The Last Story of 2014: Will New "Relaxed" Mortgage Standards Lead to Another Housing Bubble?
We picked this last story for 2014, as it's not gotten much attention since first revealed by the press in November. Some large lenders will relax standards for mortgage applications. So with "relaxed" standards, will a new housing bubble blow up? Apparently not.
To understand this new turn of events, remember that the banks' imprudent lending resulted from the government's insistence that they loosen their standards. The theory behind this loosening was at first a claim that people who lived in certain neighborhoods were the victims of some form of prejudiced treatment based on either their economic status, their race, or some combination thereof. The government used a carrot and stick approach to encourage, and in some instances force, banks to lend to people who historically would not be considered good risks. The Democrats especially pushed this phase of the loosening.
But while some Republicans may have objected to this phase, they came up with their own agenda that ultimately resulted in looser standards. They decided that America was better off if more people owned their own home rather than rent. And in order to spread the "benefit" of home ownership, they created their own set of rules and regulations that, again, encouraged banks to grant mortgages to people who historically would not be considered good risks. And so, over time, the increased lending created its own momentum, serving the political agendas of both parties, the one championing certain disadvantaged people who really couldn't afford to own a home, the other championing a theory that wider ownership of homes somehow benefited the "greater good," with the result that people who really couldn't afford to own a home could now - by some sort of magic - now afford to own a home.
So what really happened then was that mortgages sold to home owners who were less than creditworthy - so-called "sub-prime loans" - were sold by the lenders to Fannie Mae and Freddie Mac, who apparently turned the other way while this fraud was perpetrated. And having ignored the fraud, Fannie and Freddie sold these loans to Wall Street firms who "packaged" them and sold these packages to investors, with "AAA" ratings from rating agencies who, knowing the loans were garbage, claimed that by having the garbage collected and placed into a special "security" by Wall Street firms somehow magically transformed this junk into a highly-rated investment fit for pension plans, endowments, even rich individuals.
As you might imagine, Wall Street raked in enormous commissions fees packaging and selling these loans. And as the money poured in, the demand for more mortgages to package and sell grew, which led to the final stage of this housing bubble. Additional mortgage products were developed which were not only based on looser qualifying standards, but also consisted of loans granted to prospective home buyers who simply lied about their finances, putting down false information regarding their income and assets on applications. They got away with lying, because no documentation was required to support the written applications. These were the so-called "liar loans" you probably heard about.
Now, if you thought that banks would eventually pay a price for these liar loans, that a day of reckoning would eventually bite the banks right where it hurts, that's understandable. Any reasonable person might conclude this. But that's not what happened.
After this chicanery led to the 2007-2008 financial collapse and what has been called the "Great Recession," Fannie and Freddie, acting like they didn't know that banks had sold them garbage, then forced the banks to buy back the loans. (Remember that Fannie and Freddie were on the verge of collapse because of their own financial mismanagement themselves and needed cash - provided by selling the loans back to banks - to avoid bankruptcy.) And all through this, the vast majority of executives running this scam not only avoided any negative repercussion, but continued to collect their ample bonuses (as did the executives of Fannie and Freddie, by the way).
Is it possible this new loosening of standards could signal "Return of the Housing Bubble"? One hopes not. One hopes that the looser standards will be constrained by prudent underwriting guidelines. Can we justify our hopes? Perhaps at the moment, yes. It seems Wall Street has gotten itself busy with pooling and packaging sub-prime auto loans and sub-prime student loans these days, so they don't really need to revisit mortgages - at least not yet. Maybe the new standards will - as is the stated intention - allow qualified buyers to qualify for an appropriately sized mortgage. It could happen, you know.
In any event, we'll leave this story to continue in 2015, and sign off for 2014. Stay safe tonight, especially if you plan to go out to a New Year's Eve party. If you don't know what "defensive driving" means, don't go out tonight. If you do, stay sharp and get yourself home safely.
We'll see you next year.
