Tightening mortgage credit standards are slowing down the housing recovery, according to two top economists.
In a paper released Monday, former White House policy advisor Jim Parrott and Moody’s Analytics Chief Economist Mark Zandi argue that for the housing recovery to continue, mortgages must become easier to obtain without returning to “the recklessly loose standards of the bubble years.”
“The recent turn in the housing market has been powered in part by strong demand from investors who have been buying up distressed properties at a voracious rate, driven by low house prices and strong rental demand. However, with fewer remaining distressed properties, rising house prices, and easing rental demand, investor demand has begun to wane,” Parrott and Zandi wrote. “For the housing recovery to maintain its momentum, first-time and trade-up home-buyers must fill the void left by investors. The recent rise in interest rates complicates this transition… Although mortgage rates are still low by historical standards, when combined with higher house prices they make single-family housing no longer as affordable as it was just a few months ago. “
Higher rates and rising prices are combining with constricting credit standards to make getting a mortgage tough for many borrowers, the authors wrote.
“All but those with the most pristine balance sheets find it difficult to obtain loans,” they wrote. “The average credit score on loans to purchase homes this year is over 750, some 50 points higher than the average credit score, and 50 points higher than the average among those who took loans for home purchases a decade ago, before the housing bubble.”
Tightening credit standards are the result of a number of “mutually reinforcing factors,” according to the report: the high cost of servicing distressed borrowers, the “reputational and legal” consequences of servicing high numbers of delinquent loans, the amount of industry resources devoted to refinancing.
However, constricting credit standards are also at least in part the fault of the government, according to the report. Lenders face “deep uncertainty about when and why Fannie Mae, Freddie Mac, and the Federal Housing Administration will force lenders to take back credit risk for underwriting mistakes exacerbates all the other factors already mentioned,” Parrott and Zandi wrote. “When a lender makes a loan to be purchased or insured by one of these institutions, which together cover 85% of the purchase market, they do so with the understanding that they will not bear the cost of any subsequent default. However, the government retains the right to put the cost of a defaulting loan back on the lender if it is later determined that the lender did not follow the rules in making the loan.
“… In recent years, these institutions have been much more aggressive about putting defaulting loans back to lenders. This aggressiveness, combined with lender uncertainty about the rules they are supposed to follow to avoid put-backs, has led them to discount the credit-risk protection they receive from the institutions. Lenders are only willing to make loans intended for purchase by Fannie or Freddie or insurance by the FHA if there is little prospect of default, so that they do not expose themselves unwittingly to the risk that they will bear the cost.”
The solution, according to Parrot and Zandi, is for Fannie and Freddie to strike a balance, easing the aggressiveness of their put-backs to allow lenders to relax credit standards.
“To be clear, the objective is not, and should not be, a return to the recklessly loose standards of the bubble years, but to strike a sensible balance between risk management and access to credit,” they wrote. “Today’s market has overcorrected, and it is hurting the nation’s recovery.”