Americans collectively own homes worth nearly $30 trillion. They have mortgages on those homes totaling about $11 trillion. | John Bazemore, File/AP Photo
Kevin Erdmann is a visiting fellow with the Mercatus Center at George Mason University and the author of “Shut Out: How A Housing Shortage Caused the Great Recession and Crippled Our Economy.”
The coronavirus outbreak means a deep and sudden economic contraction is likely now upon us. Public authorities have two important priorities here. The first is stopping the spread as quickly as possible. The second should be to limit the economic damage as much as possible, minimizing hardships like mass unemployment, debt defaults, and corporate failures.
Cash injections and other financial support from the government will be an important part of the response. Lawmakers are debating how to dispense money where it is most needed, whether that means loans to various industries hard hit by the pandemic, direct cash payments to American families, or the expansion of social safety net programs. Each requires large outlays of public expenditures, so part of the debate is how much of this public spending American taxpayers can bear over the long term.
However, there is a large source of potential cash that doesn’t have any of the challenges and problems of public spending: home equity.
Americans collectively own homes worth nearly $30 trillion. They have mortgages on those homes totaling about $11 trillion. That leaves $19 trillion in home equity. In the decade since the financial crisis, Americans have been deleveraging and mortgages now only represent about 34 percent of the value of owned homes. The last time leverage was lower was 1991.
In the response to the financial crisis, many new regulations and mandates were implemented in the mortgage origination process. Take for example, cash-out refinancing. Since the crisis, Fannie Mae, Freddie Mac, and the Federal Housing Administration have all added rules that prevent borrowers from using a mortgage refinance to take out some extra cash if that will leave them with less than 20 percent equity in their homes.
The new rules also require lenders to engage in time-consuming and expensive underwriting processes. They must prove to regulators that they are using new guidelines to make sure borrowers are qualified. And, if a borrower defaults, lenders are at risk of being punished by regulators in addition to bearing the normal costs of foreclosure.
The effects of these new regulations on mortgage lending have been noticeable. Compare the first quarter of 2003 and the fourth quarter of 2019, periods that are largely similar in terms of the interest rate environment. According to the Federal Reserve Bank of New York, during the first quarter of 2003, lenders originated $304 billion in new mortgages to borrowers with pristine credit scores above 760. In the fourth quarter of 2019, they originated $479 billion to borrowers with credit scores above 760 —an increase of 57 percent. Borrowers with the best credit never really reduced their borrowing activity during and after the crisis, and with the recent drop in interest rates, they are borrowing more than ever.
Contrast this with borrowers with credit scores below 760. During the first quarter of 2003, they took out $665 billion in loans. In 2019, they only took out $273 billion —a decline of 59 percent. In other words, the people who are most likely to struggle in the coming months have less access to home lending resources than they did prior to the events that fed the financial crisis. The same is true when it comes to leveraging their own home equity.
The New York Fed has also tracked a significant decline in home equity lines of credit (HELOCs). The value of HELOCs outstanding topped out at about $710 billion in 2009 and has declined nearly every quarter since then, to a current level of $390 billion.
This suggests that there are many households that might want to either tactically refinance hundreds of billions of dollars’ worth of mortgages or tap their home equity for cash, but have been prevented from doing so by the current set of regulatory hurdles.
Certainly, the 2008 financial crisis has created some reasonable fear about mortgage lending. But the dangers that were present in 2008 are not present today. There aren’t millions of recently purchased homes in cities where prices have suddenly doubled in a short period of time. Most borrowers will be long-time homeowners who braved the worst housing market in nearly a century and managed to hold on. In other words, unlike the housing bubble, these borrowers won’t be naïve new buyers speculating on a frenzied market; they will be established homeowners seeking financial safety during a pandemic. If ever there was a time to suspend the post-crisis regulatory framework, that time is now.
We should carve out an exception to the post-crisis mortgage regulations, at least temporarily. For the next three months — with an important caveat — banks should have the ability to offer customers a home equity line of credit or a cash-out refinance.
The caveat is that banks that make these loans should be required to hold them in their own portfolios. This ensures that they can’t pass the risk onto others, either the government or other investors. To make sure these mortgages are solid, banks should bear the risk themselves. Let them decide, solely with their own discretion, which loans they think are good risks. Let them perform underwriting on those loans like they would have for decades before the 2008 crisis, without all the time-consuming extra documentation they are required to file now. Call them “Coronavirus HELOCs.”
There is no guarantee that large-scale public policy responses will get money to all the Americans who need it most. We can, however, provide a financial lifeline for many American homeowners by letting them decide for themselves if a refinancing or HELOC is a good option for them. Americans could tap their homes for a trillion dollars in home equity and still not be any more leveraged than they had been in the 1990s when the housing market was quite docile and without driving up the national debt. This would be a simple way to use the private sector to quickly infuse cash into local economies.