Surprise! Mortgage Standards Being Lowered

As you no doubt know, various government agencies have moved the ball pretty far down the field with respect to loosening down-payment requirements for loans from Fannie and Freddie. The return of the 3% down mortgage seems to be pretty much assured. Arnold Kling offered this with respect to a Calculated Risk post on the availability of mortgage credit.

Is mortgage credit too tight?–Calculated Risk.

Not by the standards currently set by politicians. If you tell banks you have zero tolerance policy for making type I errors (making loans that eventually default), you have to expect many type II errors (passing up good loans). Of course, 10 years ago, the political pressure was the opposite.

The standards to which he refers are the multibillion dollar fines levied for past mortgage origination sins. Banks naturally took these actions as a not so subtle clue to tighten loan standards. We could differ on the reasons the fines were imposed but the political class has at least given lip service to the idea that a return to the old regime was unacceptable. In essence they profess to have learned their lesson well – until now.

Consider these two graphs. The first one shows the relationship between credit availability, or perhaps more appropriately relative looseness of standards, to mortgage delinquencies. You can overstate the correlation in this data, demographics, interest rates and consumer psychology likely played a big part in this disaster, but the easy availability of credit was certainly a contributing factor. . I do wish I could find an HCI which went back further as a comparison to today’s lending standards, but this is all I have or could find.

The second graph traces the performance of median home prices since 1970. Notethat the dips have been just that, blips, not catastrophic crashes save for what began to transpire in 2006. The point being that real estate cycles, particularly as they relate to single family homes are typically very long.

So to Kling’s observation that the politicians have pushed banks towards tight standards in an effort to avoid type I errors, I doubt that they know the difference between type I and type II errors. The fines and posturing were merely grabs for money and a means of directing blame towards the financiers (not to say that they weren’t culpable) and away from the policy errors which contributed to the debacle. Politicians and the real estate industry, including the financial sector, are well aware of the second graph. They know full wellthattoday’s laxity is unlikely to come home to roost for a long, long time, while the rewards politically and financially come with little risk, at least for the current participants. Certainly, this is just the first step back down the same tired old road and another disaster will ensue, but the risk of error right now is passingly small, the rewards large and the eventual disaster a problem for someone else.

The U.S. is addicted to the 30-year fixed-rate mortgage. It’s a financial product which is non-hedgeable and thus exists solely via the use of the government’s balance sheet. Absent abandonment of it, the extension of mortgage credit and the terms which accompany those loans is going to be subject to political whims and those whims will inevitably be slanted towards easy credit.

1.Sorry this ran over into the marging. Going to have to work with my tech guy on how to avoid this. If you want to give me free advice feel free to do so.

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