Why The Mortgage Marketplace Is Never Normal

The Urban Institute has come out with a new study which suggests that as many as 1.2 million people per year are not getting mortgages because of tight lending standards. It’s an interesting and provocative report, one which is getting much attention, but is it true?  Are tight lending standards responsible for 1.2 million missing loans?

In its new report, the Urban Institute asks: “Where Have All the Loans Gone?” The answer, it says, is that “if credit availability were at normal levels” then an additional 1.2 million new loans would be made each year. This is a figure every critic of Wall Street reform will now quote as evidence that new government rules are not working.

Are the estimates from the Urban Institute off base?

The report shows that in 2001 the country generated 4.93 million new purchase money mortgages, a figure which rose to 6.03 million in 2005 when the go-go years of mortgage lending were in full swing. By 2012 the number of new loans to buy homes had fallen to 2.74  million, 54.5 percent less than in 2001.

Do these numbers prove that tight credit is the cause of fewer mortgages today?

Not hardly. First, all-cash  transactions have grown enormously, from 17.8 percent of the market in 2001 to 39.5 percent in 2012 according to the Urban Institute’s own figures. By  definition, all-cash buyers do not require new mortgages. The difference in all-cash transactions between 2001 and 2012 is 21.7 percent. In 2012, says the National Association of Realtors, there were roughly 4.65 million existing home sales so if all-cash transactions represented an additional 21.7 percent of the market and by themselves would account for more than 1 million fewer mortgage originations.

Second, existing home sales have declined, going from 6.25 million units in 2001 to 5.01 million units in 2012. It follows if home sales are down that the demand for purchase money mortgage financing will also fall.

Third, nearly 7 million people lost their homes to foreclosures after the mortgage meltdown, individuals who in many cases are still unable — or uninterested — in new mortgage financing.

Tight Credit and Credit Scores
The Urban Institute properly notes that more loans were made to individuals with credit scores above 750 in 2012, when compared with 2001. Is this the evidence that tighter credit standards are slowing home loans?

Again, not hardly. The crucial problem with the Urban Institute study is the idea that mortgage originations ever have “normal levels.”

For instance, do not incomes impact  mortgage lending? The term “income” does not even appear in the Urban Institute report and yet the Census Bureau reports that median household income was  $51,017 in 2012 — that’s 9 percent lower than in 1999. Less income means that even applicants with solid credit are not applying for loans simply because they have fewer dollars.

Tight Credit and Minority Loans
A central thrust of the Urban Institute report is that “the trend of decreasing purchase originations is not uniform across race and ethnicity. Minority borrowers, especially African Americans and Hispanics, have been disproportionately shut out of the market.”

“From 2001 to 2005,” says the UI report, “the volume of purchase mortgages to African Americans increased by 102 percent, for Hispanics by 129 percent, and for Asians by 106 percent. The expansion for non-Hispanic whites was more modest, at 41 percent.”

Increased loans to minority borrowers — when the loans being offered have the same rates and terms as those being sold to majority citizens — are a positive development but that’s not the explanation for more loans to minority borrowers from 2001 to 2005. Instead, the Urban Institute report documents precisely the years when the origination of toxic loan products was heating up, the very loans at the center of the mortgage meltdown. As Michael Hudson explains in The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America  — and Spawned a Global Crisis, “subprime lenders had expanded in large measure by promoting themselves to African-American consumers in inner-city neighborhoods.”

“Up-front fees on subprime loans  totaled thousands of dollars,” Hudson explained. “Interest rates often started  out deceptively low — perhaps at 7 or 8 percent — but they almost always  adjusted upward, rising to 10 percent, 12 percent and beyond. When their rates  spiked, borrowers’ monthly payments increased too, often climbing by hundreds of dollars. Borrowers who tried to escape overpriced loans by refinancing into another mortgage usually found themselves paying thousands of dollars more in backend fees — “prepayment penalties” that punished them for paying off their loans early.”

The bottom line: Generating more loans is neither the best measure of industry performance nor the hallmark of superior mortgage products. One also has to look at the cost to borrowers and how many loans result in foreclosure.

Tight Credit and Consumer Confidence
The Urban Institute report does  not mention consumer confidence. In December 2001 University of Michigan Consumer Sentiment index stood at 88.8 while in December 2012 it was at 72.9, a huge decline.

It’s hardly a surprise that consumer confidence declined, just look at job creation. Under the Clinton Administration (1993-2001), 22.7 million jobs were added to the economy during  his administration. Since then, the Bush Administration (2001-2009) produced 1.1 million jobs, while the Obama Administration (2009-present) has added 1.2  million new positions. Little wonder that more people wanted homes in 2001 when compared with 2012.

The relationship between jobs, income and home purchases is obvious and clear. In looking at today’s market, Frank Nothaft, Freddie Mac’s chief economist, explains that “in order to have solid home sales in 2014 we need to see continued improvement in the labor market.” He adds that “with more jobs, wage growth should continue to accelerate giving American households much needed income to help sustain the emerging purchase market.”

We generally associate first-time home purchases with new household formations because when people come together and create a new household they often buy a first home. Unfortunately, new household formations are drying up. As a recent report from the Federal Reserve points out, “household formation over the last five years appears to have been  far lower than in any other five-year period over the 40 years for which we have annual data.”

Another curious assumption in the Urban Institute study is the idea that “tighter credit” equals fewer purchase money mortgages and, therefore, tighter credit must implicitly be a bad thing. It’s hard to know what is or is not the proper level of “tightness,” but what we do know is that loose credit leads to no-doc loan applications, toxic mortgages and ultimately a massive number of foreclosures that reduce home values nationwide and imperil the entire economy. If “tight credit” is somehow a bad thing then what are we to say about “loose” credit? Should we overlook the remarkable fall in new foreclosures since the introduction of Dodd-Frank in 2010?

RealtyTrac reports that February foreclosure levels were at a seven-year low, something which should please everyone.

When you add together increased cash purchases, reduced income, lower consumer confidence, a tougher job market, household formations, millions of individuals who have lost homes to foreclosures and fewer home existing sales you simply can’t say that “tight credit” alone is responsible for fewer mortgages. All you can say is that was then, this is now and there’s nothing “normal” about any of it.

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