By Eduardo Porter, The New York Times, October 28, 2014
Is it time to temper the American dream of homeownership?
If you want to curb the power of Wall Street and reduce the risk that the financial system will bring the rest of the economy tumbling down again, there may be no other choice.
Consider what happened last week, when regulators pretty much threw in the towel on new rules requiring mortgage bankers to keep on their books a minimum share of all but the safest loans.
The idea was perfectly reasonable — a way to keep bankers’ “skin in the game” to encourage prudence. In the end, however, officials decided that just about all mortgages were supersafe. No need for banks to keep a chunk.
“The loophole has eaten the rule,” Barney Frank, the former chairman of the House Financial Services Committee and co-author of the Dodd-Frank financial overhaul, told my fellow columnist Floyd Norris last week. “There is no residential mortgage risk retention.”
Phillip L. Swagel, an economist at the University of Maryland who was an assistant secretary of the Treasury under George W. Bush, called the decision simply “perplexing.”
The reason for the about-face, though, is not exclusively, or even mainly, the formidable power of the Wall Street lobby. The ability of the financial industry to fend off attempts to hem it in also relies on an argument that is difficult for outsiders to refute: We cannot live without it.
Unable to determine the risk that finance imposes on the broader economy, voters — and the politicians they put in office — have a strong incentive to give the industry a pass.
“What is the cost of a crisis I don’t prevent against what is the cost to tame finance?” asked Alan M. Taylor, an economist at the University of California, Davis. “We’ve only been thinking about this for a short time.”
Mortgage lenders dodged the proposed rule by joining homebuilders and advocates of low-income homeownership to convince hundreds of lawmakers that defining supersafe mortgages as those with significant down payments would curtail mortgage lending to the struggling middle class and poor.
That argument, while only partly related to the notion of requiring lenders to have skin in the game, pretty much stopped a central tenet of financial reform.
The breakneck growth of our modern banking system closely tracks the rise of the long-term home mortgage. A recent study by Professor Taylor, Òscar Jordà of the Federal Reserve Bank of San Francisco and Moritz Schularick of the University of Bonn found that mortgage lending across the industrialized world rose from the equivalent of 20 percent of annual economic activity at the start of the 20th century to about 69 percent in 2010.
In 1928, mortgages accounted for 39 percent of American banks’ lending to nonfinancial private companies. By 2007, on the eve of the financial crisis, the share was 68 percent.
“The changing nature of financial intermediation has shifted the locus of crisis risk towards mortgage lending booms,” the authors wrote. Financial reform that gives mortgages a pass is not going to cut it.
Most Americans have an interest in being able to obtain a reasonably priced mortgage. But there is a fundamental tension between Wall Street’s interests and those of the rest of us.
Financial institutions will naturally prefer to take more risks. After all, for them risk-taking has historically carried a lot of upside and, with taxpayer funds as the ultimate backstop, only a limited downside. Ordinary people have a very different experience.
“Financial deregulation is similar to relaxing rules on nuclear power plants,” argue Anton Korinek of Johns Hopkins University and Jonathan Kreamer of the University of Maryland in a working paper for the Bank for International Settlements. It makes it easier and more profitable for the utilities, their shareholders and executives. It might also help ordinary Americans get cheaper electricity. “However, it comes at a heightened risk of nuclear meltdowns that impose massive negative externalities on the rest of society.”
Tightening mortgage rules would no doubt make it more difficult to buy and sell homes. It would lead to more renters and fewer homeowners.
That might be worth it, though. Germany is doing fine with a homeownership rate of 45 percent, compared with about 65 percent in the United States, which is actually down from a peak of near 70 percent in 2004.
The Explosion of Mortgage Finance
Mortgage lending has led the growth of the financial system since World War II, according to a new study of 17 industrialized nations, including the United States and most of Western Europe.
Sheila C. Bair, who ran the Federal Deposit Insurance Corporation throughout the buildup of the mortgage bubble and its implosion, argues that a policy of pushing mortgages for every American family is hardly ideal.
“There is this religion about homeownership being the primary path to wealth accumulation — notwithstanding the bad experience we’ve had with it,” she said.
Indeed, in an uncertain economy with so little job security, it makes less sense for policy to encourage workers to lock themselves into mortgages. Even when homeownership is the right call, “I don’t think low-income people should be in private-label subprime mortgages,” she added. That is what the Federal Housing Administration is for.
Yet this is a Rubicon that our elected officials are afraid to cross. “On the margin, regulation does increase the cost of credit in the good times,” Ms. Bair said. “Regulators are battling a political system that wants to let the good times roll.”
Still, many experts say Washington is at least moving in the right direction. “Regulations are putting the system in much better shape than it was,” said Douglas J. Elliott, a former banker at J. P. Morgan who is now at the Brookings Institution in Washington.
This is not merely a self-serving, American view. Across the Atlantic, John Vickers, a professor at Oxford and the former head of Britain’s Independent Commission on Banking, agrees. “I wish there had been greater steps,” he said. “But major steps have been made toward a less fragile system.”
