Record Income Inequality = U.S. Credit Downgrade?

Financial FAQs

Graph: MarketWatch

The current debate whether the U.S. will escape the ‘new normal’ of slower economic growth since the Great Recession (when homeowners lost a collective $9 trillion in value) is taking a new turn with Moody’s Investor Services now warning of a credit rating downgrade of U.S. Treasury securities from its AAA rating, something Standard & Poor’s had already done in 2011 when Republicans threatened to shut down the Federal government over their refusal to raise the debt ceiling.

Why the Moody’s downgrade now, when it has kept U.S. sovereign debt at AAA rating? America’s income inequality has worsened since the Great Recession and more pressure will be put on our government to increase so-called transfer payments—especially social security, Medicare, Medicaid, and other government benefits paid to seniors and lower income household just to keep them out of poverty—at a time of record federal debt, said Moody’s.

Only the top 10 percent income earners have seen their incomes increase since the Great Recession. Most American households have seen either flat income growth or an actual decline for the bottom 40 percent of income earners.

In fact, the income declines have been happening since the 1970s, as globalization of the workforce by multi-national U.S. corporations have steadily shipped many of the best paying manufacturing jobs to cheaper countries and regions, while American workers’ salary bargaining rights have been steadily chipped away by more conservative congresses and compliant Republican and Democratic administrations.

Now new evidence has surfaced of another reason for decline in higher-paying jobs—robots, mainly concentrated in manufacturing regions. The Brookings Institute originated a study on the effects of robots replacing mainly manufacturing jobs. To no one’s surprise, most of the robots are concentrated in ‘rust-belt’ manufacturing right-to-work states in the Midwest and South that severely restrict union collective bargaining rights.

Brookings Institute

Brookings’ analysis of data from the International Federation for Robotics determined that more than half of more than 233,000 industrial robots in the country are found in just 10 Midwestern and Southern states, led by Michigan, Ohio, and Indiana. As of 2016, the overall national average for red states” was 2.5 robots per thousand workers. The national average for blue states that mainly vote Democrat was 1.1 per thousand.

Moody’s has become decidedly pessimistic about the future of America’s credit worthiness because it sees little that the U.S. can do to mitigate the increased income inequality, the worst in developed countries “…fiscal consolidation efforts that attempt to reduce the burden of entitlement spending, by hiking payroll taxes or cutting benefits, would ultimately exacerbate inequality,” said Moody’s.

What can be done to reduce the worst household income inequality since 1928, just prior to the Great Depression? The CIA World Factbook ranks the U.S. 39^th from the bottom in the distribution of family income based on the Gini Coefficient Index that measures income inequality.

I respectively disagree with Moody’s pessimism about the prospects for improving U.S. credit worthiness. Cutting benefits would certainly harm growth, taking away incomes that increases consumer spending of the bottom 40 percent; spending that in turn increases tax revenues. And states with the political will to restore bargaining rights of union and government workers would restore some of the lost wages that increase tax revenues.

Then there is a need for massive investments in public infrastructure in all the sectors that increase efficiency and labor productivity—from physical structures to education and R&D that sent us to the moon and created the Internet. Studies show they more than pay for themselves, which also increases tax revenues and pays down federal debt.

There is in fact no reason for pessimism if such ‘antidotes’ are applied to America’s ailing fiscal health, and Moody’s as a responsible credit rating agency should be the first to recommend them.

Harlan Green © 2018

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Record Mortgage Originations in 2015, In Spite of FHFA, Treasury

The Mortgage Corner

In addition to very large Consumer credit borrowing that rose $17.2 billion in February (but excludes mortgage lending), the number of new first mortgages increased to a post-recession high in 2015, according to new data from credit rating company Equifax. In fact, it is approaching pre-recession levels thanks to the Fed’s low interest rate policy, which should also help the housing shortage by stimulating more new-home construction.

This is in spite of the Obama Administration’s efforts to downsize Fannie Mae and Freddie Mac, the conforming mortgage GSEs that continue to guarantee the bulk of affordable mortgage loans.
According to the company’s latest National Consumer Credit Trends Report, the total number of new first mortgages originated in 2015 rose to 7.71 million, an increase of 31.6 percent from 2014. Meanwhile, the total balance of new first mortgages was $1.82 trillion, a year-over-year spike of 42.9 percent.

Equifax also found that first mortgage lending to subprime borrowers grew in 2015, with 366,900 loans made – an increase of 25.2 percent over 2014 – and a total subprime balance of $59.7 billion, a 41.3 percent increase.

