U.S. Regulators Easing Mortgage Credit Requirements

Fri, Oct 31, 2014 - 9:12am

Last week, Federal Housing Finance Agency (FHFA) director Mel Watt announced two measures designed to spur U.S. mortgage lending, as the U.S. housing market continues to lag. He aimed to ease Dodd-Frank legislation governing when banks could be forced to repurchase sub-par mortgages they’d sold to government sponsored housing giants Fannie Mae and Freddie Mac. He also suggested that FHFA might guarantee loans with down-payments as low as 3 percent.

Watt, as FHFA director, controls policy for Fannie and Freddie, which have been under Federal conservatorship since their near-death experiences during the financial crisis — one of the largest Federal interventions in financial markets in U.S. history.

Mortgage Standards Too Tight — Or Are Other Factors At Work?

Jamie Dimon, the CEO of J.P. Morgan Chase, commented favorably on the announcement, saying that “mortgage credit is too tight,” and praised the decision to loosen the rules under which banks could be forced to repurchase defaulted loans they’d sold to Fannie and Freddie.

Of course, Mr Dimon has a vested interest here. Easing mortgage terms, and reducing banks’ risk exposure when those mortgages go bad, are good for banks. Whether it’s good for U.S. taxpayers is another matter.

Mr Dimon is not the only one to have made the assertion that lending is too tight for first-time homebuyers and others with less than stellar credit; Moody’s chief economist concurred. Is the assertion accurate?

Housing Market Doldrums

It is true that the housing market is struggling. Although home sales in September hit a high for the year, they were down 2 percent from the same month in 2013. Home-purchase lending is expected to be down 13.5 percent from last year, and refinancing lending has dropped sharply.

However, other analysts have pointed out a few secular developments suggesting that slowing lending and home-buying has a demand-side element as well. The population is aging; median wages are stagnant in spite of incrementally recovering employment; and, perhaps most importantly, consumer psychology may have shifted since the financial crisis: consumers are more wary of taking on new debt.

Seeing the Big Picture

These policy shifts will have a positive effect over the next couple of years. They could help spur lending and homebuying, and bring the housing market into a more positive position to strengthen the U.S. economy.

That is probable, but longer-term another outcome is perhaps more clearly imaginable, because we saw it play out in 2008. Subprime lending, in conjunction with other structural and regulatory failures, was one of the critical elements in precipitating the financial crisis.

The process may also work to cement the role of government-sponsored entities such as Fannie and Freddie in the housing market, and by extension, in the nation’s capital markets. We don’t argue with Mel Watt’s intentions, but the history of such intervention is not encouraging (we note that Mr. Watt has deep populist credentials). We would suggest that the best way to strengthen the housing market would be through job and wage growth — by making more consumers who can reliably borrow, rather than by lowering lending standards and creeping back towards moral hazard.

Investment implications: Watch the ongoing saga of Fannie Mae, Freddie Mac, and the Federal role in the housing market. Benefits may accrue for the next couple of years as mortgages become more available. Far from winding down Fannie and Freddie, which was the talk last year, we see that there may be an emerging trend that will keep them shambling along — and that makes us want to watch developments carefully.

About the Authors

Chief Investment Officer
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tdanaher [at] guildinvestment [dot] com ()