Preventing “Mortgage Default Crisis: The Sequel”

Yesterday I wrote about the need for new underwriting standards at Fannie Mae and Freddy Mac to steer a careful course between two rocks:

  • The risk to the taxpayers of continuing the practices that got them into this mess in the first place; and
  • The risk of tightening lending standards so much that it kills the housing market and drags the rest of the economy along

Some analysts today are saying that we may be seeing the bottom of the default crisis in the foreseeable future.

The reasoning is apparently like this: "borrowers got in trouble by purchasing $400,000 homes that they couldn't afford. But now the prices are down to $250,000, so everything will be all right."

This sort of thinking ignores the key contributor to the crisis - energy and transportation costs. A $400,000 house in suburban sprawl does not commit its owner to only $400,000 of costs over 30 years. It commits the household to almost $800,000: $400,000 to buy the house, over $300,000 to drive to it, and over $75,000 to pay the utility bills. If the price of the house comes down to $250,000, the total commitment is still $650,000. It hasn't changed much!

And since without changes in underwriting standards, the house at the lower price will be considered "affordable" to households with even lower incomes than before (all the lender thinks about is that the purchase price has come down more than 35%), Fannie Mae and Freddie Mac would just be setting up the sequel to the default crisis of 2008.

Now that Fannie Mae and Freddy Mac are responsible to the taxpayer, let's make sure that their lending policies are financially responsible. And also environmentally responsible.

New underwriting standards should be based on the total of monthly obligations resulting from transportation costs, utility bills, and house payments all taken together, rather than considering house payments to the exclusion of these other two large obligations.

Not only will this help with economic growth and financial responsibility, it will also help with fairness in lending. In the cases where we have been able to get data, the most location efficient neighborhoods have much more diversity and also lower rates of home ownership. New standards will help improve environmental justice in home ownership opportunity.