Monday, October 24, 2011

Bank Lending Dilemma

In the Financial Times, Larry Summers argues lenders should pay more for past bad loans, and also make more now:
First, and perhaps most fundamentally, credit standards for those seeking to buy homes are too high and rigorous.
Surely there is a strong case for experimentation with principal reduction strategies at the local level.
Fifth, there were substantial abuses by financial institutions and almost everyone in the mortgage industry during the bubble. Just compensation to the victims is a legitimate objective of public policy. But allowing negotiation over the past to dominate present policy creates overhangs of uncertainty that impose huge costs on the financial system and inhibits lending.
Bank regulators could facilitate inevitable restructuring of underwater mortgages by requiring banks to treat second mortgages and home equity loans in realistic ways.

Summers seems to recognize that punishing banks hurts new lending, but he also thinks some form of bank punishment would be just. Until they get over this and let the banks alone, lending will remain weak because banks are wary of the lookback option being giving to borrowers who 'bought' houses without the means or willingness to pay it back. In the US, loans are already 'non-recourse', meaning borrowers can walk away and let the lender eat most of the loss, but people want 'just compensation', which is a code word for an expropriation from banks to NINJA borrowers.

Until regulators, legislators, and the experts that advise them stop hounding banks for their old home loans, new home loans won't be forthcoming. It's all good and well to say we should just nationalize home lending, but if public housing is any guide that's a disastrous endgame.

Obama's latest housing effort seems like the last iterations (Hope Now, Hope for Homeowners, the Home Affordable Mortgage Program, the Home Affordable Refinancing Program, the Hardest Hit Funds), but until things like the Department of Justice's lawsuit against banks gets cleared up, banks won't consider homelending anything but toxic.


Dave Pinsen said...

Why not write a letter to the editor of the FT in response?

Derek S. said...

Is there something wrong with homelending as it is now? I think the headwinds facing the housing market are lack of buyers due to a poor economy and reluctance to sell at current market price.

To be clear, I'm not with Summers either. I think that with the current standards, people are being forced to make realistic housing choices.

Mercury said...

Larry Summers is either crazy, talking his book or both. There are maybe two sentences in the entire editorial that aren’t flat out false – starting with the first which enlightens us that the way to fix a debt bubble is with more debt. Pay no attention to what your grandparents said about hard work and thrift kids, it’s actually all about consumption and debt.

The purpose of FNM/FRE is not to "mitigate cyclicality" it’s to subsidize and (more recently) misprice loan risk.

Here’s another beauty: “Statistics suggest the characteristics of the average applicant in 2004 would make an applicant among the most risky today.” Common sense suggests that too Larry but whatever. This would be an inaccurate assessment in his view because housing prices have already fallen 35% and the odds of another 35% decline (based on the good kind of statistics I guess) are pretty slim. Larry, if you don’t have a job, the current mark-to-market of your house has little bearing on your ability to cover the next mortgage payment. And how many tech-bubble stocks stopped going down after a 35% slide?

This is a pretty good summation of how the administration views the US residential real estate market and this is why we are nowhere near the bottom in RE or the economy in general.

Patrick R. Sullivan said...

Along the line of Mark Twain saying, 'Wagner's music is better than it sounds.', I like this:

'In retrospect it would have been better if financial institutions and those involved in regulating them, especially the Federal Housing Finance Agency, recognised that house prices can go down as well as up, if more rigour had been applied in providing credit, if the government-sponsored enterprises (GSEs) had been more careful in monitoring those originating and servicing loans, and if there had been more vigilance about fraudulent behaviour.'

Which is like saying, 'Ya know, Ted Day and Stan Liebowitz were right back in the 90s, to warn against the fashionable idea of lowering underwriting standards; that it would blow up in everyone's faces. Maybe there's a lesson for us there.'

And this ought to warm the cockles of Scott Sumner's heart:

'The Federal Reserve could support demand and the housing market by again expanding purchases of mortgage-backed securities.'

I.e., monetary policy has been too tight.

Plamen said...

"In the US, loans are already 'non-recourse', meaning borrowers can walk away and let the lender eat most of the loss..."

Erm, sorry, not true (or rather not completely true) - see, for example, here or here. Only 12 states are non-recourse/anti-deficiency - although "biggies" like CA, TX and Florida are among them. They account for approx. 118 mln people out of the population of 308 million, or 38%. Thus, if you are a random American, or live in a random state, odds are you cannot just walk away from a loan.

This nit-picking aside, I agree with your general point.