Mark Calabria is in a familiar position: at odds with the broader world of housing market policymakers and analysts.
The former director of the Federal Housing Finance Agency, made headlines last week by saying there is a “ticking time bomb” in the mortgage industry that harkens back to the housing bubble of the mid-2000s.
During an interview on Intrafi Network’s “Banking with Interest” podcast, Calabria said poor underwriting standards at the Federal Housing Administration were setting the market up for failure. As fears of a recession mount, he said a reckoning could be imminent.
“This is going to boomerang in a way where you see this huge contraction once these borrowers go into foreclosure,” Calabria said. “We’re already seeing one in 10 FHFA borrowers delinquent today — in a strong housing market, in a strong economy. What’s going to happen when that turns?”
Home prices have gone up 30% nationally since the first quarter of 2020 and increased by some measure in almost every market in the country, according to the credit agency Moody’s Analytics, often outpacing local income appreciation. There is broad consensus that this activity has been detrimental to prospective first-time buyers and the run-up in property values fits the mold of an asset bubble. Yet most analysts offer a more sanguine outlook than Calabria.
Moody’s published a white paper on the topic this month. It deemed the risk of a sharp, nationwide decline in housing prices to be low. Like many observers, the report’s authors point to a decade of underbuilding combined with rising demand from millennials entering their prime home-buying years bolstering the market against a precipitous drop for the foreseeable future.
Calabria argues that a fixed supply means prices can decline just as quickly as they have risen in recent years if demand were to fall. And it need not reach zero for market prices to be impacted significantly, he said, adding that those buying homes for investment purposes rather than their own occupancy are likely to drop out of the market first.
“Prices are set at the margin, not the average and there are the margin borrowers whose demands are purely speculative as investors,” he said. “A very modest decrease in demand from investors could have a significant price impact in some markets.”
Because the FHA requires a down payment of just 3.5% and allows some closing costs to be financed, Calabria said most borrowers are already “underwater” when they take possession of a home. Add in what he views as laxed vetting standards for household debt and credit scores and the agency is playing with fire, he said.
Others see things quite differently. Mark Zandi, Moody’s chief economist, called Calabria’s mortgage market assessment “way off base,” noting that lenders have become far more selective since the last housing crisis and most borrowers are taking on “plain vanilla fixed-rate 30-year and 15-year mortgages” instead of the riskier products that were prevalent 15 years ago.
Zandi said mortgage credit issues are likely to increase as higher interest rates — and a potential recession — tamp down housing demand. He also said FHA borrowers, typically lower income first-time homebuyers, would bear the brunt of such a decline, but that does not mean the market is in a dire strait.
“The mortgage market is about as strong as it has ever been from a credit perspective,” he said.
Calabria, in an interview with American Banker this week, said he does not expect an immediate collapse of the mortgage market, offering a slightly more tempered outlook than what he expressed last week. Instead, he said he wanted to put the market on alert early to address its shortcomings before they become problematic and encourage federal housing agencies to capitalize themselves accordingly.
“I’m not saying things are going to blow up today,” he said. “I’m saying our mortgage market is not going to be robust enough when there are bumps in the road.”
Those who are more confident in the housing market’s long-term prospects say Calabria is singing a familiar tune. Before being appointed by the Trump administration to lead the FHFA, Calabria was a frequent critic of government-involvement in the mortgage market.
Former Federal Housing Commissioner David Stevens, described Calabria’s views on the housing industry as “extremist” and out of step with even most right-leaning economists. He said the same holds true for his most recent comments on the state of the mortgage market.
“Mark’s focus on this model right now, I think, is a bit of yelling fire in a crowded theater, meaning I don’t think it’s helpful,” Stevens said. “It’s too extreme to present this crash and compare it to a recession that was the closest to the Great Depression that we’ve ever seen in American history.”
Calabria said he’s comfortable being at odds with the majority of housing policy advocates in Washington, the majority of which, he says, “have no freaking idea what they’re talking about.”
He touts a record that includes predicting the housing market crash in 2006, arguing that the Tax Cuts & Jobs Act of 2017 — which he contributed to as then-Vice President Mike Pence’s chief economist — would not damage the housing market, and forecasting a limited forbearance spike early in the pandemic.
“Show me where I’ve been wrong,” Calabria said. “I think I’ve got a damn consistent record of being right.”
