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The Housing Bill has passed in the Senate with some Republicans grousing that it is an unfair bailout at the taxpayer’s expense.

Some highlights:

Increase the Federal Housing Administration’s role.

Establish a stronger regulator for the GSEs.

Permanently increase “conforming loan” limits.

Create home-buyer credit.

Bar down-payment assistance for FHA loans.

Create an affordable housing trust fund. Give grants to states to buy foreclosed properties.

Bolster Fannie and Freddie
All of these moves are good moves. We need a stronger and more vital FHA; the FHA rotting on the shelf is precisely what created the vacuum filled by the sub prime niche. The aid to Fannie Mae and Freddie Mac are controversial, but I support them. I am a free market guy, but the government has to act in some cases, and this is one of them. Unlike the S & L scandals and subsequent bailouts in the late 80’s, aid to F & F is not rewarding bad lending. As a matter of fact, if more people went conventional, the magnitude of the problem would be diminished. Fannie and Freddie sustained collateral damage from sub prime; they were not part of it. We all should remember that.
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I make no secret that I stand quite a bit to the right of the NY Times editorial board on most fiscal matters. In today’s editorialon the presidential candidates, the Times portrays McCain as a Whig and Obama as a Caped Avenger. Both portrayals are problematic. Most government solutions are window dressing at best and have terrible unintended consequences; the last thing we need is feel good political maneuvering for hard core problems. We already know the solution, and the president who will make the most difference is actually Roosevelt. The FHA made a difference in the 30’s. It will help just as much now.

The government has already expanded the FHA to both cover for the gaps in the credit crunch and ensure that future systemic problems will be avoided. Just yesterday they waived the 90 day waiting period on rehabbed resales (“flips”). I propose that the bulk of government aid be to lenders who responsibly allow for defaulting borrowers to exit via a short sale. That would allow a more organic return to a normal market and minimize the unintended consequences of many government panaceas.

The editors of the Times either don’t know or don’t care that less is more. The damage has been done, and while we need more from Uncle Sam, the focus should be more on the preventative than the curative.

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In light of my earlier post framing the FHA loan program as part of the solution to an industry recovery, the NY Times is reporting that the program has lost $4.6 billion. The article does not say if it was in the past 12 months or in 2007. It doesn’t matter. The problem is not the program itself.

Brian D. Montgomery, the F.H.A. commissioner, attributed the unanticipated losses primarily to the agency’s seller-financed down payment mortgage program, which has suffered from high delinquency and foreclosure rates in recent years.

In other words, legalized fraud. If I were selling you a home and I funneled you a 3% down payment in an undocumented side deal, I would be a criminal. But if we were to funnel the money through a “nonprofit,” it would be kosher. But the result would be the same: the borrowers would have no skins in the game so to speak, and the default rate would be far higher.

The lesson is clear. 100% financing, zero down, or whatever nomenclature you choose to use, causes more harm than good. People who do not have their own money in the deal do not have enough at stake. To put it another way, if you have no money for even a 3% down payment, you have no business buying a house. The FHA, therefore, is right to drop this practice post haste.

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This is a commentary that I submitted to the Journal News recently that they have not (yet) published.

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With the problems facing the real estate and mortgage industries, I look to the Oval Office to be the catalyst in the recovery of the nation going forward. I am not referring to President Bush, nor am I referring to the hypothetical Presidents McCain, Obama, or Clinton.

 

The president who will make the biggest difference in solving the current crisis is Franklin Delano Roosevelt.

 

It is hard to conceive that a free market, right leaning capitalist who abhors government bureaucracy like myself would invoke FDR. However, a realist with a rudimentary understanding of what makes our industry work will understand.

 

It can be argued that the National Housing Act of 1934, which gave birth to the FHA mortgage program was the single most important piece of FDR’s New Deal legislation outside of the Social Security program. FHA made millions of previously unqualified Americans eligible for home ownership by significantly lowering the barriers to entry. A 3% down payment replaced the typical a 20% previously required. Conventional credit restrictions were relaxed. Uncle Sam would insure the loans, which was unheard of at that time. It was an innovative expansion of the home buyer base, put people back to work, and stimulated the economy.

