Home truths in new mortgage rules
New regulations on home mortgages from the Consumer Financial Protection Bureau will raise ethical standards and lower risks. But they don't reduce government incentives that might create another housing bubble.
The housing bubble – whose collapse led to the Great Recession – had many causes: deceit and neglect in mortgage lending, a mass delusion and false optimism about rising home prices, and easy government credit.
Now a set of new federal rules on mortgage lending aims to prevent at least some of those mistakes. On Thursday, regulators at a new agency, the Consumer Financial Protection Bureau, unveiled requirements for new mortgages as part of the 2010 Dodd-Frank Act.
The rules aim to end the kind of lies, coverups, and excesses that surrounded so many of the home loans in the past decade.
Mortgage borrowers will no longer be able to take on a total debt – including credit cards and student loans – that exceeds 43 percent of their pretax income. They will need to show extensive documentation of their ability to repay the loan. And they must be able to pay the highest payment that will apply in the first five years of a mortgage.
In other words, no more “liar loans” or other exotic mortgages in which borrowers are allowed to show no proof of income or overall indebtedness. Job stability will be an even bigger factor.
In addition, lenders will need to retain some “skin in the game” by holding on to a percentage of the mortgages. This reduces their incentive to be deceptive about the quality of those loans resold to security investors.
If the new rules work, they would raise ethical standards in the mortgage industry, bringing in more transparency and accountability for what is, to most home buyers, the biggest financial transaction of their life – and often the most complex.
But the rules fail on one key level. They don’t address the government incentives for homeownership, such as the mortgage interest deduction, zoning, and backing of mortgage underwriters Fannie Mae and Freddie Mac. These have the potential to renew the perception that prices will always trend upward, once again turning home buying into a speculative market.
In anticipation of the new rules, a 2012 study of the industry by economists at the Boston Federal Reserve came to this conclusion: “If borrowers and investors made bad decisions due to a collective belief that housing prices would rise rapidly and could never fall, then better disclosures, simpler products, and improved incentives for intermediaries would have made little difference.”
As a nation, the United States is at a critical economic point to shift incentives away from the housing industry and toward investments in industries with longer-term, more productive jobs, such as in manufacturing exports and high-tech innovation.
One study found that $1 dollar invested in a typical California home in 1980 was worth $2.98 in 2010. If that dollar had been invested in the Dow industrials index, it would have been worth $11.49, or nearly four times as much.
The new rules don’t require lenders to inform consumers that home prices might actually fall. Fortunately, polls show would-be home buyers have lower expectations of big gains in house prices than before 2007. And renting is now popular.
Washington needs to end the mirage of wealth in homeownership, driven in part by the many federal benefits. Improving ethical behavior in mortgage lending will help dampen many excesses. But as the Fed study stated, “The facts refute the popular story that the crisis resulted from financial industry insiders deceiving uninformed mortgage borrowers and investors.”