Is this enough to close the gap between Wall Street’s unbridled appetite for risk and the broader public interest?
Recent research suggests the growth of credit increases the odds of a financial crisis. Researchers have also found little evidence that more finance brings faster growth to industrialized nations.
The problem is, as long as we can’t precisely measure the cost of financial excess, we will be prone to believe that the financial industry is simply too fragile to be meddled with.
And with growth disappointing in just about every developed country, many people may be willing, even eager, to roll the dice again.
Despite all the new efforts at regulation, Ariell Reshef of the University of Virginia noted, “there’s maybe a slowdown in the growth of finance, but not a reversal.”
In a study published last year, Professor Reshef and Thomas Philippon of New York University concluded, “If finding more growth opportunities becomes ever harder with development, then a larger financial output and a larger share of income may be needed to sustain growth.”
Professor Vickers cited another paradox. “Ironically, the macroeconomic damage done by the crisis shows how important a well-functioning banking sector is,” he said.
The question is whether our banking sector is well functioning.
* * *
By Peter J. Wallison, The New York Times, October 30, 2014
WASHINGTON — SEVEN years after the housing bubble burst, federal regulators backed away this month from the tougher mortgage-underwriting standards that the Dodd-Frank Act of 2010 had directed them to develop. New standards were supposed to raise the quality of the “prime” mortgages that get packaged and sold to investors; instead, they will have the opposite effect.
Responding to the law, federal regulators proposed tough new standards in 2011, but after bipartisan outcries from Congress and fierce lobbying by interested parties, including community activists, the Obama administration and the real estate and banking industries — all eager to increase home sales — the standards have been watered down. The regulators had wanted a down payment of 20 percent, a good credit record and a maximum debt-to-income ratio of 36 percent. But under pressure, they dropped the down payment and good-credit requirements and agreed to a debt-to-income limit as high as 43 percent.
The regulators believe that lower underwriting standards promote homeownership and make mortgages and homes more affordable. The facts, however, show that the opposite is true.
In the late ’80s and early ’90s, down payments were 10 to 20 percent. The homeownership rate was 64 percent — about where it is now — and nearly 90 percent of housing markets were considered affordable (that is, home prices were no more than three times family income). By 2011 only 50 percent were considered affordable, and by 2014, just 36 percent — even though down payments as low as 5 percent are now common.
How could this be? Consider this: If the required down payment for a mortgage is 10 percent, a potential home buyer with $10,000 can purchase a $100,000 home. But if the down payment is dropped to 5 percent, the same buyer can purchase a $200,000 home. The buyer is taking more risk by borrowing more, but can afford to bid more.
In other words, low underwriting standards — especially low down payments — drive housing prices up, making them less affordable for low- and moderate-income buyers, while also inducing would-be homeowners to take more risk.
That’s why homes were more affordable before the 1990s than they are today. Back then, when traditional standards for “prime” mortgages prevailed, homes were smaller; they had fewer bathrooms, and the kitchens were not appointed by Martha Stewart. A family could buy and live in a “starter home” for several years before selling it and using the accumulated equity to buy a bigger or better appointed home.
In a competitive housing market not subsidized by lax standards, home builders would similarly adjust by reducing the size and amenities of new homes to meet the financial resources of home buyers entering the market. Home prices would stabilize and not rise faster than incomes. Low- and moderate-income families and millennials might have to wait to save for a first home, but they would be able to afford it.
If the government got out of the way, would sound underwriting standards come back? History suggests yes. Although Fannie Mae and Freddie Mac were government-backed, they were shareholder-owned, profit-making firms. They adopted strong underwriting standards to avoid the credit risk of subprime and other high-risk mortgages. But after Congress enacted affordable-housing goals, administered by the Department of Housing and Urban Development, in 1992, underwriting standards declined.
Republicans generally favor eliminating the government’s role in housing finance, while Democrats worry that without government support, mortgages would be too expensive for low- and moderate-income families. Although it runs counter to the current Washington view, good underwriting standards can satisfy the objectives of both parties.
It’s clear that today’s policies create winners and losers. The winners include real estate agents and home builders, who want to increase borrowing and sell ever-larger and more expensive homes. The losers, as we saw in the financial crisis, are borrowers of modest means who are lured into financing arrangements they can’t afford. When the result is foreclosure and eviction, one of the central goals of homeownership — building equity — is undone.
After the financial crisis, Representative Barney Frank — the Massachusetts Democrat who led the House Financial Services Committee during the crisis, and a champion of credit programs for low-income buyers — admitted, “It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.” Policy makers who support homeownership would be wise to consider who is hurt and who is helped when we abandon traditional underwriting standards.
Peter J. Wallison, a senior fellow at the American Enterprise Institute, is the author of the forthcoming book “Hidden in Plain Sight: What Really Caused the World’s Worst Financial Crisis and Why It Could Happen Again.”
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