Graph: Econoday

 

Why is it taking this long for the housing market to recover? The so-called qualification criteria of conforming loans have become ever stricter since the housing bubble. It is even more difficult to qualify for a subprime mortgage, or the origination totals would be even higher. There has to be some measure of the ability to repay as part of the mortgage application process these days. For subprime mortgages it can be the 12-month total of deposits from non-business bank accounts—no more No Income, No Asset mortgages, in other words. And it has to be a 5 or 7-year fixed rate ARM that converts to an adjustable rate for the rest of the 30 years, rather than the plain vanilla 30-year fixed rate.

“We saw a nice jump in mortgage lending in 2015 that was driven by both rising home-purchase activity and solid refinancing volumes,” said Amy Crews Cutts, Equifax senior vice president and chief economist. “While low interest rates are helping, continued gains in employment and consumer confidence are key. What we are not seeing is any meaningful loosening of underwriting, at least with respect to credit scores. The median credit score on new first mortgages in the fourth quarter of 2015 was 750 and 90 percent of first mortgage borrowers had a score in excess of 646; these values are essentially unchanged for the past three years.”

There is a reason for the higher credit scores. Both Fannie and Freddie add large ‘penalties’ for credit scores lower than 720. This discourages many borrowers, as the US Treasury and the Federal Housing Finance Authority, their nominal conservators, don’t seem to want the GSEs to expand their credit guarantees.

Why? It’s a long story, but the Treasury (the real puppeteer pulling their strings) has said several times they want to dissolve the GSEs, and have Congress replace them with something more streamlined, but without an implicit government guarantee. The catch is it will raise interest rates, since the latest Treasury proposals require originating lenders to put some skin into the game (such as retaining liability even when sold to investors), which defeats the purpose of making home ownership more available.

This overturns the reasons Fannie Mae, created as part of Roosevelt’s New Deal, and Freddie Mac, created post-WWII, were formed. They were never the cause of the housing bubble, nor contributed to its failure. That was due to the likes of such non-banks as Lehman Brothers and Bear Stearns lending money they themselves had borrowed. Why on earth does the Obama Administration oppose the GSEs, as long as there are eligible home buyers?

Harlan Green © 2016

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

HARP 2.0 Loan Modifications Begin This Week

The Mortgage Corner

The revamped HARP 2.0 loan modification program for Fannie Mae and Freddie Mac loans kicks off this week, which allows unlimited loan-to-values for existing 30 or 15-year fixed rate mortgages owned by Fannie and Freddie, and maximum 105 percent ltvs for adjustable rate mortgages. It should stimulate as many as 9 million refinances of conforming loans, reports Fannie Mae in it press release.

And, nationwide housing starts edged down 1.1 percent to a seasonally adjusted annual rate of 698,000 units in February. This was the second-best pace of new construction since October of 2008 following an upwardly revised 706,000-unit pace in January.

Graph: Inside Debt

"Builders are reporting increased buyer interest and are expecting demand for new homes to improve in the coming months, but continue to exercise caution regarding new projects until that interest translates into more signed sales contracts," noted Barry Rutenberg, chairman of the National Association of Home Builders (NAHB). "This process is certainly being slowed by today's overly tight lending conditions, the difficulty of obtaining accurate appraisals on new construction and competition from distressed properties that can make it tough for prospective new-home buyers to sell an existing home."

Here are the HARP 2.0 basics:

• Unlimited LTV, CLTV, and HCLTV
• No minimum credit score
• All occupancy is acceptable (OO, 2nd HM, NOO, 1-4 Units)
• Income documentation might be required, depending on u/w approval
• Rate/Term only
• Max 2X60 mortgage late payments in 2 years
• Borrower must benefit with either lower payment/rate, more stable payment (longer ARM fixed rate period, or from 30 to 15 or 25 fixed rate)
• Must be originated prior to June, 2009

Prospective borrowers can look up the Fannie Mae and Freddie Mac websites to ascertain if their mortgages are eligible for the program.

\http://www.fanniemae.com/loanlookup/

https://ww3.freddiemac.com/corporate/

Harlan Green © 2012

What Explains So Many Foreclosures?

The Mortgage Corner

The delinquency rate for mortgage loans on one-to-four-unit residential properties dropped to a seasonally adjusted rate of 9.85 percent of all loans outstanding as of the end of the second quarter of 2010, a decrease of 21 basis points from the first quarter of 2010, and an increase of 61 basis points from one year ago, according to the Mortgage Bankers Association’s (MBA) National Delinquency Survey. But is it only the recession that explains such horrendous numbers, the worst since the 50 percent default rate of the Depression?

