Incredible shrinking market
U.S. regulators and financiers could be focused on the wrong mortgage market. They’re right that healthy home lending hinges on the ability of the private sector to finance all or most of it, rather than relying on government-run Fannie Mae and Freddie Mac or their equivalents. But the architects of the post-crisis home loan market may be assuming it needs to be larger than it really does. A post-crisis market could be scarcely half as big as the current $10.5 trillion – and therefore much easier to finance.
Size matters because regulators, the financial industry and community groups are sweating the details of mandated reforms, including setting a new gold standard for mortgages. Tougher criteria – making mortgage lending less risky and home price boom-and-bust cycles less severe – are likely to reduce the supply of loans. If important constituencies are targeting the wrong market size, they risk striking the wrong balance.
Today’s figure for outstanding mortgages is still only 6 percent below the pre-crisis peak, while home prices are down by a third. That’s one hint the market hasn’t bled out the excesses. Once foreclosures, sharply lower home values and the swelling ranks of renters are baked in, the market should be smaller. Currently, the mortgage market is more than twice as big as in less-frothy 2000. If home prices had appreciated in lock-step with consumer price inflation since 1996 and loan-to-value ratios stayed the same, there would now be roughly $5.3 trillion of home loans outstanding, just over half the current level.
Or consider a simple calculation starting from the latest figures. First, assume 4.3 million severely distressed loans are repaid or written off once the relevant homes are foreclosed and resold. That could lop close to $1 trillion off the market. Then suppose the national rate of home ownership drops a couple more percentage points to the 64.5 percent average over the three decades to 1999. That could knock another nearly $300 billion off the market. Then overlay the drop in home prices from the 2006 peak, and a fully deleveraged mortgage market might be around $6.6 trillion in size.
Demographics also argue for smaller homes, and by extension smaller mortgages. Harvard’s Joint Center for Housing Studies expects 3.8 million baby boomers to downsize their homes over the next 10 years. The mortgage market may not quite be cut in half. But policymakers shouldn’t ignore the possibility. A smaller market is a more manageable one – maybe even one that can function without the government backstop most in Washington still want to see in place.