The Fed printed $2.5 trillion to prop up the mortgage market and the Government “refurbished” all of the mortgage programs it sponsors (Fannie Mae, Freddie Mac, FHA, VHA, USDA) in a way that positioned the Government/taxpayer as the new subprime lender of choice. The two programs combined inflated a new housing bubble – one that ended up fueling housing price inflation more than sales volume. The FHA program was the first program to replace the collapsed subprime mortgage lenders of the mid-2000’s with a 3.5% down payment program. It’s market share of mortgage underwriting rocketed from 2% in 2008 to around 20% currently.
As home sales began to falter in mid-2014, the Government rolled out a revision to the Fannie and Freddie programs in early 2015 that reduced the down payment requirement from 5% to 3% and reduced the monthly cost of mortgage insurance. The VHA and, believe it or not, the USDA (U.S. Dept of Agriculture) programs provide low interest rate mortgages with zero down payment.
Fannie and Freddie permit the borrower to “borrow” the down payment or receive down payment assistance from a home seller willing make price/fee concessions in an amount up to the 3% down payment. In other words, under FNM/FRE, a homebuyer can close a conventional FNM/FRE mortgage with zero down payment. These alterations to the taxpayer guaranteed mortgage programs provided another short-term bounce in home sales volume and sent home prices soaring.
The housing market is headed south again. Just in time, the Government is making it even easier for a potential buyer to load up more debt to leverage into the American dream. Fannie Mae is raising the debt-to-income ratio on its 3% down payment product from 43% to 50%. DTI is the total household monthly debt payments divided by pre-tax income. While the credit standards are not quite as insane as during the last housing bubble, the current mortgage underwriting standards facilitated by the Government do not allow any cushion for household financial instability. This is especially true considering more than 50% of all households can’t write a $500 check to cover an emergency.
The latest iteration from the Government reeks of desperation. But wait, it gets even better. Some mortgage companies are now offering a 1% down payment mortgage that includes a 2% “gift” from the mortgage company in order to conform to the 3% FNM/FRE underwriting convention. The mortgage lender pays the 2% portion of the down payment.
However, this is not a free lunch “gift.” The mortgage lender assesses a higher rate of interest to the borrower than would be otherwise available from a standard FNM/FRE 3% down-payment mortgage. The mortgage lender, as the servicer of the mortgage, keeps the difference between the interest rate on the mortgage paid by the borrower and the amount of interest payment “passed-thru” to FNM or FRE. Over the life of the mortgage, assuming the borrower does not default, the mortgage company makes substantially more than was “gifted” to the borrower.
If a homebuyer does not have enough capital to make a 3% down payment, the odds are that the buyer also does not have the financial strength to maintain the cost of home ownership. Home-buyers who are “gifted” 2% of their down-payment do not need down-payment assistance, they need earning assistance.
This is going to end badly, especially for the taxpayer. Obama promised after his mult-trillion dollar Wall Street bailout that the Government would not bail out the banks again. This “promise” guarantees that it will happen again. Only this time the source of financial nuclear melt-down will be many: mortgages, auto loans, unsecured household debt (credit cards) and student loans. Oh ya, then there’s the derivatives. The sell-off in the banking sector since March 1st reflects the market’s awareness of the rising degree of risk lurking in the financial system from an orgy of reckless debt creation.
I don’t know when the this giant Ponzi bubble will blow, no one does, I just know that it will be worse than 2008 when it does blow. The balloon latex is stretched so tight at this point that any systemic “vibration” not anticipated by the Fed could impale the thing.
The above commentary was partially excerpted from IRD’s latest issue of the Short Seller’s Journal. Two financial sector stocks and one auto sector stock, all three of which have been falling and could easily get cut in half from their current level by year-end with or without a market “accident” were presented. To find about more, click here: SSJ Subscriber Information.
I look forward to any and every SSJ. Especially at the moment as I really do think your work and thesis on how this plays out is being more than validated at the moment with the ongoing dismal data coming out, both here in the U.K, and in the U.S – James