Capital Markets

Government Is Encouraging Lax Lending Standards

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The Obama Administration is prepared to do anything, including dramatically lowering mortgage lending standards, to keep real estate prices inflated, as demonstrated by statements, reports and events in the month of October.

How high can the government push real estate prices.

First came the Federal Housing Authority inspector general's report [pdf] on the FHA's lender approval process, which found that FHA was missing or ignoring relevant information, failing to document loans, not preventing convicted financial criminals from participating in its lending program, and in most other ways failing to "ensure that lenders met all applicable requirements." The IG's spot check revealed, for example, that just one out of 22 approved applications contained all the documentation needed to meet the FHA's own standard for guaranteeing a loan.

The FHA's much more serious offense against lending standards—its dangerously low 3.5 percent down payment minimum for guaranteed loans—became the focus of attention this month when the authority admitted it was shown to be close to bankruptcy, and Rep. Scott Garrett (R-New Jersey) introduced legislation to boost that minimum to 5 percent.

There is both anecdotal and statistical evidence that the debased lending standards being pushed by FHA and other government entities are creating a dangerous dead cat bounce in real estate markets. Anecdotally, here's a profile of a new home borrower who as of this month is paying 54 percent of her income on a house. Statistically, defaults on government-approved loans continue to rise, with Fannie Mae-backed loans now breaking through a 3.3 percent delinquency rate.

We have covered the increasing rate of mortgage redefaults here, and it's notable that all mortgage modifications are now being done under the watchful eyes of the agencies that guarantee them. Yet redefaults continue to rise, strong evidence that the standards for loan mods are getting worse, not better, under government supervision. Lax lending standards are now policy. The only question is whether the policy is official or unofficial.

Real estate in October 2009 a classic dead-cat bounce.

That's the dead cat part. Here's the bounce: While all economic indicators, from rising unemployment through rising mortgage defaults, describe a market in collapse, real estate prices continue to increase. The Case-Schiller August index, announced today, was up 1.2 percent. The National Association of Realtors (NAR) is celebrating a 9.4 percent jump in existing home sales. This Goldman Sachs report issued last week concludes government largesse is adding a full 5 percent to current real estate prices.

How are people buying all this expensive real estate? With nearly the same ratio of debt to down payment as they had in 2005. According to NAR, the median down payment is 4 percent—slightly above what it was earlier in the decade—but a third of all U.S. houses are still being bought with no money down.

That's a bad bet for us, because we will be on the hook for the defaults. As this San Francisco Federal Reserve report notes, nearly all mortgage securitization is now being done by the nationalized government sponsored enterprises, and virtually none by the private sector. So lenders are not just gambling on bad credit risks, but gambling with your money. Not surprisingly, it's the administration that gets the benefit, as real estate prices, in marked contrast to unemployment, are doing better than the most-adverse projections of the bank stress test conducted earlier this year. (Calculated Risk compares the trendlines.)

I'll have more about all this in an upcoming Reason print column, assuming the United States still exists at that time. There is plenty of rich material, including the way the above efforts concentrate costs at the bottom of the market, thus condemning poor folks—whom Democrats and watchdogs like the strangely silent Center for Responsible Lending claim to champion– to company-store-style indentures.

Meanwhile, it appears that October may be remembered as the month that the evidence, and the statements of many officials, all pointed to the same conclusion: The Obama Administration has taken a no-parachute leap of faith that real estate will stay inflated. If you're keeping score at home, this is the precisely the behavior Sen. Obama used to blame on the "ethic of greed."

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  1. “the authority admitted it may be headed for bankruptcy”

    The FHA didn’t admit squat. The FHA pushed back and said everything is fine. It was former Fannie and Freddie guys, and other outside people who are saying it’s doomed.

  2. There is both anecdotal and statistical evidence that the debased lending standards being pushed by FHA and other government entities are creating a dangerous dead cat bounce in real estate markets.

    There is even better statistical evidence that relaxed lending standards, be it for a house or a loan or a credit card, is exactly why our economy fell apart like the house of cards it is, wiping out trillions of dollars in wealth in the process.

    Until there are even minimally reasonable lending standards for everything, not just housing, the credit bubbles will continue to blow up and pop over and over.

    “If you don’t have the money, you can’t buy it” is not wishful thinking, it’s reality. Unfortunately our government will never speak the truth about this reality.

    1. “If you don’t have the money, you can’t buy it”

      No – If you don’t have the money, you CAN buy it, provided you can get a private group or individual to lend you the money.