The new guidelines, to take full effect Dec. 1, resulted from an agreement in October meant to clarify when lenders would be penalized for making mistakes on mortgages they sell to Fannie and Freddie. Lenders have blamed the lack of clarity for tight credit conditions that have made it difficult for many consumers to qualify for a mortgage.You see, as a result of the collapse of the residential housing bubble in 2006-2007, lenders paid a pretty penny in penalties for their imprudent selling of mortgages to unqualified home buyers providing the fuel that ignited the blowing up of the bubble in the first place. And if you didn't know what really happened, how and why banks sold mortgages to unqualified buyers, you might think that their penalties were simply just punishment for bad lending practices. And you might think that after a period of appropriate penance for their financial sins, this "relaxation" would be a kind of natural return to an ordered world of prudent underwriting. But all that, even as reasonable as it might sound, captures neither what happened then nor what's happening now.
To understand this new turn of events, remember that the banks' imprudent lending resulted from the government's insistence that they loosen their standards. The theory behind this loosening was at first a claim that people who lived in certain neighborhoods were the victims of some form of prejudiced treatment based on either their economic status, their race, or some combination thereof. The government used a carrot and stick approach to encourage, and in some instances force, banks to lend to people who historically would not be considered good risks. The Democrats especially pushed this phase of the loosening.
But while some Republicans may have objected to this phase, they came up with their own agenda that ultimately resulted in looser standards. They decided that America was better off if more people owned their own home rather than rent. And in order to spread the "benefit" of home ownership, they created their own set of rules and regulations that, again, encouraged banks to grant mortgages to people who historically would not be considered good risks. And so, over time, the increased lending created its own momentum, serving the political agendas of both parties, the one championing certain disadvantaged people who really couldn't afford to own a home, the other championing a theory that wider ownership of homes somehow benefited the "greater good," with the result that people who really couldn't afford to own a home could now - by some sort of magic - now afford to own a home.
So what really happened then was that mortgages sold to home owners who were less than creditworthy - so-called "sub-prime loans" - were sold by the lenders to Fannie Mae and Freddie Mac, who apparently turned the other way while this fraud was perpetrated. And having ignored the fraud, Fannie and Freddie sold these loans to Wall Street firms who "packaged" them and sold these packages to investors, with "AAA" ratings from rating agencies who, knowing the loans were garbage, claimed that by having the garbage collected and placed into a special "security" by Wall Street firms somehow magically transformed this junk into a highly-rated investment fit for pension plans, endowments, even rich individuals.
As you might imagine, Wall Street raked in enormous commissions fees packaging and selling these loans. And as the money poured in, the demand for more mortgages to package and sell grew, which led to the final stage of this housing bubble. Additional mortgage products were developed which were not only based on looser qualifying standards, but also consisted of loans granted to prospective home buyers who simply lied about their finances, putting down false information regarding their income and assets on applications. They got away with lying, because no documentation was required to support the written applications. These were the so-called "liar loans" you probably heard about.
Now, if you thought that banks would eventually pay a price for these liar loans, that a day of reckoning would eventually bite the banks right where it hurts, that's understandable. Any reasonable person might conclude this. But that's not what happened.
After this chicanery led to the 2007-2008 financial collapse and what has been called the "Great Recession," Fannie and Freddie, acting like they didn't know that banks had sold them garbage, then forced the banks to buy back the loans. (Remember that Fannie and Freddie were on the verge of collapse because of their own financial mismanagement themselves and needed cash - provided by selling the loans back to banks - to avoid bankruptcy.) And all through this, the vast majority of executives running this scam not only avoided any negative repercussion, but continued to collect their ample bonuses (as did the executives of Fannie and Freddie, by the way).
Is it possible this new loosening of standards could signal "Return of the Housing Bubble"? One hopes not. One hopes that the looser standards will be constrained by prudent underwriting guidelines. Can we justify our hopes? Perhaps at the moment, yes. It seems Wall Street has gotten itself busy with pooling and packaging sub-prime auto loans and sub-prime student loans these days, so they don't really need to revisit mortgages - at least not yet. Maybe the new standards will - as is the stated intention - allow qualified buyers to qualify for an appropriately sized mortgage. It could happen, you know.
In any event, we'll leave this story to continue in 2015, and sign off for 2014. Stay safe tonight, especially if you plan to go out to a New Year's Eve party. If you don't know what "defensive driving" means, don't go out tonight. If you do, stay sharp and get yourself home safely.
We'll see you next year.
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