“Credit screws” getting tighter

From the WSJ:

‘Predatory’ Politics
November 27, 2007; Page A18

The housing recession still hasn’t hit bottom and a new Goldman Sachs report suggests falling home values could cause a broader economic slump. So right on cue, by a veto-proof vote of 291-127, the U.S. House earlier this month passed a bill that would reduce homeownership. That’s not the stated intention of the “Mortgage Reform and Anti-Predatory Lending Act of 2007,” but it is the probable result.

Chief sponsor Barney Frank boasts that his bill will avoid a recurrence of the subprime lending meltdown. That it might do, but only by exposing mortgage banks to so many new financial penalties and lawsuits that they will refuse to lend to many low- and moderate-income homebuyers. The companies that securitize mortgages — by packaging and reselling them to investors — will also have an incentive to abandon the subprime market because the bill makes them liable for any improper actions by the loan originators.

The bill bars banks and securitizers from “steering any consumer to a loan that the consumer lacks a reasonable ability to repay, does not provide a net tangible benefit, or has predatory characteristics.” Got that? No one has ever defined what a “predatory” loan is, but rest assured the trial lawyers will try to define it as any loan that a marginal borrower accepts but later can’t afford to repay. A legal analysis done for the Consumer Mortgage Coalition concludes that the House bill “will likely generate significant litigation” and that lenders will “rarely, if ever, be able to dispose of even frivolous lawsuits” thanks to the bill’s subjective standards. That’s probably an understatement.

This legislation comes at the worst possible moment for the ailing U.S. housing market. Banks hardly need new incentives to stop lending. A few months ago Wells Fargo Home Mortgage halted all subprime lending because of high default rates. Countrywide Financial, the nation’s largest mortgage lender, announced this month that the number of new mortgages it issued this past quarter plummeted by 40% from a year ago. The share of its new loans that are subprime fell to 0.2%. Two years ago subprime loans constituted between 10% and 20% of the new mortgage market.

Now the credit screws are so tight that low-income homebuyers without stellar credit ratings are finding it nearly impossible to get any home loan — which will further drag down home values. The broader danger is that this lending aversion will limit credit even for higher-income home buyers who have less than pristine credit histories.