      As long as the government isn’t doing the lending, or insuring, I don’t think any of us gives a shit.

      1. No, someone can “lend” you the money but then you aren’t buying anything, you are “borrowing” it. I didn’t “buy” my house when I got a mortgage, my bank did. They are letting me borrow the house until I finish paying them for it.

        1. Unless the debt was secured, you are buying things with money you borrow. If they don’t have legal standing to come take the stuff you bought, it’s not really practical to call it borrowing.

          1. you are buying things with money you borrow.

            Yes, I realize that credit is the grease in the gears of any free market, but trade is predicated on the idea that you present value for value, and our reliance on the idea that “some day” we’ll pay for it is exactly the reason our economy is such a disaster right now. And sooner or later our creditors will decide that the value of our promise (ie the dollar) is not a valuable enough risk to allow us to “buy” things we clearly can’t afford to buy on our own.

          2. Unless the debt was secured

            Which in the case of a mortgage, it is. These days no one is buying houses with credit cards like they did in the early 80’s.

  3. Also, Joan S. Hobbs is asking to be fired like other IGs who stand in the way of Hope. As does The Honorable Kenneth M. Donohue, the Inspector General of HUD, for saying similar things. (Seriously, he is styled as such.)

  4. You mean artificially easy credit and a limited time house purchasing subsidy might make things better than they are and have bad long term consequences?

    Nah, couldn’t be.

  5. assuming the United States still exists at that time.

    You know Tim, this is why I like to read your stuff. It just fills me with so much hope.

  6. btw Tim, don’t forget that the Big Mac is the real canary in the coal mine.

    !

    I for one am not getting nervous until I see McDonald’s pulling its franchises out of the US.

  7. Until there are even minimally reasonable lending standards for everything, not just housing, the credit bubbles will continue to blow up and pop over and over.

    With TARP, the government has implicitly guaranteed that they will cover all lending losses.

    Where have I heard implicit guarantee before? The F&F twins?

  8. If only these people were regulating the financial markets more vigorously ….

  9. am i missing the niven reference?

    1. That’s not a Ringworld, it’s a Stanford torus. And yeah, I wonder what it’s doing there, too.

      1. Lots of houses.

      2. Lots of houses, floating in a void.

  10. There is even better statistical evidence that relaxed lending standards, be it for a house or a loan or a credit card, is exactly why our economy fell apart like the house of cards it is, wiping out trillions of dollars in wealth in the process.

  11. I didn’t “buy” my house when I got a mortgage, my bank did. They are letting me borrow the house until I finish paying them for it.

  12. My loan was finalized today. But unlike the deadbeats out there, I put a full 20% down on a conventional loan. And I got the lowest rate possible. Thanks to the the culture of default, I had to undergo a colonoscopy to qualify.

    It may be racist to say it, but I’ll say it anyway: if you can’t afford a house, don’t buy a house!

    1. Slightly off-topic, but speaking of banks and rectal probes, today I discovered my Citibank card wouldn’t work. Apparently my check for $3.54 got lost in the mail, and being a week overdue, they decided not to call me to investigate this unusual situation, or drop me an email, or even send a letter. No, the best thing to do with a trouble-free customer of 11 years is apparently to suspend his card with no warning or notification.

      To clear it up, I paid over the phone with a debit card. I can expect the card to work again in “24 to 48 hours,” since we all know how slowly those electrons crawl around the intertubes and inside bank mainframes.

      1. It’s Citibank, what do you expect? They were the first in line blowing the government for handouts. They don’t make money off you, they make money off the taxpayer’s teat.

      2. No, the best thing to do with a trouble-free customer of 11 years is apparently to suspend his card with no warning or notification.

        When you say “trouble-free,” do you mean that you always paid in full each month? At many credit card companies, they call that “less profitable.” They want someone who will rack up fees and interest, but never default.

        We who are responsible have been enjoying rewards and such partially subsidized by the irresponsible, and living with the possibility of penalties if we should slip up. The new credit card law made it much harder for credit card companies to penalize people suddenly if they make a mistake. The result of this is that people who pay penalties and fees will be a little better off (unless they’re denied credit), and people with good credit will be paying higher rates or annual fees, or having smaller rewards. (I prefer the higher rates.)

        Fixed rate credit cards are dead, since the new law makes it way too hard for the company to ever change that fixed rate.

      3. So cancel your card, and get one from a bank that isn’t a dysfunctional government owned welfare whore.

        I won’t do business with anyone who was bailed out. Period. Full stop. End of discussion.

