Tag Archives: Zandi

Insuring Mortgages Through the Business Cycle

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Mark Zandi and Cristian deRitis of Moody’s, along with Jim Parrott of the Urban Institute, have posted Putting Mortgage Insurers on Solid Ground. They wrote this in response to the Private Mortgage Insurance Eligibility Requirements set forth by the FHFA. While generally approving of the requirements, they argue that

Several features of the rules as currently written, however, would likely
unnecessarily increase costs and cyclicality in the mortgage and housing markets.
With a few modest changes, these flaws can be remedied without sacrificing the
considerable benefits of the new standards. (1)

I would first start by reviewing their disclosure:  “Mark Zandi is a director of one mortgage insurance company, and Jim Parrott is an advisor to another. The authors do not believe that their analysis has been impacted by these relationships, however. Their work reflects the authors’ independent beliefs regarding the appropriate financial requirements for the industry.” While, I understand that the authors believe that their views are not impacted by their financial relationships with private mortgage insurers, readers will certainly want to take them into account when evaluating those views.

The authors argue that FHFA’s requirements are procyclical, that is they become more burdensome just as mortgage insurers are facing a distressed environment. This could contribute to a vicious cycle where mortgage credit tightens because of regulatory causes just when we might want credit to loosen up. This is certainly something we should look out for.

They also argue that the FHFA’s requirements will increase mortgage insurance premiums unnecessarily because they increase capital reserves too much. I find this argument less compelling. The Private Mortgage Insurance industry has typically done terribly in distressed environments from the Great Depression through the 2000s. Not only have there been failures but they have also reduced their underwriting of new insurance just when the market was most fragile.

But there are certain shaky assumptions built into this analysis. For instance, they argue that Private Mortgage Insurance companies will need to maintain their historical after-tax return on capital of 15%. But if the business model is shored up with higher capital reserves, investors should be satisfied with a lower return on capital because the companies are less likely to go bust. That is, instead of increasing premiums for homeowners, it is possible that higher capital requirements might just reduce profits.

The authors write that while “the increase in capital requirements is clearly warranted, there are certain features of the requirements as currently drafted that will increase mortgage insurance premiums unnecessarily, running counter to the aim of policymakers, including the FHFA, to encourage greater use of private capital in housing finance.” (2-4) Policymakers have lots of goals for private mortgage insurance, including having it not implode during down markets. An unthinking reliance on private capital is not what we should be after. Rather, we should seek to promote a thoughtful reliance on private capital, taking into account how we it can best help us maintain a healthy mortgage market throughout the business cycle.

Pandora’s Credit Box

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Jim Parrott and Mark Zandi posted Opening the Credit Box, a call for “[e[asing mortgage lending standards.” (2) Parrott has had high level positions in the Obama Administration and Zandi, Moody’s Analytics’ chief economist, was mentioned as a possible Director for the FHFA. Given the importance of these two authors to debates about the housing market, I think it is worth evaluating their views carefully. I have to say, they are somewhat worrisome.

They favor easing “mortgage lending standards so that more creditworthy borrowers can obtain the loans needed to purchase homes” in order to support “the current recovery,” but also to support “the economy’s long-term health.” (2) This is wrongheaded, as far as I am concerned.  Mortgage underwriting standards should not be set to support the economy. They should be set to balance the availability of credit with the likelihood of default. If we want to support the economy through the housing sector, we can do so through various tax credits or direct subsidies. But starting down the path of employing underwriting standards to do anything other than evaluate credit risk will quickly lay the foundation for the next housing bubble.

The paper contained a number of similarly disturbing cart-leading-the-horse statements. For instance, they write that for “the housing recovery to maintain its momentum, first-time and trade-up homebuyers must fill the void left by investors.” (2) Again, the goal of of encouraging new entrants in the market should not be to drive demand in the short-term. Rather, it should be done in order to allow creditworthy potential homeowners to have the opportunity to purchase a home on sustainable terms.

The authors take pains to step back from the extreme version of their position.  For instance, they write, “To be clear, the objective is not, and should not be,a return to the recklessly loose standards of the bubble years, but to strike a sensible balance between risk management and access to credit. Today’s market has overcorrected and it is hurting the nation’s recovery.” (2) But given the arguments that they have made, I find this coda to be too little too late.

I also found disturbing their analysis of put-back risk (whereby Fannie and Freddie can make loan originators buy back loans that violate various representations and warranties). Their analysis portrays originators as victims of unfairly tightened standards. The fact is, however, that originators had a long run of pushing off junk mortgages onto Fannie and Freddie. The industry will certainly need to figure out a new normal for put-backs and reps and warranties. It seems a bit premature, however, to say that Fannie and Freddie should just loosen up just as it is settling suits with these same originators for billions of dollars.

We should work toward housing market that balances access to homeownership with mortgages that households are likely to be able to afford in the long term. Once that relatively undistorted market finds its baseline, we can talk about tweaks to it. But jumping in today with policies intended to fill a void left by speculative investors seems like a recipe for disaster. In the Greek myth, Pandora opens up the box and lets loose all of the evils of humanity. I worry that rashly opening up the credit box will do the same for the housing market, once again.