Rolling the dice, again

The headline on Reuters at Mon Oct 20, 2014 6:05pm EDT read “U.S. regulator targeting lower down payments on mortgages.” At first, we thought perhaps the headline was from 2004, not 2014. After the financial crisis of 2007-2009, it seemed inconceivable that U.S. authorities would again put some of the largest U.S. intermediaries – or the taxpayers who provide for them – at risk of failure. Sadly, we were wrong.

In a speech to the Mortgage Bankers Association, Melvin L. Watt, the Director of the agency that regulates Fannie Mae and Freddie Mac, made the following statement:

“To increase access for creditworthy but lower-wealth borrowers, FHFA [Federal Housing Finance Agency] is also working with the [Government-Sponsored] Enterprises to develop sensible and responsible guidelines for mortgages with loan-to-value ratios between 95 and 97 percent.”

What Reuters dutifully reported is that the FHFA is developing rules to allow government guarantees on mortgages where borrowers put down as little as 3 percent of the purchase price. Ironically, Mr Watt delivered this astounding news in Las Vegas, where today, house prices are still more than 40% below their pre-crisis peak (see chart).

S&P/Case-Shiller Index of Housing Prices: Las Vegas and 20-city Average

 Sources: S&P Dow Jones Indices LLC and FRED.

Sources: S&P Dow Jones Indices LLC and FRED.

We can only hope that the U.S. government will quickly abandon this plan. The global cost of the financial crisis has been measured in the tens of trillions of dollars. While the crisis had many causes, it was initially known as the U.S. subprime crisis for a reason. Highly-leveraged lenders took on enormous risks and encouraged U.S. households to do the same. As a result, many people who could not afford to make mortgage payments became homeowners with little or no equity. In effect, they were renters who owned an option on the upside of the house price. We know how that turned out: the House of Debt came tumbling down with the price of houses.

Today, most jurisdictions are trying to figure out ways to ensure that borrowers can afford their mortgages.  This generally means raising the minimum down payment (or lowering the maximum loan-to-value ratio) to lower leverage and reduce the probability of default. We know of no other regulator who proposes to return to the good old days of a decade ago.

Put simply, it is difficult to overstate how bad this idea is.  

Let's be clear: we are not against homeownership. And we are not against subsidizing homeownership for young families or first-time homeowners. But there are good ways and bad ways to provide that subsidy. As we explained in an earlier post, if the government wishes to promote homeownership, it should provide people with home equity, not more “cheap” debt. We hope that the proponents of this plan, who supervise Fannie and Freddie, will read it.