Stevens, who led the FHA during the first two years of the Obama administration, said the credit landscape today is much sounder than it was in the mid-aughts. High-risk lending practices, such as negative amortization adjustable-rate mortgages, no income-no asset underwriting and 100% loan-to-value financing were rooted out by the Dodd-Frank Wall Street Reform Act, he said.
“There is no comparing the credit environment of today to the credit market prior to the Great Recession of 2008,” Stevens said. “Contrary to Mark’s view that liberal credit policies are similar, the antithesis of that is true.”
Similarly, Jim Parrott, a nonresident fellow with the Urban Institute and former senior advisor on Obama’s National Economic Council, said mortgage credit risk has remained well below its long-term average for both government and private borrowers. The default risk for GSE mortgages ticked up slightly from 2020 to 2021, but he said that was to be expected given the economic distress of the pandemic. Default risk also remained at less than half the level seen in 2007, according to Urban Institute data.
Among FHA loans, 11% were at least 30 days delinquent, according to the agency’s March Housing Market Indicators Report, down from 16 percent the year prior. But policymakers note that short-term delinquency is common among FHA borrowers, most of whom are first-time homeowners with lower incomes. The serious delinquency rate, which tracks loans that are 90 days behind plus loans in-foreclosures and bankruptcies, was 6% this past March, down from 12% 12 months prior.
Parrott noted that most of the recent increase in the value of the overall housing market has come from an uptick in equity, meaning there is a significant cushion for homeowners in case there is a sudden decline in prices. He said the outlook for the market shows few signs of the weakness that was evident 15 years ago.
“Mortgage credit risk is modest by historic standards, and well below what we saw in the run-up to the last housing crisis,” Parrott said. “The credit characteristics of those getting loans are in line with historic standards, most borrowers have considerable equity to cushion their fall, and there is none of the product risk that we saw in the sub-prime era because of the product limitations in Dodd-Frank.”
Stevens also noted that increases to the FHA’s mortgage insurance premium that he orchestrated during the Obama administration have positioned the agency to better absorb periods of increased delinquency.
“A few things are happening,” he said. “One is that delinquency rates are lower than what they were in the Great Recession, and the premiums being collected can withstand significantly higher default rates than even occurred back then, let alone the more normalized delinquency rates we see today.”
Yet, Calabria does not see Dodd-Frank as a cure-all to the housing market’s ails. He argues that the FHA is catering to the same type of low-credit borrowers that were targeted by subprime lenders before 2008. While lending practices may be more conservative, underlying risks remain.
“I constantly hear that Dodd-Frank fixed everything but I’m not so sure about that,” Calabria told American Banker. “People who make that argument are essentially arguing that [debt-to-income ratios], [loan-to-value ratios] and FICO scores don’t matter and they sure as heck do. 2008 was not purely some exploding [adjustable-rate mortgage] crisis.”
One area of consensus that emerged from Calabria’s 80-minute podcast appearance was that FHA could be playing with fire by allowing its borrower’s debt-to-income ratios — which measures how much of an individual’s monthly pay will go toward debt services after a mortgage is issued — to exceed 50% if certain criteria are met. Most lenders cap DTI at 28%. Stevens agreed it is an area of concern. So did Edward Pinto, director of American Enterprise Institute Housing Center.
Pinto said his organization has long pushed for revision to FHA underwriting. The AEI has urged the agency to switch to 20-year mortgage terms instead of 30 in an effort to limit default risk. Instead, the FHA rolled out an optional extension to 40 years for borrowers impacted by COVID-19.
Still, even with the FHA’s embrace of riskier borrowers and practices, Pinto said the market is in much sounder shape than it was leading up to 2008. According to AEI’s stress modeling, if the circumstances that led to the episode were to repeat, the default rate today would be between 12% and 13%, compared to 36% at the height of the last crisis.
“That gives us some level of confidence that we’re not we’re not looking at an event that is going to be the magnitude of that last event, a 25% price decline in a few years,” he said. “Even if we had that price decline, the overall stress mortgage default rate would be a third of what it was in 06, 07.”
With unemployment near an all-time low and job openings outpacing job seekers, a mere technical recession — two consecutive quarters of shrinking GDP — might not be enough to force the housing market into a correction, Pinto said.
“It’s going to take a fair amount for the unemployment rate to … start having significant impacts on home prices,” he said. “Back in the financial crisis, it went up to 10%, in the early 80s it went up to 10% and we had some serious price declines. We are very far away from 10% unemployment. It’s not to say it couldn’t happen, but we’re very far away.”