Mortgage Paralysis
February 22, 2008
Long-term rates are beginning to trickle back down from the peculiar spike of the last two weeks. The lowest-fee mortgages from 6.375% to 6.25%, the 10-year T-note from 3.90% to 3.80%, the immense spread a measure of deepening crunch.
The data continued a pattern going back to last fall. The job market is holding surprisingly well: new claims for unemployment insurance have been steady for two months at an elevated but non-recession 350,000 weekly. Inflation is real, the core rate way out of bounds at 2.5% complicating the Fed’s life. The Philadelphia Fed’s newest survey continued to indicate recession, this time a longer-term slowdown.
The public policy response to the credit crunch here is paralyzed; not in Europe, where outright bailouts of banks by the dozen are underway from the UK to Germany. Secretary Paulson insists that this adventure is a normal, cyclical re-pricing of credit; he must know otherwise, but does not know what to do. Perfesser Bernanke might as well be on African safari with Dubya -- and would rather be there than face Congressional music next Thursday and Friday in a required annual appearance.
Worse than paralysis: the soap-opera focus on preventing foreclosures. The press is packed with truly sad stories, scary forecasts, and grotesque misinformation about the actual situation, cause, and possible resolution.
Americans have deep residual memory of millions of families unfairly foreclosed during the Depression. Lost in today’s mass appeal to that memory: the great difference in circumstance. In 1930, American mortgages were short-term renewable affairs; borrowers had to re-qualify and survive re-appraisal as often as every five years. Even those who still had jobs -- in a time of 25% unemployment -- were often evicted. My Okie parents’ puzzled memory: “Nobody had any money... the banks were gone, and there just wasn’t any money....”
In that awful decade, most who lost their homes did so for no fault of their own, financially healthy households collapsed by external force. That is not today’s problem. To get at the heart of today we must put aside blame and cries of greed and predation among lenders, borrowers, Wall Streeters, investors, all. The sad reality: the vast majority to suffer foreclosure today were weak financial households to begin with.
Until roughly 2000, the dividing line between prudence and foolishness had for 76 years been the underwriting standards of the FHA -- the first long-term loan, invented in 1934 to stop the Depression foreclosures. The FHA allowed low-downpayment loans, only 3%, but you had to prove your income. If your job history looked weak (intermittent, or shaky by classification -- hourly construction, new commissioned sales, seasonal), you would be declined in underwriting. You didn’t have to have money in savings, but if your new house payment would be higher than the rent you had paid, you either had to prove increased income, or demonstrate by savings that you had enough slack in your rental household budget to afford a higher payment.
FHA market share fell by more than half in the last decade, as did loans made with traditional mortgage insurance, because those lenders maintained income and “payment shock” standards, and lost out to the foolish ease of subprime and Alt-A.
The few households suffering temporary bad luck (job loss, health, divorce) deserve all the “workout” help the system can provide. The inherently weak households will defy every effort. Even extraordinary re-writes will beget re-default, the poorly maintained house creating deeper loss in the ultimate foreclosure, the troubled inventory overhanging the marketplace and preventing recovery.
Policy makers should look forward, not to the last, lost battle: the number-one-prime priority is restoration of an adequate supply of credit. Not just to re-work existing loans, but to enable quality borrowers to buy. If that means the Fed or Treasury entering the market to buy top-quality mortgage-backed securities to drive down this absurd spread to benchmark, then get on with it.
