How to fix the mortgage crisis
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.