Taking the Bait

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62 | Th e M Rep o RT O r i g i nat i O n s e r v i c i n g a na ly t i c s s e c O n da r y m a r k e t SECONDARY MARKET LocaL edition report: loan risk remains High The AmericAn enTerprise insTiTuTe sees "no discern- ible impAcT" from Qm. Washington D.C // Despite a slight pullback in March, risk in the mortgage marketplace remains perilously high, say researchers. The American Enterprise Institute's (AEI) International Center on Housing Risk released its latest National Mortgage Risk Index (NMRI), a measure of like- ly loan default rates in the event of another economic crisis. For its March data, the group calculated that under stress, 11.5 percent of recent home purchase mortgages would default, just down from 11.6 percent in February. Even with the decline—the second consecutive drop—poten- tial default rates remain nearly double the 6 percent maximum AEI says is conducive to a stable market, suggesting there's been no "discernible impact from QM [Qualified Mortgage] regulation," the group asserted. As AEI points out, while all of the purchase loans covered in its index classify as QM, half have a down payment of 5 percent or less, and nearly one-quarter have total debt-to- income (DTI) ratios exceeding 43 percent. Federally guaranteed loans are exempt from the 43 percent cutoff. "High DTI loans are risky, with a stressed default rate well above that for all loans regard- less of DTI," analysts said. Also troubling is the fact that while the composite index was down over the month, expected default rates among loans held by Fannie Mae and Freddie Mac continued to climb up to 6 percent, while the rate for loans insured by the Federal Housing Administration (FHA) and Rural Housing Services (RHS) inched up to 24.1 percent. Both values repre- sent new highs for each category. Explaining the decline in the headline index, AEI notes the share of high-risk loans decreased again, hovering just above 35 percent, partially due to a fall in FHA loan share. Ahead, the Center on Housing Risk sees no let-up in risk rates, especially as lenders—and some regulators—move to open up credit standards to allow more borrowers in. "In a housing boom, mortgage lending moves out the credit curve," the group said. "Credit risk is rising as political pres- sures are again pushing for degrading lending practices." How loan limits Have Failed today's Housing market currenT limiTs don'T fiT wiTh TodAy's mArkeT, sAys TruliA's chief economisT. Washington D.C // One of the limitations of a feder- ally regulated housing finance system, according to Jed Kolko, chief economist at Trulia, is that there is no one housing market. In some areas, home prices can be as much as 10 times higher than in others, and individual markets vary wildly due to local and state housing and building laws and job opportunities. One way the federal govern- ment has accounted for local market differences is through the conforming loan limit: the maxi- mum amount of a home loan that Fannie Mae and Freddie Mac can guarantee. When the bottom fell out of the housing market that year, the Housing and Economic Recovery Act set higher conforming loan limits for higher-cost areas. This upper- end limit currently is $625,500— 50 percent above the $417,000 limit that applies in most of the country. According to Kolko, this current system falls far short of reflecting the actual differ- ences in local home prices and ends up favoring borrowers in lower-cost markets. Kolko's argu- ment is most vividly illustrated in California, where more than 30 percent of homes for sale are priced above the conforming loan limit. The most exaggerated example, according to Trulia, is in San Francisco, where 61 per- cent of homes for sale are above the conforming loan limit. In most of the rest of the country (excluding some markets in the Northeast, such as New York/New Jersey, where 30 percent of homes for sale are also above the higher conform- ing loan limit), Kolko says, only 10 percent of homes for sale are above the limit. "If loan limits fully reflected local housing market differences," Kolko said, "then a similar share of homes in every metro would be above the local loan limit." Indeed, in some metro areas— most notably El Paso, Little Rock, Memphis, Dayton, Toledo, Akron, Detroit, Rochester, Syracuse, and Buffalo—only 2 to 4 percent of homes for sale exceed the local loan limit of $417,000, according to Trulia. One advantage of conform- ing mortgages for borrowers, Kolko says, is that they typically have lower mortgage rates than jumbo loans, which has helped those buying more modestly priced homes. And while this might sound like a fair leg-up for the little guy, the problem, says Kolko, is in assuming that people buying homes in expen- sive markets are all rich. "In expensive markets, households spend more of their income on housing," Kolko said. "The current system of conform- ing loan limits isn't sufficiently aligned with local home price differences to give households at the same income level similar ac- cess to conforming loans." Complicating things further is the looming Johnson-Crapo bill, a Senate proposal that seeks to phase out Fannie and Freddie over five years. The bill would maintain a government back- stop for mortgages through a newly created Federal Mortgage High DTI loans are risky, with a stressed default rate well above that for all loans regardless of DTI.

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