Think a $70,000 home loan with $500 down is a good idea? Your government did.
The document is sure to add fuel to the debate about the propriety of the government pushing banks to take on risky low-income borrowers. Documenting "how public resources can mitigate the risk to the lender, benefit the home buyer, and achieve local development goals," the paper provides the example of leveraging a $500 down payment into a $70,000 purchase. How do you accomplish that feat of financial wizardry? By having government agencies engage in the shadiest of subprime lending practices.
First is the issue of establishing a buyer's equity. The document calls for a $500 down payment, coupled with $1,000 in "sweat equity" for minor repairs, like painting. Waive some local fees, and you have a buyer with no more than 3 percent equity -- remember this the next time a politician bashes investment banks for operating with 30x leverage. Since a loan-to-value of more than 95 percent is difficult to disguise as reasonable, $22,000 in other government funds will be used to make subordinated loans, with the bank taking the first mortgage.
The "city and county's low-cost funds to the borrower," the OCC notes with no hint of irony, actually makes the loan-to-value for the bank's first mortgage a low 64 percent. How low-cost are the government funds? Here, the majority (close to $19,000) carry zero interest for the first five years, while the rest also carry 0 percent but are due at the time of sale. Try that for a teaser rate.
Now, the model outlined above was set against a number of nice points about the hypothetical borrowers -- they received extensive pre-purchase counseling, they were brought to the bank from a church group, their new home will be in a nice area with schools and public transit -- and it serves to perfectly outline the public debate here. Home ownership is always spoken of highly, but when you have a borrower with essentially zero real equity and an artificially low mortgage, you don't actually have a home owner: you have a renter receiving a tax subsidy and an option to buy.
This is not to say a handful of $70,000 loans to borrowers with low equity brought down the banking system. But it does raise the question of where the appropriate boundaries lie between politics and banking. Using the financial system to achieve public-policy goals involves distorting the incentives that naturally exist in the capital markets. We need to be careful involving ourselves in such a process.