High-Debt Borrowers Signal Warning and Can You Bank at the Post Office?

During my travels last week, I picked up a Wall Street Journal and found two articles interesting in the May 14th edition.  The first is by Bob Eisen and is titled “More High-Debt Borrowers Backed by Fannie, Freddie”.  It starts, “The gatekeepers of the American mortgage market are increasingly backing loans to borrowers who have heave debt loads, highlighting questions about mortgage risk as policy makers debate ways to change the system.”

In 2018, nearly 30% of all mortgages that Fannie Mae and Freddie Mac packaged into mortgage backed bonds, went to home buyers whose total debt payments exceeded 43% of their incomes according to Inside Mortgage Finance.  This share has doubled since 2015.  In my banking career when I was doing home loans, the threshold was at 36%.  I remember vividly when the limit rose to 38% and the debate within our shop, as to if this was leveraging customers too highly. 

But these hard and fast debt/income ratio goes out the window with the new computerized algorithms used to underwrite loans today.  But even so, 43% is extremely high and how does this happen? 

It appears an obscure half decade old rule made these mortgages with people with high debt loads possible.  This provision started after the Consumer Finance Protection Bureau introduced tighter mortgage lending standards after the financial crisis while at the same time creating temporary measures to avoid slamming the mortgage door shut on some borrowers.  This exception was nicknamed the “qualified mortgage patch” allowing Fannie and Freddie to lend to highly leveraged borrowers.  Fannie said two years ago it would guarantee mortgages with debt/income ratios between 45-50%. 

Let me wrap my mind around this.  In the mortgage crisis, we did see some bad actors.  Appraisers who inflated values.  Mortgage brokers who pushed deals through just to get a paycheck.  Bankers who financed houses to make their bonus and present a large source of income to their shops.  But we cannot forget about one of the largest causes of the problem—the secondary market.  Market makers created methods to purchase more mortgages, package pools of good loans with bad loans and call them all “investment grade” and expanded underwriting standards to make it so any adult with a pulse could get a mortgage or even several.  If the market would purchase the mortgage and no residual risk was posed to the appraiser, mortgage broker, or banker, then why not do it?  The main drivers behind the markets are the government sponsored entities of Fannie and Freddie. 

Some economists bring up a valid point that facilitating house loans to borrowers with a large proportion of debt requirements to their income has a negative impact on the broader housing market.  This can artificially inflate house values.  We saw this in the 1990’s, a decade with real income annually increasing around 3%, while average house values nearly tripled in those ten years.  The article quotes Ed Pinto, co-director of American Enterprise Institute’s Housing Center, “We have a huge shortage of housing.  You can’t address that shortage by driving house prices up through leverage, which is what we’ve been doing.”

Some wonder if we will face some retraction in housing prices when the “mortgage patch” provision ends in 2021 or whenever Fannie and Freddie decide to take underwriting standards to stricter levels as was common in the not too distant past. 

In the same edition of the Journal, in the opinion page is a column titled “Bernie and AOC Are a Credit Risk”.  The article states that two of the “loudest socialists’, Sen. Bernie Sanders and Rep. Alexandra Ocasio-Cortez called for capping interest rates on consumer loans at 15%.  Today’s median rate on credit cards at 21%, is too high given that banks can borrow from the Federal Reserve at 2.5%. 

But is that an accurate argument?  The writer points out that credit cards function as payment networks with functions such as processing countless small dollar transactions, sending monthly bills, offering on-demand customer service.  The cost of daily operation is high, yet in 2010 Congress capped the interchange fees that financial institutions can charge.  The result was many institutions found other ways, such as increased fees on deposit accounts to make up that lost income. 

In Economics 101, we learn that price ceilings on any good or service cause shortages.  Demand increases since the public sees this good as being cheaper, given its utility.  Supply for the good decreases as the producer now has less profit reason to produce (remember economics is:  people respond to incentive).  Shortages of consumer credit would hit with a cap and it would impact those folks who would benefit the most from the higher credit card rate when compared to options of a pawn broker or payday lender. 

But the pair has another suggestion to help address the lack of financial services widely available.  Let Americans get checking accounts or even low-interest loans, from their local branch of the U.S. Postal Service.  Credit Unions see constant market share being eaten away from banks and many non-bank competitors today.  Now we must worry about the federal government. 

The convenience is not at the USPS.  My local post office is open only 5 hours a day on the weekdays and 3 on Saturday.  The experience level of delivering financial service is not there.  How is the USPS supposed to set up an ATM network, deposit accounts, and underwrite loans with no deep experience in any of these areas?  How can they do this where it is anywhere close to break even financially with an entity that lost $3.9 billion last year and has unfunded pension liabilities and retiree health care of $100 billion?  Politicians would push the postal bank to further lower underwriting standards and fees as they fight those who are on the outside of banking services.  This strategy seemed to work great in the mortgage business.  The losses would be incredible and would be forced on the heads of the U.S. taxpayer.

We worry about entities like Apple, Starbucks, Amazon, or Wal-Mart for supplying banking services and how this impacts the landscape of our credit union members and those-who-could-be a member.  Now if the proposal from AOC and Sanders comes true, your new competition comes from a group with unlimited money.  The oversight for the USPS bank is not as concerned with sound financial management as they are pleasing the populace to gain more favor for the leadership whenever elections occur.  That, indeed, could be a challenging competitor for us.