One of the lessons learned from previous government efforts to solve complex problems is known as the "law of unintended consequences." According to this concept, whenever the government devises some master program, tax, or regulatory scheme as part of an effort to achieve some purpose, it invariably creates other unpredictable outcomes—the unintended consequences.
The term is widely used by the political party that is out of power to argue against the policies of the party in power; citing the potential negative unintended consequences their opponent's plan would cause. Despite its use as a weapon of political combat, the concept of unintended consequences is a fundamental precept of economic theory dating to Adam Smith and his description of the “invisible hand.” It is important to note, however, that unintended consequences can sometimes be positive.
We are currently reeling in the midst of multiple disruptive economic events: the credit downgrade of U.S. debt, the European debt and banking crisis, a general economic growth slowdown, and a bold statement of intent by the U.S. Federal Reserve to keep the Fed funds rate near 0% for 22 months. While the credit downgrade was certainly related to government policies over the course of several decades, and most recently with the underwhelming deal to raise the debt ceiling, it is the potential unintended consequences of the recent Fed move that creates the opportunity to move the housing market from crisis to recovery.
With the Fed pledging to keep Fed funds rate at 0% until the middle of 2013, everyone seems to be focusing on the ability for homeowners to save money by refinancing an existing mortgage, which is a positive. One thing, however, that is being overlooked is how this may help the housing market begin the recovery process.
The Fed's announcement has, perhaps as an intended consequence, made returns in short term Treasuries negligible at best. This is causing banks to start to look outside the box for better returns and away from the pure-vanilla Fannie, Freddie and FHA mortgages.
We were already seeing some traction in the jumbo market with several banks coming out with new jumbo products. But this recent Fed move could spur lenders—both banks and nonbanks—to introduce more creative mortgage products in an effort to realize higher yields.
This could be just the shot in the arm that the housing market so desperately needs. There are thousands of people who can afford to make a regular monthly mortgage payment on time that simply don't qualify under the stringent underwriting standards that are currently in place. In order to capitalize on the extremely low cost of funds we can imagine, and would welcome, the introduction of some creative mortgage products that are so desperately needed in order to fill a void in the market.
Let me make it clear that I am not advocating the return to subprime lending. But given all the tools now available for quality origination (i.e., financial values-based software) and for quality underwriting (i.e., compliance and fraud check tools) the HVCC (Home Valuation Code of Conduct) and better disclosure forms, the market seems well-positioned to accept these more creative financing alternatives without compromising the overall credit quality of the loans.
What we are positioned for better than ever before is the concept of true risk-based pricing for loans. Each consumer who presents a loan application is unique and represents a singular risk to lenders and investors. Under risk-based pricing the lender would offer them a price (interest rate) and terms (fees for insurance, etc.) that is commensurate with the risk they reflect at that time. Investors need higher returns, consumers with less-than-perfect underwriting profiles need an opportunity to participate in the housing market. This is a win-win scenario.
We need loan products that can provide a vehicle for Americans to purchase the excess housing inventory that is available at significantly reduced costs. We need products that will allow working but imperfect borrowers the opportunity to purchase homes from those who are facing unemployment—unlocking equity or freeing the homeowner and the lender from likely foreclosure. We need mortgage products that lead to follow-on consumer spending on household goods and services. We need homeowners who have the ability to renovate and rehab existing properties to improve values and neighborhoods. We need construction jobs from new housing construction. We need Americans buying in to the American dream rather than giving in to the American decline—rhetoric that is growing louder by the day.
At the end of the day, an unforeseen benefit of the Fed move will hopefully be the start of the housing recovery.
John Walsh is president of Total Mortgage Services, Milford, Conn.
