For months there have been reports that some U.S. regulators were weighing watering down some of the mortgage curbs proposed after the financial crisis. Now it seems that they’re really going to do it.
The revision to the rules is underway. Nothing is final yet, write Nick Timiraos and Alan Zibel at the Wall Street Journal, but what is in the works would be a “major U-turn” from regulators’ initial approach to reforming the housing market.
Here’s what it’s all about. The backbone of the housing market overhaul is the so-called Dodd-Frank law, a bill passed by Congress in 2010 that also sets out the general principles for shaking up Wall Street and the financial sector. For the residential real estate market, it establishes that: a) lenders should be legally responsible to ensure that homeowners can actually afford their mortgage; b) mortgage originators packaging the loans into securities without government backing should have to hold on to a portion of those loans. The latter is the “keep some skin in the game” principle, the idea that if you can’t dump all the risk on someone else, you’ll be more careful about the quality of the financial products you’re selling. Congress, though, introduced an exception to the skin-in-the-game requirement: Certain safer loans, it decided, wouldn’t be subjected to the new rule. Lawmakers left it up to federal bureaucrats to define what exactly “safer” means.
The bureaucrats’ earlier idea, proposed in March 2011, was that safer mortgages are those with a downpayment of 20% or more of the value of the house. The consensus, though, is now leaning toward scrapping that requirement and allowing issuers of mortgage-backed securities to retain no portion of the loans on their books even in the case of mortgages with very small downpayments. The skin-in-the-game rule would still apply to interest-only (also called zero-down) mortgages and loans made to borrowers who don’t meet certain other standards meant to ensure their ability to repay.
A few thoughts about this:
– It is not entirely clear why regulators think the downpayment requirement is a bad idea. Fed Governor Daniel Tarullo is one of those said to be in favour of ditching the downpayment rule, but he hasn’t, to my knowledge, detailed his thinking in public. In general, critics seem to say that the downpayment requirement would restrict lending without doing much to increase the safety of the financial system. That lending would be curbed somewhat is indisputable. That downpayment standards don’t make a difference is less obvious. Very small downpayments make defaults more likely because even a small drop in prices leaves homeowners owing more than their house is worth. The financial crisis clearly showed that homeowners must have some skin in the game too.
– It is clear that there are enormous lobbying efforts on multiple fronts to scrap the downpayment requirement. The U.S. media has documented this very well: Pressures to relax lending standards are coming from both the financial industry and consumer advocates. It’s easy to see how this unholy alliance would be able to reach through to a broad spectrum of both conservative and liberal politicians.
– It is also clear that Washington is anxious for the housing rally to keep up and possibly gain even more momentum. Hardly a Congressional hearing goes by without some lawmaker, Democrat or Republican, reporting complaints from the home constituency about credit-worthy citizens being turned down when applying for a mortgage. Banks are indeed still very reluctant to lend, and irrationally so. But the problem seems to be one of attitudes, not excessive regulation: Lenders’ haven’t quite shaken of their post-financial crisis risk aversion. Politicians, though, seem to be itching to cure the bank’s lingering post traumatic stress disorder with a dose of deregulation. In his most recent speech on the economy, President Barack Obama promised to “cut red tape for responsible families who want to get a mortgage, but the bank says no.” What red tape??
– The idea that renting can be good clearly hasn’t entered most policymakers’ minds. The housing bubble and subsequent meltdown wasn’t just about exotic mortgage practices, it was also about a policy mandate to encourage homeownership that got out of hand. One of the lessons of the crisis is that not all Americans should be trying to buy their own house. Every politician pays lip service to that truism now, but I suspect that, with median incomes stagnating and social mobility sort of stuck, the actual share of the population that shouldn’t be able to afford a mortgage is much larger than what most progressives are ready to live with. The temptation is to revert back to inflating homeownership by easing mortgage regulation, which seems the wrong way to go about it. An alternative approach would be to ensure better living standards and more affordability for renters, but there aren’t very many people talking about that, except for a few lone bloggers like Slate‘s Matthew Yglesias. Obama, for his part, just called homeownership one of the “cornerstones” of what it means to be middle class. Sigh!
Erica Alini is a California-based reporter and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.