It's been nearly a decade since the beginning of the nationwide banking emergency that triggered the Great Recession. So it's about time to take a hard look at what's going on today. This isn't about getting all gloomy-doomy. I think it's better to think and talk about the data so that maybe we can keep ourselves from falling down the rabbit hole again.
I'm a Portland area real estate agent with a background in lending, business strategy, and technology. I do my best to keep an eye on many different facets of real estate. The specter of the Great Recession still throws its shadow over the market but it's not something you hear spoken about much anymore. I've noticed a few things in the past week that have made me look back and wonder:
Are we edging back into lax lending standards?
Let's look at the evidence.
When people apply for home equity loans and lines many banks are using automated appraisals (AVMs). That includes for larger dollar amounts (100k+). Automated valuations are often nowhere close to the actual home value, and seem to be coming in very high right now.
If the bank sets a maximum 90% combined loan to value (CLTV), then a homeowner is already underwater if the automated value comes in 20% higher than real value. Some banks are now going up to 100% CLTV.
Already you can purchase a home with little to no down payment, or down payment almost completely subsidized by the bank. Little to no skin in the game leads home buyers to purchase homes that are outside of reasonable affordability.
If this market continues for the next few years, with home prices seeing double digit gains in many areas, will competition among banks push them to ever more creative lending programs? Will they continue to take on riskier loans with no thought that another bubble could form?
Banks are now usually checking your income sources by requesting paystubs, tax returns, etc., but the debt to income maximums have always been outside the realm of reason, even with the more conservative banks. A home buyer should not rely on what the bank thinks is affordable.
I've heard endless debates on how much responsibility the borrower should have for taking out loans they can afford, versus the bank's responsibility to only make loans that can be reasonably expected to be paid back. Unfortunately, no matter where you fall on the spectrum of personal responsibility, the reality is that many, if not most, people figure that if they qualify for a particular loan amount, then they can afford it. That fact isn't going to change anytime soon. So what should we do about it?
FICO scores have been the gold standard of lending for, I don't know, a long time. Maybe I'll Google how long we've been relying on FICO scores after I'm done writing all this. But probably not. Because I'm totally lazy.
In January, the FHA dropped their FICO score requirement 60 points down to 580 with 3.5% down (or 500 with 10% down). The banks are following suit by relaxing their requirements for conventional loans. There's no standard for conventional loan programs; it's up to the bank to set their lending guidelines (scary, huh?).
We may be on the cusp of an automotive bubble. Lending standards for vehicles have slackened considerably with low rates, very loose (or nonexistent) income requirements, and longer loan terms. It's almost like lenders didn't learn anything at all from the mortgage crisis.
The ratio of vehicles to drivers has risen considerably and the resale value of vehicles has dropped. Because of longer loan terms and resale values dropping, more people are staying underwater on their auto loans for much longer than they anticipate. The United States has recently set records for the number of auto loans that are underwater: in the first 3 quarters of 2016, nearly 1/3rd of all vehicles traded in were worth less than the balance of their auto loan.
What does this have to do with housing? Since no one expects their everyday car to increase in value it's not at all like a home loan, right?
Banks that are pushing risky auto loans to increase their portfolio are the same banks loosening their home loan standards. A bubble bursting in one industry will likely cause a disruption in another industry and the US economy in general.
Mortgage Backed Securities - What's going on with those nowadays?
This is when you stop reading if you don't want to go into nerd-territory... What, we already passed nerd-territory a few paragraphs ago? Fair enough, my nerd-meter might be set a little low.
What about those mortgage backed securities that we've heard so much about (or at least learned about while watching Margot Robbie in that bathtub seen in "The Big Short")? Those aren't full of subprime loans anymore, right?
Fannie Mae and Freddie Mac have redefined subprime to a credit rating below 620. Prior to the mortgage crisis, these companies and regulators defined subprime as being below 660. This means that Fannie and Freddie, the organizations that guarantee the mortgage backed securities (and are themselves "Government Sponsored Enterprises"), may be buying "prime" mortgages and packaging them into securities that are weaker than the "prime" mortgages they were buying before the mortgage crisis.
They are also still wrapping subprime and sub-subprime mortgages into their mortgage backed securities. That, in itself, isn't necessarily a bad thing. As long as the mixture of prime to subprime loans is a reasonable and known quantity, the rates are enough to cover the cost of loans that default, someone is paying close attention, and a contingency plan is in place, then the current state of mortgage backed securities should be fine. Also, if the housing market never flatlines or falls again and default rates stay low forever, then who cares, right?
Well, there are indicators that a recession might be coming. Annual reports show that at least 36% of Freddie's portfolio contains weaker mortgages insured by companies that don't have the best of credit ratings themselves. Which means if the loans start to default in larger quantities, the insurance companies that insure them will fail, and here we go again.
One more scary thought to inject: before the mortgage crisis, mortgage backed securities were packaged, sold, and purchased by both private firms (like Wells Fargo and Bank of America) along with Fannie/Freddie. After the crisis, private companies got out of the market and have just barely started to indicate that they might dip their toe back into the pool. Which means it's all on the shoulders of Fannie and Freddie.
On the bright side, that means taxpayers won't need to help bail out private enterprises should mortgages start defaulting in a big way. On the not-bright side, it means it would be entirely on taxpayers shoulders to bail out Fannie and Freddie if things go sideways again. Also, do we trust Fannie and Freddie to keep a close eye on these mortgage backed securities? At least before the crisis, private firms did some amount of examination into the quality of mortgages they were packaging (well, at least a little bit). Who's keeping an eye on things now?
In Freddie's 2016 annual report, the company said, "Expanding access to affordable mortgage credit will continue to be a top priority in 2017". That, coupled with lower credit standards, doesn't sound like a company that's even thinking about another potential crisis.
It feels like we're not paying attention again and this time it could be even more dangerous. Our national debt is at $20 trillion and the Fed's balance sheet at $4.5 trillion. A recession at this point would be disastrous.
For right now the economy is, for the most part, doing well. The housing market is definitely booming in Portland and rapidly improving throughout most of the United States. Unemployment is down. While other indicators aren't as strong as we all wish they could be, there is plenty to be positive about. So let's make sure to remember the Great Recession and use the data available to start a dialogue about what we can do to keep things on track.
So that was some seriously upbeat info! If you are thinking about preparing to buy or sell a home feel free to contact me anytime or fill out the form below.