Opinion

Felix Salmon

Getting the housing market back on track

By Felix Salmon
August 12, 2010

David Streitfeld’s NYT piece on home-equity defaults is so aggressively anecdotal, rather than quantitative, that he even says at one point that “the amount of bad home equity loan business during the boom is incalculable”. I really don’t think that’s true: a lot of very smart analysts have done a lot of pretty accurate work on that front. And Streitfeld himself belies the statement by including a pretty illuminating chart with his story.

streit.tiffThe key thing in this chart isn’t the drop from 2009 to 2010, which is a function of the fact that the 2010 data covers only the first quarter. Rather, it’s the fact that first mortgages actually account for a minority of home-loan write-offs, and that home equity lines have accounted for significantly more, in the way of write-offs, than second mortgages.

Which brings me to the first of three op-eds that the NYT has published today on the subject of Frannie and the FHA. Here’s Katherine Stone:

Until recently, most Americans paid for their homes through 30-year self-amortizing mortgages, in which interest and principal are paid at the same time. These work well as long as homeowners have stable, long-term jobs that enable them to regularly make their monthly payments.

But these days such careers are increasingly scarce. Therefore, any effort to recover from the crisis must include more flexible mortgages that take today’s employment landscape, with its frequent job-hopping and episodic unemployment, into account.

The problem here is, as a glance at Streitfeld’s chart will show, that “more flexible mortgages” are also more dangerous mortgages. Home equity loans had all the flexibility you could possibly want — and they failed disastrously.

What’s more, Stone doesn’t actually want to get rid of the 30-year fixed-rate mortgage. She just wants to layer gimmicks on top of it: an option to pay only interest if you’re laid off here, an escrow account available in the event of unemployment there. These things don’t really make the mortgage more flexible, they just make it more expensive for the borrower, who has to pay either for the option (which he might not want or need) or else has to pay directly into the escrow account, which would be a sure-fire money loser due to paying an interest rate lower than the rate being charged on the mortgage.

Bill Poole, meanwhile, has a plan which would make mortgage rates rise much further still, assuming that mortgages were available at all:

Fannie and Freddie could not be shuttered immediately; they are too large. A sensible transition plan would have them stop buying new mortgages, and their portfolios would decline as the mortgages they own are paid down. Within 10 years, the portfolios would shrink to insignificance…

In 10 or 15 years, the companies would be gone, closing a chapter in American financial history that enjoyed considerable success but ended very badly and at great taxpayer cost.

The fact is, as John Carney says in his own op-ed (the most sensible, but also the narrowest, of the three), that the FHA and Frannie now back more than 95 percent of new mortgages. If they simply stopped buying new mortgages, the entire housing-finance business in the US would come to a screeching halt. No one could buy, no one could sell, and home values would be entirely hypothetical for years.

Yes, it’s possible to slowly build an entirely private system of mortgage lending. But you can’t do that overnight, as Poole seems to think. And he’s completely wrong, too, when he says that “if the home finance market were fully private, then it would bear the losses from its own mistakes in pricing and insurance”. Not true: when there’s a major housing crash, the government ends up bailing out the lenders whether they’re public or private. Look at Ireland.

So let’s embrace Carney’s idea of forcing lenders to retain 5% of whatever they originate, even when they sell their loans to the FHA or Frannie. And let’s try to get these state-owned behmoths out of the mortgage business in a controlled and non-chaotic manner. But let’s not do anything drastic. The last thing we need is another housing crisis, before the current one has even finished playing out.

Comments
10 comments so far | RSS Comments RSS

Ameriquest is dead. Long live Ameriquest / Argent / ParkPlace…

There is quite a list of lenders who were not bailed out, mostly the non-bank finance types lending to sub-prime / non-prime / NegAm: New Century, Novastar, Ameriquest…among others (many, many others).

Those firms failed, and servicing was sold and/or transferred. Quite possibly to an institution that later received a bail-out though.

Posted by McGriffen | Report as abusive
 

I completely disagree re: getting FNMA/FMCC out of the business.

A much more appropriate thing to do would be better controls on how the manage their book and compensate employees.

1 – They should ONLY be in the business of funding and packaging “standard” loans….like they were doing very, very well before this bubble. 80% LTV only with the requirement for PMI on top of that.

