The Second Coming Of Housing Horrors – Shah Gilani – What Moves Markets – Forbes
The Second Coming Of Housing Horrors
Mar. 22 2011 – 10:42 am
By SHAH GILANI
The FHA insures mortgages that conform to their underwriting standards. Too bad their standards aren’t very high.
The housing market is nowhere near its bottom.
In fact, the second punch of a devastating one-two combination is about to be thrown.
Housing prices are already reeling from the huge overhang of shadow inventory, courtesy of stalled foreclosures and sellers waiting for price firming before putting out their for-sale signs.
But as far down as home prices have fallen, they still have further to go.
With the realization that easy and cheap financing isn’t going to be available for would-be buyers, banks sitting on big inventories and impatient sellers will resort to lowering prices again.
There’s just no way the housing market can recover if buyers can’t afford mortgages.
I’m not even talking about the negative impact rising interest rates would have on the mortgage market, that’s a problem we’ll have to face farther on down the road. I’m talking about the likelihood of having to come up with a 20% down-payment.
The Dodd-Frank Act, enacted last year, calls for lenders to retain 5% of the credit risk they would normally pass along when they pool loans into mortgage-backed securities to sell to investors. Banks aren’t all that keen on keeping loans on their books because they have to hold reserves against all their loans in case there are repayment issues. Even holding 5% of a MBS on their books represents a liability against which reserves must be held.
But there’s a way for lenders to not have to endure the 5% risk retention requirement. If mortgages are made against a 20% down-payment, and better income documentation and higher underwriting standards are met, those loans are considered “qualifying residential mortgages” and the risk retention requirement is waived on a pool of those mortgages.
Of course there’s a problem with putting down 20%. It’s extremely prohibitive for most would-be buyers. According to California-based CoreLogic, “nearly half of all current homeowners with a mortgage and 70% of first-time buyers would not make the cut.”
For the past few years lenders have been raising underwriting standards and down-payment requirements. Banks now have to keep more loans on their books because the securitization market is dead and they haven’t been able to easily offload mortgages like they used to in the past. As a result fewer people are able to meet the new higher standards lenders are incorporating to protect themselves.
So, where did buyers with no meaningful down-payment money and poor credit-ratings end up going for their mortgages over the past few years?
To the government of course.
The Federal Housing Administration (FHA) insures mortgages that conform to their underwriting standards. Too bad for taxpayers the FHA’s standards aren’t very high.
Conforming loans that the FHA insures require only a 3.5% down-payment and often as little as only a 550 credit score (that’s been raised recently).
A report from the George Washington University School of Business found that almost 56% of home-purchase mortgages made in 2009 were FHA insured. That’s up from only 6% in 2007. Not only did the FHA save the day for low income home buyers, whom they were meant to help, in high-cost markets loans for up to $729,750 can qualify as “conforming.” If it wasn’t for the FHA the housing market would already be a lot lower.
With only a 3.5% down-payment, a home’s price doesn’t have to fall too far before the loan is underwater, meaning the borrower owes more than the house is worth. A tiny 4% drop can be the beginning of real trouble if the price falls more and a homeowner with no real “skin-in-the-game” walks from the loan. That’s been happening a lot.
Taxpayers are sick of picking up the tab for government-backed mortgage financing programs that are too easy for borrowers to walk away from. The FHA’s programs are already facing scrutiny and may face dramatic changes and possibly future unwinding.
The signposts all point in the same direction. With over 6 million homeowners already having been foreclosed on over the past 3 years and another 3 million likely to face those dim prospects, inventory overhang is going to remain very, very high.
Now, with the high hurdle of a 20% down-payment and increasingly tough underwriting standards becoming the norm and government sponsored entities being bridled back from their runaway generosity, housing may be facing a knockout blow.
A lot of investors have been eagerly anticipating a bounce in the housing market and with that a bounce in homebuilder stocks like Toll Brothers , Lennar Corp., and KB Home. It looks like they’re going to have to wait a lot longer.
In the meantime, with all those foreclosed houses sitting idle and in need of repair once they are sold, and with folks holding on to their old homes longer, I’m betting that Home Depot and Lowe’s won’t give investors a black eye.