Tuesday, July 8, 2008

Negativity on the Home Lending Market

If you’ve been reading (or watching) one of those Wall Street outlets, you might think there is a consensus that most of the home lending meltdown is behind us. Ha! If you want to get dirty with the current state of home lending, you need a lively discussion that includes unemployed bankers, scared real estate agents, and a list of hundreds of possible bank failures. And that’s what you get at The Mortgage Lender Implode-O-Meter. Four out of five headlines agree that the state of mortgage lending keeps getting worse. Sure, the site is loaded with advertising, but laid-off bankers have to make money somehow!

A headline today for those who thought the bad loans were mistakes made in the past: “Fed to Clamp Down on Exotic and Subprime Loans.” According to Fed chairman Ben Bernanke, the bad loans are still happening every day, and banks need to be restrained by new, much more restrictive lending rules before the banking system can have any hope of stability. (This should also silence the Wall Street critics who have said repeatedly that Bernanke is an “academic” who would never really do anything.)

It’s not that banks are lending as freely as they were up until a year ago. According to the National Association of Realtors, pending home sales fell 4.7 percent in May. Part of the reason is that more would-be buyers than ever are having to cancel because they are turned down for mortgages. Yet banks continue to issue variable-rate loans to marginal borrowers, which is the key practice behind the current troubles.

It makes sense to me that government backing for home mortgages should insist on only fixed-rate mortgages for borrowers who can’t document a substantial net worth and on really large down payments, not just 20 percent but perhaps 45 percent, for investors who will not be living in the buildings they are buying. If banks cannot pass along the risks of these loans to someone else, they will be much more careful about the quality of loans they make. And some have suggested rules that would be much more restrictive than this.

The reason we are still talking about how to change the rules of lending is that banks are still making so many bad loans. It is worth making the rules a little too tight in the short run if it means fewer banks go under.