NEWS: Higher Odds Of Regional Housing Busts

By RUTH SIMON and JAMES R. HAGERTY

Staff Reporters of THE WALL STREET JOURNAL

June 20, 2005; Page A8

A report by Fannie Mae says the probability of housing busts has "risen sharply in certain parts of the country," partly because of looser lending standards.

The report, presented to a group of home builders in Washington last month but not yet released publicly, finds conditions in many parts of the country "mirror past conditions that preceded regional housing busts." Among other things, it cites increases in the number of riskier loans, including ones that allow buyers to delay repaying the principal or that aren't backed by full documentation of the borrower's income and assets.

The report adds, however, that it is impossible to know whether there is a housing "bubble" until after the fact.

The analysis is notable because Fannie and the smaller Freddie Mac are the nation's biggest purchasers of mortgage loans. The two government-sponsored companies buy loans from lenders and package them into securities for sale to investors. They have long played a big role in setting standards for home loans.

Their ability to set standards, however, is eroding rapidly as they lose market share to private-sector rivals. Fannie and Freddie helped finance about 43% of new home mortgages in 2004, down from 59% a year earlier, according to Inside Mortgage Finance, an industry publication. Lenders increasingly are selling loans to rivals with more flexible credit standards. Fannie's capacity to buy loans also has been hampered by its need to shore up capital in the wake of an accounting scandal.

The Fannie analysis shows a loosening of standards for loans included in "private-label" mortgage securities, those that aren't backed by Fannie, Freddie or Ginnie Mae, a government agency that guarantees payments on federally insured loans.

The shifts are particularly notable for home-purchase loans to people with blemished credit records. Nearly 24% of the total value of "subprime" loans included in private label securities last year were adjustable-rate mortgages with an interest-only payment feature. On such loans, borrowers don't need to pay down the principal in the early years. Interest-only mortgages are considered riskier because borrowers don't build up any equity during the interest-only period and face sharply higher payments once they have to start paying back the principal.

Debt loads also are climbing. Mortgage borrowings rose to an average of 91% of the home value last year, from 85% in 2001. If home prices fall, high debt levels make it more likely a house will be worth less than the mortgage balance.

The report found similar shifts among home buyers taking out mortgages larger than the maximum size purchased by Fannie and Freddie, currently $359,650. For instance, the share of "jumbo" mortgages issued with full documentation of the borrowers' income and assets fell to 49% last year from 73% in 2001.

Of course, Fannie could hope to gain by questioning rivals' practices. Asked about that, a spokeswoman said "a chorus" of voices is raising concerns about "the layering of risks." What is more, Fannie and Freddie do buy interest-only loans and mortgages without full documentation.

The report says lending patterns of the past year are similar in some ways to those of the late 1980s, shortly before prices fell in parts of the U.S., including Southern California and New England.

Table: Easier Money
Percentage of subprime home-purchase laons with interest only payments
2001 0%
2002 1.8%
2003 8.2%
2004 23.5%

Percentage of fully documented income and assets for home purchase loans

2001 70.4%
2002 60.9%
2003 57.6%
2004 55.1%

Note: Data are for home purchase loans in mortgage securities not guaranteed by Fannie Mae, Fredie Mac, or Ginnie Mae.

Sources: Fannie Mae, UBS, LoanPerformance