  13. You just hate poor people. Why do you hate poor people?

    This kind of files under no shit for anyone cynical about the status of the mortgage lending market. That file has been growing since the early 90’s and shows no sign of hitting the slimfast.

  14. The lunatics are in charge of the asylum, folks.

  15. The lunatics are in charge of the asylum, folks.

    And this has changed when?

    .. Hobbit

    1. Well there are different flavors of lunatics you know. Everyone once in a while they trade out with each other, just to make sure everybody gets a turn. Because in today’s world, nothing is as important as making sure everybody gets a turn.

  16. Why is it that inflation is bad for food, clothing, transportation, utilities and health care, but its the bees knees for housing? At first I figured that real estate has traditionally been an area of investment, but c’mon, condos don’t even involve land. Then I thought, well, everybody owns a house, so a majority of the people want houses (which depreciate) to rise in value. Of course, everybody owns a car too, but they don’t really go up in value. Why are inflated housing values to darned important?

    1. Because people mistakenly think of their house as an investment, not the place where they live.

      1. Yeah, the “house as investment” thinking always disturbs me. I figure investments, despite the name, are gambling. A house is a necessity, like food or water. If GE craters and my stick is worthless, my investment portfolio may be fucked, but I’ve got a place to live.

        And I’m still giggling because I got 15 year mortgage earlier this year at just over 4%. I’ll own my house in no time, and only have to worry about the perpetual lien from property tax.

        1. Shelter is a necessity. A house is not. That’s what got us into this mess in the first place. It became social ideal for everyone in best country on earth to own a house.

          Healthcare is also not a necessity. Neither is it a right. You also don’t have a right to the “necessities” – shelter, food, and clothing.

          You don’t have to pay for rights – seeing as they’re God given and all.

          1. “It became social ideal for everyone in best country on earth to own a house. ”

            Wow, I’m writing in Luna speak…

            1. I’m greedy and materialistic. A house is a necessity, if only to hold my stuff.

              And since nobody around here… well, nobody that matters, anyway, subscribes to positive rights theories, a necessity is not a right.

      2. Ditto. We get pissed when gas prices rise, but cheer when home prices rise. Instead of thinking of our home as a financial investment, we should be thinking of it as a personal investment.

    2. You can’t resell your food, utilities, and health care 10-20 years after you purchase them.

      1. But you can resell your clothes and your car. Besides, the vast majority of things we buy depreciate. Why is housing so different, especially condos where there is no land?

        1. Why is housing so different, especially condos where there is no land?

          Demand. People want to live in a good location.

          This is why a house is an investment – it can actually mature.

          1. Or, if the city builds a sewage treatment plant next door it can go down in value. No guarantees, are there?

          2. Unless they’re units in Patri’s Seastead Luxury Townhomes, condos DO have land. You don’t own just the airspace in a condo, you also have part ownership in the entire complex.

            1. Brandybuck, you are correct, depending on the condo declaration. But unless you own the entire parcel in fee simple, the title is encumbered and not marketable (i.e., essentially worthless to you). The reason developers generally convey the land to the condo association or owners is so that somebody else can pay the taxes and maintenance. In the northeast there are a lot of “condos” that are houses built on land that the developer leases to the unit owner (like a glorified mobile home park).

          3. “Demand” doesn’t explain why government refuses to allow prices to fall when demand falls. Indeed, “demand” can’t explain it because it would be on both sides of the equation.

        2. Interesting Wiki bit: “The first condominium law passed in the United States was in the Commonwealth of Puerto Rico in 1958. English Common law tradition holds that real property ownership must involve land, whereas the French civil law tradition recognized condominium ownership as early as the 1804 Napoleonic Code; thus, it is notable that condominiums evolved in the United States via a Caribbean government with a hybrid common-civil legal system.”

  17. “Demand. People want to live in a good location. This is why a house is an investment – it can actually mature.”

    Your missing the point of the question. When demand falls for any other product, the price goes down. When demand falls for housing, there are enormous outcries for gov’t to prop up the prices. The question never was why do houses go up in value (as everything does, including utilities, food, etc.), but why it is such an outrage when prices go down.

    1. Because people were expecting to flip that house and retire. The market failure has robbed them of their retirement! How cruel of you not to care.

      /sarcasm

  18. I found a new loan modification that has been launched at http://www.foreclosurepreventionplan.com

    Hope this is helpful to somebody.

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