Interesting food for thought from the WSJ. Didn't US "experts" heavily criticize Japanese lenders for this same behavioral pattern very recently? Hmmmm...
interactive.wsj.com
June 5, 2000
The Outlook
NEW YORK
Amid signs that the economy could be cooling, investors might want to spare a thought for an area more mundane than the stock market: What would a sharp slowdown mean for mortgages?
For years investors have viewed the mortgage market as one of the safest struts underpinning the economy. But recent political battles over the rapid expansion of Fannie Mae and Freddie Mac -- the shareholder-owned mortgage companies that were set up by Congress to maintain a steady supply of affordable home loans -- have prompted some economists to wonder what would happen to the mortgage market in the event of an economic recession.
The basic worry is this: By improving liquidity, mortgage backers such as Fannie Mae, but also other investors, have been encouraging banks and other lenders to make far more loans than ever before, and more frequently to higher-risk borrowers. The banks don't fret over risk because they can sell the loans in the hungry secondary market. The result, many fear, is a classic "moral hazard" in which banks make ever-spiraling numbers of bad loans because they think there's no way they can get hurt.
"There's no doubt that we're doing much riskier loans than we ever did in the past," says David Olson, a managing partner at Wholesale Access, a Columbia, Md., mortgage-research firm. And if there's a recession, with unemployment levels topping 8%, "the losses could be horrendous," he says.
Consider: Banks will take stock assets as collateral if you're short of cash, and they'll accept 3% down, or in some cases even 0% down, rather than the usual 10% to 20% mortgage down payment. Fannie Mae alone purchased $4 billion of 3%-down loans last year, up from $100 million in 1990.
Never mind that stock assets can evaporate fast, or that loans with 3% down foreclose four times as often as loans with 10% down -- and that's in a strong economy.
At the same time, lenders are pushing into the subprime market, which includes borrowers who have credit problems. Lenders made $150 billion of subprime loans in 1998, up from just $20 billion in 1993, according to the Department of Housing and Urban Development.
Much of the easy-terms lending is made possible by the frenzied growth of the secondary mortgage market, where loans are bundled together, turned into securities, then resold to investors. The overall market has soared to $2.84 trillion from $989 billion in 1989. That year, the secondary market bought just $3 billion in subprime loans. By 1998, the figure was $84 billion. That appetite gives lenders an outlet for loans they used to be loath to make.
The explosive growth of Fannie Mae and Freddie Mac -- they have tripled in size in the past decade and now handle about $2.5 trillion of mortgages -- and the fear that taxpayers would have to bail them out if they cratered, have sparked debate in Washington. Rep. Richard Baker, a Louisiana Republican, recently offered a bill that would limit their expansion. Just last month, Federal Reserve Chairman Alan Greenspan expressed concern about the growth of the companies in a letter to Rep. Baker.
The argument in favor of a vast secondary market is that it disperses risk among the investors who are most willing to take it. The market's growth also has helped standardize a subprime realm once populated by buccaneers, enabling families that might not have been able to get loans to qualify. That has helped boost home ownership to a record 70.1 million people.
Even so, some economists wonder how much of a good thing is too much. After all, there's a reason many of the newest homeowners didn't have homes before: They're riskier borrowers.
Moreover, a larger secondary market doesn't eliminate risk from the system, it just transfers it from one player to another, from banks to investment funds or other private investors, or mortgage insurers.
And it's not like banks don't have plenty of exposure of their own. They keep many loans on their own books, encouraged by capital regulations that let them hold less capital against mortgages than other loans. At the same time, they carry an unprecedented amount of debt issued by Fannie Mae and Freddie Mac; if one or both of the so-called government-sponsored enterprises ever get into trouble, and the value of their debt plummets, banks could be big losers.
Banks say that they're usually well capitalized, meaning it would take a lot for them to go belly up in a recession. "We've had 8% or 9% unemployment before and the sky hasn't fallen," says Peter J. Wissinger, president of Wells Fargo Home Mortgage Inc. in Des Moines, Iowa, which recently launched a "zero % down" mortgage.
Still, the landscape is littered with lenders who flew high on profits from sub-prime and other high-risk lending in recent years, then crashed when conditions changed. Many specialized in home-equity loans, which are riskier than ordinary mortgages, but economist worry the same fate could befall conventional mortgage lenders.
Of course, a slowdown could persuade banks to curb their lending and investors to buy fewer high-risk loans. But prudence might not prevail, and the situation might even worsen.
"What's already been done might not be the real danger," says Diane Swonk, chief economist for Bank One in Chicago. If interest rates keep rising, banks could be pressured to offer even more gimmicks and incentives to keep lending. And that, she says, is a "recipe for higher risk."
-- Patrick Barta
Write to Patrick Barta at patrick.barta@wsj.com
KJC |
