The WSJ on December 24 had a front page story entitled “Push for Cheaper Credit Hits Wall”.
The story’s main theme is that “economists posit that banks are keeping rates artificially high, boosting profits and depriving the economy of the full benefit of the Federal Reserve’s efforts.” Charles Dickens could not have done a better job making banks out to be Scrooges.
How about letting some facts get in the way of opinions posited by economists? The article starts on solid ground by pointing out that mortgage loan rates are about 57 basis points higher than the norms of 2003-2005 (a basis point is 1/100th of a percent), but quickly founders by failing to apportion this increase among various possible causes.
It turns out the biggest contributor to “artificially high rates” is not lender rapacity, but government action. First, it is well known that Fannie and Freddie (the GSEs) had been seriously mispricing credit risk for a couple of decades. This is the reason Congress, in 2011, ordered the Federal Housing Finance Agency, the GSEs’ regulator, to assure that the GSEs’ guarantee fees “appropriately reflect the risk of loss, as well the cost of capital allocated to similar assets held by other fully private regulated financial institutions.” As a result, guarantee fees have increased from an average 22 basis points per year in 2003-2006 to about 54 basis points per year today. This increase of 32 basis points accounts for 55% of the 57 basis point rate increase.
Second, it is also well known that increased regulations have added substantial time and expense to the loan origination process and that this has to get reflected in the rates charged. While hard to precisely quantify, I would conservatively put this added expense at 12-15 basis points. So the reality is that government actions account for 44-47 basis points or about 80% of the increase. That leaves maybe 12 basis points or about 20% attributable to Grinch-like banks accused of stealing Christmas. The truth is, thanks to direction from Congress, credit risk is on the road to appropriately reflecting the true risk of loss and capital.
The bad news is that since the Government Mortgage Complex continues to account for 90% of mortgage credit risk, the bulk of these fees are effectively paid as dividends to Treasury, whereupon they are immediately spent. They should be accruing as capital and contingency reserves held by private sector mortgage guarantee entities. Instead we have a government-dominated $10 trillion housing finance system with virtually zero capital behind it (correction: with the FHA’s insolvency, the total is actually negative) and taxpayers are being left once again to pick up the tab. Contrast this to a healthy private housing finance market that would be backed by about $300-$400 billion in core capital, which capital would be supported by appropriated priced loan guarantee fees.