Hobbling a Housing Recovery

Dan Nagasaki and Glenn Doi

For the real estate market to recover, we must have solvent investors able to get loans to buy housing. But the Democrats' new financial regulation bill, which President Obama will sign today, makes banks less innovative and responsive to future housing demand, and it won't prevent future foreclosures. Instead, the plan is making it harder for investors to get back in the residential real estate market, eliminating many potential borrowers, and delaying any recovery in housing prices. ("Investor" is defined here as anyone wishing to buy real estate for rental purposes.)

The housing meltdown, which should have been a housing dip, wasn't caused so much by lax loan requirements at the time of purchase, but rather more by too many loans on home purchases, with low required down payments. Refinancing and loans against equity also saw corresponding low required equity.

The new bill requires that lenders ensure that a borrower is able to repay a home loan by verifying income, employment, and credit. Interest-only loans and stated-income loans, even with large down-payments, are unlikely to meet the government's definition of "qualified" mortgages and will be avoided by most lenders.

Before the crash, some buyers were obtaining, with government knowledge, first and second mortgages amounting to 100% of a home's value. The government could have prevented much of this with tighter controls and less protection for additional loans against the property. Refinancing loans which would result in home equity of less than, let's say, 20% under normal circumstances, and perhaps 30% when housing prices were rapidly rising, could have been prohibited. This would have preserved property equity and reduced the risk of foreclosure in the event of lower property values.

The kind of "safe" loans that will be allowed under new government guidelines will also default in the next housing crash because the problem isn't a lack of verified buyer income — properties recently defaulted primarily because of little or no down-payment, or too little equity in property. A high verified income at the time of purchase won't help buyers pay their mortgages when they no longer have a job, or prevent them from walking away when their home is undesirable and unsalable because they now have negative equity in their home.

This type of one-size-fits-all mentality is typical of government bureaucracies, including FHA and Fannie Mae (FNMA), which have for years emphasized income over down payment and home equity in qualifying potential buyers. The Obama administration has made it more difficult for self-employed individuals to obtain a loan and for high-down payment investors to get multiple FNMA loans, while giving an $8,000 credit to first-time buyers and pushing FHA loans, which require only a 3.5% down payment.

Just as President Obama attempts to solve high unemployment while showing his preference for government employees over private-sector businesses, who actually create wealth, he is trying to prop up property values by trying to get first-time buyers to invest in real estate while making it more difficult for those with more substantial money.

For now, there's nothing Republicans can do about this latest financial regulation, but we hope that one day, they will consider breaking up FNMA and introducing some true loan competition, which would hopefully result in more innovative, yet less risky loans, which will adjust and reflect changing markets.

Federal officials should ask themselves this question: "Given this housing market, if this were your personal money, would you lend your money to a first-time buyer with a 3.5% down payment (FHA) and enough income to qualify, or would you rather lend your money to someone wealthier, retired, with inconsistent income but good established credit, who is willing to put down, let's say, 30% of his own money to purchase a property?"

If the housing market goes down an additional 10% or 15%, who is more likely to default, walk away, and become a burden to taxpayers — the FHA buyer or the buyer who just made a down payment of 30%?

Dan Nagasaki is the author of The Beginner's Guide to Conservative Politics, and Glenn Doi is a real estate broker in Los Angeles.

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