“The FHFA hopes that increasing demand for low-income mortgages from Fannie and Freddie will spur lenders to make more of these loans. That is certainly the way things worked before the financial crisis, when lenders could be counted upon to quickly adapt their lending practices to satisfy the appetites of the mortgage giants…

…that dominate housing-finance markets. This time around, lenders might not be so willing to follow Fannie’s and Freddie’s lead. The risk is that the expansion of low-income goals may actually lead to a lending contraction. That is because banks don’t want to make any type of loan that they wouldn’t want to keep on their balance sheet. As multibillion-dollar mortgage settlements with the Justice Department and other government entities have made clear, doing otherwise opens them up to liability for allegedly faulty underwriting. And repurchase demands can force them to take back loans they never planned on holding.”, John Carney, “Burned Banks Unlikely to Embrace Mortgage Fix”, Wall Street Journal

Heard on the Street

Burned Banks Unlikely to Embrace Mortgage Fix

By John Carney

Bloomberg Finance LP

The latest plan to juice the mortgage market and improve access to credit could backfire.

The Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, wants to make it easier for low-income Americans to take out mortgages and refinance home loans. Late last month, it released proposed goals for Fannie and Freddie aimed at increasing their support for such loans.

Under the FHFA proposal, loans financing single-family-home buying by low-income families would continue to make up 23% of mortgages purchased by each of Fannie and Freddie. The share of low-income family refinancings, however, would rise to 27% from 20%. In addition to this, regulators would have the companies raise the share of purchases of mortgages in low-income areas with sizable minority populations.

The FHFA hopes that increasing demand for low-income mortgages from Fannie and Freddie will spur lenders to make more of these loans. That is certainly the way things worked before the financial crisis, when lenders could be counted upon to quickly adapt their lending practices to satisfy the appetites of the mortgage giants that dominate housing-finance markets.

This time around, lenders might not be so willing to follow Fannie’s and Freddie’s lead. The risk is that the expansion of low-income goals may actually lead to a lending contraction. That is because banks don’t want to make any type of loan that they wouldn’t want to keep on their balance sheet.

As multibillion-dollar mortgage settlements with the Justice Department and other government entities have made clear, doing otherwise opens them up to liability for allegedly faulty underwriting. And repurchase demands can force them to take back loans they never planned on holding.

What’s more, persistently low interest rates and narrow credit spreads mean the rewards for these risks are vanishingly small. It makes more sense for a bank to just hold the line and only make loans that its internal models consider low risk.

This could kick off a negative cycle that feeds upon itself: Without growth in low-income lending, the FHFA’s new goals could just shift demand away from other types of mortgages. Banks will then be faced with the choice of shrinking their other mortgage books or piling additional mortgage exposure onto their own balance sheets. The latter seems unlikely as banks are still attempting to slim down their home-loan exposure.

It is possible that nonbank mortgage lenders will step into the gap, making the low-income loans that Fannie and Freddie want to buy. But that has its own risks, as nonbank lenders aren’t as tightly supervised as the banks. In fact, it was the growth of nonbank lenders that helped push the mortgage market over the edge of sanity during the last housing bubble.

In any case, the new goals seem like a recipe for shrinking bank mortgage lending—and therefore bank earnings.

Posted on September 12, 2014, in Postings. Bookmark the permalink. Leave a comment.

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