Re-Inflating the Housing Bubble?

It is well-documented that a key factor in the subprime mortgage crisis was the relaxation of lending standards by banks.  As a result of laxer standards, people with shaky credit histories were able to obtain mortgages which vastly exceeded their income, sometimes without even a down payment.  When these homeowners began defaulting on their mortgages, the housing market plummeted and the shock waves rocked the global economy.

The housing market has since stabilized.  A clear sign of this is the improving health of the government-sponsored entity Federal National Mortgage Association (“Fannie Mae”).  Fannie Mae plays a key role in the housing market by purchasing mortgages from the banks that issued them, which frees up the bank’s capital, which in turn lets the banks make loans to more prospective homeowners.  Fannie Mae often securitizes the mortgages it buys from banks, and for a small fee, guarantees the investors who purchased these mortgage-backed securities that they will receive their principal and interest even if the homeowners default.

While Fannie Mae received billions in government aid during the subprime crisis, it has turned things around; it reported over $17 billion in net income for 2012, the highest in the company’s history.  The average weighted credit score in its portfolio of mortgages is an impressive 761 and the serious delinquency rate on those mortgages has dwindled to 3.3 percent.  The data thus suggests that tightening lending standards has helped Fannie Mae’s bottom line.

The tightening of lending standards, however, means that some people who wish to buy homes- often young people or people with low incomes- are unable to do so.  An April 2013 Washington Post article stated that purchases of new homes by people with fair credit scores (from 620 to 680) declined an astounding 90 percent between 2007 and 2012.  In addition, people who wish to refinance their mortgages to take advantage of historically-low interest rates are sometimes unable to do so if their equity in their house is too low.

Lobbyists in the real estate and housing industries claim that the inability of people to purchase homes and to refinance existing mortgages make the housing market more sluggish than it should be.  These advocates for looser lending standards point out that the housing market often has a “ripple effect” across the economy.  The Obama administration recently added its voice to the call for relaxed lending standards.  The Washington Post article claims that “Housing officials [in the Obama administration] are urging the Justice Department to provide assurances to banks, which have become increasingly cautious, that they will not face legal or financial recriminations if they make loans to riskier borrowers who meet government standards but later default.”

There are two obvious problems with the call for laxer lending standards.  First, banks are likely hesitant to offer mortgages to lower-income Americans while addressing a wave of lawsuits stemming from the subprime debacle, which often allege racial discrimination or fraud.  Second, the American taxpayer should be very concerned with a call for less stringent standards; if history repeats and another subprime mortgage crisis occurs as a result of loans being made to people with poor credit histories, the American taxpayer is likely to foot the bill for bailing out Fannie Mae and other entities once again.

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