The Federal Housing Finance Agency has made a key change for new loans that the entities it oversees, Fannie Mae and Freddie Mac, will purchase or guarantee. Under the new plan, FHFA will identify and reject faulty loans earlier in the process, rather than after the fact, once the loans sour. By “faulty loans,” they mean loans that do not comport with underwriting guidelines meant to be a prerequisite to purchase by Fannie and Freddie. By intervening early in the process, this will provide certainty that the GSEs won’t come back down the road to demand repurchases.

“Lenders want more certainly about their risk exposure, and the enterprises want to ensure the quality of the loans,” Edward J. DeMarco, FHFA’s acting director, said yesterday in a North Carolina speech where he outlined the changes [...]

Under the new rules, the companies won’t force lenders to repurchase defaulted loans if borrowers have made 36 months of consecutive on-time payments. Banks will be protected from buyback requests after only 12 months of payments for certain types of loans, such as those originated under the federal government’s Home Affordable Refinance Program, DeMarco said in the Raleigh, North Carolina, speech.

Notice how this not-too-subtly encourages HARP refinances. After only a year of payments, banks get immunity from repurchases. This could be why the mortgage industry is newly interested in a bill from Barbara Boxer and Robert Menendez, that would make it easier and cheaper to refinance. Banks reduce tons of their risk exposure through HARP, in addition to making money on the origination fees (and trapping their borrowers and forcing them into higher interest rates, which Boxer-Menendez purports to rectify).

Aside from that clear handout to HARP, I don’t think this is such a bad idea if the up-front audits are diligent and sustained. Lax lending standards had a lot to do with the housing crisis, and a lot of people looked the other way. What FHFA is saying here is that they will put in place the mechanisms at Fannie and Freddie, still the 800-pound gorillas of the mortgage business, right at the start, to force compliance. That could lead to a safer mortgage market, at least from the perspective of origination. And if it means increased underwriting standards, as well as lower housing sales and access to credit generally, that’s a damn sight better than the alternative, which has cost trillions in lost wealth and millions of jobs.

Importantly, this does not indicate a surrender by FHFA on the existing loans that they want banks to repurchase; it would only apply to loans originated after January 1.