Slow-Motion Katrina. Rep. Barney Frank's House Committee on Financial Services began its hearings on the meltdown in subprime mortgage credit this morning, taking testimony from key regulators. I would be surprised if the resulting policy changes are bold enough.
Congress first needs to act to prevent a rolling epidemic of foreclosures, that will only depress property values and, in turn, create more foreclosures. We need to help both innocent borrowers who filed good faith applications, and those who were the victims of either a bait-and-switch mortgages or of a falling housing market. I'd exclude speculators. "Only" one to two million homes are expected to go into foreclosure in the next year because of back-loaded hikes in interest rates -- unless Congress or the executive branch does something big.
On a national scale, two million foreclosures would represent a lot of heartbreak and would accelerate the slide in housing prices, but some experts argue that the overall economic hit would not be that severe. However, a lot of these expected foreclosures are highly concentrated in low income and minority neighborhoods, and for those areas this is a true Depression-scale disaster. Think of it as Katrina without the water.
Like the response to Katrina, the Bush's administration's proposals are too little and too late. These borrowers are precisely the people targeted by Bush's "Ownership Society" rhetoric -- hard working low income, first time homeowners aspiring to join the American dream. The Democrats are proposing to have Fannie Mae and Freddie Mac refinance some of these distressed mortgages, but what we really need is something like FDR's Home Owners Loan Corp, which refinanced millions of homes during the Great Depression. Applicants would apply for refinancing, and would be assessed on whether they were speculators or bona fide owner-occupants deceived by misleading terms.
The cost to the government of subsidizing the interest would be in the single-digit billions. That's not petty cash, but it's a lot less than the cost of the Savings and Loan collapse of the 1980s (over $400 billion), and if the result is to stave off a cratering of housing values or a further hit to credit markets, the national benefit could be in the trillions.
Predators as Housing Policy. Ever since the subprime scandal broke, the mortgage industry presented itself as the virtuous friend of the low-income homebuyer -- even though the industry knew full well that the escalating payments were beyond the reach of many, and represented pure legal larceny for others. The deeper reason for the ability of predatory lenders to get into this business is the fact that the federal government has all but exited the business of helping first time homebuyers.
For an example of what can be done with creative policy, here is part a letter I received after my most recent piece on the subprime scandal, from Clark Ziegler, executive director of the Massachusetts Housing Partnership.
After the 1989 Boston Federal Reserve study on discrimination in mortgage lending, we joined up with community groups to create the Soft Second Loan Program, which was negotiated with the Mass. Bankers Association, Fannie Mae, and the major banks (all of which are now gone): Shawmut, BayBank, BankBoston, Boston Five, etc. The program was launched in 1990 and has now provided $1.5 billion in financing for more than 10,000 low-income, first-time homebuyers across Massachusetts. The delinquency rates are no higher than conventional mortgages (currently just above 2 percent) and we've only had 37 foreclosures over the course of 17 years, despite the fact that most borrowers are below 65 percent of median income. Minority borrowers account for more than two-thirds of our loans in Boston and nearly half of our loans statewide.
The elements of our program are almost exactly what you suggested… mandatory pre-purchase counseling from an approved nonprofit agency, a fixed-rate graduated payment structure where state funds subsidize the interest rate in the earlier years, 3 percent minimum down payment, real underwriting standards (no exceptions from Fannie Mae debt/income ratios without compensating factors), post-purchase support, and immediate contact from a nonprofit counselor whenever a borrower is more than 30 days delinquent. The banks provide a rate discount, don't charge any points, and agree to a state loan loss reserve fund in lieu of mortgage insurance…
I think our program is a great example of what can be achieved by bringing public funding to bear in an appropriately-regulated mortgage market.
The larger point here is that the federal government needs to get back in the business of subsidizing first time homeownership and policing credit standards, rather than leaving aspiring homeowners to the tender mercies of predatory lenders.
Here a Little Slice, There a Little Cut. The real enablers of this disaster were the big investment banks, with the help of the bond-rating agencies like Moody's and Standard and Poors. The bankers advanced credit to unregulated mortgage companies, then they bought the mortgages, and working with private bond-rating agencies they sold off the paper to investors like pension funds. At each step along the way, all of the middlemen took their cut, at the expense of borrowers. This affair is entirely unregulated, although the Federal Reserve and the SEC have all the unused regulatory power they need to police both loan origination terms and the process of assigning supposed risks to so called securitized mortgage credit. Once again, we've learned that finance is too important to be left entirely to financiers.
I'll have more to say about the Barney Frank hearings shortly. Let's see who steps up to the plate, and who is content to let this crisis fester and worsen.
