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Johnson-Crapo Could Steal Your Home Equity

Adam Rust's picture

Posted April 21, 2014

Two facts to consider when the Senate Banking Committee meets next week to start discussing the newest iteration of GSE reform: 

  • Half of US Households have Zero or Negative Net Worth. Almost forty percent have
  • Over the next ten years, seven of every ten new households will come from one of the following demographic groups: Millennials, racial or ethnic minorities, working-class Americans, and rural residents. 

Those two facts collide with one of the main principles in the new Johnson-Crapo bill. That legislation, as

currently written, says that borrowers who get a conventional government-insured mortgage must put down at least five percent. There is a carve-out for first-time homebuyers that allows them to put down slightly less. 

A lot of people would contend that homeowners should have some "skin in the game." That is what makes it so difficult to find the right answer. No one wants a new housing finance system that duplicates the previous context, where private investors were set up to make profits while the government was prepared to take losses. Theoretically, putting some money down should reduce risk. It certainly gives banks a better chance to bleed less from a foreclosure. 

Nonetheless, Johnson-Crapo is a blunt tool. It creates a system that is indifferent to individuals that have been paying their bills but not building wealth along the way.  

But at that bar, an awful lot of people are going to be shut out. In terms of geography, it portends a future where you can virtually write-off first-time homeownership is some metros: in a place like New York City, the northern suburbs of Virginia, or the Bay Area, a borrower is going to need at least $20,000 to buy a starter home.  Trulia says that the average California home sold for $739,351 during the week ending April 9th. Three states were even higher. In my state (North Carolina), the average sales price was $280,000. North Carolina is a middle-of-the-road state where many counties still suffer through high unemployment. 

I can understand where the legislators are coming from when they move to make higher down payments a basic fact of buying a home. But the concept is out of sync with asset formation among future homebuyers. Wven if down payment requirements are good medicine, the treatment will have some nasty side effects. 

Too many people who could be the future candidates to buy a home are not on tract to accumulate the kinds of assets needed to pay for a home - or at least one priced at the norms of our current housing market. Earlier I mentioned that future buyers will draw from many minorities. Well, minority households are going to be impacted by down payment rules. According to research from the Pew Research Center, median wealth of African-Americans was only $5,677 in 2009. For Latinos, the story was only slightly better. But holding assets of $6,325 - as was the case with the median Latino household - the difference is negligible. Unless the goal is to purchase a singlewide, another $700 is meaningless. One quarter of each group owned nothing besides a vehicle. Pew got that information from the Federal Reserve's Survey of Income Program and Participation. 

Young people are similarly challenged in this kind of scenario. In 2011, the SIPP data said that 32.9 percent of households headed by a person under the age of 39 had a net worth of more than $25,000. Given that it is a fair assumption that most of the ones with larger balance sheets already had homes, it leaves very few that are going to buy homes. It is true that many young people with little or no wealth are still homeowners, of course. More than a few are "under-water." But for the sake of this conversation, the significance is still the same: they probably won't be buying another home anytime soon. This conversation is inextricably linked to our student loan crisis. Right now, college graduates with student loan debt are leaving school with an average of approximately $30,000 in debts. 

Perhaps most relevant is SIPP's finding that only one in five renters has a net worth greater than $25,000.

The Loss of the 30-Year Mortgage Could be even more Impactful

Some people have suggested that the 30-year fixed rate mortgage will become a thing of the past as soon as private investors take over the secondary market. At the moment, private investors show little interest in snapping up 30-year mortgages bearing less than five percent interest. I doubt that will change.  Moreover, if the government's backstop weakens and the Federal Reserve starts selling its portfolio, things will only get worse. What happens? Well, interest rates go up. In fact, it is likely that rates would probably increase by a lot.

In today's conservative lending environment, delinquency rates on residential mortgage loans (1sts and 2nds) are still above 8 percent.  Interest rate risk is going to be really high with a term of 30 years. Given that, the 30-year might be replaced by a variety of flavors of ARMs: 7-1, 5-1, or perhaps a 10-1 at the longest.  

In that scenario, the groups referenced above are not the "biggest losers." Those households will suffer because they will be able to borrow less. But their loss will pale in comparison to what happens to the people that own homes now. As with everything in economics, the market will find a new balancing point. If seventy percent of borrowers can only borrow half as much under the new system, then home prices will fall to meet that diminished capacity. Home equity will vanish. A borrower would currently pay $1,043 per month (excluding taxes and insurance) to buy a $200,000 home on a 30-year FRM bearing an interest rate of 4.75 percent. At 10 years and 6.75 percent, the same payment only covers a home worth $90,859.