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Goldilocks and The Three Credit Bears

Is Credit Too Tight, Too Loose or Just Right?

Mark Fleming    |    Housing Trends, Mortgage Performance

One of the most pressing issues in housing finance today is the availability of credit. The lack of access to credit has been cited as a reason for the slower-than-hoped-for growth in home sales. The often cited Federal Reserve Loan Officer Survey tells us whether lenders are tightening or loosening credit, but tells us much less about the overall level of availability of credit. Furthermore, terms like tight credit or loose credit imply a normative goal of the right amount of credit. In fact, when discussing this topic, one can’t help but think of Goldilocks and the Three Bears: one bed is too hard, another too soft, and the last one is just right.

In order to determine whether credit is too tight, too loose, or just right CoreLogic has developed the Housing Credit Index (HCI) that measures the range and variation of residential mortgage credit over time and multiple housing credit underwriting attributes. The index includes attributes that are relevant to the assessment of credit risk for a borrower applying for credit. For example, in a mortgage application, credit scores, the amount of downpayment, the debt-to-income ratio, whether a loan is adjustable or fixed rate, the amount of documentation and the loan origination channel are all assessed before offering a loan to the borrower. The HCI uses mathematical techniques popularized in the economic inflation forecasting literature to handle multiple correlated attributes. The HCI combines the housing credit underwriting attributes over time to determine the correlated range and variation across the attributes into one measure of the multidimensional variation. It can be thought of as measuring the size of the “credit box,” although in this case the box is a multivariate correlated distribution. The index reflects these correlated changes such that a rising index indicates increasing openness, or looseness, of credit; and a declining index indicates a decreasing openness, or tightening, of credit. The index is benchmarked to 100 in January 1998, the most recent period of relative normality in the housing market. As with home price indices, the changes relative to 100 can be thought of as shares or percentages, so if the index increases to 200 then credit is twice as loose as the base period.

So is credit currently too loose, too tight or just right? In Figure 1, the HCI is shown from 1998 to early 2014 measured on the left axis along with the overall serious delinquency rate measured on the right axis. In the refinance boom of the early aughts, credit availability expanded significantly and then declined, but to a level moderately elevated compared to before the refinance boom. The result of increased credit availability was a modest rise from about 1 percent to 1.25 percent in the overall serious delinquency rate. The mid-aughts saw the significant expansion of credit to double the normal level and the very quick and dramatic contraction with which we are all far too familiar. Credit availability reached its tightest point in late 2010 at only one-third the normal level of the late 1990s. It is safe to say that credit was too tight. Of course, this was a natural response to the quickly rising serious delinquency rate that turned upward dramatically starting in 2006. Since 2010 credit availability has eased in fits and starts with the utilization of modification and refinance programs aimed at struggling homeowners. Most recently, the index is indicating a slight easing, but remains tight by historic standards.

Goldilocks tried every bed before finding just the right one. Over the last 15 years we have tried too loose and too tight credit with varying degrees of success. Consider lending standards in the late 1990s when the “credit box” was twice the current size and the serious delinquency rate was only 1 percent. That bed feels just right.

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