Is Tight Credit Holding Back a Stronger Housing Recovery?

The housing market recovery – in particular the recovery of housing starts and new home sales – continued in 2014, but was weaker than one would have expected given the improving labor market and the relatively low level of housing inventory.

Total housing starts in 2014 through November were 927,000, which is slightly higher than the full-year 2013 level of 925,000. New home sales through October were 373,000, up from 366,000 over the same time period in 2013. The changes in starts and sales in 2014 continued the slow annual increases from the lows of 554,000 starts in 2009 and 305,000 sales 2011, but are substantially lower than the average annual levels of 1,438,000 starts and 664,000 sales from 1980 through 2000.

Could it be that tight mortgage credit has held back a stronger housing recovery? While there is no single measure of the overall level of availability of mortgage credit, there are some measures that indicate that credit has been tight. The Federal Reserve’s October Senior Loan Office Opinion Survey shows that the net percentage of banks reporting they had tightened standards on residential mortgages spiked in 2007 and 2008 and remained high through early 2010. Only in the two most recent quarterly surveys has there been a modest increase in the net fraction of banks reporting an easing of standards.

High credit score requirements provide further evidence that some borrowers are finding it difficult to get mortgage loans. According to Black Knight Financial Services, 56 percent of new mortgage originations in 2014 (through October) had credit scores higher than 740. This compares to 39 percent, 44 percent, and 51 percent in 2005, 2008, and 2011. Black Knight reports that only 2 percent of new mortgages in 2014 went to borrowers with scores below 640, which compares to 15 percent in 2005 and 2008 and 5 percent in 2011.

Credit score requirements have also remained high and near the peak levels established in 2009 for government-guaranteed loans, such as loans purchased by the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac, or by the Federal Housing Authority (FHA) or the Department of Veterans Affairs (VA). These government-backed loans still dominate the market, with GSE, FHA, and VA mortgages making up 51 percent, 12 percent, and 9 percent of new originations, respectively, in the first three quarters of 2014.

In an effort to ease the credit conditions for GSE loans, the administration in 2013 appointed Mel Watt as Director of the Federal Housing Finance Agency (FHFA), the regulator for the GSEs. After a heated confirmation battle that led to changes in the Senate’s filibuster rules, Mr. Watt was sworn in as Director in January, and immediately signaled a shift away from his predecessor’s emphasis on reducing taxpayer exposure by shrinking the footprints of Fannie and Freddie. Throughout the course of the year, Director Watt took steps to ease mortgage credit, including delaying a series of increases to the guarantee fees, shelving plans to reduce the maximum loan amounts that are eligible for purchase by Fannie and Freddie, and most recently, allowing the GSEs to back mortgages with down payments as little as three percent.

Perhaps the biggest focus this year for Director Watt and FHFA was to attempt to clarify and relax the system of representations and warranties that can force lenders to repurchase loans after they are sold to the GSEs and subsequently default. This risk was frequently cited by lenders as the reason for requiring high underwriting standards (including high credit scores) and for charging credit overlays (fees in excess of those required by Fannie and Freddie) for the loans they originate, fearing that any loans that went bad might be “put back” on their balance sheets in the future, as frequently happened following the housing collapse. Throughout the year, including at a speech here at Brookings, Director Watt announced a series of steps to address this “put back” concern, including allowing two delinquent payments in the first 36 months after the GSEs acquire a loan and eliminating the automatic repurchases of a loan when its primary mortgage insurance is rescinded.

The verdict is still out on the degree to which these measures will ease mortgage credit, and indeed if they have moved too far, exposing our economy to some of the risks that precipitated the financial crisis. But combined with the current low mortgage rates (which have returned to the pre-Taper-Tantrum levels), relatively low inventories, and most importantly an improving labor market, 2015 should see stronger growth in home construction and sales, helping feed stronger economic growth.