Do this, don't do that

It's looking like Congress is going to have to sprint through a minefield to keep the downturn in the housing market from becoming a bust. Clamp down too hard on lenders, and the resulting credit crunch will only fuel more delinquencies and foreclosures. Take too long to get FHA, Fannie Mae and Freddie Mac in position to help, and subprime borrowers will have to depend on private-label lenders who have lost the backing of Wall Street investors. Read on to hear what Inman News columnists are saying about the increasingly perilous situation.

Don't blame loosened underwriting standards or fraud for the current boom in foreclosures -- and don't expect problems to be confined to subprime loans -- says mortgage broker and syndicated columnist Lou Barnes (read his latest at Inman News).

The crux of the problem dates back to 2000, when two generic classes of "suicide loans" -- 100 percent loan-to-value, and "adjustable-rate mortgages with last-cigarette adjustment structure" -- were rolled out, Barnes says. With those loans, "if you have no equity at purchase, and prices go flat, and anything goes wrong in your household, you're cooked," he writes.

That observation leads Barnes to challenge a couple of assumptions about how we'll get out of this mess. For those who are optimistic that price reductions will get the market back on track, Barnes cautions that "would extinguish the equity in another 15 percent of households beyond the 15 percent that have little or none now." 

Think workouts or loan modifications will save the day? The equity problem again rears its ugly head, Barnes says. Adding delinquent payments to a mortgage " works if there is equity, but without any, the borrower is toast." And allowing interest rate adjustments would only deepen panic among investors who purchase mortgage-backed securities on the secondary market, adding to the current credit crunch, Barnes says.

Planned sales of investment rated collateralized-debt obligations -- a conduit for investment capital into mortgage lending -- dropped to $3 billion in June, down from $20 billion last month, Bloomberg News reported today, in a story that argues ratings agencies have understated the risk on about $200 billion in securities backed by home loans.

Losses in CDOs could total $125 billion to $250 billion, rivaling losses of the savings and loan crisis, Bloomberg reports, citing studies by Graham Fisher & Co. and Institutional Risk Analytics.

Market forces have already tightened up lending standards -- meaning many people facing those "last-cigarette" rate resets won't be able to refinance -- and federal regulators today issued new guidance for subprime lenders which could make it harder for many to qualify for ARM loans.

The Mortgage Bankers Association called the guidance, which instructs banks to qualify ARM borrowers at the fully indexed rate, "a strong statement that will help curb abuses, but will likely also constrain consumer credit choices" (see Inman News story).

But syndicated columnist Jack Guttentag -- "The Mortgage Professor" -- says the guidance is "easily (and legally) evaded." And a good thing, too, Guttentag says, because otherwise, for every foreclosure that's averted, even more good loans would be prevented.

Guttentag just wrapped up an insightful five-part series on subprime lending with his take on a possible solution: an overhaul of the Federal Housing Administration loan guarantee programs.

The FHA is a "viable substitute" for the subprime market, Guttentag says, but only if Congress is willing to make "far-reaching changes," such as allowing FHA to introduce risk-based pricing and back zero-down loans. To enlist the support of mortgage brokers, FHA should relax capital and audit requirements, even as it adopts rules protecting borrowers against broker and lender abuse (such as crediting yield spread premiums to borrowers, who would have to authorize their payments).

But Guttentag thinks Congress will have a hard time accepting risk-based pricing, because FHA would need to be able to set insurance premiums as it sees fit, without favoring any one category of borrowers.

An FHA modernization bill now making its way through Congress would give the Secretary of Housing and Urban Development some flexibility to set risk-based premiums, allow FHA to insure zero-down loans, and raise the eligible loan limit in high cost areas.

Others say Fannie Mae and Freddie Mac could ride to the rescue, if Congress would finally push through a GSE reform bill that's been stalled by debate over limits on the mortgage repurchasers' loan portfolios. The House approved a version of the bill in May.

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