March 4, 2016
Mortgage Shenanigans Returning
In another ominous sign of a returning housing bubble, Bank of America is introducing a new mortgage that requires only a three percent down payment. The reason for doing so is to get around Federal Housing Administration (FHA) backing for mortgage loans, as banks have been penalized in recent years for errors in originating those loans. This new 3%-down mortgage will be targeted toward lower-income households. On the high end, we’ve already seen no down payment jumbo loans.
Coupled with these new loans is the fact that more and more mortgages are being originated not by banks but by non-bank mortgage lenders. Whereas banks are able to diversify their risk by lending to people in numerous areas of the country and lending to borrowers purchasing various types of assets, mortgage lenders focus on lending to homebuyers. Many of them see undoubtedly see themselves as entrepreneurs. They know that there is money to be made in the housing market by loaning money to homebuyers, so they get into the market. As long as the Federal Reserve keeps the easy money spigot open, things are good. But if the Fed turns it off and the housing market collapses, those mortgage lenders find themselves in a difficult situation. Should they find themselves in a tough spot, they will have to turn to banks for lines of credit to keep their business going. But the odds of a bank sticking its neck out for a mortgage lender is likely quite slim.
Two possibilities then arise. Either: 1.) non-bank mortgage lenders going under will contribute to a financial crisis, or; 2.) the Federal Reserve will create new emergency lending or credit facilities to provide funds to non-bank mortgage lenders. The latter scenario is more likely. While many of the mortgages originated by non-bank lenders are backed by FHA, and FHA is supposed to guarantee these mortgages, if enough of them go bad FHA may be completely swamped. They would then have to call in the cavalry, the Federal Reserve. Although the Fed has offered assistance in the past to non-bank financial institutions, emergency credit or lending facilities would still lead many to question whether it really is proper for the Fed to expand its role in such a way.
On the bank side there are risks too. A 3% down payment is very low. Assuming there is private mortgage insurance on the mortgages, those companies then take the risk if the mortgages go bad. Otherwise the bank is on the hook, assuming they don’t do what they did before the financial crisis and package mortgages together into mortgage-backed securities so as to shift the risk completely onto others. The Fed still holds nearly $1.8 trillion in mortgage-backed securities and continues to add to that total. In the event of another financial crisis it would not be surprising to see the Fed purchasing more mortgage- and housing-related assets. That assumes, of course, that a housing bubble is the cause of the next crisis, which may not be the case. Total mortgage debt outstanding is still lower than before the crisis, although it is growing again. All the Fed’s easy money has to go somewhere, and it seems to be flowing back into the housing market now. Even if it doesn’t turn out to be the cause for the next crisis, it certainly will get a lot of the focus.
About the Author
Paul-Martin Foss is the founder, President, and Executive Director of the Carl Menger Center for the Study of Money and Banking, an Arlington, VA-based think tank dedicated to educating the American people on the importance of sound money and sound banking.
Copyright © 2016 Carl Menger Center for the Study of Money and Banking.