Housing Economics | Lenders cut home loans without due diligence

Housing Economics | Lenders cut home loans without due diligence

Home ownership 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. (Lawrence Summers says: “In the history of the world, no one ever washed a rented car.")

Once the government decided home ownership was in the public interest, it went about making it more affordable. Mortgage interest and real estate taxes are deductible. The first $250,000 (Rs1.02 crore) of profit ($500,000 for a married couple) from the sale of a home you’ve lived in for at least two years is exempt from capital gains taxes.

Government-sponsored enterprises (Fannie Mae and Freddie Mac) were created to expand the flow of funds available for mortgages and to help lower the costs of buying a home. (The latter assertion has come under scrutiny).

The federal housing administration (FHA) insures mortgages. The office of fair housing and equal opportunity, part of the department of housing and urban development (HUD), administers federal laws that ensure equal opportunity for potential homeowners.

There are laws against red-lining, 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—and says a lot—about housing.

While the federal government’s involvement in housing dates to the 1930s, the early 1970s saw a “big push for low-income homeownership," says Michael Carliner, formerly an economist at the National Association of Homebuilders and now a consultant on housing economics.

In “the most ambitious effort to subsidize homeownership to date," HUD provided low-rate mortgages to low-income households to purchase 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 ultra-low interest rates and rapid home price appreciation conspired to turn the residential real estate 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 income, ratings companies were slow to recognize the risk, and investors behaved as if there wasn’t any risks and gobbling up collateralized mortgage and debt obligations that carried a gilt-edged AAA rating.

If it seemed too good to be true, it was. Rising real estate prices were the glue that held the whole 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 casino gambling going on!

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 homebuyers) to the necessary (some degree of regulation for non-bank lenders).

Late last week, US President George W. Bush responded to the hue and cry for help 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 a property.

“The bottom line is these proposals will have a limited impact and will not materially alter the vicious cycle of higher delinquencies, tighter credit conditions and lower home prices," says Andy Laperriere, a political economist at the ISI Group Inc. in Washington, D.C.

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.

“There were strong voices not so many years past encouraging banks to reach out to bring more people into the financial mainstream," says Wayne Abernathy, executive director for financial institutions policy at the American Bankers Association also in Washington, D.C. “Banks have done that with positive results."

Banks’ share of the home loan market has gotten 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’, which was at risk.

Lenders reached too far this time, and borrowers grabbed too much. The home-loan market has come full circle in the process. Decades ago, lenders could be sued for discrimination if they didn’t make a loan.

Now they face accusations of fraud because they did. BLOOMBERG

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