Mortgages: Will Paulson's Plan Fix the Mess?

More-stringent lending standards are aimed at avoiding more problems, but analysts say banks have already implemented the needed changes

by David Bogoslaw

Many U.S. mortgage lenders and home builders have already been brought to their knees as contagion from the subprime meltdown has effectively closed down credit markets. The announcement of more stringent rules across the financial industry has some people wondering what the implications could be for mortgage lenders and home builders.

The recommendations put forth on Mar. 13 by Treasury Secretary Henry Paulson reflect the consensus of the President’s Working Group on Financial Markets, comprised of the heads of the Federal Reserve Board, the New York Federal Reserve Bank, the Securities and Exchange Commission and other financial policymakers and regulators. The suggestions range from enforcing tougher lending standards to improving oversight by state and federal regulators to ensuring that banks hold ample capital to cover the risks they assume.

The thrust behind the proposed rules is to rein in excessively permissive practices in the interest of preventing future credit crises.

But some analysts believe the advice comes after most home lenders, burned by the knock-on effects of the subprime debacle, have already implemented changes in the way they do business.

Gary Gordon, an analyst who covers banks for Portales Partners in New York, says he’d be surprised if nearly all of the proposed requirements hadn’t already been implemented.

“The world has change dramatically. The secondary market for mortgages has collapsed. Buyers of mortgages require much stricter documentation now,’ he says. “So much has changed already that they don’t need regulators to tell them to change.”

He said he doubts new regulations that emerge from the Working Group’s recommendations end up leading to any tighter standards than already exist.

By requiring adherence to even tighter standards, regulators also run the risk of disabling the mortgage industry even further and potentially disrupting the housing markets for longer as a result, he warns.

It may seem prudent to put pressure on lenders and require more from them, “but this country can’t survive without debt,” Gordon says. “There’s only so much you can squeeze before you kill the economy.”

He believes that banking regulators realize they need to be somewhat flexible in dealing with lenders and argues that raising lending standards has already contributed to a likely recession.

One of the Working Group’s suggestions is to calling for mortgage brokers to be licensed according to nationwide standards, in much the same way that real estate brokers already are.

Richard Bove, an analyst at Punk, Ziegel & Co., says he has no doubt that the licensing will be enforced, but he’s convinced it won’t prevent the same unethical practices from occurring again.

“I don’t know of any period where poor people didn’t want to borrow money and there weren’t people who wanted to lend it to them,’ he says. “ I don’t see why that’s going to change” just by requiring mortgage brokers to take a licensing examination.

He points to excesses that took place in the mid 1990s by lenders such as First Plus Financial and The Money Store that regulators tried to correct with stricter accounting rules, which didn’t stop other lenders from going down the same road.

There’s certainly a need for better regulatory oversight of the information flows about mortgages both to those investing in mortgage-backed securities and to home buyers getting the loans, says Gary Painter, director of research at the Lusk Center for Real Estate at the University of Southern California in Los Angeles.

To the extent that disclosure was to improve, he believes mortgage lenders on the whole would benefit because investors would know what they are buying, which would make for a healthier industry in the long run.

The potential impact of tougher rules on home builders, whose inventories of unsold homes have ballooned since the credit bubble burst, is less clear, however.

Whenever policymakers say they plan to make lending guidelines stricter, it makes it harder for home builders to sell their product, says Rashid Dahod, an analyst at Argus Research in New York.