2 – Don’t let them use the implied backing of the government to buy/invest in mortgages outside of their lending standards…of any kind!

3 – This should be a boring, bureaucratic job….compensate it accordingly. Don’t turn it into a pseudo Wall Street, multi-million dollar position.

In a way, I think it would be better to take the pseudo government backing and make it actual. Don’t have them be publicly traded institutions – it’s apparently not appropriate.

Posted by rfreeborn | Report as abusive
 

On the other hand, Carney starts off his article from a false premise, namely that Fannie/Freddie were at the center of the subprime bubble, even though they weren’t. (WaMu/Countrywide/citi/merrill were far more important; moreover, Fannie/Freddie mortgages weren’t securitized and made into WMDs by the banks (and thus did not contribute to the Lehman collapse etc.)

Posted by Foppe | Report as abusive
 

It’s a misguided assumption that rates would rise very much at all if Fan/Fred were wound down in an orderly manner. What’s with saying rates raising “further still”, anyway? We’re at all-time record lows at the moment. If anything the 30-year amortization term might not be the standard anymore, but so what – plenty of other countries have robust availablity of mortgages at market rates without the help of GSEs. Their time was 50 years ago. Capital is much more fluid now.

As to Carney’s “take away the GSEs and “No one would buy” argument – what bunk. No one IS BUYING even with the GSEs around right now. They’re just refinancing if anything. Depsite, again – 50 year low rates. So what good are the GSEs again? Please, as a taxpayer, I’d like to know.

Posted by Shnaps | Report as abusive
 

Unless I misread Carney, I think he was calling for Frannie & the FHA to retain 5% of what they securitize, not for the originators to retain a chunk of what the sell to the agencies. But he neglects to point out that Frannie has always retained 100% of the credit risk in the mortgages they pass-through to investors. Is that not enough skin in the game?

Posted by Sandrew | Report as abusive
 

@Sandrew,

I think you have in fact misread Carney. When he says “this crowding-out effect will be magnified if, as many in the industry expect, regulators also exempt Fannie- and Freddie-backed mortgages from the 5 percent requirement …”, he is referring to mortgages, not the agencies. That is, he is worried that the originating banks will be released from the 5% requirement on all agency-backed mortgages in order to maintain parity with specifically FHA-backed mortgages. The consequence he anticipates is that there will be no non-agency-backed mortgages. The point is that he doesn’t trust agencies to manage mortgage risk and he wants originators to retain that role.

Posted by Greycap | Report as abusive
 

Home equity loans and second mortgages are naturally riskier. Very few people (especially early in their lives) can afford to pay 100% cash, so traditionally they would save up 20% and finance the rest.

Second mortgages are for those who don’t have the cash flow or patience to save up 20%. Home equity loans are for those who need to borrow against their savings to support their lifestyle. (Even if used for remodeling or upgrades, only a portion of the money can be recouped in a sale.)

Always riskier to loan money to those without skin in the game and to those who can’t manage their daily finances.

Posted by TFF | Report as abusive
 

Home equity loans and second mortgages are naturally riskier. Very few people (especially early in their lives) can afford to pay 100% cash, so traditionally they would save up 20% and finance the rest.

Second mortgages are for those who don’t have the cash flow or patience to save up 20%. Home equity loans are for those who need to borrow against their savings to support their lifestyle. (Even if used for remodeling or upgrades, only a portion of the money can be recouped in a sale.)

Always riskier to loan money to those without skin in the game and to those who can’t manage their daily finances.

Posted by TFF | Report as abusive
 

why would the private sector want to deal with mortgages? wasn’t that what so many in wall street sold to investors as MBS. and how did that work out? think the odds of investors buying those any time soon will really happen? why? are they that dumb? the only way they might buy them is with government guarantees. but then why bother with shutting down F&F?

Posted by willid3 | Report as abusive
 

History has proven that the private sector will risk ANYTHING for a profit. If they stick to the basics, mortgages can be written safely and profitably. You just need to follow sensible underwriting standards, require a substantial downpayment, and don’t bundle/slice loans in the hope that you can turn cheap meat into filet mignon.

Posted by TFF | Report as abusive
 

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