There is evidently no idea bad enough and no failure severe enough to stop the government from trying it once again. In myopia remarkable even by abysmal government standards, the White House is pushing for policies that fueled the housing bubble, which burst a mere five years ago. Reintroducing those policies at this stage of a nascent recovery in the housing market will set the stage for repeating history, and very likely leave taxpayers on the hook once again for another bailout.
Last week, the administration began exerting pressure on banks to lend to people with lower credit scores, arguing that the gains from the current modest recovery are largely being captured by either investors or provident people with excellent credit scores, and that this strategy leaves out a pool of potential purchasers. The problem is, of course, that banks are in the business of making profits. Some bank surely would lend to these people if it made sense to do so. Under the current legal and economic circumstances, it does not, in fact, make any sense to make these loans. Far from fueling growth, distorting the market further will make economic recovery that much more difficult.
The main problems with the functioning of the housing market are the extensive intervention by government on the one hand and monetary policy that keeps interest rates at levels extraordinarily low by historical standards on the other. The housing market is further distorted by the existence of Fannie Mae and Freddie Mac, which remain major players, and the Federal Housing Administration (FHA), which generates a third of new loans, well above its pre-bust and even pre-bubble share.
The FHA’s role traditionally has been restricted to providing insurance for people with down payments as small as 3.5 percent of the purchase price, and credit scores too low to qualify for a mortgage without this federal insurance. The role changed with the bursting of the housing bubble and the Federal Reserve’s policy of loose money, which drove interest rates down far below historical levels. With mortgages at less than 5 percent, and often lower, the return to banks shrank. At these low interest rates, banks had little incentive to accept risk. Accordingly, they made their loans as low-risk as possible, limiting themselves to borrowers with significant down payments and stellar credit. The result was that new home purchases fell precipitously for people with respectable — but not perfect — credit.The FHA’s existence exacerbated the problems of the housing market. In theory the FHA — that is, the taxpayers — insure against the risk of default to encourage banks to make loans to people with less money to put down or with mediocre credit scores. Even FHA-insured loans saw borrowers’ average credit scores rise, following years of investigations into alleged wrongdoing by lenders, including a lawsuit filed last year against Wells Fargo, the nation’s largest mortgage lender. Banks quite rationally feared that they would be left holding the can if FHA-insured borrowers defaulted, and they reacted to the regulatory environment by declining to make higher-risk loans.
Caught between the rock of low interest rates and the hard place of federal penalties, banks are lending less. Using FHA to ramp up lending is a policy doomed for failure. It already has a negative net worth of more than $32 billion, and a capital shortfall of at least $52 billion, according to the American Enterprise Institute’s Ed Pinto. Almost 16 percent of its loans are in delinquency. Expansion almost certainly sets up the agency for a taxpayer bailout.
While homeownership is all very well, Pushing ownership on people who cannot afford it is a policy destined to backfire. In a particularly cruel twist, policies designed to make homeownership affordable leave those who can least afford it worse off, and inflict greater damage on the more modest neighborhoods where these families reside. Prince George’s County in Maryland, for example, was hit harder by the bust than wealthier neighboring Howard County. Higher rates of foreclosure, which are inevitable when families take on mortgages they cannot afford, damage not just the borrowing families but also the neighborhoods left with empty houses.Instead of further distorting the housing market, we should be trying to reduce the extent of government intervention across the board. Low interest rates reduce the supply of mortgages, but demand is constrained by the lack of new jobs, particularly from young people already struggling to pay off student loans and facing higher rates of unemployment.
Coercing banks to make loans that defy basic economics will simply set the stage for another bubble-bust cycle and the trauma that ensues.
Nita Ghei is policy research editor at the Mercatus Center at George Mason University.