How to fix the mort­gage cri­sis

The Washington Times Weekly - - Commentary -

Though un­prece­dented real es­tate growth in re­cent years tremen­dously ben­e­fited the econ­omy in most states, the mort­gage mar­ket is at con­sid­er­able risk. Cur­rently, Congress is ex­plor­ing how to “fix” the res­i­den­tial loan cri­sis. Con­gres­sional pro­pos­als tend to fo­cus on solv­ing bor­rower de­faults with­out ad­dress­ing the root of the prob­lem — ir­re­spon­si­ble mort­gage loan orig­i­na­tion.

In his pend­ing House bill, Rep. Bar­ney Frank, Mas­sachusetts Demo­crat, aims to ad­just some prob­lems in lend­ing prac­tices with tar­geted spend­ing to ad­dress the cri­sis. His pro­posed bill will “tem­po­rar­ily in­crease the port­fo­lio caps ap­pli­ca­ble to Fred­die Mac and Fan­nie Mae, to pro­vide the nec­es­sary fi­nanc­ing to curb fore­clo­sures by fa­cil­i­tat­ing the re­fi­nanc­ing of atrisk sub-prime bor­row­ers into safe, af­ford­able loans. [. . .]”

De­spite th­ese good in­ten­tions, in­creas­ing fund­ing with­out a means to ad­dress how those funds will be backed in the event of fore­clo­sure is an in­ad­e­quate re­sponse. Re­lated is­sues in­clude Fan­nie Mae lim­its and the po­ten­tial costs as­so­ci­ated with un­af­ford­able loans, or even new loans.

Within the bank­ing in­dus­try, there is some quiet talk about just let­ting the sys­tem do its work with­out gov­ern­ment in­ter­ven­tion such as low­er­ing or not low­er­ing the Fed rate, or let­ting the bad loans go bad to “get it over with.” In that vein, Mr. Frank would po­lit­i­cally ben­e­fit if the bill passes by ap­pear­ing to help with­out ac­tu­ally do­ing some­thing that caused more harm.

Steps that pro­long the process could worsen the sit­u­a­tion by hav- ing long-term neg­a­tive ef­fects. Imag­ine, for ex­am­ple, ap­ply­ing a De­pres­sion-era men­tal­ity to­ward lend­ing and bank­ing to to­day’s gen­er­a­tion. A global eco­nomic col­lapse would en­sue be­cause con­sumer debt loads are so much greater pro­por­tion­ately to house­hold wealth than even be­fore. The con­sumer­driven Amer­i­can eco­nomic house of cards would col­lapse.

Of course, short-term panic can re­sult in sim­i­larly bad, long-term ef­fects.

The mort­gage cri­sis re­quires leg­is­la­tion that sup­ports pun­ish­ing ex­ist­ing lenders for poor or mis­lead­ing busi­nesses prac­tices. Specif­i­cally, en­force­ment must fo­cus on orig­i­na­tors and bro­kers. Ser­vicers should be of­fered some pro­tec­tion from po­ten­tial losses be­cause loans may have been in­ap­pro­pri­ately orig­i­nated, but il­le­gal busi­ness prac­tices per­sist in res­i­den­tial lend­ing that must be stopped. Reg­u­la­tion Z (truth in lend­ing), RESPA (Real Es­tate Set­tle­ment Pro­ce­dures Act), and state laws need teeth. The gov­ern­ment needs funds to ap­pro­pri­ately au­dit sus­pected orig­i­na­tors and bro­ker prac­tices. Law-abid­ing par­tic­i­pants should be en­cour­aged to iden­tify those who vi­o­late fed­eral and state lend­ing prac­tices.

