It looks like regulators are chickening out on a major tightening of lending standards for mortgage loans. Low down payments are here to stay, and may be poised for a big comeback.
Although this certainly helps homebuyers, owners and Realtors, it won’t do much to protect the banking system or smooth out the ups and downs of the real estate market, which have become particularly volatile in San Diego.
On Tuesday the Federal Reserve outlined new regulations that may eventually reduce systemic risk by increasing the amount of equity a “too big to fail” bank must hold. The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. are scheduled with the Fed this week to unveil detailed proposals on leverage.
But the Fed went easy on small and regional banks, and it backed away from a proposal that would have discouraged lenders from making loans without at least a 20 percent down payment from the borrower.
What a difference a few years makes.
In 2009 Washington was full of talk about raising minimum down payments. Prices were plummeting in the U.S. housing market, and mortgage defaults were skyrocketing. This had triggered a global financial panic as investors and creditors discovered that giant banks were holding highly leveraged portfolios of troubled mortgage-backed securities.
President Obama talked about requiring borrowers to contribute at least 10 percent of a purchase price for a mortgage down payment. Sheila Bair, Obama’s former chief of the Federal Deposit Insurance Corporation, gave speeches calling for a 20 percent standard.
Their reasoning was straightforward. The more equity borrowers have in their houses, the less likely they are to walk away from their mortgages. And when properties do fall into foreclosure, lenders are less likely to lose money when their loan balances are smaller percentages of the values.
They were right about one thing: Federal support for cheap and easy mortgages helped pump up the housing prices – and led to the big deflation – so removing some of that support could at least moderate the next cycle. This is a big deal for San Diego, where zoning constraints on new construction tend to increase the swings in prices up and down.
To be sure, there were multiple causes for the historic rise in foreclosures, which began in late 2005 and peaked in early 2009. But several studies point to negative equity as a major cause, surpassing low credit scores, unemployment and the expiration of low, “teaser” interest rates.
But here’s another telling statistic: Defaults were unusually high among “prime” loans, or those to borrowers with high credit scores and large down payments. This suggests that the size and rapidity of the drop in housing prices — rather than only the “nothing down” phenomenon — was responsible for much of the negative equity that caused people to give up on paying their mortgages.
On the other hand, it was the pell-mell willingness of lenders to make loans to unqualified buyers that inflated the housing bubble to begin with. With home prices rising, lenders grew overconfident that they could simply sell foreclosed properties and get their cash back.
By 2005, you could routinely get a mortgage with nothing down, a low credit score and without even proof of income. Bankers were crazy.
Those days are over, at least for now. Credit has been tight for five years, with standard mortgages limited to those with big down payments, great credit scores and steady jobs.
But the federal government has filled the gap. Buyers can get mortgages with zero down payments from the U.S. Department of Veterans Affairs or the Rural Housing Service, and 3.5 percent down through the Federal Housing Administration.
Such loans shot from 5 percent of the market in 2006 to more than 40 percent in 2011 and remained “elevated” last year, according to apresentation in May by Elizabeth Duke, a member of the Fed’s board of governors.
Officials worry that removing the stimulus of low-equity loans will hurt the housing recovery, which is barely 18 months old. They are particularly reluctant to chase away first-time homebuyers, who represent the first rung on the ladder of a “move-up” real estate market.
With prices again rising, the credit market is beginning to respond.
Navy Federal Credit Union, which at 4 million members is the nation’s largest, has seen “robust” demand for its zero-down mortgages, according to CEO Cutler Dawson. The loans, which are designed for members who don’t qualify for VA mortgages, don’t charge the private mortgage insurance fees that typically accompany loans with less than 20 percent down.
Dawson says that careful underwriting has kept default rates close to those in his portfolio of prime loans. “We make an attempt to know our members,” he said.
But foreclosures surely will rise again if prices retreat.
A recent working paper by Fed economists estimated that requiring a 15 percent down payment or greater on all new mortgages would reduce foreclosures by 30 percent, without hurting housing prices substantially. This view on pricing is controversial; many economists say that wiping out the population of buyers who can’t raise the cash for down payments could kill the recovery and suppress prices.
But few dispute that requiring more equity from borrowers would make banks safer. In the great debate about preventing the next crisis, officials aren’t ready to pull the plug on the housing market.