Housing Finance Still Stuck on Stupid

by Marilou Moursund on November 16, 2010

in Banks,Credit Crisis,Debt,Residential Real Estate

I got out of graduate business school in August of 1983, and unemployment was also at 9.5% then.  I was fortunate to get a job with a local savings and loan where the president needed help with the growing mortgage-backed securities portfolio.  We got called on every week by various New York investment banks, many of which don’t exist any more, who wanted us to securitize more of our home loans.  We had the highest rating by Fannie and Freddie which meant that they had come to San Antonio, pulled loan files, and verified our underwriting standards.  This high rating indicated that our loans were very high quality and less prone to default.  It also made them more attractive for pooling because the fee paid to Fannie and Freddie out of the pool’s loan was lower and the pool could have a higher pass-through rate.

I learned a lot, but I quickly came to the conclusion that I needed to get out of the S&L business.  My employer was very conservative, and they were struggling to make a spread on the very high deposit rates they were having to pay to keep up with the more risky outfits in town.  I managed to get a position with the largest money manager in town in 1986 right before the S&L crisis really hit home.

We had large positions in Fannie and Freddie, and at some point in the mid 1990’s, the Freddie IR officer came to our offices.  He described how they were going to be even more profitable by shifting to a “black box” approach to credit analysis.  Instead of concentrating on enforcing underwriting standards at the lender level, they were going to focus on models that were based on the consumer’s credit score to rate their pools.  We didn’t like what we were hearing, but I didn’t know at the time that I was seeing the inception of today’s housing crisis. 

We are now in the midst of a foreclosure crisis which is also a consequence of poor underwriting and documentation.  All the major home lenders are trying to straighten out their paperwork so they can legally take back title on loans that are in default.  The scope of the problem is still unclear, but until it is resolved, the housing market will continue to struggle since prices are not able to find a clearing point.

Low interest rates may also be a part of the problem according to Robert Brusca, the chief economist of Fact and Opinions Economics.  On CNBC this morning, he said that instead of helping the economy, QE II could be hurting sentiment as well as impeding lending.  According to Mr. Brusca, with rates this low, a lender who makes a home loan has three outcomes, and two of them are bad.  The worst outcome is a bad loan that goes into default.  The next bad outcome is that the lender has a low performing asset on their books for thirty years.  The best outcome is that they make the loan, and sometime in the next ten years the borrower moves and pays back the loan.  

It seems counterintuitive, but higher rates may actually help the economy get back to a more normal growth rate.

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