Sunday, January 27, 2013

The much vaunted Consumer Financial Protection Bureau recently released it's new rules for mortgages, but Megan McArdle points out some significant caveats:
1. This will probably make it harder to get a mortgage, particularly if you are poorer.

2. Nonetheless, it will not do that much to prevent default Arnold Kling, a former Freddie Mac economist who has long been my favorite source on housing finance, points out that debt-to-income ratios aren't a very good predictor of default risk.
As I point out in a new essay, mortgage defaults are driven largely by the borrower’s loss of equity. Thus, the most important risk factor at the time the loan is made is the size of the down payment. The rules ignore that. Instead, the focus in the borrower’s debt/income ratio, which is far and away the least predictive of the major factors used in predicting default (the down payment is most useful, followed by credit score and then by loan purpose, although the effects of these variables interact with one another so that it is not so easy to rank-order their importance).

4. The new rules tell you a lot about how the CFPB thinks The new rules are part of the CFPB's drive to create "qualified" mortgages: low-risk, easy to understand products that will prevent consumers from getting themselves into trouble. Their mandate is not to protect banks (and savers) from default; it's to protect borrowers from themselves. That's why their approach is focused on the household income statement.
But, most troubling:
3. The government can continue writing mortgages under the old rules
This is especially important as the GSEs have already cost the taxpayers $180 Billion, and the FHA may require a bailout:
As private-financing options have disappeared, the role of the FHA has grown. Its market share has increased to about 30 percent today from 3-4 percent in 2007. That’s because the agency is now practically the only game in town, accepting borrowers with down payments of as low as 3.5 percent. As the last few years have made clear, sizable down payments -- or “skin in the game” -- are the key to avoiding defaults in the near term and to achieving a stable housing market in the long term.

So how has the FHA fared financially in serving borrowers with low down payments? As the housing bubble burst in 2007, and the number of mortgage-related defaults started to climb, the FHA’s capital reserves declined to $3.5 billion from $22 billion.

This means that the FHA is on the verge of requiring a bailout to support its outstanding mortgage guarantees, which are projected to exceed $1 trillion in 2011.
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