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No More Lender Assisted Down Payment

Posted Wednesday, August 6, 2008

Recent economic data point to further weakening of the economy in the second half of 2008, which will in turn place further downward pressure on the housing market. The July employment report showed the economy shedding jobs for the 7th consecutive month, with the private sector losing jobs for the 8th month in a row.

The rate of job loss to date has been slow compared with prior recessions, but this could change in the months ahead. Large job cuts have been announced in both the airline and retail sectors, which should show up in the fall. The sharp declines in house and car sales have not been reflected at all in the employment in these sectors. There will presumably be more job loss in the months ahead. In addition, with new fiscal years for many cash-strapped governments beginning in July, the strong job growth in this sector is likely to come to an end.

The decline in the housing market thus far has been primarily due to the bursting of the housing bubble. Going forward, it is likely to be amplified by the effect of the weakening of the labor market.

Relatively high inflation means that there is little prospect for help from lower interest rates any time soon. Interest rates continue to creep upward. Interestingly, the decision by the Fed to place slightly less emphasis on inflation yesterday led to a rise in long-term rates. At this point, long-term rates are likely to creep higher regardless of what the Fed does.

The biggest question from the standpoint of the housing market is whether credit will continue to flow to the housing sector in an orderly manner. The bailout of Fannie Mae and Freddie Mac should keep the spread on conformable mortgages from rising further, although the 0.25 percentage point increase in fees announced by Fannie is not helpful. Jumbo mortgages are likely to continue to pose problems as banks will face large losses in the months ahead and may cutback on their lending. In this respect, the rollback of the loan limits for Fannie and Freddie to $625,000 at the end of the year may pose a problem in higher priced markets.

The change in FHA rules on lender-assisted down payments is also likely to have a negative impact on the market, which will begin to be felt almost immediately. The ban on down-payment assistance applies to loans issued after October 1. Given the lead time between contracts and closing, home sales being contracted now may not close before the change in policy. There may be a burst of sales for July and early August to get in before the change of policy, but September is likely then to see a falloff at the bottom end of the market.

The New York Times started a controversy yesterday by reporting that an analyst at Freddie Mac had warned of troubles in many of the loans the firm was buying. Freddie responded angrily, questioning whether the analyst had actually passed along the warnings and raising questions about his credibility.

This debate misses the fundamental point. Everyone in Freddie (and Fannie) should have been warning about the risks in their lending practices. The basic problem was the housing market was in a bubble. The bubble was certain to burst at some point and any institution whose only assets are mortgages and mortgage-backed securities is inevitably going to take a large hit when the bubble bursts.

If Fannie and Freddie had been acting responsibly, they would have been both tightening up their lending policies and issuing public warnings about the risk of large housing price declines. The claim by Freddie's CEO that it was restricted in its response to the bubble because it has a public mission to promote homeownership is nonsense. Promoting home purchases in a bubble-inflated market does not further any public interest. There can be no excuse for the failure of these institutions to recognize the housing bubble and to try to take every step within their power to rein it in.
By Dean Baker