The new face of U.S. mortgage lending

Today's must read housing market news comes via this story in the Washington Post where the near total control of the U.S. mortgage market by the U.S. government is detailed.

Mortgage Market Bound by Major U.S. Role
Classes of Borrowers Cannot Find Loans as Publicly Backed Debt Mounts
By Zachary A. Goldfarb and Dina ElBoghdady

In the go-go years of the U.S. housing boom, virtually anybody could get a few hundred thousand dollars to buy a home, and private lenders flooded the market, aggressively pursuing borrowers no matter their means or financial history.

Now the pendulum has swung to the other extreme. Only one lender of consequence remains: the federal government, which undertook one of its earliest and most dramatic rescues of the financial crisis by seizing control a year ago of the two largest mortgage finance companies in the world, Fannie Mae and Freddie Mac.

While this made it possible for many borrowers to keep getting loans and helped protect the housing market from further damage, the government's newly dominant role -- nearly 90 percent of all new home loans are funded or guaranteed by taxpayers -- has far-reaching consequences for prospective home buyers and taxpayers.

While the focus of the article is split between the long-term implications of such heavy government involvement in mortgage lending and how rapidly changing lending standards have caused credit-worthy borrowers to be excluded, you have to wonder why.

This relatively small side-effect of "freezing out" marginal buyers who may, in fact, truly deserve a new mortgage will probably end up working out in their favor as home prices continue to fall over the next year or so - they're probably doing them a favor...

The much more troublesome aspect of this story is the one we've all been reading about lately, particularly since news broke last week that the FHA may be in trouble after zooming from just a few percent of market share a couple years ago to writing nearly a quarter of all new mortgages, most of these loans requiring only 3.5 percent down payments.

At the same time, taxpayers are on the hook for most of the loans that are still being made if they go bad. And they are also on the line for any losses in the massive portfolios of old loans at Fannie Mae and Freddie Mac, which own or back more than $5 trillion in mortgages.

There is growing evidence that many loans being guaranteed by the government have a significant risk of defaulting. Delinquencies are spiking. And the Federal Housing Administration, another source of government support for home loans, is quickly eating through its financial cushion as losses mount.
...
All told, the government now stands behind 86 percent of all new home loans, up from about 30 percent just four years ago, according to Inside Mortgage Finance.

Here's where the writers go awry...

Some people who are no longer eligible for loans elsewhere have turned to FHA, which does not demand top-notch credit scores or sizable down payments. But for some consumers, such as Lisa McCracken of Stafford County, the FHA's minimum 3.5 percent down payment can be a stretch.

McCracken, a traveling nurse, has been scrimping to raise the down payment, living with her parents to save money. "I think I can swing it, but it won't be easy," she said. "I'll be wiping out a lot of my savings to buy a house." The self-employed face difficulties because they tend to have a tough time documenting their income, as required by Fannie Mae, Freddie Mac and FHA loans.

Donald Prieto, who owns a roof contracting business in San Diego, has shelved his plans to buy a new home. Five years ago, he and his wife purchased a small home without having to verify his income. They have made their payments on time, have maintained solid credit scores and have plenty of cash in the bank, he said. Now, they have three children. They want a larger home, but several lenders have turned them away because he does not have two years' worth of paychecks to show.

For that reason, Prieto has incorporated his company and started cutting himself formal paychecks. "No bank wants to take risks anymore, and I understand that," Prieto said. "I just have to wait."

Saving 3.5 percent is a stretch?

It's about one-third of the stretch that it should be and about one-sixth of the stretch it was for most of the 20th century.

Little or no "skin in the game" is a big part of the reason why we're in this mess.

As for the self-employed getting a mortgage, back about ten years or so ago, before mortgage lending went off its rails, even in a place like California you needed to come up with a downpayment of 25 percent if you wanted to finance the purchase of your primary residence while running your own small business.

No ifs, ands, or buts.

We seem to have veered so far away from what seemed to be quite prudent lending standards that worked so well during most of the 20th century that no one remembers what they were.

There's a lot to like in this article, but lamenting the woes of those who are being "frozen out" of new home purchases today is not one of them.

Doug Noland's most recent commentary at Prudent Bear offers a much harsher assessment of the new mortgage lending environment (skip to the end) and is also well worth a look. In fact, that should have been the subject of this post instead of the WaPo story.

Oh well ...