Friday, January 2, 2015

A house is not a credit card

 NOV 17, 2014


THIS autumn, federal regulators made a controversial decision to back down from tough new underwriting standards for mortgages. Some affordable-housing advocates, allied with parts of the corporate housing industry, had successfully argued that the proposed standards would make it too hard for people to qualify, thereby reducing home ownership and hurting the housing market. Last summer, that same trump card stopped a bipartisan Bill to reform the mortgage market, more than six years after Fannie Mae and Freddie Mac had to be taken over by the government.

All of this ignores a crucial fact: Much, and at times most, of what happens in the mortgage market doesn't have anything to do with home ownership. A sizeable percentage of mortgages - including most of the risky ones that were made in the run-up to the financial crisis - are not used to buy a home. They are used to refinance an existing mortgage. When home prices are rising and mortgage rates are falling, many home owners choose to replace their mortgage with a bigger one, taking the difference in cash. In other words, mortgages are a way to provide credit.

Refinancing is a relatively modern phenomenon. According to Mr Joshua Rosner, a managing director at research consultancy Graham Fisher & Company, by 1977, only 8 per cent of home owners had ever refinanced. By 1999, 47 per cent had refinanced at least once. By the peak of the bubble, home owners were extensively using refinancings to extract cash. Mr Rosner also points out that while home ownership peaked in 2004, home prices peaked in 2006, because refinancing drove up prices.

One of the most abjectly false narratives about the financial crisis is that risky mortgages proliferated so that people who couldn't afford homes could nonetheless buy them. Modern subprime lending was not about home ownership. Instead, the 1990s crop of subprime mortgage makers allowed people with bad credit to borrow against the equity in their existing homes.

According to a joint HUD- Treasury report published in 2000, by 1999, a staggering 82 per cent of subprime mortgages were refinancings, and in nearly 60 per cent of those cases, the borrower pulled out cash, adding to his debt burden. The report noted that "relatively few subprime mortgages are used to purchase a house".

According to the financial statements of New Century, the huge lender whose bankruptcy in early 2007 helped kick off the financial crisis, cash-out refinancings were 64.2 per cent and 59.5 per cent of its business in 2003 and 2004; home purchase loans made up only 25 per cent to 35 per cent for the two years.

A New Century executive told Congress its customers needed to "tap into their home equity to meet other financial needs, such as paying off higher-interest consumer debt, purchasing a car, paying for educational or medical expenses and a host of other personal reasons". I'll always remember seeing a bank ad blowing in the windy, bleak Chicago winter of 2009. "Let your home take you on vacation," it read.

According to Mr Jason Thomas, now director of research at Carlyle Group, only about a third of subprime mortgages that were turned into mortgage-backed securities between 2000 and 2007 were used to buy homes.

Putting the financial crisis aside, the logic behind this is completely messed up.

If we want homes to be a vehicle for saving and building wealth, as they used to be, why are we instead encouraging people to increase their indebtedness? Even worse, we now know that too much credit results in people who once owned their homes losing them. It creates homelessness, not home ownership.

The problem, of course, is that the conflation of home ownership and consumer credit is so convenient for the powers that be. It allows lenders to cloak themselves in the American-as-apple-pie mantle of home ownership, thereby making it less likely that anyone will crack down on their practices. It allows members of Congress, many of whom depend on the financial industry for campaign contributions, to pretend that something that's bad for us is actually a good thing for which we should be grateful.

There's an argument that refinancing doesn't much matter today. Because interest rates can't go much lower, and home prices aren't skyrocketing, "refis" will be a smaller part of the market. According to Freddie Mac, 28 per cent of borrowers took cash out in the third quarter of this year. But that's still a significant percentage of the market, and ideally, we're setting up a housing finance system that should be right not just for now, but for decades to come.

One possible solution would be much tougher standards for cash-out refinancings than for mortgages used for purchases, such as requiring far more equity in a home, or making lenders keep the loan on their own books instead of selling it. Or perhaps Fannie Mae and Freddie Mac shouldn't be allowed to guarantee payment on a mortgage unless it is used to purchase a primary residence.

In Washington, there's been scarce public discussion of this. But if we're going to put government resources behind home ownership, and engage in practices that threaten the safety of the financial system in the name of home ownership, shouldn't we at least talk about the fact that we're actually encouraging the opposite?


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