The mortgage industry has come under tremendous fire over the past two years because of the collapse of subprime lending. Every economic ill in the nation has been blamed on mortgage companies, banks and mortgage brokers, with the biggest “harrumph” coming over the notion that the players in the mortgage market were fools to think that giving loans to people who have no stake in the property could do anything but end badly.
Such backwards-visionaries ignore the many years when such policies actually worked. Subprime, after all, was not a new invention. It escalated with the rise of mortgage securitization, but with that escalation came social progress. People who had otherwise been locked out of homeownership were able to buy houses of their own. And for the first eight years of this phenomenon, every expansion, every move to widen the chance to make good on the American dream, was a success. More people did buy homes. Default rates were no worse on subprime loans than they were on conventional loans. The economy grew, mortgage and housing markets thrived and social good was done.
Yes, as the market became overheated, some fraud began growing and some bad decisions were made. But those elements are prevalent even in good markets. It wasn’t greed and evil that did in the mortgage industry and the economy, but a failure to understand that even well-intentioned programs and activities need to be limited by common sense and fiscal conservatism.
Which brings us to today’s market. Conventional wisdom among the populace has it that subprime lending is dead, dead, dead. But that is hardly true. Subprime continues unabated. Except that instead of independent mortgage companies championing the practice, its biggest proponent is now the U.S. government. As Walt Kelly once wrote for the great philosopher, Pogo: “We have met the enemy, and he is us.”
In the too-hot era of subprime, the biggest underwriting sin of all wasn’t income verification, but down payment requirements. Most borrowers can show sufficient income to pay current monthly mortgage payments. But if they suffer any economic trouble that hurts their cash flow – unemployment, a prolonged illness, major repairs – they’re much more likely to default on their mortgage if they have no equity at stake. That’s why traditional bankers used to ask for minimum 20 percent down payments, and why the era of no-money-down house buying turned into the debacle it has.
Three years ago, the Federal Housing Administration’s insured loan program accounted for just about 2 percent of the mortgage activity in the nation. Today, it’s more than 30 percent. That’s because the FHA allows buyers to purchase a home with as little as 3.5 percent down. But it also allows seller concessions of as much as 6 percent of the purchase price. That means that, at closing, FHA buyers can put next to nothing down, and many can even walk away from the table with money in their pocket.
And that doesn’t even yet take into account the $8,000 housing stimulus tax credit. On a $200,000 starter home bought under FHA, the necessary down payment is just $7,000. With the tax credit alone, buyers come out plus $1,000.
Given that the U.S. government has been fighting to clean up the massive economic mess left in the wake of Hurricane Mortgage, why would it also be working so hard to continue the failed policies of the past?
Much like the mortgage industry did, the government sees the need to push the economy forward, and that won’t happen without getting people into houses.Like the mortgage industry, FHA went too far. Its default rates are rising, and its capital is below mandatory minimums. Last week, it announced new rules to tighten its underwriting.
The housing market is in the midst of a nascent recovery, and it needs FHA support to get back on its feet. The agency needs to make sure it’s got its fiscal house in order. But its mission is one that should be applauded. And in the echoes of that applause, we might listen carefully for the ghosts of the mortgage industry gone by: the one that did not plan for an economic disaster, but was confident that it was boosting everyone to new heights.
