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Suspicious Opposition to Reasonable Lending Standards   June 9th, 2011
Many want to reestablish conditions that led to housing collapse       

 
QUICK OBSERVATIONS

More observations...
 

Historically, I recall lending guidelines were 20% down and debt payments that don't exceed 1/3rd of income. When I first thought about buying a house (actually a condo), it turns out I couldn't qualify. I didn't have the required down payment and I wouldn't have been able to meet the debt-income ratio.

So what did I do? I didn't buy a condo. I rented. I worked. In fact, I worked and rented for another 16 years before I revisited the idea of buying a home. This time, I qualified and I bought a house.

I also remember soon after I bought my house (at the height of the housing bubble, no less) hearing advertisement after advertisement on the radio with offers to extend mortgages to people with no credit check, no verification of income, and no money down. Although I didn't dwell on it (I already had a home and wasn't yet writing economic commentary on a regular basis), I remember in the summer of 2006 on many occasions thinking, "How is this possible? Seriously? There's no way that can work."

Another way of looking at it, in colloquial terms, is: "It didn't seem sustainable."

And it wasn't.

  • The problem with loaning hundreds of thousands of dollars to someone with no credit check is that the lender doesn't know if the individual has a history of paying on time, so it's entirely possible that they won't pay on time.

  • The problem with loaning hundreds of thousands of dollars to someone without verifiable income is that they might not actually have income, so it's entirely possible they won't pay on time.

  • The problem with loaning hundreds of thousands of dollars with no money down is that if the value of the house drops, it's entirely possible that the individual has no motivation to pay what he owes when the house is now worth less.

People with bad credit histories got subprime mortgages and those were the first to explode. Then went the "Alt-A" loans that lacked "full documentation" (which should've been a red flag in and of itself). And finally we had the creditworthy people with full documentation that put little or no money down and are now strategically defaulting simply because their home is worth less than they owe.

It was entirely predictable, and some people did. But didn't all of us know in our gut something was wrong? Did any of us really think that literally everyone could now buy a house, there was no risk, and that the old lending standards were, I guess, just racist lending requirements to ensure minorities couldn't own a home?

The old lending requirements weren't racist. The lending requirements were common-sense objective specifications to ensure that the person borrowing such huge quantities of money would have a reasonable expectation of being able to pay it back. It wasn't based on who was black and who was white. I'm white and the lending standards prevented me from buying that condo 16 years ago--and it's probably a good thing because the purchase would've left me with very little disposable income at the time.

But people claimed that minorities weren't getting "enough" loans (whatever that means). Instead of considering why minorities weren't making enough money to qualify for loans, the CRA assumed that the lending industry was racist. So banks started lending to individuals even though the time-tested and objective lending standards suggested many of those loans didn't meet the financial standards (whether they were white or black, or anything else).

So, irrespective of race, the policies produced a situation where too many people that really weren't ready or able to afford a house ended up purchasing houses. And, since lending standards had been thrown out the windows, it's not surprising that many of the loans ultimately could not be paid.

That's when the housing market collapsed and we learned our lesson. And those few people that didn't already have a gut feeling that no-credit-check/no-income-verification/no-down-payment loans were unreasonable realized, "Wow, duh, we should've realized that throwing out lending standards was going to cause problems!"

Well, we now have the benefit of 20/20 hindsight. We have learned the hard way that people that cannot afford houses should not be loaned money with which to buy houses.

So, having apparently learned our lesson, there are efforts to reinstitute some semblance of lending standards:

Proposed rules sparked by the financial industry meltdown of 2008 could have the effect of clamping down credit so hard that lower-income buyers and many others would be shut out of the mortgage market, critics say...

"If this rule goes through as it stands, the demographic of borrowers who get (favorable rates) will be white and wealthy," said David Stevens, chief executive officer of the Mortgage Bankers Association and former commissioner of the Federal Housing Administration. "African-American, Latino and first-time home buyers will be charged higher prices."

Stevens was commenting on 376 pages of proposed rules for "Qualified Residential Mortgages," which would require a 20 percent down payment and limit a borrower's debt payments to no more than about one-third of income.


As best as I can recollect, this 20% down/one-third debt to income ratio is pretty much what the historical standard has been. It's the standard that served us well for decades and which we only suffered an economy-shaking housing collapse when we abandoned.

But once again "critics" are saying that "lower-income buyers and many others would be shut out of the mortgage market... the demographic of borrowers who get (favorable rates) will be white and wealthy... African-American, Latino and first-time home buyers will be charged higher prices."

Have we learned nothing from our current economic crisis? This sounds like there are people that want to repeat the whole fiasco all over again.

Motivation

The article says the opponents are an "unlikely coalition of mortgage lenders, consumer advocates, housing industry officials and lawmakers." While it's not surprising to see consumer advocates and housing industry officials (and maybe even lawmakers) opposing solid lending standards, what about the mortgage lenders?

Mortgage lenders have absorbed huge losses over the last several years and many have gone out of business or been bought out by stronger institutions.

So why, then, would mortgage lenders be opposed to lending standards that would decrease the chances of extending bad loans? I have two guesses:
  1. Bailouts - Can't Lose. I think the major institutions that are left are fairly certain that if they really get into trouble again, the government will bail them out again. The precedent has been set. So why would banks want to potentially lose business that might generate some profits when, if it falls apart, the government will be there to bail them out anyway? They have nothing to lose and profit to gain.

  2. Fear of Further Collapse. As I've written before, we have too many houses and not enough demand. That has driven housing prices down--and will drive them down still further. As prices continue to drop, it's likely that more people will choose to strategically default. Continued defaults threaten banking profit so they may believe that they can avoid more defaults and more losses by propping up the housing market. How? By making sure there is as much demand for housing as possible.

Unfortunately, even though lower lending standards will create more demand in the short-term, that's exactly what caused the housing bubble in the first place. The housing market needs demand by homeowners that can actually afford the home they purchase. The alternative offered by reduced lending standards is to repeat our past mistakes and reinflate the housing bubble which will pop at some point in the future, just as it popped in the past.

Reasonable Lending Standards

Lending standards are objective, numerical standards. They are not racist. They ensure that there's a high probability that the loan will be paid back regardless of race. Obviously if there's evidence of qualifying minorities being refused loans on the basis of race, that should be prosecuted under the law.

But it's absolutely astounding to read about people that are complaining that the traditional lending standards that kept our economy strong for decades discriminate against "lower-income buyers." That's exactly what lending standards are supposed to do! Because lower-income buyers, by definition, probably can't afford to buy a home. They don't discriminate against any race, they discriminate against insufficient income levels--including white applicants when they don't earn enough money to qualify.

If we've learned anything from the housing crisis, it's that our economic policies must be based on solid economic principles--not on misguided policies intent on selling homes to those that can't afford them.

We already know how that game ends.


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