Of course the recent recession and burst housing bubble have contributed to much of the foreclosure problem, but studies by the FDIC have shown deeper, underlying causes. In fact, the foreclosure rate has been rising since the 1970s, when it was as low as 0.2 percent.

“These latest delinquency numbers contain a mixture of somewhat good news and somewhat bad news.  The good news is that foreclosure starts are down and the inventory of homes anywhere in the process of foreclosure fell for the first time since 2006 and had the largest drop since 2005.  The fact that both the 90+ delinquency rate fell and the foreclosure start rate fell means that a significant number of these seriously delinquent loans have been successfully modified and reclassified as performing, current loans,” said Jay Brinkmann, MBA’s chief economist.

So-called underlying causes are worth studying because many factors go into the foreclosure pot besides the usual reasons of divorce and job loss. And though underlying causes may not directly precipitate a foreclosure, they make economic shocks such as job losses incurred during recessions harder to weather. There is of course a direct correlation between job losses and unemployment. Florida and Nevada with 12 and 14 percent unemployment rates, respectively, also have the highest delinquency rates.

The most obvious underlying trend studied by the FDIC is the rise in loan amounts as a percentage—or loan-to-value (ltv)—of the purchase price. The ltv for new mortgages has risen to almost 80 percent, from as low as 58 percent in the 1950s. This has particularly hurt homeowners whose housing values have plunged during this recession.

Another startling fact is the rise of mortgages not serviced by their lenders—i.e., that have been sold to investors. Today, 60 percent of new mortgages are sold to investors in the so-called secondary markets, when it was below 20 percent in the 1970s, according to the FDIC. This larger percentage of so-called service-released mortgages correlates with higher delinquency rates, probably because the originating lender (who is no longer responsible for servicing the loan) has in many cases loosened their underwriting standards—especially for the no income/no documentation subprime mortgages.

Today on a seasonally adjusted basis, the overall delinquency rate has decreased, driven by decreases in the rate for fixed rate loans and VA loans. However, ARM and FHA loans saw increases this quarter, said the MBA survey. The seasonally adjusted delinquency rate stood at 5.98 percent for prime fixed loans, 13.75 percent for prime ARM loans, 25.19 percent for subprime fixed loans, 29.50 percent for subprime ARM loans, 13.29 percent for FHA loans, and 7.79 percent for VA loans.

“Ultimately the housing story, whether it is delinquencies, homes sales or housing starts, is an employment story.  Only when we see a consistent increase in employment will we see an increase in sales and starts, and a sustained improvement in the delinquency numbers.  Until we see the increase in the number of households that comes with an increase in the number of paychecks, all measures of the health of the housing industry will continue to be weak,” said MBA’s Brinkmann.

The study’s conclusion is that “shocks to individual lifestyles or “trigger events,” such as divorce or job loss, have increased the risk of default. But “…the (overall) risk posture of individuals has increased, especially as individuals increasingly leverage their homes as part of a broader strategy of managing their overall wealth portfolio.”

And though during good times such underlying factors may not surface as proximate causes, they increase the risk of foreclosure during economic downturns.

Harlan Green © 2010

WILL HOMEOWNER ASSISTANCE PLAN WORK?

President Obama’s newly announced $275B mortgage stimulus program has many parts, which means it is attacking the foreclosure problem from many sides. This will certainly help to put a bottom on home values, which are at the root of the foreclosure problem.

Below is a list of key elements of the plan outlined this week by President Obama that aims to aid as many as 9 million households in fending off foreclosures:

• Allows 4 million–5 million homeowners to refinance via government-sponsored mortgage giants Fannie Mae and Freddie Mac.
• Establishes $75 billion fund to reduce homeowners' monthly payments.
• Develops uniform rules for loan modifications across the mortgage industry.
• Bolsters Fannie and Freddie by buying $200B more of their shares.
• Allows Fannie and Freddie to hold $900 billion in mortgage-backed securities — a $50 billion increase.

A separate program would potentially help 3 million to 4 million additional homeowners with jumbo mortgages by allowing them to modify their mortgages to lower monthly interest rates through any participating lender. Under this plan, the lender would voluntarily lower the interest rate, so that payments are just 38 percent of gross monthly income, and the government would provide subsidies to the lender to lower it further to a 31 percent debt to income ratio.

