At a critical moment for the U.S. economy, the Bush Administration is sending mixed signals about its plans for the largest and most important investment market in the world – the U.S. housing market.  It looks like all the experts in the world don’t really understand the problems we face – or at the very least no one in government is getting them all to work together.  A strong guiding hand is needed at the tiller right now, or we could have another shipwreck.  So isn’t it time for President Bush to buttonhole a key government manager to coordinate all these recovery efforts?  (Maybe that person should be the Secretary of the Treasury? I realize that kind of sarcasm is completely uncalled for.)

Odd things are happening.  FHA, for example, is considering changing its whole approach to lending, Kenneth Harney tells us in the Washington Post.   The agency wants to use credit scores instead of income as the main tool for deciding what interest rates that can be charged to home buyers.  FHA’s planned standard would say that if you make a large down payment and you have a high credit score, you should receive a lower interest rate.  The surprise is that this hasn’t been the agency’s expectation to date.  Harney writes that FHA Commissioner Brian Montgomery called it “counterintuitive” that people with lower incomes would have higher credit scores.  But it turns out that people with less money coming in are more careful about how it goes out.  Surprise!  Score one for the people who have been trying to make ends meet.

FNMA and FHLMC (Fannie Mae and Freddie Mac), the private mortgage corporations backed by the government, seem to be going in the opposite direction.  Let’s remember that removing the high down payment requirement allowed lots of people to get into mortgages they couldn’t afford (I know, because some months I feel like one of those people).  But as Lynn Adler of Reuters reports, Fannie Mae will reduce down payments in areas hardest-hit by foreclosures.  This may be a sound strategy to help people in high-rent districts.  But it also might be a a way for Fannie and Freddie to keep up with the once-moribund FHA.  The Federal Housing Administration, with a traditionally-low 3% down payment requirement and new higher lending ceilings, is “really taking off” in terms of loans processed, according to an expert quoted by Elizabeth Razzi in the Washington Post.  

In any case, you have to wonder if it makes sense to go back to low down payments – unless the requirement for strong credit ratings will stick.  It’s especially odd at a time when both Fannie and Freddie are under fire for being undercapitalized, as James Hagerty writes in the Wall Street Journal.  Critics charging that Fannie Mae and Freddie Mac are undercapitalized – that the agency doesn’t have enough cash, hard assets, and guaranteed revenue from investments in relation to its total obligations (mortgages and other loans that the companies have taken on).  

Are Fannie and Freddie overextended?  Fannie now has $50 billion in capital.  A commercial bank that did not have government backing would, according to one expert cited in Hagerty’s article, have to have capital reserves three times as large.  

By lowering their down payment requirements, Fannie and Freddie will only decrease their capital relative to the debt they hold.  I’m not a banker, but that seems to be a risky strategy.

Luckily, at FNMA, FHLMC, and FHA, it is always possible to pass the buck back to Congress, which can increase their lending capabilities by setting aside more in the budget or just by changing the law.  So in a sense, these agencies can take extra risks that commercial lenders cannot.  But whose money (like the $300 billion mortgage insurance fund being proposed) are they risking it with?  Mine.  And yours.  And, for example, your granddaughter’s.

Ned Hodgman

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