We learned nothing from the last financial crisis. The housing market is set to collapse, again, and a key culprit, again, is artificial demand created by government policies.
For starters, mortgage-software firm Ellie Mae reports that the average FICO credit score of an approved home loan plunged to 719 in January (the latest month for which data is available) from 731 a year earlier, and well below 2011’s peak of 750.
It’s a dangerous sign lenders are loosening underwriting standards. Lower FICO scores correlate with higher risk of loan default.
The Federal Housing Administration is a big reason for falling credit scores. So are Fannie Mae and Freddie Mac. The government housing agencies have slashed credit requirements under pressure from the Obama administration — like the Clinton administration before it — to qualify more immigrants and minorities with low incomes and “less-than-perfect credit.”
Meanwhile, home lenders are approving more debt-strapped borrowers. According to Ellie Mae, applicants approved for mortgages in January had an average household debt-to-income ratio of 39%, up from 2012’s annual average of 34%. Borrower debt loads have been creeping higher each year since 2012, when Ellie Mae first started tracking such data.
Flip and flop
A recent report by the Office of the Comptroller of the Currency, a federal agency that regulates the nation’s banks, warns that declines in mortgage underwriting standards are mirroring pre-crisis trends.
“Underwriting standards eased at a significant number of banks for the three-year period from 2013 through 2015,” the report said. “This trend reflects broad trends similar to those experienced from 2005 through 2007, before the most recent financial crisis.”
Not since 2006, it noted, have lenders taken on so much credit risk, and it says the hazard will continue to grow this year: “Examiners expect the level of credit risk to increase over the next 12 months.”
A large chunk of the risk is coming from first-time home buyers with shaky credit and so-called “rebound” buyers who previously defaulted on home loans.
This is especially true in hot spots like California, where subprime-mortgage lenders offering interest-only loans with no FICO-score requirements are cropping up from the ashes of Countrywide Financial, the bankrupt Calabasas, Calif.-based subprime giant.The American Enterprise Institute reports that its National Mortgage Risk Index for first-time buyers jumped almost a full percentage point in January from a year earlier, driven by “loose credit standards.” The demand from otherwise uncreditworthy home buyers “is driving home prices up faster than incomes and inflation,” noted Edward Pinto, co-director of AEI’s International Center on Housing Risk in Washington.
In another sign housing is overheating, home “flipping” is red hot again and hitting levels not seen since just prior to the mortgage meltdown. Nationwide, almost 180,000 homes were sold and then resold last year — the highest level since 2007.
In fact, according to RealtyTrac, flipping in a dozen metro areas — including New York, Los Angeles, San Diego, Miami and Jacksonville, Fla. — exceeded peaks set in 2005, when investors took advantage of low interest rates and easy credit.
Analysts warn sales from home flipping artificially inflate home prices, increasing the risk of a housing bubble.
“When home-flipping numbers go up, it is usually an indication that the housing market is in trouble,” said Matthew Gardner, chief economist at Windermere Real Estate in Seattle.
What goes up…
The last housing bubble began inflating in 1997 and lasted 10 years before finally bursting in 2007, in a monumental collapse that crashed markets the world over.
Analysts say the current real-estate bubble started in late 2011, when housing values bottomed. Since then, real median home prices have rebounded to a level that is only about 8% below their pre-crisis peak, which was an all-time record.
Like the last bubble, this one is fueled by artificial demand from government-induced lax lending standards and accommodative interest rates set by the Federal Reserve.
“The result has been a rapid increase in real, inflation-adjusted home prices, with prices up nationally about 16.5% since the home-price trough in 2012,” Pinto said.
He notes that once prices hit 20% or higher, historically, a painful drop in prices follows.
“Home prices are subject to the law of gravity,” he said. “What goes up must come down.”
Pinto noted that prices for entry-level homes have climbed by an even higher 19%, making it harder for low-income borrowers to buy without taking out a high-risk loan they really can’t afford.
Today’s relaxation in mortgage-underwriting standards is largely a function of government housing-policy changes at FHA, Fannie Mae and Freddie Mac, which dominate the nation’s mortgage activity.Yet these kinds of borrowers are qualifying for such home loans thanks to the liberalization of credit terms. New federal rules regulating mortgages under President Obama’s “financial reforms,” despite claims of toughness, are not limiting the volume of high debt-to-income loans. While the rules do recommend a DTI ceiling, they never set minimum down-payment or credit-score requirements.
As in the last easy-credit cycle, we are seeing “the promotion of policy to push firms to seek riskier products to promote growth,” Wells Fargo Chief Economist John Silvia said.
All three agencies have slashed down-payment and other requirements under pressure from Obama regulators, who include, most significantly, former Congressional Black Caucus leader and Obama appointee Mel Watt, head of the new Federal Housing Finance Agency, which now controls Fannie Mae and Freddie Mac.
