Mortgage Loans with Low and High Risk
The centerpiece of Min’s critique is a chart that shows the serious delinquency rate for four categories of loans:
Subprime 28.3 %
Freddie 620-650 credit score: 10.04
Freddie over 90% loan-to-value ratio: 8.45%
Conforming: 6.8 %
Min’s point is that the middle two categories, which Pinto classifies as high risk, seem to perform about as well as conforming loans. Therefore, it is wrong to classify them as high risk.
I am not sure what to make of this. The 6.8 percent serious delinquency rate on the conforming loans is horrible. The way Min breaks down the loan categories, every category is high risk.
If I were doing this work, I would try to find categories of loans for which the serious delinquency rate is under 1 percent. Now, they might be loans with loan-to-value ratios under 70 and FICO scores over 720, and only loans to purchase an owner-occupied home or refinance it to reduce the interest rate (in other words, no second mortgages, investment properties, or cash-out refis). I have no idea. But when I was with Freddie Mac in the late 1980’s and early 1990’s, we would not have said we were happy with a portfolio of loans with a serious delinquency rate anywhere near 6.8 percent, under any scenario.
If my view is correct, then Wallison and Pinto probably understate the shift toward high-risk lending that took place at Freddie and Fannie between, say, 1990 and 2007. By the same token, the extent to which this shift can be attributed to trying to meet affordable housing goals is overstated.
I feel pretty confident in arguing that Freddie and Fannie could have stopped the housing bubble by holding onto their credit standards of the early 1990’s. However, I would not be comfortable attributing their relaxation of credit standards to the affordable housing goals. I think that the management attitude toward risk changed exogenously. In part, this was due to new CEO’s with less experience in dealing with mortgage credit risk. As home prices rose, all sorts of high-risk loans performed well, and senior management misread this to indicate that it was safe to lower credit standards. Certainly, the political environment reinforced that decision. But the numerical affordable housing goals were not the dominant factor.