Mortgage Market Bound by Major U.S. Role
Classes of Borrowers Cannot Find Loans as Publicly Backed Debt Mounts
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Monday, September 7, 2009
Second in an occasional series
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.
The government has the power to decide who is qualified for a loan and who is not. As a result, many borrowers among both poor and rich are frozen out of the market.
Nearly one-third of those who obtained home loans during the boom years of 2005 and 2006 couldn't get one today, according to mortgage industry analysts. Many of these borrowers were never really able to afford their homes and should not have gotten loans. But many others could, and borrowers like them are now running into tougher government standards.
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.
The outlay has already reached about $1 trillion over the past year and is rising. During that time, the government has pumped more money into the mortgage market than has been spent on Medicare or Social Security or the defense budget, more even than Washington has paid to bail out banks and other struggling companies.
"Absent government intervention, there would be no lending," said Nicolas P. Retsinas, director of Harvard University's center for housing studies.
Government officials generally agree that it would be better for private lenders to resume their traditional role as major providers of finance for home loans. But policymakers now face some tough choices. They must decide how to reduce support for the mortgage market without letting it collapse. And they must decide what kind of support the government should provide in the long run.
"The problem was a long time brewing, and the problems in our mortgage finance system will take a long time to repair," said Michael Barr, the Treasury's assistant secretary for financial institutions.
Government Role
Fannie Mae and Freddie Mac were chartered by Congress four decades ago to create a marketplace where mortgage lenders could sell the loans they made and use that money to make more loans. The two companies were owned by private shareholders and for a fee guaranteed investors in mortgage loans that they would get paid. After the government seized Fannie and Freddie, it offered them an unlimited line of credit and pledged to inject up to $400 billion to keep them solvent.
But this is not the only form that government involvement in housing finance takes.
The Federal Reserve is purchasing hundreds of billions of dollars of mortgages with the aim of ultimately owning $1.25 trillion worth. This buying spree has flooded the mortgage market with money, forcing down interest rates and assuring lenders they have somewhere to sell their loans. The Treasury Department has a similar, though smaller, program.
The Federal Housing Administration, meantime, is dramatically increasing the amount of home loans it insures. Its share of new mortgages jumped from 1.8 percent in 2006 to 18 percent so far this year, according to Inside Mortgage Finance. It expects to insure about $400 billion this year. Several other agencies, such as the Department of Veterans Affairs, also provide mortgage guarantees.
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.
Fannie and Freddie had long played a dominant role in the mortgage market, providing traditional 30-year, fixed-rate loans. But earlier this decade, they faced competition from banks and other lenders promoting exotic mortgages, such as those that did not require proof of income or were available to people with checkered credit histories. With housing prices on the rise, these loans became ever more prevalent, and lenders figured that a struggling borrower could always get out from under a loan by selling or refinancing his home.
For the first time in decades, the rate of home ownership ticked up, reaching 69.2 percent. Many first-time buyers were of lower income, and many such buyers were black or Hispanic. Fannie and Freddie, afraid of losing more market share, also began funding risky loans.
Then, in 2006, the housing market began to tumble and many people couldn't or wouldn't pay their loans. Lenders and mortgage financiers suffered staggering losses. New loans dried up. Interest rates spiked. With investor confidence in Fannie and Freddie crumbling and the global economy at stake, the government seized the firms, nationalizing the U.S. housing finance system.
Niche Markets
Many borrowers had been put into loans they could not afford, and when the mortgages failed the results were catastrophic, precipitating the financial crisis.
The tighter market that emerged -- whether the consequence of stricter government standards or an industry retreat from risky practices -- now excludes some groups of aspiring home buyers.
"People say, 'Well that's good because of lots of people who got loans in the past shouldn't have gotten those loans at all,' " said Keith Gumbinger, a vice president at research firm HSH Associates. "But there were tiny niche markets for whom those products were originally intended, and those people who legitimately need them now won't get them."
Although Fannie and Freddie don't make loans, they effectively set standards for the mortgage industry by detailing what kind of loans they will purchase from lenders and at what cost. The companies, for instance, require documentation of income and have increased fees on loans for people who lack stellar credit and hefty down payments, especially those looking to buy condominiums.
All but gone are subprime mortgages, initially meant to help people with blemished credit until they could get another loan. All but gone are the no-money-down mortgages used by four out of 10 first-time home buyers in 2005 and 2006. Those loans originally catered to wealthy borrowers with great credit who wanted to buy a home without having to liquidate their investments.
And the advances in minority and low-income home ownership recorded earlier this decade have largely proved to be a mirage. The U.S. homeownership rate has declined to 67.4 percent.
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."
Other would-be buyers -- including investors, second-home and condo buyers, and people who need exceptionally large loans dubbed "jumbos" -- have fewer options than before.
Earlier this summer, Philip Zanga, an investor, signed a contract on a $367,000 condo in Bethesda this summer and paid a $15,000 deposit. He planned to put down 60 percent, but his loan was rejected. Investors and loans for condos are both deemed risky by Fannie and Freddie.
"Why turn away someone willing to put 60 percent down?" asked Avi Galanti, Zanga's real estate agent. "What's the risk in that?"
Mountain of Debt
Taxpayers could be hit with a staggering tab even if a small proportion of loans go bad. Fannie and Freddie now own or guarantee more than $5 trillion in home loans. (That equals two-thirds of the debt the U.S. government owes.)
And many could be in trouble. Mortgages owned and backed by the companies often required down payments of no more than 10 percent. With housing prices down sharply, many borrowers are underwater, owing more than their home is worth, so they cannot sell or refinance to pay off troubled loans.
As the economy has deteriorated, delinquencies are spiking and losses are mounting. In the past year and half, the companies have posted more than $150 billion in losses.
Similar risks threaten to engulf FHA. Nearly 8 percent of FHA loans at the end of June were either 30 days late or in the process of foreclosure, according to the Mortgage Bankers Association. That compares with 5.4 percent of such loans a year ago.
As a result, FHA has been exhausting much of its loss reserves, which are funded by premiums paid by borrowers. The reserves currently stand at an estimated 3 percent of all outstanding loans, half of what they were just a year ago. If the reserves fall below the 2 percent threshold set by Congress, they could require a taxpayer bailout.
"Having the government this heavily into the mortgage market is inherently a dangerous thing for taxpayers," said Anthony Sanders, a finance professor at George Mason University. "We've already gone through one big bubble and burst, and right now the taxpayers are on the hook for a substantial amount of money."
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