Mortgage Credit Crunch May Worsen U.S. Recession

The WealthCycles Staff

If the mainstream media headlines are to be believed, the housing market is poised for a strong comeback in 2013. Not so fast, says Chris Whalen of Carrington Investment Services in this Fox News video clip. Sure, sales, prices and building starts are all up by 3% year-over-year, but the baseline used for comparison is pretty feeble. In fact, Whalen believes that the housing market could worsen the prospects for the economy in 2013.

What worries Whalen is the lack of credit. According to Whalen, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 left only the largest of the big banks—Bank of America, Wells Fargo, JP Morgan Chase, etc.—able to stay in the mortgage market at all. Dodd-Frank “annihilated” all the third-party mortgage loan originators, the brokers, who have gone out of business because of the tightened regulations and qualification requirements of Dodd-Frank. The barriers to entry into the mortgage lending market for small, independent brokers are simply too great.

You have to do to all of these things that you didn’t have to do in the past. So the amount of capacity that the economy has to make loans, especially larger loans—above, say, half a million dollar—is diminished. The banks are doing everything; all the business they are doing is for government guarantee.

What that means, Whalen continues, is that lenders are willing to make mortgage loans only on Federal Housing Administration (FHA) qualified mortgages as the big banks above remain unwilling to own loans against collateral for which the foreclosure process remains in a legal grey area. The FHA will loan on homes in a top price range of about $600,000 in the New York metro area, with a 20% down payment required. “Jumbo” loans once available for those in upper income brackets have vanished, which means for many markets with a high average home price, there is nobody willing to write the loan.

Whalen lists three factors that he believes will be the biggest inhibitors to a recovering housing market in 2013. His first and biggest concern is credit availability. Another by-product of Dodd-Frank is the amount of capitalization required to get into and stay in the mortgage business. This has resulted in a lack of capacity in the credit market, and the banks that are offering mortgage loans are only doing so when the loan is guaranteed by the government. This means the government socialization of the residential market may be at an apex, Whalen advocates for a return of private sector housing finance as new rules continue to thwart this process.

Related to credit availability is the second mitigating factor, the number of people who can qualify for a mortgage. Tougher qualification criteria for government-backed loans have reduced the number of people eligible to buy homes. “In fact they’re rejecting 720 FICO scores at the FHA today; you need a 740 into an 80-20 mortgage… How many American qualify for that?” Whalen asks.

The third and final factor is the coming implementation of Basel III, a set of regulations adopted by the Bank of International Settlement’s Basel Committee on Banking Supervision aimed at implementing safeguards against high-risk banking practices that might threaten an institution. Basel III is expected to force the big banks out of the mortgage market because of its requirement that banks hold more cash.

If the current housing market environment is not adequate to support a real recovery then what needs to be done? As you might expect, Whalen believes that these factors, especially credit availability, have to be revisited:

Regulators are going to have to revisit a lot of these issues; the regulators are going to have to go back and say, ‘Look if we do these things, forget about the Fiscal Cliff, I think we’re going to have a recession next year anyway,’ simply because real estate is so important, all of the different industries that serve that market.

The real estate market has, historically, helped the economy by supporting labor mobility—a strength of the U.S. economy. When an unemployed worker has an opportunity to get a job out of state, for example, the ability to easily sell property is critical to being able to take the new job. If labor mobility is hampered by workers’ inability to sell homes easily, reducing unemployment will be even more difficult.

Whalen’s bottom line: the housing market must come back in order for the U.S. economy to avoid recession and begin recovery.

My friends in the analyst community, they all say, ‘Oh, we’re never going to have private mortgage-backed securities again that don’t have a government guarantee.’ No, we have to fix that market. We have no choice; we have to fix it.

Your post is very informative and I clearly understand all the concepts and facts about the mortgage credit. Yes you are right that the banks are doing everything; all the business they are doing is for government guarantee.


I believe this is an excellent "technical" analysis of the mortgage market, but not particularly practical.

Never under-estimate what the government will do to spur the economy. We already see automobile lenders falling back to sub-prime lending.

IMHO, Congress will do whatever is necessary to spur the housing market, regardless of any domestic or international regulations to the contrary.

It is in Congress' best interest to have a strong housing market, bottom line is that above is interesting but practically moot.

Congress will only do things after its bad. Not before.

Right now things appear ok. According to all published numbers, housing is on the mend. So politicians are happy and won't monkey with regulations until it all starts falling apart again.

Only then they'll re-evaluate.

Prescience is not their forte.

You are 100% right.
But you didn't expect any better,did you?

Not exactly moot, and quite excellent, as when considering potential jumping off points, one needs foundation established.

So, FICOs like those quoted above are the facts of today's FHA (which is nearly broke), could FICOs be re-lower a la '04??

We think they may do more than buy up MBS, possibly debt forgiveness at the GSE level.

Combine these facts with Whalen's private mortgage market revival, and we should see stagnant RE for 5 years with the 4.5m overhang in shadow inventory held out of market creating an artificial price lift and some positive sentiment that is doing little but tricking homebuilders into "starts" and further supply.

Meanwhile real incomes and the economy shrivel. Sounds like the present WealthCycle persists!

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