On Wednesday, I appeared on a panel discussing the state of credit underwriting in the housing market. I raised two questions:
1. Are national credit standards, set by Freddie, Fannie, and FHA, appropriate, or do they throw out too much local information?
I made a Four Forces argument that there are too many divergences in economic performance that make local information valuable. On the other hand, you could argue that simply by tracking search data, Google and Zillow have better information on local trends than would an on-site mortgage underwriter. Interestingly, the session chairman, Bob Van Order, presented information showing that after the crash loans under-performed relative to their known characteristics (including ex post home price performance) and over-performed more recently. This suggests that it is possible for underwriting to be looser or tighter than it appears based on observable characteristics, which in a way suggests that there is local information that is important.
2. Are we in 2004? That is, is the stage set for another housing bubble, and all that is needed is a loosening of credit standards?
One of the speakers, Sam Khater of CoreLogic, re-iterated what he wrote here, that “price-to-income and price-to-rent ratios are high.”
Very few mortgages originated since 2009 have defaulted. There are two reasons for this. One is that credit standards were tightened. The other is that the trend of house prices has been up. Now, there is all sorts of talk about the need to loosen standards. I pointed out that both the private sector and public officials tend to be very procyclical when it comes to mortgage credit–when the market is going up, they want to loosen standards, and after it crashes they want to tighten standards.
I would be ok with loosening standards on credit scores now, provided that the industry holds the line on down payments, meaning that we do not see an increase in the the proportion of loans with down payments below 10 percent. This is not the time for the FHA to make a big expansion in its high-LTV lending (Ed Golding, can you hear me?)
To encourage high-LTV lending now would be adding alcohol to the punch bowl just as the party is getting good.