Big Wall Street banks and consumer-advocacy groups like the Center for Responsible Lending don’t agree on much. But recently, these strange bedfellows have been brought together by their opposition to new rules governing mortgage-underwriting standards that have already been issued or are set to be issued by the Consumer Financial Protection Bureau (CFPB) in the coming months.
Ever since the Dodd-Frank financial-reform legislation was passed in 2010, these once-and-future foes have been fighting the so-called “qualified mortgage” (finalized in January) and “qualified residential mortgage” (soon to be finalized) rules. Basically, these rules say that if the loans they make don’t fit a certain profile — 20% down and a debt-to-income ratio of no more than 43% — the banks won’t get certain legal protections from borrower lawsuits, and they’ll have to retain at least 5% of the loan on their books.
The logic here is pretty simple: One of the main causes of the 2008 financial crisis was that mortgage originators made loans with little regard for those loans’ quality because they quickly repackaged them and sold them to investors. So if these banks want to keep issuing loans without keeping some of the value on their books, those loans have to meet certain requirements.
The mortgage industry doesn’t like these rules because it doesn’t want restrictions on its business decisions. Consumer groups, meanwhile, are afraid that the rules will restrict lending to lower-income home buyers. Of course, that’s the whole point of having mortgage standards in the first place: some people aren’t going to be able to get mortgages.
And that’s not necessarily a bad thing. Ever since the financial crisis, the news media have been filled with negative-sounding headlines describing the state of homeownership in America, which has recently fallen to nearly 20-year lows. More recently, we’ve heard tales of first-time buyers’ getting outbid by cash-rich investors looking to take advantage of cheap real estate.
Some may interpret these stories as further evidence of rising income inequality or another example of the middle class’s being shut out of a wealth-building opportunity. This is the argument that the Center for Responsible Lending has taken up in the past. And of course it is perfectly legitimate to be concerned about income inequality and the inability of lower-income Americans to build wealth. But loosening lending standards to allow those only marginally qualified to purchase a home isn’t the best way to do it.
First of all, even though the qualified mortgage rules may set the tone for what it takes to get a mortgage, banks will still be able to lend to those with high debt-to-income ratios or those with less than 20% down. They’ll just have to accept some of the risk of such loans by holding a piece of those mortgages on their own books. And in the long run, mortgage lenders will do what is profitable, even if it means issuing nonqualifying loans that leave them a little more at risk.
Furthermore, as housing economist Robert Shiller has pointed out time and again, in the long run real estate just isn’t that great an investment. Writes Shiller: “Home prices look remarkably stable when corrected for inflation. Over the 100 years ending in 1990 — before the recent housing boom — real home prices rose only 0.2 percent a year, on average.”
Certainly there are plenty of good reasons to buy a house. Owning a home can be a great way to force yourself to build savings. Those who opt to rent for less than what they would spend in mortgage payments, taxes and maintenance may not have the discipline to funnel the extra cash into a higher-yielding investment. And depending on where real estate prices are in a certain area, buying can turn out to be a savvy investment, especially when you factor in the tax-deductibility of mortgage interest.
That being said, the reason Dodd-Frank included the risk-retention rule is to prevent the next financial crisis. If we just scrap these rules, or weaken them beyond recognition, then we could be inviting the sort of real estate bubble that laid waste to the economy just five years ago. And whom did that crisis hurt the most? You got it — the same low- and middle-income folks we’re talking about now.
Income inequality and low levels of economic mobility are real problems in this country. But responding to those problems with lax regulation may only make those problems worse.