Mark Zandi, chief economist at Moody Analytics, published an article that first appeared in the April 11th edition of the Washington Post. About the only thing I agreed with Mr. Zandi in the whole piece is his statement that “it would be premature to declare housing healthy again.”
Mr. Zandi’s main argument to revive housing is the banks must begin extending credit to more and more individuals who fall outside today’s existing super tight underwriting standards. Ok, so that is like saying more apples need to be in apple pies.
Slightly right behind the principal declaration is Mr. Zandi’s view that Washington needs to attract more private capital into the mix. But to make that happen, housing and the economy must rebound, uncertainties like the Qualified Residential Mortgage (QRM) rule (one of the outcomes of the Dodd-Frank financial reform bill) and Basel III (a global voluntary regulatory accord that sets standards for bank capital requirements, stress testing, and market liquidity risk) must be resolved.
And then there is what to do with the mortgage giants, Fannie Mae and Freddie Mac. Poor Fannie and Freddie, everyone wants to wind them down, when in fact, they are the only game in town.
The only true recommendation that I can discern in the article for how Washington can improve housing is to expand the number of people who can refinance under the Home Affordable Refinance Program (HARP). HARP is nothing more than a thinly veiled attempt to convince homeowners to stop turning in the keys in exchange for a slightly lower mortgage payment.
The discussion we should have, and one I will promote in as many forums as possible, is how to reduce risk for homeowners, lenders, and Wall Street banks. The big three are interrelated and so simply singling out one will not suffice. Honestly, if I ran a bank there is no way I would allow any of my capital to go toward home lending. The risk –between loan buy backs, potential litigation, and outdated underwriting standards, is simply to great.
So what can Washington do to immediately begin reducing the risk associated with home lending. First, amend the Dodd-Frank financial reform legislation in two important ways. One is to define acceptable debt to income ratios. QRM is permitting a total housing allowance of 43% of gross income for borrowers to conform to that risk layer in a loan. It does not matter if the income is fully documented, that amount is insanely high, particularly since all the living expenses any family faces is not included in the calculation. At the very least, net income should be used and preferably the gold standard should be net income and no more than 33% when all debts are considered.
A second amendment should involve specifying the amount and type of liquid assets a borrower must have to get a loan. The standard for conforming loans is currently two months of a full mortgage payment (PITI) and six months for jumbo loans. Moreover, a lender can still use greater amounts of liquid assets to offset the risk posed by higher debt to income ratios. We live in a world where life events happen faster each day. Divorce, health issues, and business failures can strike at any time. I can think of no reason why at least one year of liquid assets should not be set aside in escrow for conventional loans and two years for jumbo loans. First time homeowners should have at least six months in reserve and incentivized for more.
Originators and homeowners alike will hate this in the short run but let’s look at this from another angle. Decreasing the risk of homeownership will help rebrand the industry and more importantly increase customer loyalty. Instead of we can do a loan for you, imagine the power of promoting we are the bank that is looking out for you.
Lastly, HARP, either through legislation, or executive order, should be changed to allow the right homeowners to refinance. Regardless of loan to value, the primary factors should be a combination of increasing income and liquid assets. A homeowner is always test driving the next mortgage whether they realize it or not. Simply lowering the interest rate is dangerously close to playing Russian roulette. Using the standard of net income, if a family’s monthly income has decreased more than the lower payment afforded by today’s interest rates, there is no net benefit for either the bank or the borrower. The same can be said of liquid assets.
The above suggestions are merely the first steps. Many more in the intermediate and longer term must also be implemented. One place to start is a new type of mortgage to replace the “Jurassic” era 30 year fixed rate loan. Closely related, a process to continually assess a borrower’s economic house of cards is also in order. And what about Fannie and Freddie?
Stand by for that one in an article soon to be published here.