The expression that we should give those in need “A hand up, rather than a handout” is based on the premise that responsible people will achieve success on their own if we help get them started on the right path; while giving them more than a start will destroy their initiative and sense of responsibility. In their book Nudge, Richard Thaler and Cass Sunstein describe the importance of how choices are presented to us relative to the major life-decisions we make. They argue that presenting choices to consumers that put wise decisions in a favorable light is a way to nudge people into beneficial behavior. We have come to that point in the mortgage market, where a nudge is needed. A nudge that takes the form of a marginal relaxation in underwriting standards (in exchange for higher pricing) that can have a tremendous impact on the housing marketplace and U.S. economy.
News out on Aug. 10 indicates that mortgage applications increased by 21.7 percent. This is not surprising given the dramatic drop in rates that are being impacted by the economic turmoil of the U.S. debt ratings cut, the Federal Reserve’s decision to park the Fed Funds rate at zero percent and Europe’s sovereign debt crisis. Americans have always seen the wisdom in lowering their “life operating costs” if possible through refinancing their mortgages. It’s a beneficial choice they want to make. Unfortunately, for approximately 75 percent of these new mortgage applicants, they will be denied the loan based on new stringent underwriting factors. If we can send a man to the moon, why can’t we design a mortgage underwriting scheme that properly evaluates and prices risk and then offers beneficial opportunities to more consumers?
Don’t get me wrong, some people should simply not qualify for a mortgage at any price. The “ability to repay” a loan is paramount. While a blemished credit report can be acceptable, and having only a 10 percent down payment still provides sufficient “skin in the game” to promote responsibility, a candidate’s employment, income, value and assets must be stable, sufficient and verified. We must be smart and learn from our previous mistakes. Our economy and local communities desperately need the benefits that millions of existing homeowners with lower housing costs would produce. Not only that, but our economy must have a stable and growing new housing sector before this disaster can truly be put behind us.
I am not advocating a return to sub-prime lending. Sub-prime lending turned the American Dream into the American Nightmare as every participant in the sub-prime loan process from the consumer to the originator, to the lender, to the insurer, to the securitizer, to the rater, to the investor, to the regulator, to the legislator layered risk upon risk and ignored common sense due to greed. But it doesn’t have to be this way.
Also, I understand that housing values are a major hurdle in the way of refinancing and home sales. However, price stability comes from having a balance between home sellers and homebuyers. Risk-based lending can create more potential buyers, thereby helping to support or even raise housing prices.
We need loan products that can provide a vehicle for Americans to purchase the excess housing inventory that is available at significantly reduced costs. We need products that will allow working, yet somewhat imperfect borrowers, the opportunity to purchase homes from those who are facing unemployment—unlocking equity or freeing the homeowner and the lender from likely foreclosure. We need mortgage products that lead to follow-on consumer spending on household goods and services. We need homeowners who have the ability to renovate and rehab existing properties to improve values and neighborhoods. We need construction jobs from new housing construction. We need Americans buying in to the American Dream, rather than giving in to the American Decline—rhetoric that is growing louder by the day.
One effect of the Fed’s action was to make short-term U.S. Treasuries an unattractive place to invest money. Longer-term U.S. Treasury securities and prime mortgage-backed securities (MBS) offer better, yet still anemic, returns. Investors are going to be clamoring for better returns. Growth stocks and high dividend stocks will surely fit the bill; however, a marginal relaxation of underwriting standards on privately-created and insured mortgage products that are properly rated and disclosed can also provide better returns for investors.
Fed Chairman Ben Bernanke said unequivocally that every participant in our economy must focus on doing their part, taking well-considered risks and investing in our nation if we are to prevail over this threat to our future. The redevelopment of risk-based lending can be a nudge to our system if properly conceived and regulated. Millions of Americans’ lives can be positively affected through its careful re-introduction into the marketplace. Risk-based lending is a hand up, not a handout.
John Walsh is president of Total Mortgage Services. Walsh founded Total Mortgage Services in 1997, with a customer-centric approach and a mission of responsible lending. He may be reached by e-mail at [email protected]
or visit TotalMortgage.com.