The Corner

Mandatory Home Loan Repurchases Will Bind Up Economy

The New York Times accurately pointed out last week that “investors can demand that banks repurchase loans that did not meet underwriting guidelines or were inadequately vetted or processed.” This has been standard in the mortgage-banking industry for a while, and banks large and small have had to deal with claims that they repurchase toxic mortgages that they issued or sold with limited or no documentation.

But the Times goes a step too far:

Fannie and Freddie have increased their repurchase demands on lenders over the past year, but banks are sure to resist large repurchases, setting up more clashes and disruption… Freddie Mac and the Fed should push their claims hard.

Why?

Because­—through Fannie, Freddie and the Fed—the government now owns or backs a large number of problem loans and related securities. If the banks do not take the hit, the taxpayers will.

What the Times doesn’t seem understand is that every mortgage a bank buys back is more toxic debt on their balance sheets, which means more capital tied up, unable to be lent. And that is really bad for the economy. Banks are already holding on to some $1.5 trillion more reserve cash than in normal times. Getting those dollars into the economy would be the single best way to end the recession (something the Fed has failed to do with its misguided short-term thinking).

What banks need to start lending again is an end to uncertainty and a host of good projects to invest in. The same goes for foreign capital, which sees the Fed pursuing a weak dollar policy, meaning decreased return on their investments. This means one simple thing for the foreclosure debate: Political pressure from Fannie and Freddie — tacitly run by Treasury — and from the Federal Reserve is only going to slow down any economic recovery.

Banks should buy back any mortgages required according to the normal system and established contractual terms. But they should not be forced to take on more than they would without political pressure. Sure, taxpayers are covering the GSE losses — but that is the fault of Treasury’s bailout, not the banks.

There would be no faster way of slowing economic recovery, disincentivizing business investment, and cutting off the little private funding there is for mortgages than to use political pressure to inappropriately dump toxic debt on bank balance sheets. The mere suggestion already has mortgage bankers worried.

The government can avoid hurting the taxpayer in this way by staying away from inappropriately pressing repurchases by banks. However, they are already hurting taxpayers and homebuyers with their misperception.

Anthony Randazzo is director of economic research for Reason Foundation in Washington, D.C.

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