Federally guaranteed mortgages are now nearly as risky as they were before the financial crisis, but government agencies are taking few steps to insulate themselves against potential defaults.
In a conference call with reporters on Monday, Edward Pinto and Stephen Oliner of the American Enterprise Institute noted that the National Mortgage Risk Index reached a series high of 11.84 percent in December, largely because of loose lending standards.
The NMRI estimates the percentage of government-backed mortgages that would be vulnerable to default in the event of another recession or financial crisis, and includes loans guaranteed by Fannie Mae, Freddie Mac, the Federal Housing Administration (FHA), and the Veterans’ Administration (VA).
Although the NMRI has risen steadily over the past several years, Oliner noted that, “the FHA is not compensating for the riskiness of its loans, and Fannie and Freddie are only doing so to a limited degree.”
FHA-guaranteed mortgages have the highest risk level by far, at 24.3 percent, compared to 11.5 percent for VA loans and just 6.2 percent for loans guaranteed by Fannie and Freddie. By way of comparison, the NMRI stood at 19% in 2007, just before the collapse of the housing market. (RELATED: Time to End the Taxpayer Guarantee of Mortgage Investors)
Many have blamed the financial crisis on the collapse of the federally-backed housing market. According to AEI’s Peter Wallison, “the financial crisis was caused by the government’s housing policies,” notably a 1992 law requiring Fannie and Freddie to meet certain affordable housing goals, which led them to make increasingly risky mortgage guarantees.
In order to have a stable housing market overall, Pinto said, “the preponderance of loans needs to be low-risk,” while “Fannie and Freddie would need to have virtually all of their loans be low-risk in order to get to risk levels that offer even moderate stability.”
The reason for rising risk levels, he claimed, is that there is “effectively a price war among various federal agencies for loosened mortgage credit,” even though policymakers are relying on “incomplete and unreliable data.”
“The importance of tracking these risk measures has grown as this price war has been re-launched,” he continued, pointing out that government agencies now guarantee 85 percent of all mortgages in the U.S. (RELATED: Congressional Approval Not Required: FHA to Take $1.7 Billion Bailout)
“Mortgage price wars are problematic when conducted by the private sector, but the private sector has a limited ability to engage in a price war for a prolonged period of time,” Pinto said. Governments, however, “have a unique ability to keep a price war going for a very long time because they have cheap credit and lower capital requirements.”
Moreover, official government estimates tend to understate mortgage risk because they rely primarily on information provided by a small number of large banks, which have reduced the overall riskiness of their mortgages in recent years. The rising risk index for small banks, credit unions, and other organizations, however, more than offsets the declining risk index for large banks.
“We know that policymakers and mortgage agencies are familiar with what we’re doing, and some are even replicating what we’re doing,” Pinto said, but he cautioned that, “I never underestimate government’s willingness and ability to promote looser lending.” (RELATED: Boom, Bust, Bailout: Obama, GOP Fight Over the Mortgage)
“There has been outreach specifically to the” Federal Reserve, Oliner added, because to date that agency has been “focusing on data that are not accurate.” Unfortunately, despite the apparent enthusiasm of the staff for using the NMRI, “we’re seeing very little evidence that Fed policymakers are getting accurate information.”
“There’s really a thrust by the government to promote looser and looser lending,” Pinto concluded, “and we need to counter that, because loose lending does not help people sustainably produce wealth.”
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