The Next Financial Crisis(es)

The next U.S. consumer loan crisis might not be the student lending business after all, although that might happen, too.

No, the next loan crisis might just be another residential mortgage crisis.

Of course, the student loan business isn’t getting any better. The New York Fed said recently that 11.3% of student loans were delinquent in the last three months of 2014, up from 11.1% from the previous quarter. (By way of comparison, the delinquency rate on credit card loans was 7.3%, down from 7.5%.)

Let’s not forget that the official delinquency rate on student loans grossly undercounts the actual rate. That’s because most loans don’t require the borrower to start repayment until they graduate from college, and loans that don’t require a payment yet aren’t counted as delinquent. If they were, the real delinquency rate would probably be more than twice as high.

Let’s also not forget that the student loan business is now almost entirely a government-run (i.e., taxpayer-funded) enterprise. The handful of private lenders still in the business largely make loans only to graduate students – many of whom have jobs – or directly to parents, a much less credit-risky group.

And loan balances are building all the time. Student loans outstanding now total a record $1.16 trillion, the second biggest consumer debt category after home loans. By comparison, credit card debt – which is owed to private-sector lenders, not the government – now totals only $700 billion, down 15% from $824 billion when the recession officially ended in 2009.

“Although we’ve seen an overall improvement in delinquency rates since the Great Recession, the increasing trend in student-loan balances and delinquencies is concerning,” Donghoon Lee, a research officer at the New York Fed, said. “Student-loan delinquencies and repayment problems appear to be reducing borrowers’ ability to form their own households.”

Which brings me to my main point. While we should certainly keep our eyes on this burgeoning student debt problem, we also need to stay focused on a much bigger problem.

Also according to the New York Fed, mortgage debt, which is by far the largest category of household debt, now totals $8.17 trillion, up 1.5% in the past year. And the government, through Fannie Mae, Freddie Mac, the Federal Housing Administration, and other agencies, is the mortgage market, perhaps even more so than it is the student loan market.

We all know what happened when the mortgage and housing bubble exploded in 2007. I’m starting to worry that we’re setting ourselves up for Round 2.

In January, President Santa Claus announced that the FHA was reducing its annual mortgage insurance premiums from 1.35% to 0.85%, the first reduction since 2001. The ostensible reason, of course, is to make it easier and cheaper for prospective homebuyers, mainly first-timers, to qualify for a government-insured mortgage. The National Association of Realtors estimates those lower rates would save a borrower with a $200,000 mortgage nearly $1,000 during the first year and $18,000 over the life of the loan.

Who would be against that?

The problem is that, six years after the recession officially ended, and seven years after the government took over the two main government-sponsored mortgage enterprises, Fannie Mae and Freddie Mac, at a cost of $188 billion, Washington has still not done much to clean up its act.

In testimony before the House Committee on Financial Services, HUD Secretary Julian Castro defended the decision to lower FHA mortgage premiums even though the agency’s Mutual Mortgage Insurance Fund currently has a capital reserve ratio of 0.41%. The minimum level it’s supposed to be is 2%. He told the panel that the FHA’s finances are “strong” and predicted that the fund’s capital reserve ratio would exceed the 2% minimum within two years.

Rep. Jeb Hensarling (R-TX), chairman of the committee, wasn’t buying that.

“With all due respect,” he told Castro, “Many of us have been here before listening to your predecessors, saying in no time flat, the Mutual Mortgage Insurance Fund is going to recover. We get all these rosy projections, and none of the projections have ever proven accurate. After all these years, at what point does HUD and FHA intend to follow the law? Is there some point?”

I guess we’ll see.

When the president announced the FHA premium cut, he said the government will not finance homes that people cannot afford. “You're going to be out of luck. These rates are for responsible buyers.”

I guess we’ll see about that, too.

Subsequently, we learned that, according to the Wall Street Journal, “the delay in reforming the nation’s housing-finance system, including Fannie Mae and Freddie Mac, could eventually lead to the need for a new bailout.”

That dire warning followed sharply lower fourth-quarter earnings reports from the two agencies, $1.3 billion for Fannie (down from $6.5 billion a year ago) and $227 million for Freddie (down from $8.6 billion).

So what this all means is that even as the government has failed, six years after the fact, to reform the one area under its jurisdiction that was the root cause of the financial crisis we are still dealing with today, it’s going to make taxpayer-financed mortgage lending even more risky and more available.

I’m all for extending mortgages to people with iffy credit, but it has to be done through private lenders and investors with their own money on the line, not by taxpayers.

We had a robust privately-funded subprime lending sector in the 1990s and early 2000s. But then in the interest of consumer protection and “fairness” the government – led by the two men whose names ironically grace the financial reform act passed in the wake of the financial crisis – demanded that those lenders charge lower rates and fees no matter how risky those borrowers were. We know what happened next.

Let’s hope we’re not opening the door to another debacle.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.