This Spotlight addresses some recent changes that should help open the mortgage credit spigot, which is one of the most significant constraints to the recovery in home sales.It will also clarify what is happening, and provide a realistic assessment of how significant those changes are. A recent headline in The Wall Street Journal indicated a move by the mortgage giants—as in, Fannie Mae and Freddie Mac—to “loosen lending” rules. (These two agencies will be referred to below as the Government Sponsored Enterprises or GSEs.)
BY: LYNN O. MICHAELIS
WARNING: To cover any government managed issue, you have to be prepared for acronyms. I ask your patience and forgiveness in advance for more to come.
Some analysts refer to the limitations on credit availability as the credit box. The credit box has two dimensions: tough lending standards and restricted mortgage finance options. (Other factors—such as lost employment, lower real income and higher debt loads—can limit the household demand for a loan as well.) Lenders reduce default risk by restricting loans to people with excellent credit ratings and by avoiding risky mortgage characteristics.
The extremely tight credit box should not be a surprise given policy and lender efforts to reduce default risk in the aftermath of a financial crisis, which was in large part caused by the massive financial default/foreclosure wave in mortgages after 2007. Despite aggressive Federal Reserve actions that infused massive amounts of liquidity into the financial system, mortgage volumes to purchase homes have not improved. There was a surge in refinance originations due to falling interest rates, however. Banks are aggressively lending to car buyers and are soliciting commercial real estate investors to borrow as well, but have not been willing to move up the lending rate for potential homebuyers.
Policy Changes Frame the Credit Box: Very Tight Fit
To understand the nature of the current credit box and the recent changes, you first must understand the financial reform bill (Dodd-Frank Bill) that was passed in 2010. The purpose of the legislation was to avoid a repeat of the mortgage market fiasco. Unfortunately, it also made access to credit more difficult and more expensive and cumbersome. The recently announced rules and regulation changes are efforts to clean up ambiguity and confusion created by that earlier legislation.
The bill created two oversight agencies to implement and enforce the proposed new regulations. The Federal Housing Finance Agency (FHFA) has oversight of the GSEs and is empowered to clarify specific regulations for mortgages that can qualify for government insurance and be placed in the GSE security pools. A great deal of confusion followed, because there were two sets of regulations. Let’s start with the definition of a Qualified Mortgage (QM).
The QM was supposed to provide safe harbor for a lender, which says if they meet all of the specifications of the QM regulations (laid out in a mere 52 pages) they would not be legally obligated to re-purchase that mortgage if the lender defaults. Because the rules were vague, mortgage originators were at risk and so became extremely cautious in mortgages they would originate.