Modal TriggerLast year, Fannie Mae launched a new subprime-mortgage product called HomeReady that caters to recent immigrants with weak credit and limited income.
The new loan program, which offers “income flexibility,” allows borrowers for the first time to bundle income from roommates and relatives to meet qualifications for income. They only have to put 3% down, and can use gifts from nonprofit groups to subsidize their down payments.
“There is no limit on the number of non-borrower household members who can be present on a single transaction,” Fannie advises originators. And even then there is “documentation flexibility,” a frightening echo of last decade’s “no-doc loans.”
At least before the crisis, your income had to be your own. But now, as a renter, you can get a conventional home loan backed by Fannie by claiming other people’s income. All you have to do in exchange is take a four-hour online course on the responsibilities of homeownership.
You don’t have to show personal financial independence. You can be maxed out on credit cards and even live in government-subsidized housing. Just as long as you round up enough income-earners and pool finances to help meet a debt-to-income ratio of up to 50%.
And you don’t need good credit.
“If the borrower’s credit score is less than the minimum credit score required,” Fannie tells loan underwriters, “the lender may develop an acceptable nontraditional credit profile” that takes into consideration timely payments on electricity bills and car insurance — and even gym dues — in lieu of payments on credit cards and loans.
Under HomeReady, you can even qualify for a “cash-out refinance” of your mortgage, a type of loan that led to over-leveraging and a wave of defaults during the mortgage crisis.
Why would Fannie offer the same kinds of poorly underwritten loans that forced it into bankruptcy? Because HomeReady aligns “with our housing goals” set by Watt, it says in its HomeReady literature. These are the same government affordable-housing quotas that plunged Fannie and Freddie into the subprime market under the Clinton administration.
It’s all part of a government campaign to ease access to home loans for recent Hispanic immigrants — including those living here illegally. In fact, HomeReady caters to illegal immigrants by allowing borrowers to waive Social Security documentation.
The National Association of Hispanic Real Estate Professionals, a pro-immigrant lobbying group, is praising the move, arguing it will bring tens of thousands of Hispanic families into the home market who have been “skipped over” by stingy (meaning prudent and responsible) lenders.
“It’s very encouraging,” NAHREP Chief Executive Gary Acosta said. “It demonstrates that Fannie has done a lot of work on the issue of identifying ways to qualify more people.”
NAHREP is also lobbying heavily for watered-down credit scoring that “take[s] into account the unique spending and savings patterns of Hispanic borrowers,” and it may get its wish.
Watt, who as a congressman once demanded Freddie Mac back loans for welfare recipients in his North Carolina district, has instructed Fannie and Freddie to come up with “alternative credit-scoring models” to FICO and approve more home buyers. “We have the pedal to the metal” on adopting a new model, Watt said.
Home-loan approvals hinge on FICO credit scores, which have a strong track record of predicting risk, says Pinto, who formerly worked as chief credit officer at Fannie Mae. They are the bedrock of the modern financial system.
But the Obama regime views FICO scoring as too strict, “unfairly locking” millions of low-income minorities and immigrants out of homes. So it’s pressuring Fannie and Freddie, which control 57% of primary-home-purchase loans and set the underwriting standards for the entire mortgage industry, to abandon reliance on FICO for a more accommodating standard for evaluating credit risk.
Watt and other regulators look favorably on “nontraditional credit,” such as rent, utility payments and other factors that studies show have little value in predicting default risk. The administration’s goal is to basically inflate credit grades by the end of 2016, and promote an estimated 20 million unbanked and “unscorable” from the rental market to the mortgage market.
The plan, of course, would inject a massive source of new risk into the financial system and potentially speed another mortgage collapse.
“This is not a great group, credit-wise,” Pinto said. “You’re picking up a lot of young people just out of school, and a lot of immigrants and minorities who tend to have poor credit.”
Just because a loan applicant is suddenly scorable under a new, easier standard tailored to their “unique” credit habits, it doesn’t mean he or she is suddenly creditworthy, he pointed out.
“These are really risky borrowers who don’t hold up well under economic stress,” Pinto added.
But the affordable-housing zealots in the administration don’t care.
The Federal Housing Finance Agency, the Department of Housing and Urban Development and the Federal Housing Administration, as well as the Justice Department, are running a full-court press on lenders. They’re hell-bent on “expanding the credit box,” which has shrunk since the last government-led housing bust, especially for low-income minorities, and the only way to do that is to inflate credit scores.
Watt hopes a decision can be made on transitioning to a new credit-scoring model sometime over the next few months.
The hope is that the new standard will lift scores by as much as 100 basis points, thereby qualifying millions of low-income African-Americans with subprime credit and Hispanic immigrants with thin credit for home loans.
Of course, those same minority homeowners will be hit the hardest when the entire house of cards collapses.
Once again, real-estate prices are outstripping income. But this time, income levels are much lower — real wages fell again in February — and when the bubble bursts, the pain will cut deeper.