In spite of differences between Democrats and Republicans on reforming housing finance, both sides back proposals that would make mortgages more expensive and difficult to obtain.
Government officials and lawmakers want to make the market less vulnerable to another credit crisis, and all the options lead the same general direction: Borrowers will need larger down payments than in the bubble years, have higher credit scores, and pay extra fees to cover risks and premiums for federal guarantees on government-backed mortgage bonds.
While those measures would create a sounder system, they also mean that fewer borrowers will qualify for loans and the national home ownership rate -- already on the decline -- will continue to slide.
During the bubble, mortgages were given to people “who clearly should not have gotten them,” David Stevens, commissioner of the Federal Housing Administration, which guarantees loans to first-time and low-income home buyers, said in an interview. “It would not be productive if we had that same loan access going forward.”
Ownership rates, which rose from 63.8 percent in 1994 to 69.2 percent a decade later, have since dropped to 66.9 percent, according to the U.S. Census Bureau. Stevens said he expects the rate to fall further.
The value of mortgages outstanding has also declined. According to Federal Reserve data, the total value of home mortgages rose from $9.38 trillion in 2005 to a peak of $11.17 trillion in 2007, and then dropped to $10.6 trillion at the end of the third quarter of 2010.
John McIlwain, a senior fellow for housing policy at the Urban Land Institute in Washington, said he expects home ownership rates to eventually drop to as low as 62 percent.
The impact of the pending revamp of the housing finance system on borrowers is clearer than for lenders, whose business model will likely have to change.
According to Guy Cecala, publisher of Inside Mortgage Finance, although the volume of lending has gone down, banks have been earning somewhat higher profits from mortgage originations. That’s because so many mortgage lenders collapsed during the crisis that those who survived gained market share.
For instance, the two largest mortgage lenders, Wells Fargo & Co. and Bank of America Corp., controlled 46 percent of the market in the first three quarters of last year, Cecala said, compared with 28 percent in 2008.
Cecala said that banks used to lose, on average, as much as $2,000 per mortgage origination and earn profits from servicing them. Today, he said, because of less competition, they earn as much as $1,000 per mortgage origination.
Under some reform scenarios, the entire mortgage financing system could be privatized, which would upend banks’ business model for mortgages, with unknown impacts on their profits.
Currently, most mortgages are originated by banks then guaranteed by the Federal Housing Administration or purchased by Fannie Mae and Freddie Mac, known as government-sponsored enterprises. Fannie and Freddie then package the loans into mortgage-backed securities and sell them to investors.
Because banks don’t have to hold many loans on their books for long, securitization has greatly increased the volume of loans banks issue. It also reduced costs, because the risk of the loan was passed on to investors and the government.
Democrats generally favor retaining some form of government mortgage guarantee in a reformed system. One option along those lines is a proposal by the staff of the Federal Reserve Bank of New York under which a limited guarantee would be offered just on the securities made from mortgage pools, in return for a premium that would be passed on to borrowers. A proposal by the Republican-aligned American Enterprise Institute, drops the government guarantee. What these plans have in common is that, for non-FHA loans, they foresee stricter credit requirements, larger down payments of at least 20 percent and higher fees and interest rates.
The result is that in the future, borrowers, rather than the government, are likely to bear more of the lending risk.
“We are going to have more collapses of this market if we open home ownership up to anyone who wants a home as opposed to people who can afford a home,” said Peter Wallison, an author of the AEI report and former general counsel at the Treasury Department. “People are coming to that realization now.”
Wallison said the market could operate effectively without Fannie and Freddie or some other kind of government guarantee as long as banks followed strict underwriting standards. Mortgage insurance, paid by borrowers, could also mitigate risk, he said.
Price of Safety
“There is a price of safety but that’s the way markets work,” he said.
“You’re funding a long-term loan with short-term money,” Pigg said. “If you stick with that product there is a stronger need for government involvement.”
Laurie Goodman, senior managing director for research at Amherst Securities Group LP, said that in a privatized market, investors in mortgage-backed securities would likely demand a higher yield to compensate for the added risk. That would also translate into higher retail borrowing rates.
“Some investors might pull out of the market entirely because of that risk,” said Goodman, whose Austin, Texas-based firm is a broker-dealer for mortgage-backed securities.
Fannie Mae and Freddie Mac, now in government conservatorship, have already instituted tougher mortgage requirements and higher fees. The agencies are imposing “loan- level price adjustments” and “adverse market delivery charges” on many mortgages, which can add about 3 percentage points to the cost of a loan, said Alan Boyce, chief executive of Absalon, a joint venture with the investor George Soros to develop a new housing finance system.
The GSEs’ fees have recently gone even higher, said Brian Wickert, president of Accunet Mortgage in Butler, Wisconsin, especially for borrowers who have second mortgages and want to refinance.
For instance, a borrower with a mortgage equal to 76 percent of a home’s appraised value, and a second mortgage adding another 3 percentage points, to 79 percent -- still below the 80 percent level desired by banks -- and a FICO score of between 700 to 719, would have previously paid $2,000 in fees to the GSEs in a refinancing, Wickert said. Following recent increases, those fees are now around $4,000.
‘Raising the Bar’
“They keep raising the bar because they can,” Wickert said.
Amy Bonitatibus, a Fannie Mae spokeswoman, said the agency adjusts standards and fees in response to market conditions. Higher costs, she said, reflect conditions in the market rather than a desire to boost revenue.
“These changes are intended to more accurately reflect changing risks in the housing market,” Bonitatibus said.
Analysts say the higher costs of mortgages are already hampering a recovery of the housing market. Borrowers of mortgages bought by Fannie Mae in the fourth quarter of last year had an average FICO score of 765.6, compared with 737.5 in 2008, said Cecala of Inside Mortgage Finance.
“We were way too loose in the past,” said Goodman of Amherst Securities. “The question is, are we going to be too tight to solve the problem that’s been created?”
To contact the reporter on this story: James Sterngold in New York at firstname.lastname@example.org.