How Home Loans Impact the Economy

To every action there is always and equal and opposite reaction: or the forces of two bodies on each other are always equal and are directed in opposite directions....Sir Issac Newton.

If you do not understand something as complex as physics or economics, it is easy to be misled. I think that is happening today around the topic of prime lending and subprime lending in the housing market - and it is a major economic problem.

Today, an issue dragging down the economy is access to credit - especially mortgage credit. After the 2001 debacle of of home lending standards drove a lending crisis, the government over-reacted in setting overly high lending standards (Frank-Dodd and other complimentary policy).

Here is what is at stake. 250,000 to 350,000 jobs and 500,000 home purchases.

The media would submit that the standards are just fine as The Office of the Comptroller set the minimum guidelines for a conforming FHA prime loan at 660. Subprime loans are for people with credit scores between 580 and 670. (As an aside, about 50% of loans are 740 or above). This all sounds very reasonable, because it is. The average FHA score in 2001 was 656. Today it is 669. This is a very small change, about the same as having a 50% balance on your credit card vs. a 55% balance on your credit card.

The housing meltdown had nothing to do with credit scores. It had everything to do with underwriting. It is not if a score was 656 or 669 at all. In 2001, the loans were "stated income." Stated Income underwriting standards were half of the problem. The other half was allowing loans to be bundled up and sold on the open market coupled with credit default swaps that guaranteed the loan.

If you ask the Office of the Comptroller, they say that it is a result of instability in Europe, war in the Middle East driving up gas prices, and the "fiscal cliff" of sequestration that is set to go in effect on January 1st.

If the Office of the Comptroller reduces the prime rate on conforming home loans by a mere 10 points in credit rating (which costs nothing), it will lead to home purchases and jobs. According to economists like those at the National Association of REALTORS, access to loans is what is stalling the housing recovery.