Has Obama Forgotten the Danger of Loose Mortgage Lending?
Politicians have been promising more than they can deliver since the dawn of democracy. So it’s no surprise that President Barack Obama wants to make housing more affordable, ensure that home prices keep going up, reduce taxpayer support for the mortgage-finance system and prevent future crises -- simultaneously. But some of the items on his wish list, as outlined in a speech Tuesday in Phoenix, are contradictory.
Many of the president’s goals are smart steps along the path of reform. Private lenders should have to deal with the consequences of their own bad decisions without dumping them on taxpayers. It should be easier for borrowers who are current on their loans to refinance at today’s relatively low mortgage rates. And government policy shouldn’t favor homeownership over renting, now that it’s clear renting is the better option for millions of households.
Some of Obama’s other ideas are worrisome. It’s all well and good to say that the government should “cut red tape” and “simplify overlapping regulations” so that “responsible families” have an easier time buying homes. But what does this mean in practice? Should income and down-payment requirements be eased? Lest we forget, lowering lending standards was precisely what got us into the housing mess in the previous decade.
In his speech, Obama sketched out a sensible plan for limiting taxpayers’ exposure. What he still needs is a strategy for setting minimum standards for the kinds of mortgages that can be packaged into securities by Wall Street banks.
As things stand, the federal government is on the hook for all of the losses on nearly every mortgage issued since 2009. To change this, it makes sense to abolish Fannie Mae and Freddie Mac, the government-owned mortgage financiers that buy loans from banks so they have the money to lend again, and replace them with a more limited entity devoted solely to selling insurance to protect against catastrophic losses.
In the event a borrower defaults on a mortgage, this new government insurer would reimburse investors only for losses beyond a certain point. In other words, private investors would pay a deductible before they were eligible for coverage. This would limit taxpayer risk, especially if the new insurer collected adequate premiums.
A similar reform plan proposed by U.S. Senators Bob Corker, the Tennessee Republican, and Mark Warner, the Virginia Democrat, would pay investors only for insured mortgages that lose more than 10 percent of their value in a default -- more than twice what Fannie and Freddie had to deal with during the crisis. That would be a welcome first step in removing the taxpayer crutch from the mortgage market.
So far, so good. But less progress has been made in defining what constitutes a qualified residential mortgage, and thus eligible to be sold to investors.
The Dodd-Frank Act bars lenders from offloading to investors all the risk of the mortgages they originate, unless those loans meet certain basic standards, such as a minimum down payment and a maximum debt-service ratio (the share of income spent on interest and principal payments). Lenders are still free to make riskier loans, but then they must be ready to absorb at least 5 percent of any losses if they plan to get those mortgages off their books.
Government standards distinguishing “qualified” mortgages from riskier ones still haven’t been finished. After aggressive lobbying by industry lobbyists and affordable-housing advocates, regulators agreed to lift the maximum debt-service ratio to 43 percent from 36 percent. We think that’s too high. But the minimum down-payment requirement remains up in the air. Regulators have been proposing options ranging from as little as zero to as high as 30 percent.
It’s unclear where Obama stands on this last, crucial issue. It would be unfortunate if he were to pressure regulators to take a softer line. The best way to prevent mortgage borrowers from defaulting is to make them put a large amount of equity -- at least 20 percent -- into their homes upfront. It’s roughly analogous to the sensible requirement that banks use less leverage.
Minimum down payments and strict debt-service ratios have the added benefit of mitigating destabilizing swings in house prices. Economists have shown that, during the recent housing bubble, prices rose as down payments fell. This empowered buyers who had been shut out of the market, which pushed up prices and temporarily increased the homeownership rate -- until it came crashing down.
To keep this from happening again, Obama, regulators and lawmakers must avoid the siren song of homeownership for everyone.
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