So by now you’ve probably heard that Fannie Mae and Freddie Mac are about to bring a lawsuit to a number of rather large lending institutions to recover alleged damages from all those mortgages granted with some (euphemistically speaking) less than stringent lending guidelines a few years back.
Like a scene from “Animal House”
I can see the courtroom scene now – I think it would look something like the fraternity courtroom scene from “Animal House.” The one where Tim Matheson’s character brazenly exclaims in the Delta house’s defense: “You fucked up – you trusted us!”
Well, yes, indeed. Banks did mess up royally. And we as a nation did trust our lending institutions. Silly us. And of course, we end up bailing these same lenders out to the tune of several hundred billion dollars.
Now, I’m not going to make the argument for the merits of Fannie Mae and Freddie Mac’s suit here. Clearly, the banks took liberties with their lending standards. However, it’s also clear that Fannie Mae and Freddie Mac had a great deal of pressure on them (both economic and political) to make large investments in these mortgage-backed securities. It also strains credulity to think they weren’t aware of the inherent riskiness of their investment choice.
The potential effects on property investment
But let’s say they are somehow able to prevail in court, and will be able to win a judgment in the hundreds of billions of dollars against these banks. How would that effect the small property investor?
Well, for one, the already tight credit market for everyone, not just investors, will get squeezed even tighter. If you thought it was difficult getting approved for a mortgage now, just wait for the fun to begin if Fannie Mae and Freddie Mac win their suit! For investors, days of putting 30% down with credit scores in the high 600’s will be but a golden memory. I wouldn’t be surprised if 40% down with scores in the low to mid-700’s will become the norm for investors if this were to happen.
In addition, other lending tightening may occur. When banks normally allow 75% of gross rental income to be imputed on lending pro formas, it wouldn’t surprise me if that percentage got lowered to increase lender safety standards on rental property mortgages.
Another way for lenders to increase their degree of safety for income producing property, would be to raise interest rates even higher relative to home purchase rates. Of course, this too will make financing investment property even more difficult.
Crippling an already crippled economy?
Naturally, the macroeconomic effect on the entire economy will be to slow it down from the already existing snail’s pace it currently is creeping at…which will only keep credit markets tight for the foreseeable future.
Ultimately, while Fannie Mae and Freddie Mac may have a viable case, I’ll be rooting for the banks to win this particular court battle. Otherwise, I fear some serious damage and resultant hysteria will occur in our entire lending industry, not to mention the horrible byproduct – hurting individual property investors as well as our overall economy even further.
photos courtesy of uncoverage.net, metaezra.com, thisdopeknows.com, afrmortgage.com