In home loans, you're damned if you lent and damned if you didn't
September 5, 2007
By Caroline Baum
Homeownership has long been considered a desirable goal.
Put a person in a home of his own, the thinking goes, and he starts to care about the quality of local education, maintaining a drug- and crime-free neighbourhood, and the appearance of his property and the block on which he lives.
Once the US government decided homeownership was in the public interest, it went about making it more affordable. Mortgage interest and real estate taxes are deductible. The Federal Housing Administration (FHA) insures mortgages. The Office of Fair Housing and Equal Opportunity administers federal laws that ensure equal opportunity for potential homeowners.
There are laws against redlining, laws against other discriminatory lending practices, and laws to ensure that banks serve the needs of the inner cities. In other words, the government has a lot to say on housing.
While the federal government's involvement in housing dates back to the 1930s, the early 1970s saw a "big push for low-income homeownership", says Michael Carliner, a consultant on housing economics.
In "the most ambitious effort to subsidise homeownership to date", the government provided low-rate mortgages to low-income households to buy homes, he says. The programme was abolished in 1994.
"I was always sceptical of the idea of getting marginal characters into home loans," Carliner says. "You're not doing any favours by putting someone into a house they will lose."
That's exactly what happened during the first few years of the 21st century, when ultralow interest rates and rapid home price appreciation conspired to turn the residential property market into a casino.
No one, it seems, was denied credit on the basis of race, religion, age, sexual orientation - or income.
In many cases, lenders misrepresented the terms of the loans, borrowers lied about their incomes, ratings companies were slow to recognise the risk, and investors behaved as if there wasn't any, gobbling up collateralised mortgage and debt obligations that carried gilt-edged AAA ratings.
If it seemed too good to be true, it was. Rising property prices were the glue that held the Ponzi scheme together, allowing unqualified borrowers to acquire equity in their homes and access to more credit.
Now that home prices are falling, credit standards have tightened, borrowers are defaulting, banks are foreclosing and investors are seeing losses, our elected representatives are shocked to find there's gambling going on in the casino.
The proposed solutions range from the truly terrible (shifting the liability for predatory lending to the investor, which would shut the mortgage market down as fast as you can say "sell") to the harmless (education and counselling for potential home buyers) to the necessary (some degree of regulation for non-bank lenders).
Late last week, President George W Bush responded to the hue and cry with a modest set of proposals for cash-strapped homeowners. Bush's plan would allow folks with good credit to refinance into FHA-insured mortgages and suspend an Internal Revenue Service provision that imposes a penalty for refinancing.
"The bottom line is these proposals … will not materially alter the vicious cycle of higher delinquencies, tighter credit conditions and lower home prices," says Andy Laperriere, a political economist at International Strategy & Investment Group in Washington. At least they have the advantage of making it seem that Bush is "doing something".
Maybe the root of the problem is the inherent conflict when it comes to homeownership. On the one hand, "we want to make sure borrowers aren't taken advantage of by predatory lenders", Carliner says. On the other, we want to put the American Dream within everyone's grasp.
Wayne Abernathy, the executive director for financial institutions policy at the American Bankers' Association, says: "There were strong voices not so many years past encouraging banks to reach out to bring more people into the financial mainstream. Banks have done that with positive results."
But banks' share of the home loan market has grown smaller. The more egregious abuses appear to have taken place outside the banking system, with largely unregulated and, in some cases, unlicensed brokers. It was investors' money, not depositors', that was at risk. (Banks did have credit lines to many of the mortgage lenders.)
Lenders reached too far this time, and borrowers grabbed too much. The home loan market has come full circle. Decades ago, lenders could be sued for discrimination if they didn't make a loan. Now they face accusations of fraud because they did.
Caroline Baum, the author of Just What I Said, is a Bloomberg columnist. The opinions are her own
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