The latest data confirm what housing practitioners already knew: there are simply not enough home sales today to spark a housing recovery. Whether it is a recent Mortgage Bankers Association survey on purchase applications being at a 15 year low, the Federal Housing Administration's fiscal year 2011 purchase data indicating a 30% decline or Fannie and Freddie's consistently weak purchase volume, all show a market in serious trouble.
It is no wonder that Federal Reserve Board Chairman Bernanke has been almost pleading for Congress and the administration to take "useful" steps to spur housing and help revitalize the broader economy. The phrase "housing market remained depressed" has been a staple of the Federal Open Market Committee minutes for the last 18 months.
As housing practitioners also know, there are too many promising homebuyers being excluded from the housing market. Again, the Fed chairman underscored the seriousness of this problem when he said in response to a question at his June press conference:
"… the bottom third of people who might have qualified for a prime mortgage in terms of, say, FICO scores a few years ago cannot qualify today."
This lack of financing is stifling demand and contributing to the weight on home prices and the broader economic recovery. The FOMC minutes from earlier this year detail the problem: "declining house prices remained a drag on household wealth and thus on consumer spending."
As a consequence, the primary threat today to the government housing programs and ultimately the American taxpayer emanate from weak home prices. The current dilemma is epitomized by the concern about the upcoming FHA audit expected in mid-November. Despite FHA's excellent credit quality and loan performance, the audit (and therefore questions about FHA’s solvency) depends heavily on projections about future house prices.
Recent originations are performing at historic low levels of early default. At a recent Congressional hearing, the Acting FHA Commissioner Carol Galante referred to the quality of new books of business (which comprise over 50% of FHA's portfolio) as "stellar" and the government sponsored enterprises' recent books are even better.
The current market should not be held hostage by the risky products and poor underwriting of the "bubble" years. They already have done enough damage to millions of American families.
To judge today's market based on the problems of the past would, in effect, be the mortgage equivalent of double jeopardy.
In the spirit of the movie "Moneyball" (which makes the case that doing a lot of little things in baseball, for example taking pitches and obtaining walks, can be parlayed into a winning baseball strategy), a variety of small changes in government programs and pricing along with ideas to rebalance lender contingent liability could have a meaningful and immediate impact on home purchase activity.
In the program area, the recent Senate action to restore higher GSE and FHA loan limits is a positive step. Since higher balance FHA loans perform better than lower balance ones, this change would also reduce risk for the American taxpayer.
FHA could also revisit their condominium guidelines. Since condominium loans are now performing better than those on single-family detached homes, FHA could reinstate its "spot loan program" that allowed loans to be made in existing condominium projects under a streamlined process. Finally, both FHA, particularly in its Section 203 (k) rehabilitation program, and the GSEs could look at ways to facilitate investor participation.
In the pricing area, both the amount and the method of fee increases are hurting homebuying and refinance activity. For Fannie Mae and Freddie Mac, loan level price adjustments have effectively priced them and the private mortgage insurance industry out of the purchase market. The Federal Housing Finance Agency September 2011 report on guaranty fees raises the question of whether or not LLPAs on loans above 660 credit scores are still necessary.
If price increases are indeed justified, it would help to blend them into the guaranty fee instead of creating additional upfront costs for homebuyers. Pricing adjustments would also be a critical shot in the arm for the mortgage insurance industry.
Similarly, for FHA, if recent premium increases are still necessary, it would be much less of a burden for future homebuyers if the FHA returned to the formula that worked for many years (a higher upfront premium at a level that ensures FHA’s actuarial soundness and a modest annual premium of .5 percent). The current approach is only putting another barrier in the way of homebuyers and homeowners seeking to refinance.
Finally, and probably most important, in response to concerns about contingent liability, mortgage lenders have added credit overlays (e.g. credit score "floors") on top of government and GSE lending requirements. These overlays have contributed to the increase in average credit scores for both the FHA (from 640 to 700) and the GSEs (from 720 to over 755).
However, overlays also raise the fundamental question: Why do lenders believe overlays are necessary on loans when the government is taking the credit risk? The answer is that lenders are trying to protect their companies from, what they believe is, unacceptable buyback/indemnification risk from the government.
Since both sides believe their actions are justified, the critical question for the recovery of the housing market is what can be done to get lenders to reduce overlays without jeopardizing the government's ability to hold lenders accountable for misdeeds.
Here are some ideas that could break the stalemate:
- Offer arbitration/mediation on repurchase requests. In light of their role in promoting products (stated income) that are the root cause of the problem, the GSEs should not be "judge, jury and executioner."
- Implement a prior approval program for higher risk loans. Lenders could submit loans in this category to GSEs/FHA vendors (possibly private mortgage insurers) for processing.
- Have the agencies manage the relationship with appraisers on higher risk loans. An option could be to establish an appraiser selection process like the VA's.
- Develop uniform repurchase/indemnification standards (i.e. "serious and material") similar to what FHA published in a proposed rule last October.
- Establish sunset provisions on enforcement liability (fraud and misrepresentation would run life of the loan). An error tied to an underwriting problem should surface in the first few years.
- Revisit the treble damages statute for loss mitigation processing errors (treble damages for program fraud should be continued).
In addition to addressing the buyback/indemnification issue, lenders would like to see the FHA Neighborhood Watch system, which is an excellent monitoring tool, modified to evaluate loans by specific risk category (product type, credit score, etc.). Mortgage lenders believe the current structure discourages them from originating loans that deviate from the average (currently an average credit score of 700).
In conclusion, the current situation can be boiled down to the following question: What is a bigger threat to the recovery of the housing market and the broader economy — risk from operational changes that present little or no credit liability or the risk from maintaining the status quo?
While I am sure policymakers would prefer to see more seasoning for recent books of business before making policy and pricing changes, it is pretty clear what the Fed thinks of the status quo.
Brian Chappelle is a former Federal Housing Administration official and a partner in Potomac Partners LLC, a mortgage banking consulting firm.