FDIC Chairperson Sheila Bair has also come out with her long-awaited mortgage modification program that she believes will have an effect in months. This proposal is designed to promote wider adoption of such a systematic loan modification program:

• by paying servicers $1,000 to cover expenses for each loan modified according to the required standards; and
• sharing up to 50 percent of losses incurred if a modified loan should subsequently re-default

“We envision that the program can be applied to the estimated 1.4 million non-GSE mortgage loans that were 60 days or more past due as of June 2008, plus an additional 3 million non-GSE loans that are projected to become delinquent by year-end 2009,” says the FDIC website. “Of this total of approximately 4.4 million problem loans, we expect that about half can be modified, resulting in some 2.2 million loan modifications under the plan.”

Almost one in 10 home mortgages is either delinquent or in foreclosure, and analysts estimate that at as many as six million families could lose their homes over the next three years in the absence of government action. These programs will certainly help a certain percentage of them. The foreclosure rate for single-family homes is now above 6 percent of the 100 million + mortgages outstanding, 2 percent above the historical rate of 4.25 percent, so it is not the end of the world.

The plan will take effect March 4, when the administration publishes detailed rules explaining it. Except for the provision that empowers bankruptcy judges, almost all the other elements can be enacted by Mr. Obama without further action by Congress.

Harlan Green © 2009

WHY THE FIXED RATE PREFERENCE?

Fixed rate mortgages continue to be the financing of choice, in spite of former Fed Chairman Greenspan’s attempt to sway borrowers towards adjustable rate mortgages, or ARMs. Studies from the Federal Housing Finance Board, which regulates savings and loan institutions, show that more than 80 percent of mortgages tend to be fixed-rate products versus 18 percent that are adjustable.

This puts the current adjustable rate subprime crises in proportion, since subprime loans comprise just 6 percent of outstanding mortgages, though their default rate is approaching 20 percent. The default rate for all conventional mortgages is now 6 percent.

"The fixed-rate mortgage is a cornerstone of the U.S. housing finance system and has been instrumental to the accrual of wealth on the part of many households. The low interest rates of the past two years have increasingly lured consumers seeking a predictable payment in an uncertain economy," said Stuart Gabriel, director of the University of Southern California Lusk Center for Real Estate.

The 30-year, fixed-rate mortgage is about 70 years old. The loan instrument was first offered during the 1930s after the creation of the Federal Housing Administration as part of financial reforms to combat the Depression.
Before that, most residential loans were balloons, requiring a payoff within 10 years. In addition, mortgages were made for only up to 50 percent of a property's value.

Long-term loans took off in the housing boom post World War II, when FHA and VA mortgages fueled construction in U.S. suburbs. At the same time, homeownership rates jumped once the 30-year loan became available, from 44 percent in 1940 to 65 percent in 1966; the rate is near 68 percent today.

Adjustable-rate loans have their advantages when fixed interest rates are high or rising quickly. But the subprime debacle showed us that using them when interest rates were at record lows 2003-2005, lulled borrowers into a false sense of security. The Federal Reserve under Fed Chairmen Greenspan and Ben Bernanke raised short term interest rates 17 consecutive times over 2 plus years, which burst the real estate bubble and caused the credit crunch we have today.
ARMs first became widely available in 1981, their share of the mortgage market has varied from a high of 39 percent in 1994 to a low of 12 percent in 2001, Gabriel found.

"Clearly, borrowers benefit from the availability of a wider variety of products. ARMs appeal to more mobile households, homebuyers who expect their incomes to be positively correlated with interest rate fluctuations and buyers who are down payment-constrained," Gabriel wrote. But if affordability of the monthly payments isn't a problem, "then many borrowers prefer the ongoing payment certainty of the fixed-rate loan."

There are some regional differences in the use of fixed-rate vs. adjustable-rate mortgages. Consumers in Alaska are most enamored of the fixed-rate mortgage: In 2003, 98 percent of conventional home mortgages in Alaska were fixed-rate mortgages.
Following Alaska in favoring the fixed-rate mortgage are Delaware (93 percent), Oklahoma (92 percent), Texas (92 percent), New Mexico (91 percent), Pennsylvania (91 percent) and Tennessee (90 percent.)

Homebuyers in Massachusetts are most likely to take an ARM; 32 percent did so, in part due to the higher price of homes. Other states where adjustable loans command a high percentage of the market: Colorado and Michigan, with 30 percent; California, 29 percent; and Illinois, 27 percent.

© Harlan Green