Inaccessible credit: the new normal?

Author:Couch, Robert M.

No-risk lending leaves too many locked out of the market. But how much risk is the right amount to take?

It's hard to read today's financial or political news without someone bemoaning the lack of access to mortgage credit. What has happened and what can be done about it?

Why do we care?

No one really questions that homeownership is a worthy policy goal. Good for the economy and good for families, it serves as an effective way to bridge the wealth gap.

All things being equal, the affordability of homeownership over the last 20 years has been better than renting--despite the recent run-up in prices, homeownership remains financially smarter than renting.

Yet, over the past 10 years, we have witnessed a plunge in homeownership rates to the lowest level in more than 20 years.

There are now more renters than owners in nine of the 11 largest U.S. cities, according to the February 2015 National Affordable Rental Housing Landscape report, by the New York University (NYU) Furman Center for Real Estate and Urban Policy and Capital One Financial Corporation.

Has there been a change in perception about what really is the American dream? Has there been a permanent shift in home-buying demand, with more people, particularly young adults, opting out of homeownership and "choosing" to become lifelong renters?

Not according to Washington, D.C.-based NeighborWorks America's October 2014 America at Home survey, which shows 83 percent of U.S. adults under the age of 30 still have a desire to become homeowners.

According to the June 2014 State of the Nation's Housing report from Harvard University's Joint Center for Housing Studies, Cambridge, Massachusetts, restrictive underwriting criteria are the principal culprit, causing inaccessibility of credit and declining homeownership rates.

We need to broaden underwriting criteria and "expand the pie" for what is increasingly becoming a commodity product. The mantra for the mortgage lending industry is to make sure that anyone who deserves it and can sustain it can get it.

So why can't deserving people get loans today?

What level of non-performing loans should we shoot for?

The time has come to have a serious conversation about increasing access to credit. To do this, we need to define "deserves" and "sustainable." In other words: Who should be given the opportunity to fail?

From a policy standpoint, if we want to encourage broader access to credit, it will likely come with more credit risk. We must also acknowledge that lending is an imperfect science.

Overall, we want to build a system that rewards those who make the difficult loans and encourages good lenders, recognizing that "good" may mean somewhat higher cumulative losses.

The first step is to determine which borrowers should be given an opportunity. A purely private secondary market would set the price for credit risk, and the market would find some natural level of homeownership. However, we are in a government-controlled market, so as a policy matter we must first decide what the homeownership target should be.

While some commentators have opined that the homeownership rate was dangerously high at its peak of 69.2 percent in 2004, there is near-universal agreement that its free fall since then--especially for minority families--must be reversed.

Does it follow that a higher homeownership rate necessarily means higher rates of defaults, resulting in more credit losses?

Yes, as illustrated in Figures 1 and 2--when the overall population is stratified by FICO[R] scores, almost 35 percent of the population have credit scores under 650. And cumulative losses are correlated to FICO credit scores.

Thus, the more we choose to broaden underwriting criteria, the higher the level of defaults we must accept in return.

How much risk is the industry willing to take on?

A recent report from Edward Pinto, resident fellow with the American Enterprise Institute (AEI), Washington, D.C., and co-director of AEI's International Center on Housing Risk, indicates that the industry is already taking on high levels of risk.

In February of this year, AEI's International Center on Housing Risk's National Mortgage Risk Index (NMRI), which hit a recent series high in January, was still nearly double what it was in 1990. However, according to data from the U.S. Census Bureau, the homeownership rate is at its lowest level since 1994...

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