of half-truths there. First off, it’s not that hard to get a mortgage. FHA loans, and their tiny down payments, are thriving. Buyers can put down as little as 3.5% and get an FHA-backed mortgage. According to the Mortgage Bankers Association, 15% of loan applications were FHA loans in April. (During the bubble years, FHA loans dropped well into the single digits as a percent of loans, dipping to 3.77% in 2006.) FHA loans come with high fees — we’ll get to that in a minute — but it’s a myth to say without qualification that lending standards are very tight.

You will see a lot of conflicting data about how tight or loose lending standards are for marginal buyers right now. The Wall Street Journal says that less than 1% of buyers have a credit score under 620 right now, compared to 13% in 2001.  Is that a good or a bad thing?

Throwing Money at the Problem

Housing is already becoming dangerously unaffordable again, even during this uneven recovery, when comparing median incomes and median home prices in most local markets. This is more a function of income than housing prices. Encouraging riskier lending is a terrible strategy for making things more affordable, however.  Throwing more dollars at a limited number of goods just raises the prices. More mortgage approvals will raise housing prices. It is good for those who earn fees off the transactions, however.

And to be clear, housing prices are UP, and have continued to rise – if in fits and starts – for years.

The Housing Recovery Is Uneven, But Not a Disaster

Home purchase rates were down in March.  That was scary, but so was the awful weather around the country. April purchase of Fannie-and Freddie-backed loans was up 24% over March. It was still down 4% from last year — this is an uneven recovery, one Trulia compares to drunken stumbling — but it’s not a crisis that needs dramatic priming. You know what is a crisis? Slightly higher mortgage rates have pretty much killed the refinancing market, so banks are pretty desperate to find new loans. Last year, refinances made up 78% of the mortgage market, but in the first quarter of this year, that figure plunged to 47%, according to the Wall Street Journal.

Avoiding the Real Problem

About those refinances. So it’s great that well-off folks were able to refinance every 12 months for the past four years and save another few hundred dollars on their monthly bills, but that didn’t help the real problem dogging the housing market, the recovery and the economy at large — the estimated 10 million mortgage holders who are still underwater. That’s one in five mortgage holders.

Being underwater is psychologically punishing, but it has real-life impacts, too. Mortgage holders who can’t sell their homes without owing the bank a big check can’t relocate for new jobs. In many cases, they can’t refinance and enjoy lower rates, either (or their path is much harder). There is one simple, tried and true, obvious method for helping these folks: forcing banks to write down principal. In one of thousands of practical examples of how this would help, Professor Peter Dreier tells the story of a family being evicted from their home because they defaulted on their $400,000 mortgage.  The family could afford a $200,000 mortgage, which is also today’s real value for the home and the price the bank will get for the house when it forecloses. Everyone is better off keeping that family in that home. The family, the neighborhood, and even, probably, the bank. But Mr. Watt has no innovative plans to help them, or other families like them. He’s too busy helping banks originate more new loans.

The Higher Down Payment Is Dead

During the height of the crisis, there were signals that Freddie and Fannie would some day soon only back mortgages when consumers put 20% down. That idea was scuttled early, replaced by a compromise that would require 10% down. Now that’s dead, too. Why are we in such a rush to sell $200,000 homes to people who can’t save up $20,000?

Keeping High Mortgage Limits for Freddie & Fannie

A bit like the fiscal cliff or expiring tax cuts, there was a doomsday looming for the mortgage market. During the crisis, the limit on mortgage size for Fannie and Freddie was dramatically raised — up to $417,000 for most of the country, and even higher in expensive markets. The plan was always to drop those limits, allowing free-market investors to buy the loans instead. Such a move would indeed hurt the fragile housing recovery right now.

Watt said he would postpone it, and that’s sensible — most importantly, it signals stability to investors. Similarly, Watt said he would postpone a step that would force more banks with poorly performing loans to buy them back from Freddie and Fannie, which is probably a good idea, though it is disturbingly like the moral hazard we are always so afraid of creating by giving homeowners a break. Watt also said he would create an appeals process for banks that are told to buy back bad loans. Sure wish foreclosed homeowners had the same opportunity.

One More Positive

FHA loans, which do a lot to help first-time homeowners with very little down payment get involved in the housing market, have a dark side. They cost buyers huge fees, which go into a fund that pays banks back if the homeowners default. The upfront fee was supercharged to 1.75% during the housing crisis (in addition to monthly insurance costs). FHA upfront fees basically add 1.75% to the price of a home for lower-income buyers, which is punishing. Watt suggested FHA buyers could lower their fees by enrolling in personal finance classes, which would be a welcome change.

As you read more stories about Fannie and Freddie, and their impressive rise from the ashes, keep asking yourself this: There is tremendous bias in our tax code and our banking policy toward buying a home over renting. Why is that? Who benefits from it? There’s an obvious answer: banks who make money from mortgage volume through fees. But there’s another group that might be a surprise: hedge funds that bought up millions of shares in the distressed entities. They are suing the federal government in an effort to protect their investment, and lobbying housing regulators to save Fannie and Freddie. If Fannie and Freddie were wound down, as originally planned, these investors would likely have worthless shares.  Instead, they stand to earn millions if the firms are re-privatized. Heck, they earned millions when shares leapt from $4.35 to $4.80 on the news.

The real problem for the sluggish housing market, aside from underwater homes, isn’t tight credit. It’s a generation of would-be young homebuyers who came of age during the housing meltdown and see no advantage to buying over renting. In fact, 25- to 35-year-olds won’t even buy cars. Throw in their portion of the $1 trillion student loan debt owed by Americans, when you already have a $29,000 student loan “mortgage” on your future, what’s appetizing about adding another one?

Lowered lending standards. Abandoning down payment requirements. Forgiveness for banks that originate underperforming loans. And most of all, pressure to prime a sluggish market and a sluggish economy using any means possible — and a green light from Washington, D.C. – these are all the elements that were place back in 2001 that led to the housing bubble. And while rules that have largely put an end to terrible “liar loans” and other extremely risky lender behaviors might limit the damage, you have to wonder: As we head down the road of looser lending standards again, how loose will they eventually get? It is unfathomable to think we could make the same mistake again, so soon after the last time. But then, plenty of tech observers will tell you we are living through the second Internet stock bubble right now. With housing prices rising, and our only solution being to encourage riskier buyers with looser credit, there’s plenty of reason for concern that we are headed for a sequel.

And I want to hear from you. Who has been rejected from a mortgage, and why?

More on Mortgages and Homebuying:

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its affiliates.

Image: Torian Dixon

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team