As a youth, St. Augustine famously prayed, "Grant me chastity and continence, but not yet." Somewhat similarly, after the tech bubble burst in 2000, bumper stickers popped up in Silicon Valley saying “Please God, just one more bubble.”
Both of these came to mind when I read about reports that Fannie Mae and Freddie Mac are working with their regulator, the Federal Housing Finance Authority (“FHFA”), to make more money available to borrowers with lower credit ratings and to reduce the required down payment on houses to as little as 3%.
After the financial crisis, the federal government went after financial institutions for problems with the loans they sold to Fannie and Freddie. Financial institutions have had to buy back tens of billions of dollars of mortgages, plus pay billions in damages. Needless to say, this experience, plus being demonized by politicians of all stripes, has made financial institutions hesitant to lend to anybody other than top credits, if the loan would be sold to Fannie or Freddie. The government, however, wants to stimulate the housing market. The FHFA wants financial institutions to lend to people with lower credit ratings, so it is easing the rules under which financial institutions could be forced to buy loans back in the future.
At the same time, Fannie, Freddie and the FHFA are moving to lower the minimum down payment on loans Fannie and Freddie buy to as little as 3%. The FHA is already doing loans with 3½% down, but Fannie and Freddie want to join the party, too.
But is that what we should be doing? Is the most important thing to get the housing market moving or is the most important thing to build a firm foundation for the housing market in the future? Can a solid housing recovery be built on lending to people with lower credit ratings and smaller down payments?
I don’t have any economic studies to tell me the answer. All I have is common sense, and common sense tells me that the lower the credit rating of the borrower and the lower the down payment, the riskier the loan. The problem is, as we have seen, risky loans, when there are enough of them, are not just a problem for the individual borrowers and lenders. They are a problem for the whole economy (not to mention the world).
People are still talking about the problems that are being caused by loans that were made before the financial crisis and that are, even now, “underwater,” i.e., the borrower owes more on the mortgage than the house is worth. People can’t move and yet they are stuck with a mortgage they can’t afford. One would think we would to avoid creating more of them. But as Mark Calabria, of the Cato Institute, said about 3% mortgages:
“This is the sort of thing that gets people underwater. Three percent [down payments] can disappear and become zero real quick.”
Actually, 3% mortgages are underwater from the start because, if you need to sell, it will cost you more than 3% to do so. Unless you can sell the house yourself, not the easiest thing in the world, especially when you are trying to get top dollar, the commission for the realtor will be at least 4% or 5% (and it is often more). Then there are the transfer taxes that state and local governments charge house sellers plus other costs like surveys, title insurance, etc. Voilà, a buyer who puts 3% down is effectively underwater from day one.
However, when Republicans suggested raising the minimum down payment for FHA loans to 5% (from 3½%), the idea failed. Opponents said this would be unfair to poorer people. But there is no right to house a home. People need to have adequate housing, but that doesn’t mean they have a right to own a house. Owning a house is something you have to save for.
Other countries do not have 3% mortgages. (They don’t have 30-year fixed rate mortgages, either, but that is a question for another day.) Canada doesn’t. In New Zealand, regulators don’t allow banks to make more than 10% of their home loans for less than 20% down – and even those have to have 10% down.
Several years ago, during the height of the financial crisis, I was talking to some lawyers from Italy and Germany. They were astounded that people in the United States could get mortgages for only 3½% down. It made no sense to them. It still doesn’t make sense – unless your economic theory is to be chaste later and to hope for one more bubble now.
Instead of the slow, hard work of letting the results of the boom and bust work their way through our system and then setting up a structure that will allow a safer housing market to naturally build itself (via the market system), too many of our political leaders want the quick fix of another bubble – though that means the real possibility (even probability) of another bust.
A better approach is to realize that our housing market was broken by the financial crisis it helped create. Low down payments were a big part of that crisis. Going back to them now (and staying with them for the FHA) is the wrong thing to do. We need a housing market that won’t wreck the economy if housing prices go down again. It is unfortunate that the problem can’t be solved more quickly, but it was building for a long time. Requiring real down payments and lending to people with good credit ratings may mean the housing market will grow slower than we want, but it is worth it to avoid another housing bust. We were just barely able to avoid another Great Depression this time. We need to make sure we don’t take another risk like that.
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