What Will It Take to Get Banks to Make More Loans?
Imagine if the U.S. government threw a giant, expensive party -- but paved the path to the festivities with so many obstacles no one could get there?
That's essentially what has happened in the housing market, where the government has spent trillions of dollars pushing mortgage rates to historic lows while imposing strict lending guidelines that have made credit harder to get. The level of U.S. home mortgage credit has contracted about 13 percent since its pre-crisis peak, according to Federal Reserve Chairman Ben Bernanke.
On Tuesday, the U.S. Federal Housing Finance Agency moved to ease one barrier with new rules intended to limit the risk that banks will have to buy back flawed mortgages from Fannie Mae and Freddie Mac.
Right now, banks are being forced to repurchase certain loans they've sold to Fannie and Freddie if those mortgages default. It's not small change: In the first two quarters of 2012, the mortgage giants asked banks to buy back mortgages with an unpaid principal balance of $18.9 billion.
Banks that sell loans to Fannie and Freddie make certain "representations and warranties" about the quality of those mortgages. If a loan defaults, Fannie and Freddie can force those banks to buy back loans that violate those standards. This so-called "put-back" risk has been one of the main reasons banks give when asked why they're not making more loans.
The other obstacle banks regularly cite: tough lending standards they say are being imposed on them by bank examiners who look askance at commercial and residential mortgages on a bank's balance sheet. Banks complain examiners require higher-than-necessary levels of capital and unfavorable accounting treatment for loans they think might go sour.
Bernanke has cautioned about the need for a "delicate balance" in lending standards, saying regulators must insist on "high standards" while not making it impossible for banks to lend to creditworthy borrowers.
Higher lending standards are critical to ensure we don't return to the heady days of the housing bubble, which was fueled by lax underwriting standards that allowed people to obtain houses they couldn't afford. But the pendulum has swung too far, unfairly limiting the ability of borrowers to obtain mortgages or refinance loans. And it's happening at a time when the Fed is spending huge sums of money to lower mortgage rates. The central bank could announce a new round of bond buying as early as this week to help get more credit flowing into the economy.
On Tuesday, FHFA took a big step to help ease the put-back concern. Details remain to be seen, but Fannie and Freddie won't force lenders to buy back defaulted loans if borrowers have made between 12 months and 36 months of consecutive on-time payments, depending on the type of mortgage. The mortgage giants will also try to identify troubled mortgages before they go bad.
The rules could go a long way toward improving underwriting standards, since banks will know they can limit their liability by issuing loans to borrowers who are able to make a year or more of payments. It's unclear, however, whether this will give banks the confidence they need to lend, and early comments aren't exactly encouraging. Jaret Seiberg, senior policy analyst at Guggenheim Partners, wrote in a note that the rules could actually crimp credit as banks further tighten underwriting standards.
And while the FHFA has addressed one obstacle, others remain, including the lack of final mortgage standard and risk-retention rules required by the Dodd-Frank financial law. Until all of these are resolved -- not to mention the fates of Fannie and Freddie -- lending will likely remain depressed.
Read more breaking commentary from Bloomberg View at the Ticker.