Mortgage Finance

This article by John Krainer of the San Francisco Fed has lots of information about the evolution of mortgage finance. This is important for thinking about the financial crisis of course. This is especially relevant for thinking about the relative importance of Government Sponsored Enterprises (GSE's) like Fannie Mae and Freddie Mac versus the non-agency securitizers. We can see, for example, that as the housing bubble proceeded the share of mortgages supplied by the GSE's declined:


We can also see that the non-agency lenders were more highly represented in the more risky types of mortgages at the height of the boom. For 2006 we have this picture:


Thus:

Compared with mortgages purchased by the GSEs, non-agency securitizations were much more likely to involve adjustable-rate mortgages, including option ARMs, to be rated as subprime, and to have less-than-full documentation of borrower income and assets. The median FICO credit score for the non-agency securitizations was about 30 points lower than for the mortgages held or guaranteed by Fannie Mae or Freddie Mac and much closer to the credit scores typically associated with loans guaranteed by Ginnie Mae.

These pictures are not consistent with the view that the housing bubble was the fault of the GSE's alone. Deteriorating standards seemed to accelerate as the GSE share fell.

Housing Again?

A new wave of housing defaults is in the offing according to this article in the New York Times.

Experts predict a steady drumbeat of defaults over much of the next decade as these interest-only loans mature. Auctioned off at low prices, those foreclosed houses could help brake any revival in home prices.

Interest-only loans are not the only type of exotic mortgage hanging over the housing market. Another big problem is homeowners with “pay option” loans; in many of these loans, principal balances are actually increasing over time.

Still, interest-only loans represent an especially large problem. An analysis for The New York Times by the real estate information company First American CoreLogic shows there are 2.8 million active interest-only home loans worth a combined total of $908 billion.

The interest-only periods, which put off the principal payments for five, seven or 10 years, are now beginning to expire. In the next 12 months, $71 billion of interest-only loans will reset. The year after, another $100 billion will reset. After mid-2011, another $400 billion will reset.

In a sense people with interest-only loans were really renters. They had no real equity in their homes. They were renting with an option to buy if the appreciation of home prices made their gamble pay off. But with housing prices tanking the option is no longer in the money. The problem for such people is that with the option out of the money their rent goes way up. Normally, if the rent is raised dramatically a household can move. But these people are locked in to a much greater extent, at least to the worth of their credit reputation, which will be destroyed when they default.

I guess the unknown here is how large the impact of these defaults will be on the economy as a whole. Presumably most of the shocks to the financial system have already been taken. All securitizations in the housing sector have taken hits. The major impact would be on a recovery in home prices.

Housing Plan

I need to comment about the Obama housing rescue plan, but I am not ready yet. The big problem is that I get too outraged when I think of bailing people out who took mortgages that were too large for their incomes. This prevents me from thinking straight enough to complete a post.

Fortunately, Willem Buiter has a nice post on this topic. He thinks housing in the US is the biggest racket since Al Capone. Tyler Cowen also has sensible comments. I especially agree that the problem is to get prices to fall so that markets clear, not to artificially support them at a level where they cannot be maintained. But unlike him, I cannot shake the moral outrage.