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Monday, February 25, 2013

How NOT to Fix Housing

Some Democratic leaders' new proposal, released this morning, is a blueprint for how to keep residential real estate in a state of suspended animation and semi-permanent price depreciation.

The leaders, including former House Speaker George Mitchell and former Clinton Administration Secretary of Housing and Urban Development Henry Cisneros, blame tightened mortgage underwriting standards for the inability of many prospective buyers to get a mortgage and thus to complete a purchase.

Purchasers who represent good credit risks will get mortgages at the most favorable terms.  Mortgage rates and other terms, such as those upfront fees, are set as a way for mortgage underwriters to best ensure they profit on the loan while minimizing their risk of loss on the mortgage.  

When people blame the banks for having too tight underwriting standards, they are really saying that banks should ignore the risk of loss -- the risk of loss which they alone bear -- and grant mortgages to greater credit risks for reasons other than the banks' ability to make a profit.

The problem with this argument is that banks will compensate in other ways for assuming risk, whether voluntarily or through a form of government coercion.  An entirely foreseeable result will be greater costs for all bank loans and an increasing scarcity of credit if (or when) banks respond to this mortgage push by pulling back on credit and related risk in other lending sectors not receiving as much government scrutiny or political pressure.

Proposals urging more lenient lending standards seek to support current home prices.  However, the existence of efforts to support the housing market -- that is, the current values of already-built homes -- concedes that there is price weakness, that there simply aren't enough buyers who are willing or able to purchase homes at current prices on terms which banks are willing (without prodding from regulators or Congress) to extend.  

A true, lasting recovery will occur only when the housing market doesn't need all this type of pump priming.  Unfortunately, a short-term but significant price drop might be what is needed to restore the proper buyer interest plus lender interest in the real estate sector.

Had this approach been adopted in, say, 2007, don't you think the real estate market might have recovered by now?

Instead, we've had six years of ineffective, patchwork, stopgap measures which arguably have made the problem worse, prevented a true recovery and also delayed -- but not prevented -- a still-inevitable day of reckoning.

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