There is a perfectly fine article up at the Wall Street Journal on the current, probably weakening, state of the housing market, save that it fails to discuss the elephant in the room, that of the continuing moribund conditions in the so-called private label securitization market.
The piece, “Housing Shaky as Lenders Tighten,” gives a straightforward recitation: housing sales have fallen markedly in the second half of 2010 as housing tax credits expired, even with record low interest rates. (And that tailwind may no longer be behind housing as mortgage rates moved up last week).
The piece also gives macro implications: that housing has normally provided a significant boost in all past postwar expansions (yes, Virginia, this is not a normal “recovery”). And it does acknowledge the way that lending is now dominated by government entities, which are not being terribly generous with credit now. And the article suggests that the government should do more:
“Right now, we’re in that vicious cycle where we tighten, which makes things worse, so we tighten, which makes things worse,” says Bob Walters, chief economist at Quicken Loans. “How do you get out of that cycle? Folks in government are going to have to stand in and make some calls.”
Banks have become more restrictive in part because Fannie and Freddie are stepping up demands for banks to buy back defaulted loans when they can prove that the mortgage didn’t meet underwriting guidelines, an expensive proposition for banks.
This picture is woefully incomplete. Before the crisis, Fannie and Freddie provided roughly 40% of residential lending. Their outsized role now is in large measure due to the collapse of the so-callled private label securitization market.
Now some of that lending was reckless and should not come back. But the utter failure of the private label securitization market to revive gets nary a mention in this story. The closest we see is an allusion: “But that isn’t happening now because private lenders have ceded the market to government entities.” That fails to explain what is really at play. The “lenders” mentioned in the piece for the most part are banks acting as originators. They don’t have much capacity to hold loans to maturity, and if they did, it would be at much richer interest rates than those offered by Fannie and Freddie.
The reason the lenders have pretty much only the GSEs to go to is that investors, who were badly burned on private label MBS, are simply not coming back in a meaningful way until they see real reforms. Yet the securitization industry has fought them tooth and nail, as if this were a negotiation. Wake up and smell the coffee. It isn’t. The customer is always right, and in this case, the customers have made it abundantly clear that they have no interest in buying what you used to sell.
It’s been surprising and frustrating to see the securitization industry weigh in against investor-friendly proposals, like one put forward by the FDIC earlier this year. Those proposals included:
1. Mortgages must be seasoned 12 months before they can be securitized
2. The originator must retain at least a 5% interest in the credit risk of the assets sold
3. The interest of all parties to a transaction must clearly be disclosed, along with their fees
4. Re-securitizations (meaning CDOs) are severely restricted (note a disconnect here; the e-mailed and verbal reports suggested they were banned entirely; the language at the FDIC website seems to indicate that they are allowed in limited circumstances, but any use of synthetic assets, meaning credit default swaps, in a asset-backed CDO is verboten)
5. Compensation to servicers will include incentives for loss mitigation
This plan, which is pretty consistent with the level of change investors want to see to be enticed back into the pool, was forcefully opposed by securitization industry incumbents early in 2010.
The Wall Street Journal story reminds us that the securitization market is still on Federal life support. Admittedly, a securitization market with sound standards would be a much smaller than the one we saw in 2004 to 2007. But that would be a feature, not a bug.
Perversely, the securitization industry seems to be holding out for its fantasy of a return to status quo ante, when even a mini-revival of the private securitization market would reduce the dependence on government support and might even provide some economic lift.