Mortgage finance needs new foundation

August 18, 2010

Fixing up U.S. mortgage finance involves more than just Fannie Mae, Freddie Mac and the private home loan market. The Obama administration was right to finally put the bailed-out mortgage giants on center stage at a conference convened on Tuesday. But the crisis had a third leg: borrowers got ahead of themselves.

In the decade of easy money before the crash, homeownership rates shot up to 69 percent by 2004 from an historical and fairly steady average since the 1960s of roughly 64 percent. This effectively means 5 million properties were bought by people who perhaps should never have owned them. The rate had dropped back to about 67 percent as of June, implying part of the excess has been painfully worked out.

Some of the ways to limit future bubbles aren’t new. First, borrowers should have to make a healthy down payment. By 2006, some 70 percent of subprime borrowers had mortgages worth at least as much as their real estate. Second, lenders should concentrate on the borrower’s ability to repay the loan rather than on the potential increase in value of the property. The crash has already imposed some of this discipline. But credit standards will loosen again — and regulators must be ready to rein in recklessness.

A third idea is less obvious: Give lenders recourse to the borrower when a home loan goes sour, not just to the property. That’s how Canada does it. It’s no panacea, but being on the hook ought to discourage home buyers from borrowing more than they can really afford.

A fourth idea would be to curtail the ability to refinance. The U.S. market is almost unique in offering 30-year, fixed-rate mortgages that can be refinanced at lower rates at very little cost thanks to Fannie and Freddie’s participation. But the uncertainty and built-in expense discourage private-sector mortgage lending.

The last in a handful of possibilities would be to reduce or eliminate the tax deductibility of interest. Of course, all these measures would make mortgages harder to get, more expensive, or both. But considering the recent damage caused by blind belief in the dream of home ownership, it might be no bad thing.


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In many U.S. markets it is less expensive to own than rent thus “5 million properties were bought by people who perhaps should never have owned them.” contradicts that home ownership is a reasonable need.

The mortgage/home loan market appears fatally flawed. Lenders gave mortgages at 125% of appraised value. They did “drive-by” appraisals. They often failed to handle paperwork in the legally required manner. Any “no income / no asset verification” loans made were a gross failure of the lenders to protect the future buyers of those mortgages – the CDO investors. They were charging interest rates of 9% or more to lenders who would qualify for 5% at a traditional bank. The inflated monthly payments caused increased default rates. Those mortgage broker’s commissions and the lender’s profits are the products of fraud. Abused borrowers must not be punished – all lenders which failed any legislated standard must be prosecuted. The purpose of law is to provide a remedy for every harm.

Most traditional banks did require down payments or residual equity, charged reasonable rates and fastidiously performed appraisals and all paperwork in an ethical manner. If all mortgages were made to FHA standards or better tens of millions of people would still be working, buying typical goods and services, living in their own home and paying into retirement and college savings.

Failing to legislate home loan marketers into a form that would make them unrecognizable will allow the fatalistic statement “But credit standards will loosen again” to prove true. “Regulators must be ready to rein in recklessness.” means that damage will be done since ‘necessity is the mother of intervention.’

Mortgages longer than 20 years lower monthly payments only a little while greatly increasing lender profits. A $100,000 loan at 5% for 20 years costs $659.95 per month – a total of $158,388 in payments while a 30 year term raises that to $193,255 which is a 60% increase in profit with only a 19% reduction in monthly payments to $536.82. Moreover, that 19% reduction allowed more money to be lent (if income guidelines are followed) allowing real estate prices to escalate more rapidly. $660.29 buys a $123,000 note at 5% for 360 months. A house will not sell for $123,000 in a market where a typical buyer has been limited to $100,000. Laws of supply and demand would then prevent inflation.

Inflation in real estate prices while real wages decreased coupled with outrageous mortgage practices such as terms longer than 20 years to even 50 years, interest only features, adjustable rates, balloon notes with early term reduced payments that actually increased the principal due to allowing initial payments to be less than the interest and the like – coupled with the fiasco of CDO sales caused the financial meltdown of the entire world.

All five ideas presented are harmful to any person owning or desiring to own his own home. They punish the victims economically not the perpetrators of disaster.

Posted by Periwinkle | Report as abusive

we need to swallow our pride and learn from the canadians on housing reform. the canadians didn’t bail out their banks because subprime mortgages barely exist in Canada and so banks view the income from lending to people buying homes as perfectly safe, more secure than tier one capital by the current definition. If loans for homebuyers are that safe, not only is the US not going to experience a massive housing bubble, banks will be better capitalized against any other significant bubble as the substantial income they receive on mortgages will act as a constant capital buffer against whatever eternal shock the market suffers through. Again Canada didn’t bailout their banks, the only g7 country to do so. Canada’s persnickety lending laws may be hard to implement in the US, as we aren’t great at legislating against our own interest, but it would be the best way to manage housing reform. We need to suck it up and admit canada did it better.

this article is enlightening. 11df-8b23-00144feabdc0.html

Posted by theinfamoushw6 | Report as abusive

Mortgage finance needs new foundation, the brokers and lenders are providing a new direction to it these days.

Posted by Terms | Report as abusive