New models for mortgage standards out of Dodd-Frank have banks insisting that they cannot do without federal support, just as we begin to look to the end of Fannie Mae and Freddie Mac.
As the first decade of the 2000s ushered in industry-wide privatization of the housing market, banks began to transition from more reliable long-term loans to less reliable adjustable rate mortgages (ARMs). This shift created vast uncertainty. Without any requirement that forced lenders and security holders to retain risk on their own products, or a guarantee that interest rates and housing prices would remain stable, ARMs were left subject to external forces. If the market did well, borrowers would be okay; however, if the market went under, they were in serious trouble.
In the wake of the financial crisis, which led to a slew of housing foreclosures nationwide, legal experts and consumer activists felt a growing need to address this issue of uncertainty. The fact that lenders naively thought that the optimal market forces of 2005-06 would last - while the mortgage market remained over-leveraged and un-diversified – was not only delusional but also downright dangerous, they argued. Worst of all, mortgage debt often ended up falling on taxpayers, many of whom lost their most valuable asset (their home) in the process.
The Qualified Mortgage (QM) and Qualified Residential Mortgage (QRM) standards of the Dodd-Frank Act served as a reassurance that mortgages, irrespective of market forces, would not continue to default as many did during the crash. QM was a way to limit credit risk. It mandated that lenders could only sell loans that could be repaid by borrowers, and adopted a number of rules pertaining to down-payments, fixed-interest rates, debt-to income ratios and other “ability to repay” criteria. QRM forced lenders and security holders to either retain risk on their products (roughly 5-10 percent) or adopt ability to repay rules that were even stricter than the normal QM standards. The key idea was that by realigning incentives, by emphasizing the importance of quality over volume, the private mortgage market could be regulated without being hindered or altogether shutdown.
There is now a new debate brewing on QRM between those who insist on such standards and the large lobbying cohort of lenders, brokers, developers, and construction magnates who argue that QRM would curtail the ability of lower-income borrowers to access mortgage credit. Specifically, they argue that QRM should be more in line with QM, which has broader, less strict rules. “Failing to align these rules,” according to a report written by the Mortgage Bankers Association of America, “will further entrench the market’s dependence on federal programs,” and thus keep private capital from returning to the market.
To understand the larger context surrounding this debate, there are two important functions of QRM to consider. The first is its role as the last line of defense against housing foreclosure. QRM, in this regard, is less geared toward providing access to credit than it is toward the long-term viability of the market. Sure, providing borrowers with the opportunity to purchase a home is important, but so is making sure that those borrowers are buying into a reliable, stable market. It would be foolish to ignore the lessons learned in 2008.
QRM's second function is to get lenders to retain more risk. Some banks, including Wells Fargo, have actually called for raising down-payment rates to 30 percent for mortgages exempt from risk-retention rules. The suggestion, while a bit lofty, sheds light on an important point: the end goal is not to push consumers out of the market, but to find a way to get lenders to put more skin in the game.
Why, then, are mortgage interest groups advocating for fewer requirements? Do they actually want to provide opportunity for lower-income families? In part, yes. But it is also possible that lenders are simply trying to evade risk-retention rules, and that "opportunity" is just financial self-interest under the guise of a euphemistic slogan.
QRM standards could certainly be improved. Large down-payment requirements, in particular, have shown little proof of actually working. As the Coalition for Sensing Housing Policy points out, “The QRM rule ignores compelling data that demonstrate sound underwriting and product features, like documentation of income and type of mortgage, have a larger impact on reducing housing rates than high income.”
We should therefore start coming up with alternate ways to promote market stability: incentivizing lenders and banks to sell fewer ARMs, subsidizing 30-year fixed-rate mortgages, forcing banks to assume greater financial responsibility for interest rate spikes, etc.
Part of the reason the housing issue is so sensitive is because of its cultural and emotional roots. Houses maintain a special place in the American imagination. They are the central unit of private life, where families take shape and values are taught. In the post-war years, a house was a source of great pride for any homeowner and the ultimate affirmation of making it into the middle class. We find the idea that some are unable to enjoy such a signature feature of American life, for good reason, to be both unfathomable and unacceptable.
However, more important than any cultural preconception is the substantive need to make sure that mortgages don’t default and that 2008 doesn’t happen again. There seem to be two possible routes that could be taken on the housing issue. One would be for lenders and security holders to agree to take on more risk, while providing access to affordable loans. This would satisfy the “dual mandate” of mortgage stability and broad consumer access to credit. The second option, if banks choose not to cooperate with risk-retention rules, would be to proceed with stricter, inflexible payment requirements as outlined under QRM. Most would prefer the former option. But then again, we live in an era of political sclerosis, where conciliation time and again takes a backseat to conflict. So don’t cross your fingers.
Jack Houghteling is a research intern working with Roosevelt Institute Fellow Mike Konczal and is a rising senior at Claremont McKenna College.