Another Housing Crisis?

In the wake of the great recession many Americans lost a job and that eroded their financial footing.  Constrained income led many to default on their mortgage and borrow from credit card “funds” to cover priorities such as car loan payments. Families who did not regain jobs comparable to the ones they lost were sometimes forced into foreclosure and bankruptcy.  The swoon in home prices and the large number of foreclosures caused investors to question the safety of the mortgage bonds that Fannie Mae and Freddie Mac had sold. The risks surrounding mortgage bonds earned the name “mortgage meltdown.”

The lack of faith in mortgage bonds afflicted the many large banks that held them in their portfolios.    To quell the fear that banks may be unable to convert those bonds into full value cash, the federal government offered low cost loans to big banks and doubled its Federal Deposit Insurance guarantees on consumer deposits.  As well, the Dodd-Frank legislation promised regulators who would better supervise the mortgage industry, the banks and brokers so that a taxpayer bailout would not be needed again.  The combination of loans and guarantees helped dissuade consumers and businesses from draining their bank deposits.

The restored calm allowed the main street economy and stock market to begin a slow recovery that continues to this day.  While the unemployment rate has dropped from near 10% to below 5%, many workers chose to remain outside the labor force.  Some high tech and well-paying technical jobs have migrated offshore permanently.  Labor productivity has been disappointing and as a result, many of the available jobs in recent times have been low paying.  The recovery has been welcomed but weak.  GDP has not grown at a level typical during a recovery.

Going forward the administration promised special care that mortgages would be issued only to those who could repay them.  “Low-documentation” and “liar loans” were common practices in the inept underwriting and assessment of ability to repay that led to risky mortgages.  Today, however, some of the risky practices continue for political reasons.  A fifth of mortgage loans since 2012 include down payments of 5% or less and “One big bank admits that it is selling at face value high-risk loans to the government that it expects will make a 10-15% loss due to homeowners defaulting.”  When a homeowner believes his small equity has been washed away by low home prices, there is far less incentive to take painful steps to keep mortgage payments current.

Unlike in 2007 and 2008, when banks held most of the mortgages, “banks have partially withdrawn from the mortgage game after facing swathes of new rules and $110 billion of fines for misconduct.”  Recently Fannie Mae, Freddie Mac, Veterans Affairs, the Federal Housing Administration and Ginnie Mae collectively own or have guaranteed $6.4 trillion in loans.  This time, if mortgage bonds sour, government will be holding about half of the mess.

In this recovery, families hoping to buy their own home have saved enough for a minimum down payment on a house, helped by today’s relatively low mortgage rates.  But housing is not their only commitment.  Student loans are another monthly drain on family income that averaged $242 back in 2010 when students borrowed half as much.  Americans owe $1.26 trillion in student loans and 11% of graduates are paying in arrears.

After buying a home there is a temptation to furnish it even if that means using a credit card.  Likewise, a home in the suburbs often calls for more than one car.  Credit card debt has reached $729 billion after a small decline following the great recession.  Auto loans total $1.1 trillion and new car loans averaged $482 per month in late 2015.  Even without lavish spending, a family’s income is quickly consumed by mortgages, car loans, credit card debt and student loans.

Just as in 2007 and 2008, an employment disturbance (e.g. unfavorable changes in international trade, geopolitical stresses, high interest rates or natural disasters) could destabilize families living paycheck to paycheck.  If they react as did families in 2008, they will slew spending to the highest priorities such as automobile payments and food.  Mortgages will take a position lower in the queue.  But this time, it will be the government agencies which face mortgage bonds of dubious value.  Of course they are backed by taxpayers.

Today’s home prices are not as frothy and mortgage underwriting is not as inept as in the days leading to the recession.  Nevertheless, the will to assess risk and underwrite mortgages competently seems to have been misplaced.  Once again the taxpayer will be the financial backstop for those decisions.

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