More skin in the game a key to preventing another housing crisis

Tuesday, June 11th, 2013 By

higher down payments, aka skin in the game

Higher down payments on mortgage loans are one of many reforms experts say the federal government continues to avoid. Image: Thinkstock

Weak lending standards created the housing bubble; that led to the the housing crisis, which in turn led to the foreclosure epidemic. But experts, including the chairman of the Federal Deposit Insurance Corporation (FDIC), are saying the federal government has yet to learn the lesson. An amendment calling for adequate down payments for mortgages was defeated during the financial reform debate. Federal housing agencies project a return to subprime lending. And the crisis is being perpetuated by the Federal Reserve, with policies that prevent a natural correction that is the ultimate solution to the problem.

Skin in the game vs. loan performance

Federal regulators should tighten lending rules for home mortgages in the U.S., according to Sheila Bair, chairman of the FDIC. Bair told CNBC that a new set of “common sense” rules need to be written ensuring the borrower has the capacity to repay a mortgage loan and makes a larger down payment than is currently required. She said there was a strong correlation between “skin in the game” and loan performance. The more money down a borrower is required to pay, the less likely they will be to walk away from the house. Going forward from the housing crisis, Bair said lending standards need to call for strict income documentation, higher ability to repay standards and more skin in the game.

Subprime lending redux

Weak lending standards brought down the economy, but the federal government still doesn’t get it, according to Edward Pinto at Bloomberg. Pinto writes that the Dodd-Frank bill signed into law last July makes it clear that Congress and the Obama administration don’t intend to fix broken underwriting. An amendment to the financial reform bill that would have added a minimum down-payment requirement as well as consideration of credit history, along with definition of a “prudent underwriting” standard, was defeated. Plus, in early September, the Federal Housing Finance Agency finalized affordable housing mandates that focus nearly exclusively on low income borrowers with low credit scores — subprime lending redux. Pinto said the new policies are riskier than those resulting in the Fannie Mae and Freddie Mac taxpayer bailout.

Ignoring problems won’t make them go away

The current government response to the housing crisis will extend today’s problems into the future, according to Bill Bonner at the Christian Science Monitor. Bonner writes that the government continues to extend credit and cash to those who don’t deserve it and pretends there is no more problem. The U.S. financial system is holding hundreds of billions in mortgage debt that won’t be repaid. So the Federal Reserve bought up the bad mortgage debt and called it an “asset.” Bonner said the real solution is the market correction the government is trying to avoid. The government finances more mistakes, keeps paying for the old mistakes and pretends that everything will be fine–until it finally runs out of money.

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