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October 25, 2011
Obama: Reckless Lender
On Monday, Oct. 24, President Obama announced that the White House would by-pass Congress and institute new rules to make it easier to refinance a mortgage. If there is any doubt that the federal government is the source of reckless housing policies those doubts should be put to rest by the fact that the administration is pushing loose lending at a time when banks have become bastions of conservative credit.
What is Obama doing? Home owners who are underwater find that they can't refinance and take advantage of historic low mortgage rates. Bankers know inadequate equity levels increase a homeowner's probability of default. While Obama can't directly force banks to make risky loans, he has power over Fannie Mae and Freddie Mac.
Campaigning in Nevada, one of the bubble-and-burst states, Obama said, "So I'm here to say to all of you -- and to say to the people of Nevada and the people of Las Vegas -- we can't wait for an increasingly dysfunctional Congress to do its job. Where they won't act, I will." By Presidential fiat, Fannie and Freddie, through their regulatory guardian, the FHFA, will loosen lending standards including "[r]emoving the current 125 percent LTV ceiling for fixed-rate mortgages backed by Fannie Mae and Freddie Mac." This LTV level means the loan is 25% greater than the home value--an extremely risky level.
During the housing bubble only the most risky subprime lenders gave mortgages 25% greater than the value of the house. Traditional prudent lending generally requires a 20% downpayment by issuing a loan for 80% of the value of the house. The house is collateral to protect the lender in case of default. The costs of foreclosure can easily exceed 20% or worse if prices fall. Mortgage lenders who allowed lower down payments charged higher rates to compensate for the risk. It wasn't enough.
Prior to the housing bust, national home price never exhibited a yearly drop (not adjusting for inflation) in the post-war years. Professionals, as well as homeowners, didn't adequately price the risk of a falling market. The data for bear markets was limited to regional declines, all prior to the existence of a sizable subprime market. While it is clear that inadequate collateral is risky, an appropriate spread (incremental higher rate) should compensate for the risk. After all, there is no collateral behind credit card debt but the 18% compensates the lender for the risk.
Here at American Thinker we've reviewed the government's role in the housing bubble including the effect of the Community Reinvestment Act and government sponsored Fannie and Freddie. Private subprime lenders stepped in where Fannie and Freddie were forbidden by legislation on "conforming limits" (although Fannie bought the loans in securitized form.) From 2001 to 2007, the subprime market grew too fast too quickly to have an appropriate track record to adequately price the risk.
Bankers know better now. Our government apparently fails to understand the lesson.
Prudent lending requires a downpayment. Risky lending requires compensation by an appropriately higher mortgage rate. Risk is difficult to assess when historical statistics is limited.
The current proposal to give high LTV home owners the same mortgage rate as owners with adequate equity violates prudent lending standards. It doesn't make any difference that the loan is originated by a refinance process or purchase of a new home. The mortgage rate should reflect the risk.
We are told by the White House to ignore the risk of underwater borrowers if "[t]hey've paid all their bills and kept current on their home loans." Of course, similar rationales were given when subprime and alternative-A (an intermediate category) loans were originated during the '00s. The fact is that low equity is a significant predictor of default even for those who are current on their mortgages. The White House is simply making excuses.
The major economic purpose isn't about housing. This will do little to change the dynamics of the housing market. This policy is advanced as a stimulus package. By lowering mortgage rates, households will have more to spend on other goods. However, even this, estimated at $24 billion, isn't the real reason.
It isn't accidental that President Obama announced this program in Nevada, one of the boom-and-bust states built on risky lending. He needs to win in Nevada and he is shamelessly buying votes with the same risky policies that created our problems in the first place. This is democracy at its worse.
This should clarify the dynamics of risky lending. It isn't some drooling banker pushing predatory lending on unsuspecting housing virgins. That may make for good Hollywood movies. The truth is much more frightening. Ronald Reagan expressed well when he said, "The nine most terrifying words in the English language are, 'I'm from the government and I'm here to help.'"
There is no excuse this time.
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