Fed's Pianalto: Tight Mortgage Credit holding back Economy

From Cleveland Fed President Sandra Pianalto: Housing in the National Economy: A Look Back, a Look Forward

A major reason why the economic recovery has been so slow and has required so much policy support has been the performance of the housing market. Ordinarily, deep recessions are followed by strong economic snap-backs. But an economist at my Bank and his co-author found two exceptions to that rule: the Great Depression and the recent recession. [see: Deep Recessions, Fast Recoveries, and Financial Crises: Evidence from the American Record]. In this last episode, the evidence points to the collapse of the housing market as the key explanation for the slow recovery. Most of the time, home construction and spending on household goods can be counted on to provide a big push to the recovery. Historically, residential investment has contributed about half a percentage point to GDP growth in each quarter during the two-year period immediately following a recession. During the first two years of this recent recovery, however, the contribution from residential investment to GDP growth was basically zero. Because the recent recession was caused in part by a housing crisis, the housing market was too damaged to provide its customary lift to GDP growth.
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So that is where we have been--a housing bust followed by a recession and sluggish economic recovery that was made all the more sluggish because of the weakened housing market. Looking ahead, tight conditions in mortgage credit markets will continue to hold the housing sector and broader economy from getting back to full strength more quickly.

Let me elaborate on that point. In a recent Federal Reserve survey of senior loan officers, bankers reported that credit standards for all categories of home mortgage loans have remained tighter than the standards that have prevailed on average since 2005. Financing companies no longer assume that houses will provide adequate collateral for borrowers with fragile credit histories. In addition, financial market regulators are standing vigilant to ensure there is no recurrence of the housing bubble that almost brought the financial system and global economy to its knees.

Moreover, access to mortgage credit has become far more restrictive. To get a mortgage today, it helps to have a very high credit score. Lenders are more likely to extend mortgage credit to consumers they perceive as very low risk. As a result, the pool of potential mortgage borrowers has shrunk. Households with low credit scores that were able to get credit before the crisis now are the least able to refinance their homes, or to obtain new mortgage loans. These are also the households who seem to be especially cautious in their spending these days. For these households, the days of extracting "free cash" from their homes are over. It is now mostly households with ample savings that spend and save as they normally would.

Another development that could lead to tighter credit conditions in the future involves the secondary mortgage market. The outlook for the government-sponsored enterprises Fannie Mae and Freddie Mac is uncertain. The GSEs, as they are known, had to be rescued after the financial crisis and Congress is weighing reforms that might greatly reduce the government's large position in housing finance. The housing market today is being heavily supported by Fannie and Freddie. Without the government guarantees on mortgage-backed securities, the amount of credit available for mortgage originations would be substantially smaller today.

To sum up my remarks, it was the housing bust that got us into this situation. And the lasting consequences of the bust continue to hold back the housing market and broader economy. The big picture is that many households are still adjusting to the large shock to their net worth that occurred during the financial crisis and are dealing with uncertainty over their future earnings prospects. For these reasons, consumer spending will likely continue at a moderate pace. But over time, I expect these effects to fade and credit conditions to improve.
emphasis added

Lenders are still very cautious, however lending standards are loosening - just very slowly. No one wants to go back to the almost non-existent standards of the early-to-mid 00s. I expect credit to slowly become more available, but please no NINJA loans (no income, jobs, or assets) and please no Alt-A (stated income, self-underwritten) loans.