Housing Risk In 2015: It’s Déjà Vu All Over Again!

whiplash“24% of all purchase loans have a debt-to-income ratio greater than the CFPB’s Qualified Mortgage rule limit of 43% [of debt to income], a new series high.“  ~Mortgage Risk Index-March 2014 Release, AIE’s International Center on Housing Risk

Hmmm. I thought the CFPB was the new sheriff in town, protecting the Little Guy from the villainous Big Banks. Isn’t that why it created the Qualified Mortgage or “QM” rules?  Wasn’t QM that safe harbor, giving peace and comfort to lenders who stayed within the guidelines deemed “safe”?  Wasn’t a debt-to-income ratio[1] over 43% deemed “risky”?  And for those lenders foolish enough to stray outside of the QM box, they became subject to the draconian Ability to Repay, or “ATR” rules, which, if violated, gave borrowers the right to sue lenders for giving them loans they should not have taken out. Huh?

Here’s what the CFPB said in December 2013, about the 43% DTI ratio [right before rolling out the QM and ATR rules]:

Evidence from studies of mortgage loans suggest that borrowers with a higher debt-to-income ratio are more likely to run into trouble making monthly payments. The 43 percent debt-to-income ratio is important because, in most cases, that is the highest ratio a borrower can have and still get a Qualified Mortgage.

What is the CFPB doing about this flagrant risk-taking?  And the administration – is it up in arms and threatening Wall Street again [while simultaneously pocketing their political contributions]?  The short answer is that these rules, for all the handwringing they caused at the time, are ancient history.  They were political window-dressing, to make it appear that the government was watching out for consumers – something they failed to do in the run up to the credit crisis, when Big Banks were making no-doc loans to anyone who could fog a mirror.

You see, time calculated by regulators and politicians is the same as dog years – seven. For them, these rules are soooo yesterday!  But for mere mortals, we remember that the QM and ATR rules were just finalized in January, 2014. What is more important today is lining up the Administration’s lending policy with its immigration policy.

So what is the Administration saying about banks and borrowers taking on more risk? Apparently, it’s OK, despite QM and ATR.  According to Housingwire, here, HUD’s new chief, Julian Castro, recently addressed several real estate trade groups, saying:

FHA’s work alone will not solve all the industry’s challenges, which is why I appreciate this focus today on out-of-the-box thinking,” he said. “I know that new credit scoring models are being developed so that non-traditional factors can be considered when determining creditworthiness.”

Castro said FHA is exploring the use of new credit scoring models.  “We’ll look at every option that brings housing opportunities within reach of more Americans,” he said.

In an April 2 Housingwire article, they reported:

After the pilot program is complete in the coming months, FICO expects to make the score based on alternative credit data available to more lenders later this year.

FICO’s data scientists found that alternative data such as property records, telecommunications and utility information can reliably be used to score 15 million consumers who do not have enough credit data to generate FICO scores.[2]


“Working with Equifax and LexisNexis, we set out to help unbanked, under-banked and disadvantaged people gain equal access to the standard credit products enjoyed by millions of Americans,” said Jim Wehmann, FICO’s executive vice president for Scores.”

“We’re excited by our pilot program’s strong results thus far. FICO’s focus is on expanding access to credit; not simply scoring more people. Our approach also addresses a paradox for people seeking their first traditional credit product – you often need a credit history before you can get traditional credit,” added Wehmann. [See, “It’s official: FICO announces new credit program for risky borrowers”]

This is eerily reminiscent of the pre-crisis years of 2005 – 2007 when the ratings agencies were telling gullible investors that the toxic loans they were buying from Wall Street investment houses were actually triple A investments.  Except now, it’s the consumer credit rating companies telling lenders that their borrowers’ scores are solid gold, based upon a new set of “non-traditional” rating metrics.  It’s deja vu all over again!

So what is risk anyway, if it can be so easily manipulated by tweaking a few algorithms?  According to AIE’s International Center on Housing Risk, which created a National Mortgage Risk Index or “NMRI” it tracks “…home purchase loans that have been (1) acquired and securitized by Fannie Mae or Freddie Mac or (2) guaranteed by the Federal Housing Administration (FHA), or (3) the Department of Veterans Affairs (VA), or the Rural Housing Service (RHS).”

The NMRI measures how “…loans originated in a given month would perform if subjected to the same stress as in the financial crisis that began in 2007.” Their methodology is detailed here.  It defines a “low-risk” loan as:

 …a loan with a stressed default rate of less than 6%. This definition is calibrated from two sources – the original QRM proposal to implement Dodd-Frank and FHA’s underwriting standards from 1935 to 1955 – both of which yield an average stressed default rate of approximately 3%. The 3% average is consistent with a maximum stressed default rate of approximately 6% on individual loans, assuming a uniform distribution starting at 0%.

Here is a summary of some of the key findings for February/March 2015:

  • The NMRI for Fannie and Freddie purchased loans was 11.93% in February, “up 0.1 percentage point from the average for the prior three months and 0.8 percentage point from a year earlier.”
  • FHA’s NMRI stood at 24.48% in February, up 0.2 percentage point from the average for the prior three months and 1.6 percentage points from a year earlier[3]
  • A marked shift in market share from large banks to nonbanks accounts for much of the upward trend, as nonbank lending is substantially riskier than the large bank business it replaces. [For the full report go to this link.]

Conclusion. In a perfect world, everyone who wants a home loan, should get a home loan. But, if we are to remember anything from the fairly recent past, i.e. circa 2005 – 2007 – when everyone who wanted a home loan did get one – not everyone should have a home loan. Making loans to “risky borrowers” by re-defining risk, is delusional.  Despite the best efforts of regulators and politicians, they cannot have it both ways. George Orwell described this in 1984 as “Doublethink,” “…the power of holding two contradictory beliefs in one’s mind simultaneously, and accepting both of them.” 



[1] Per the CFPB, here: “To calculate your debt-to-income ratio, you add up all your monthly debt payments and divide them by your gross monthly income. Your gross monthly income is generally the amount of money you have earned before your taxes and other deductions are taken out.  For example, if you pay $1500 a month for your mortgage and another $100 a month for an auto loan and $400 a month for the rest of your debts, your monthly debt payments are $2000. ($1500 + $100 + $400 = $2,000.) If your gross monthly income is $6000, then your debt-to-income ratio is 33 percent. ($2000 is 33% of $6000.)”

[2] Let me get this straight:  The fact that someone pays their electricity and water bills regularly is a valid predictor as to whether they will pay their Visa card? Does paying your Visa card keep the lights on or water running?

[3] When the credit and housing markets collapsed, what were then known as “subprime lenders” disappeared. It is no secret that FHA stepped in to filled that void. With loans carrying a collective NMRI score of 24.48%  – four times that of a “low risk loan” – FHA has become the new subprime lender. The only difference today is that when private subprime lenders failed in 2007-2008, American taxpayers did not foot the bill. But when FHA loses money, they do pick up the tab. In 2013, the federal government bailed FHA out – for the first time – to the tune of $1.7 billion. It likely will not be the last.