Jared Bernstein: Opening Up the Credit Box:
Credit constraints still abound, particularly in the housing market. Potential homebuyers are…grappling with exceedingly tight mortgage credit conditions. All but those with the most pristine balance sheets find it difficult to obtain loans…. In a WSJ article on [Jim Parrott and Mark Zandi] Nick Timiraos writes:
Easing lending standards to return credit scores to pre-bubble levels would boost home sales by around 450,000 units and new single-family home construction by around 275,000 units, according to estimates from Zandi… >reduce the unemployment rate by 0.4 percentage points.
Why is credit still so tight and what can be done to help? Parrot and Zandi (P&Z) identify… the lack of regulatory clarity on the put-back rules…. When a lender makes a loan to be purchased or insured by one of these institutions, which together cover 85% of the purchase market, they do so with the understanding that they will not bear the cost of any subsequent default. However, the government retains the right to put the cost of a defaulting loan back on the lender if it is later determined that the lender did not follow the rules in making the loan. This allows Fannie, Freddie and the FHA to enforce their underwriting guidelines and thus better manage their risk.
Nothing wrong—and a lot right—with that, of course. Bad underwriting was at the heart of the housing bubble and subsequent meltdown. But the problem is that current put-back guidelines lack clarity…. There’s a balance between bubbles and healthy credit markets, between risk aversion and risk mismanagement. Left to its own devices, the market hasn’t exactly been getting that right for a while now. It would thus be helpful for regulators to work with stakeholders to help find that balance in the market for housing finance. The sooner the better.