Today’s Courier Herald Column:
As we approach the fourth anniversary of the financial collapse caused by the bursting housing bubble, we’re still trying to figure out exactly what we’ve learned. More specifically, we’re trying to ensure that we don’t repeat the same mistakes. They are getting quite expensive.
Much as is the case where federal policy intersects a large financial problem, policy makers who previously resisted any effort for the government to head off problems decry the lack of regulation within the affected industry and frantically propose new rules. These solutions often serve to further exacerbate the problem.
Such is the case with proposed regulations regarding the secondary mortgage market. The securitization of mortgages has allowed for a nationwide mortgage capital market. It has allowed banks to rid themselves of long term interest rate exposure while allowing additional capital to be made available to homeowners at historically low rates. It’s also confused and obfuscated who actually owns mortgage debts, who is responsible for working out issues with homeowners when there is a problem, and has taken any sense of default risk away from those who approve the mortgages.
As such, changes to the system are in order. At the same time, however, the mortgage market remains a complete function of the federal government. Roughly 9 of every 10 mortgages made in this country today are backed in some form by the federal government. Fannie Mae, Freddie Mac, FHA, and the VA have been essential to there being any mortgage market at all for the past 4 years. Private money has vacated the market except for where the government is willing to backstop risk in these very uncertain times.
Lawmakers are struggling with the best way to reduce the federal government’s role in the market and encourage private investment to return. Yet they are also still trying to find the right mix of rules and regulations to ensure that the industry rebuilds itself on sound underwriting and credit standards. There remains natural friction between the two goals.
Georgia Senator Johnny Isakson weighed in via a guest editorial published by the Atlanta Journal Constitution this week. He has sponsored legislation calling for the phase out of Fannie Mae and Freddie Mac within 10 years to re-establish private risk taking as the primary driver of the mortgage market. He is also seriously concerned over a proposed regulation that would set a minimum 20% down payment for those purchasing homes if their mortgages are to be bundled into securities and sold in the bond market. These securitizations remain key if private markets are to be able to maintain low interest rates by allowing investors to assume long term interest rate risks.
The Obama administration, which Isakson credits with adopting his proposal to allow homeowners current on their mortgages to refinance at lower rates regardless of appraisal, wants to require lenders to retain 5% of the risk on mortgages they originate if they allow mortgages with less than 20% down. While the amount sounds relatively low, it would tie up a significant amount of capital of smaller institutions and continue to expose them not only to credit risk, but also long term interest rate risks.
Sound underwriting of mortgages is a must. Income documentation and appropriate credit risk must be considered when approving mortgages, as they are the primary determinant of loan repayment. The amount of down payment, however, is not. As an example, a comparison of FHA to Fannie Mae illustrates this point.
The Federal Housing Administration has historically allowed home purchases with as low as a 3.5% down payment. FHA also has some of the most strict documentation requirements for both income and appraisal standards. They also have steep mortgage insurance premiums on loans with small down payments. Despite all of the money that taxpayers have sent to bail out Fannie Mae and Freddie Mac, no bailout money has been used on FHA.
Securitized loans need full documentation. They need to have interest rate pricing and mortgage insurance commensurate with the credit risk. Borrowers need to be able to document their ability to repay. If they do this, FHA has demonstrated that they do not also need to put 20% down to purchase a home.
Isakson literally grew up in the housing business. He’s also spent a career helping make government policy. He is where the two fields intersect. On the matter of down payments and the future of securitized mortgages, Isakson has this one right.