 

Some conservatives at the time saw the Program as a naïve and risky ploy to buy votes from the democratic blue-collar base. Yet 62 years later in 1996 when I started my career in real estate, the program’s efficacy was firmly established. Its foreclosure rate was low. The interest rates were competitive. The red tape one expected of a government program was surprisingly manageable. Appraisals were more stringent than those of other loans, but understandably so, given the increased importance of collateral in highly leveraged, often credit-challenged scenario. It had been the go-to home purchase program for the citizenry for decades because it worked for borrower and lender alike.

 

Pragmatic management kept the Program in step with the times, from GI’s returning from overseas in the 40’s to single women in the 90’s.  Loan amount limits varied by market area and were raised when needed. Racist underwriting guidelines were expunged in the 60’s when fair housing laws were passed. When tweaking was needed, it was done regardless of administration or what party was in the majority.

 

Unfortunately, in the post 9/11 spike in home values, the Program stopped changing with the times. Ignoring market trends, the ceiling for an FHA loan on a single-family home in Westchester County was a paltry $290,319 in 2005. This was unrealistically low for a county where the median home price was $700,000. In 1997, FHA loans accounted for 9.1% of all new originations. That number dropped below 2% in 2007. The Program gathered dust and was supplanted in market share by sub-prime products, which had higher loan limits and lax underwriting guidelines.

 

Industry professionals should have seen sub prime paper for the fool’s gold that it was. B and C loans zigged where the FHA zagged. Appraisals, which were strict under FHA, were far too lenient with sub prime. Income and asset documentation, another cornerstone of FHA, was de-emphasized by sub prime lenders, and in the case of stated income loans, thrown out the window. Judgments and charge-offs on credit reports were ignored (FHA required them to be satisfied before closing). The only thing the programs had in common was that they targeted cash-poor, riskier borrowers. There was no mortgage insurance. To compensate, or more accurately, to hedge their bet, B/C lenders charged higher rates.

 

They had it backwards. Poorly qualified people are even less qualified at higher rates, and the whole house of cards fell last summer in the worst rash of bank failures since the Great Depression, which brings me back to FDR.

 

Earlier this year, in a move that eerily resembled erecting a stop sign at a dangerous intersection only after a fatality occurs, the government finally dusted off Mr. Roosevelt’s FHA program. Better late than never. Congress acted, and the loan threshold for a single-family home was tethered to the conventional limit of $417,000 (more in “high cost” locales like Westchester County, where it is $729,750). Other adjustments were made, but the important thing is that the vacuum left by the sub prime implosion was filled and the Program was relevant again.

 

Other political solutions to the housing crisis in 2008 are tone deaf and ill advised. Maryland has outlawed “stated income” mortgages, which will hurt that state’s economy more than it will help. Stated mortgages themselves aren’t bad; for decades, self-employed professionals with excellent credit who had to put 20% or more down used them. Often 1099 professionals, doctors and small business owners, they had a tougher time verifying their income than the typical w-2 employee. The problem was that these loans were expanded to wage earners with shakier credit and smaller down payments who often misrepresented their income. The prohibition will prevent the well-qualified people from buying at a time when the pool of borrowers needs to be prudently expanded, not obtusely contracted through knee-jerk legislation.  After the savings and loan crisis of the late 80’s and the current sub prime meltdown, we really ought to know what works and what doesn’t. We don’t need politicians in 2008 reinventing the wheel. I’ll take 1934’s remedy any day.

 

Given the current credit crunch, if anything saves our collective bacon in this market, it will be the rejuvenated FHA mortgage bringing a larger pool of buyers into responsible home ownership. Credit challenged borrowers will have fixed lower rates instead of higher interest, riskier ARM products. Unqualified borrowers will no longer sneak into a home they cannot pay for because there is no stated income or asset allowed by FHA underwriting. Appraisals will once again ensure that the collateral matches the loan amount, minimizing the all-too-common instances of negative equity and short sales. History will repeat itself and the new crop of FHA borrowers will be a solid performer. In this case, we would be wise to never again marginalize the FHA program and stability will return to a recovering market.

 

When that happens, this laissez-faire fiscal conservative will tip his hat to Mr. Roosevelt.

 

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