With the news of the impending finalization of the Fannie Mae and Freddie Mac bailout, my questions turn to the impact on the housing market. Will this move improve or restrict financing options? Immediately, it should ease investor concerns and likely make for easier borrowing that will improve liquidity and maybe lower interest rates.

But delinquency continues to be a problem, and something must be done to maintain a balance between opening up the financing options and reducing risk of growing defaults.

• defaults of at least 30 days - 9%, increased from 8.1% in 1st quarter and from 6.5% last year
• 35 states had increases in number of foreclosures
• 1 of 5 homeowners with subprime adjustable is in default
• 1 of 10 homeowners with prime adjustable is in default

Understanding the cause of mortgage defaults is important. It can lead to corrective lending practices that are needed to restore stability. It is also important to know, so that changes are not made that miss the real causes and work to destabilize further the industry and the nation by cutting off programs that are needed to fund the housing market recovery.

If people cannot buy then builders cannot build and sellers canot sell.

Alan Zibel, business editor for the AP press, in the article linked above tries to identify the causes of the growing mortgage delinquency. His article points to four causes.

Subprime credit - high debt ratios and historically bad credit. Will future credit markets enable any type of lending to home owners with subprime credit histories? How can weak credit profiles be evaluated in such a way to provide reasonably priced mortgages that can be repaid - balancing risk and return. Surely the hybrid ARM days are gone for good. In 2007 subprime mortgages lead the mortgage crash, and at one time it was thought that the problems would be limited to the subprime industry. That has not proven to be the case.

Exotic loans - adjustable loans have been a fixture since the early 80's when interest rates were very high. They have continued into today's market when interest rates have been low, even at times when rates have been historically low. To the traditional adjustable rates loans, we had added negative amortization, interest only, pay option, balloon notes. These alternatives encouraged the view that home purchases were for speculation rather than for equity building.

"Egregious lending practices and rampant speculation" - not sure whether this refers to unwise relaxing of reasonable lending guidelines or to the practice of near fraudulent mortgage originating practices. Perhaps both. Rampant speculation implies overbuilding and purchases based on the assumption that demand and prices would always increase.

Lending guidelines would include, lowering of credit standards, income and asset documentation requirements, lowering required downpayments, especially on investment properties, allowing undocumented property appreciation, allowing unlimited number of investment properties, increasing allowed debt to income ratios, and many other targeted niche programs.

Origination practices would include abuse of the stated income programs, inflating appraised values, misrepresenting sources of downpayment money, among other abuses.

Economy - Unemployment is its highest in 5 years at 6.2%. Gas prices are pushing the cost of transportation and many other necessary items. Spending on non essential items is down. The number one cause of mortgage defaults is a significant loss of income. This present economy is impacting individual incomes on several different fronts.

The federal takeover of conventional lending that appears to be taking place will bring changes to conventional lending. How will these changes impact the economy and mortgage lending in particular?

Can the patterns of delinquency reveal the causes of the problems in a way that guidelines can be revised without stiffling mortgage lending?

If the above are the causes of the mortgage and credit crisis, can a restructured Fannie Mae and Freddie Mac create programs to enable market growth and manage short term and long terms default risk?

I think that the markets will likely only respond favorably to a new make up of the conventional lending structure. They need to know how that stability and soundness is going to be maintained.

At present the market does not know what will become of existing stocks or of future stocks, not of existing or future bonds. This is uncertainty is not good for anyone.

Government take over will bring an end to this uncertainty. Likely that stock holders will lose, but bond holder will gain. Capital stability will be restored, but what type of loan programs will be available.

My hope is that mortgage lending will not be curtailed, and I am sure that the intention is to spur lending.

The areas that seem to need to be addressed are how to offer low down or no payment loans, how to evaluate credit both in the actual pay history and in the depth of that history, and how to ensure payment flexibility is balanced with long term affordability and equity accumulation.

Stated income lending is another concern. There are several borrowers whose incomes do not qualify according to conventional underwriting requirements. The issues involve such considerations as evaluating overtime and commission, allowable IRS deductions, and documentation of continuance and of receipt.

Stated programs were surely abused in the Alt A and subprime programs, but will the new conventional lending rules enable some lending to borrowers whose incomes cannot be documented according to conventional guidelines. If so, how will this be done?

It does seem certain that Monday will be the beginning of a new world in mortgage lending, and given the current state maybe the new mortgage world will be better.

Richard Smith
American Acceptance Mortgage, Inc
Toll Free 888-474-9920 Cell 423-280-0345
Home financing in Tennessee, Georgia, and Alabama.
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