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How do you get lenders to loan more money? This is the question the architects of our shaky housing recovery have asked time and again.

The latest answer by the new Director of the Federal Housing Finance Agency (FHFA), which oversees the government-sponsored entities (GSEs) Fannie Mae and Freddie Mac, is to give a little. In a recent speech at the Mortgage Bankers Association Conference in Las Vegas, Director Melvin L. Watt pledged some changes that might coax lenders to open their vaults and help more families become homeowners.

Promised changes include:

  1. Reducing the minimum down payment requirement to just 3%. This is below an already low 3.5% requirement for Federal Housing Administration (FHA)-insured mortgages.
  2. Decreasing the chances of mortgage buy-backs, which occurs when a mortgage sold to the FHFA falls below FHFA standards and the bank is forced to repurchase the mortgage. The FHFA is promising to only go after banks that have a pattern of selling substandard mortgages, and not just one or two, which might just be innocent mistakes on behalf of the bank. Further, the FHFA will not automatically force the bank to buy back a mortgage that has had its private mortgage insurance (PMI) rescinded. Finally, they will not force a buy-back on the bank as long as the mortgage has had no more than two delinquencies within the first 36 days of acquisition.

Watt assures that details of the FHFA’s plans will be made available in the coming weeks. Frankly, Mr. Watt is in a conversation with the wrong audience, pitching them the old-time religion they want to hear.

This road looks familiar

On one hand, the proposed changes might encourage lenders to be a little more forgiving when it comes to qualifying a potential homebuyer. Lenders often cite the fear of mortgage buy-backs as a main deterrent to lending to anyone with less than stellar credit. To cover this buy-back risk, lenders properly charge a higher interest rate. Thus, a higher bar for buy-backs means more homebuyers can be qualified (and hopefully at lower interest rates) without the worry of the FHFA forcing mass buy-backs.

However, when the FHFA loosened its buy-back regulations in 2013, it had little to no effect on lending activities.

This brings us to the other hand. Relaxed standards and decreased down payment requirements are what got us into this mess of a housing recovery in the first place. Mortgage fundamentals are the same today as they have been for the past century, and each time they are abandoned we have a crisis.

Simply put, a 3% down payment is insufficient to guarantee the homebuyer has skin in the game. Home prices waver from year to year, meaning a new homeowner with an extremely low down payment is just as likely to be underwater as solvent in the year following origination. An underwater homeowner with very little invested in principal has very little reason to stay and pay. Then, when they walk away from their mortgage, the FHFA/GSE (taxpayers) are stuck with the bill. Alternatively, the FHA’s mortgage insurance premium (MIP) at 1.1% of principal for the life of the loan offsets taxpayers becoming the stuckee, a condition guaranteed with the FHFA down payment abandonment plan without the mortgage insurance or higher interest rates.

The alternative plan

So, how do you get lenders to loan more money — without pushing the housing market towards a cliff? The answer lies with:

  • clearer (not fewer) regulations on mortgage buy-back arrangements with the FHFA/GSEs; and
  • higher down payment requirements.

The FHFA is rightly concerned with helping lower-income households who have trouble saving up for a down payment. However, instead of addressing the problem by essentially subsidizing lenders while reducing their skin in the game based on retained investment requirements, the government needs to fix the problem at its source: stagnant incomes.

Here in California, jobs have nearly returned to pre-recession (2007) levels as of September 2014. Counting the working-age population increase of roughly 1.2 million between the start of the recession and today (seven years and counting), we’re unlikely to reach the actual jobs recovery until 2019 if all goes well with the global economy.

In the meantime, real incomes have slowed to a crawl (while GDP has grown handsomely to the benefit of others). From 2000 to 2013, real incomes in California grew by a per individual average of 4% – yes, 4% purchasing power increase in 14 years. Couple that with the over 200% price increase in homes over the same period of time. So viewed, it’s no wonder would-be homebuyers are having trouble qualifying when borrowing money is tied to income, not prices. Prices of homes must drop or personal income must rise before the population of end-user homeowners can rise.

Instead of the FHFA concentrating on efforts that benefit lenders (and home sellers at today’s prices), why not help homebuyers by setting up a tax-free savings program for individuals saving for a down payment?

It’s going on seven years since the outset of the recession. It’s about time we adjusted our strategy from a mortgage lender perspective of short-term band-aids to long-term thinking. That means investing in future homebuyers — not the systems that so far have prevented renters from becoming homeowners.