Why have lending standards tightened so much?

Supposedly the US credit crunch is over, but ordinary borrowers still have difficulty getting access to credit.  David Wessel has an interesting WSJ column that shows how higher credit scores are now needed, even among those with steady jobs and a good credit history.  This keeps buyers out of the home market and makes it more difficult for those with homes to refinance. 

While no one wants to see a return to the days when a person could get a home loan for zero percent down, one has to wonder why lending standards have swung so far the other way.  Many of the people Wessel talked to pointed their fingers at our old friends Fannie Mae and Freddie Mac.  Burned by so many bad loans, have they now become too risk averse?

Bye-bye to Fannie and Freddie?

So it seems, according to press accounts in NYT and WSJ.  The Obama administration laid out three scenarios for the future of mortgage finance, none of which included Fannie or Freddie.  One option is for the federal government to get out of the mortgage insurance business altogether (except for a scaled-down FHA).  Another is for the government to stay out of the way most of the time except in periods of financial shocks (question: define a financial shock).  In the last case, the government would guarantee mortgages issued by the private sector, but would charge a fee for the service -- much like what is currently done with the FDIC for bank accounts.  

It remains to be seen which approach can get through a divided Congress.  In any of the three scenarios, mortgages would become more expensive and fewer households would qualify.  But after the turbulence of the last few years, that is not necessarily a bad thing. 

Do we need Fannie and Freddie?

Two recent articles coming out quite differently on this question.  In a WSJ op-ed the American Enterprise Institute's Peter Wallison argues that most other countries get along fine without any implicit federal guarantee of repayment.  In a NYT op-ed journalist Bethany McLean raises concerns that banks would make significant changes in mortgages if government guarantees were to vanish, such as ending 30-year and fixed-rate mortgages. 

In simple economic terms, McLean essentially argues that interest rate subsidies for housing are socially worthwhile whereas Wallison is unconvinced. 

The latest on Fannie and Freddie

Last week the Federal Housing Finance Agency issued its latest estimates of how much the bailout of Fannie Mae and Freddie Mac will cost taxpayers.  NYT reports that the U.S. Treasury already has pumped $148 billion into these two operations.  This is what we call in economics a sunk cost.  There is a wide range of uncertainty concerning how much more of a tab the two housing finance agencies are going to run up.  WSJ reports that under a best case scenario, it will be a mere $6 billion.  Worst case scenario?  If home prices drop another 20-25 percent, we could be in for another $124 billion. 

Fannie and Freddie keep rolling along

A front page story in today's NYT publicizes what many economists have long known: at the end of the day we are going to spend a lot more bailout dollars on mortgage repackagers Fannie Mae and Freddie Mac than we will on AIG and a bevy of banks.   The bill right now stands at $146 billion, but the Congressional Budget Office estimates that it will eventually hit $389 billion.  Nothing has really changed for these two institutions; those who bought their mortgage-based securities always assumed they were guaranteed against default by the US Treasury even though there was never any explicit commitment.  Now Uncle Sam owns and runs both agencies and there has yet to be any serious debate in Washington about how they should be managed in the future.  Another case of financial institutions that are too big -- and too politically connected -- to fail.