For at least a year, the Obama administration has been pushing lenders to make mortgages more widely available to responsible people looking to buy homes.
“Now that we’ve made it harder for reckless buyers to buy homes that they can’t afford, let’s make it a little bit easier for qualified buyers to buy the homes they can afford,” President Obama said last August in a speech at an Arizona high school, adding that too many qualified families are getting rejected by banks.
But the hurdles remain tough. The Mortgage Bankers Association said that access to credit is running at roughly one quarter of the pre-housing bubble rate of 2004.
The administration has been meeting with key stakeholders, including David H. Stevens, the MBA’s chief executive, throughout the year to understand why the situation isn't improving. Stevens says he told administration officials that many potential buyers are getting shut out of the market because lenders don’t want to take a chance on them.
In an interview with The Washington Post, Stevens explained why and shared some of the material that he showed the White House’s key housing advisors. A major stumbling block for potential borrowers, he said: “Credit overlays.”
This interview was edited for length and clarity.
Dina Elboghdady: What are credit overlays?
David Stevens: In order for lenders to sell mortgages to Fannie Mae, Freddie Mac or the Federal Housing Administration, the mortgages have to meet minimum standards for some key variables: the credit score, the amount of debt the borrower has relative to his or her income, and the documentation. But lenders are applying standards that are more conservative than what is required, and those are the credit overlays. For instance, FHA allows credit scores that can be as low as 500, but most lenders insist on a minimum of 620 or 640 because they think it’s risky to do anything under that. They’ll demand a higher credit score on a loan because data shows that higher scores perform better.
I showed this chart to the White House. It clearly reflects that credit scores below 640 have been all but eliminated from the mortgage market.
(Note: Fannie, Freddie and FHA do not make loans. FHA insures lenders against losses should the loans go bad. Fannie and Freddie buy loans, package them into securities and sell them to investors. For a fee, they insure the loans and pay investors should the loans default.)
DE: Why are the lenders doing that?
DS: There are a variety of reasons for overlays that include both regulatory and legal risk. Lenders are putting policies in place for self-protection. All you have to do is read the headlines about the massive legal settlements against the largest lenders for loans they made that went into default. There’s been very aggressive enforcement in response to the housing bust, to bad mortgage programs that should have never been created, and to lenders who did the wrong thing, many of which are now out of business. And there’s no end in sight. Lenders are saying we’re going to have clear lines so our decisions can never be questioned when a loan defaults. Lenders feel like there really have to be zero errors now. They also don’t want to risk having to buy back loans that have minor, non-material errors.
DE: Aren't the lawsuits more about holding lenders accountable for fraud rather than minor errors?
DS: I’m not passing judgment at all on the lawsuits themselves, and the big ones have fairly aggressive claims in them. But there are others that don’t make the headlines. We have cases where lenders hired third-party appraisers, and followed all the requirements for ordering an appraisal. The borrowers made their payments for five, seven or even 10 years before defaulting. The investor who purchased the loan then said: “We don’t think the appraisal was done right.” Is there some point at which you should sunset the risk? If a borrower defaults in the first year or two, that probably means they got into the wrong program or the lender made a mistake. But if they default many years later, that probably reflects changes in their lives and changes in the economy. It’s less likely to be the result of the manufacturing of the mortgage years earlier. The regulator that oversees Fannie and Freddie has made some minor policy changes in this area.
DE: Why shouldn't there be a zero tolerance policy for errors?
DS: The average loan file today is somewhere between 300 to 500 pages, depending on the state and the loan product. There’s a lot of human intervention involved in putting that loan file together. The likelihood of a minor defect is almost 100 percent, like getting the middle initial wrong on the application versus the title.
DE: Almost a quarter of the banks surveyed by the Federal Reserve in July said they’ve loosened standards for prime mortgages, the most since the 2007 housing bust. Last week, Fannie Mae’s chief executive said that credit overlays are easing. Are you also seeing signs of that?
DS: We’re seeing credit standards ease most for wealthier borrowers with big down payments rather than for marginal first-time borrowers with less wealth and lower down payments. Our Mortgage Credit Availability Index shows that access to credit is running at roughly one quarter of the pre-bubble (2004) rate.
We showed the White House a chart with the results of MBA’s Weekly Application survey, which covers 70 percent of all mortgage applications, and data from the National Association of Realtors, which captures mortgages and all-cash sales for sales of previously-built homes.
DE: As a former FHA commissioner, can you tell us how FHA is faring in this environment?
DS: We are clearly seeing a shift away from certain products by the larger institutions. FHA is a prime example. FHA is stepping up its pursuit of pay-backs. If a loan goes to default, goes to claim and FHA finds a mistake in the file, you are subject to treble damages, or three times the outstanding balance of the loan. The risk is very significant. It’s why you hear cries from people like Jamie Dimon.
(Note: Jamie Dimon, chief executive of JPMorgan Chase, has questioned whether his bank should do business with FHA. He cited JPMorgan’s massive losses on FHA loans, and griped about the $614 million settlement paid by the bank to resolve the government’s allegations that JPMorgan improperly approved thousands of mortgages backed by FHA and others. He said the court case should have been nothing more than a “commercial dispute.”)
DE: How has the industry reacted to Jamie Dimon's comments?
DS: Many lenders are concerned about publicly saying what Jamie said, but many believe Jamie told the truth. A couple of CEOs have told me they’re not far from doing what Jamie has threatened to do. I can tell you first hand, having been someone who enforced rules and regulations, and someone who spent a lifetime helping people getting into homeownership, these are not the statements of irresponsible financial executives who caused the financial crisis. Many of the irresponsible ones are long gone from the industry. The people who are left are focused on maintaining safe and sound posture in the marketplace. But they can’t expose themselves to greater risk from government and class action lawsuits. If you look at the large settlements, they completely erased all the collective profits from multiple years of mortgage originations at these companies. Put another way, it would have been cheaper to be out of the mortgage business based on these settlements.
DE: What was your advice to the White House on this issue?
DS: I told them that regulators need to hold lenders accountable for egregious behavior. But they also have to create better clarity for lenders on what they will be held accountable for down the road.
There are about a dozen regulators involved in housing finance. The OCC, FDIC, Federal Reserve, HUD, the Justice Department, even the Department of Labor, which looks at loan officer pay, overtime compensation, etc. The administration needs to look at the overall collective impact of an overly aggressive regulatory and legal framework. The problem with a lot of these rules and regulations is that they get made by groups. The administration is trying to understand the tension points. The White House can’t call an individual regulator and tell them what to do. This is more about educating and making all the stakeholders aware of what happens when everybody is involved in the same kind of rulemaking. It ultimately piles on so deeply that nobody wants to take any risk.