Will this crisis reshape mortgage industry?

SEATTLE, WASHINGTON - January 30, 2008 - It was a crazy time in housing finance in America. Home buyers took huge gambles on interest rates, shunned the plain-vanilla 30-year mortgage and plunged into risky and exotic types of loans that threatened to bust their budgets and send borrowers into foreclosure.

It all came to a predictable end.

Which was: Interest rates plunged, home buyers refinanced at much more palatable rates and they dodged financial disaster.

Or at least that’s what happened 25 years ago when the housing finance industry faced the sort of national calamity not seen until … 25 years later when home buyers took huge gambles on interest rates, shunned the plain-vanilla 30-year mortgage and plunged into risky and exotic types of loans that threatened to bust their budgets and send borrowers into foreclosure.

That also came to a predictable — but very different — end.

Twenty-five years ago, home buyers, lenders and the economy as a whole got lucky. Their bet turned out to be the right one.

This time, though, the bet turned out horribly wrong.

So horribly wrong that the president, Congress, various regulators, state legislatures, the Federal Reserve and much of the banking industry now feel compelled to address the resulting destruction, or at least sweep the rubble into neat piles.

The circumstances and details may differ, but the outcomes of both housing-finance calamities were predictable for this simple reason: There aren’t that many outcomes from which to choose. Interest rates will either go up, down or remain the same. Home prices will either go up, down or remain the same.

Twenty-five years ago, borrowers and lenders were dealing with an economy in which mortgage rates were pushing 20 percent. In order to qualify for any sort of house, borrowers resorted to such exotic loans as five-year balloons, which combined a slightly lower payment with a requirement that the balance be paid off at the five-year mark. Had rates not come down, the landscape might have been littered with foreclosed homes, busted borrowers and desperate lenders.

In fact, rates did come down, much to the relief and benefit of everyone.

This time, however, lenders and borrowers trying to cash in on rising home prices combined to place risky and complicated wagers: The amount of the down payment and documentation of income and employment are not important. You can always refinance at a low rate. If you need to get out of a house, you’ll be able to sell for more than you paid.

This time the dice came up snake eyes on all three propositions.

So just what will housing finance look like after all the short-term fixes and cures are done, the wreckage has been cleared and the dust has settled?

Will housing finance be dramatically and permanently altered — or will people write this off as another of the industry’s cycles, albeit more severe than most? Who will be left to make loans? And what kinds of loans will they be making?

“We’re going back to where we were several years ago,” says Sheryl Nilson, chief executive of Lynnwood-based Pacific Crest Savings Bank and a past president of the Washington Mortgage Lenders Association.

“It’s going to look a lot like the ’90s, before we got the big drops in interest rates and the refi boom,” adds Robert Story, president of Seattle Financial Group, which includes both a savings bank and a mortgage company. “We’ll get back to more of a normalized market.”

Gone, both Nilson and Story say, will be the exotic loans — low or no documentation requirements, no down payments, negative amortization payment schedules, low teaser rates with resets — that are blamed for the current crisis. “I certainly hope we don’t see that kind of mortgage product available again,” Nilson says.

“People will need to qualify for loans and people will need to buy homes they can afford,” Story adds.

But will lenders and borrowers be scared straight?

“This is probably severe enough, and people have long memories,” Story says.

Maybe. The industry has been through lots of cycles before. But those tended to be localized and driven by regional economic trends (such as is occurring now in the Midwest). The current crisis is national and driven more by internal excesses than external factors.

“This is different; it’s much bigger,” Nilson says. “This is the worst I’ve ever seen.”

Perhaps the best historic parallel for what might happen to the mortgage industry comes not from housing but from technology. The tech sector put itself through a financial and structural downsizing, in the form of the dot-com bust, which even the mortgage industry of 2007-08 will be hard-pressed to match. Yet the tech sector did not disappear; it regrouped, restructured and returned, perhaps wiser and more cautious for the lessons it learned.

But for how long?

Will this crisis reshape mortgage industry?
By BILL VIRGIN | Seattle P-I