To use Florida, a state that re­cently ex­pe­ri­enced very high real es­tate ap­pre­ci­a­tion rates and is now an at-risk mar­ket, as an ex­am­ple: Florida law such as Reg­u­la­tion Z pro­hibits the ad­ver­tis­ing of in­ter­est rates with­out us­ing dis­clo­sure terms like the APR (an­nual per­cent­age rate). But how are th­ese en­forced? The Of­fice of Fi­nan­cial Reg­u­la­tion claims they do not reg­u­late that part of the statutes. The Florida De­part­ment of Pro­fes­sional and Busi­ness Reg­u­la­tions said com­plaints can be filed against their li­cense, but they would only have an au­di­tor re­view the file if they re­ceive enough com­plaints. Even then, there is no guar­an­tee any ac­tion will be taken. This in­cludes cir­cum­stances where news­pa­per ads of­fer ab­surdly low rates with­out an APR dis­clo­sure.

With state au­thor­i­ties not re­spond­ing, per­haps the Fed­eral Trade Com­mis­sion (FTC), which en­forces that part of Reg­u­la­tion Z, will. The FTC is no­to­ri­ously over­worked, un­der­paid and un­less it is a na­tional ad cam­paign or some­thing “sig­nif­i­cant,” they will not take any ac­tion. The FDIC only steps in if it in­volves a fed­er­ally reg­u­lated bank. The De­part­ment of Hous­ing and Ur­ban De­vel­op­ment has no vir­tu­ally no role in this mat­ter. The Of- fice of the Comptroller of the Cur­rency is not in­volved. There­fore, no ex­ist­ing agency would send even a no­tice to an un­scrupu­lous lender to ad­dress a com­plaint or to stop a prac­tice. There is vir­tu­ally no fear of puni­tive ac­tion.

A truly con­cerned Congress should task agen­cies to iden­tify abu­sive orig­i­na­tors by in­ves­ti­gat­ing bor­row­ers’ de­faults. Cur­rently, many lenders reg­u­larly get away with all kinds of quasi-le­gal and il­le­gal prac­tices that lead bor­row­ers to in­ap­pro­pri­ately use money. For ex­am­ple, cus­tomers may be told that they will get a fixed rate loan at 1.99 per­cent, but in­stead re­ceive a teaser rate with a neg­a­tive amor­ti­za­tion loan. Bro­kers may lie about many other de­tails. Still there are no sto­ries in the news­pa­pers about bro­kers that are raided or even ques­tioned about their il­licit busi­ness prac­tices. The lend­ing com­mu­nity needs to be fear­ful of th­ese loans, not just large in­vest­ment bankers. Orig­i­nat­ing prac­tices need to be scru­ti­nized, oth­er­wise Congress is not ad­dress­ing the prob­lem of the cre­ation of bad loans — we’re just fix­ing them af­ter they get shoved through the door.

The ef­fec­tive­ness of state guide­lines should fall un­der in­creased scru­tiny. The lack of con­sis­tent and ef­fec­tive state reg­u­la­tion to pre­vent preda­tory lend­ing may not be solved by fed­eral guide­lines, but it can be­come more ef­fec­tive.

Few lenders want more reg­u­la­tory en­force­ment. The gov­ern­ment does not need ad­di­tional reg­u­la­tions — they just need to en­force the ex­ist­ing reg­u­la­tions.

Much of this prob­lem will sub­side if state and fed­eral gov­ern­ments do their jobs. In­creased fines and penal­ties could help sub­stan­tially off­set el­e­vated en­force­ment costs. Ad­di­tion­ally, the shift of at least some of the cost of the cri­sis to mort­gage in­dus­try par­tic­i­pants will re­lieve tax­pay­ers.

How­ever, adding more reg­u­la­tions to those that al­ready ex­ist will make com­pli­ance more costly and less ef­fi­cient. The in­dus­try claims to have an al­ready large bur­den com­ply­ing with cur­rent reg­u­la­tions. Thus, the in­tro­duc­tion of ad­di­tional reg­u­la­tions will only fur­ther bur­den an in­dus­try that is al­ready crit­i­cized for com­plex­ity as a re­sult of cur­rent reg­u­la­tions. Much of the cri­sis lies with lend­ing reg­u­la­tions that are ig­nored, mis­un­der­stood, or sim­ply not en­forced.

Josiah Baker is a pro­fes­sor at Ge­orge Ma­son Univer­sity.

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