Economics, U.S. Economy

The CFPB makes mortgage lending a risky bet

Image credit: Kevin Shorter (Flickr) (CC BY-SA 2.0)

Image credit: Kevin Shorter (Flickr) (CC BY-SA 2.0)

It will be a surprise if there is much left of the mortgage market now that new rules on the so-called Qualified Mortgage (QM) were put into effect today by the Consumer Financial Protection Bureau (CFPB). Both the CFPB and the QM are artifacts of the Dodd-Frank Act, adopted in July 2010. The unique thing about the QM is that it purports to punish the lender if the borrower can’t afford the mortgage. This is quite unique in concept, but is a product of the behavioral economics school, which holds that consumers are easily deceived about financial products. Hence, if it turns out that the borrower cannot afford a loan, the presumption is that the lender was either not careful enough in explaining it or was reckless in providing it in the first place.

Following this logic, the punishments for the lender can be severe, and include a defense to foreclosure, which of course provides an incentive for borrowers to be less than fully candid with lenders. We will be seeing many more rules like this as the CFPB moves along in the future, because its economic policy staff is dominated by behavioral economists.

The new proposed rules are complicated, of course, but basically they say that if a QM is a “prime loan”—a mortgage that does not involve any special compensation to the originator and is approved by the automatic underwriting systems of Fannie Mae, Freddie Mac, and the FHA—the lender has a “safe harbor” exemption from the penalties the act and the regulation contemplate. That sounds pretty good until you look at what the lender has to be sure about before the safe harbor kicks in. The regulation outlines eight key factors the lender has to address in order to gain the safe harbor. Most of them are numbers that can be knowable, like monthly payments that the borrower must make on this and other loans. However, at least three of them are subject to considerable ambiguity, making the mortgage a risky bet for the lender.

The lender must determine, for example, the borrower’s “current employment status” and “reasonably expected income or assets.” These are not objective facts. Is the lender supposed to know if the financial condition of the borrower’s employer is shaky? Should the lender be aware of news articles about the employer’s sales and future prospects? Or should the lender be charged with knowledge about whether the borrower is a well-regarded employee whose long-term employment prospects are good? In local communities, lenders can actually know these things and might be charged with the knowledge if the borrower actually loses his or her job and cannot meet the mortgage obligations. Another requirement for the lender is to know the borrower’s “credit history,” but the FICO credit score is not mentioned as an objective test.

Thus, for mortgage lenders in the future making a mortgage for anyone but a bullet-proof credit will be a crap-shoot, a risk that many will not be willing to take. Moreover, the defense to foreclosure creates a risk for investors in mortgage-backed securities. They may find their returns significantly affected if the originators of the loan lose their safe harbor exemption and the borrower establishes the defense to foreclosure.

Dodd-Frank set about to prevent the deceptive lending practices that its sponsors believed, without much evidence, were one of the principal causes of the 2008 financial crisis. It now appears that they have thrown the baby away with the bathwater.

7 thoughts on “The CFPB makes mortgage lending a risky bet

  1. Alan Greenspan had all the authority within the Fed to regulate unsafe lending practices with regard to home mortgages by regulated financial institutions (and the SEC had the authority with regard to the shadow banking system) — when regulators fail to regulate, or don’t believe in Government regulation and so do not regulate, we can see the results. Passing this authority to anotherr agency achieves nothing. What is regrettable is that several yeas later, even afte Dodd-Frank, we still have the same financial system and we are back to business as usual.

  2. When the disciplines of time-tested lending criteria were displaced by an aggressive government social agenda, the ball game was over. Millions of perfectly good renters became millions of horrible owners and the rest is history.

    • “When the disciplines of time-tested lending criteria were displaced by an aggressive government social agenda, the ball game was over. Millions of perfectly good renters became millions of horrible owners and the rest is history.”

      You’ll go to your grave believing this bullsh*t. Help yourself.

  3. “Hence, if it turns out that the borrower cannot afford a loan, the presumption is that the lender was either not careful enough in explaining it or was reckless in providing it in the first place.”

    That’s right, Peter. Because in the normal course of events, it is up to the CREDIT GRANTOR, not the applicant, to deternine the creditworthiness of the borrower.

    While I have issues with the new rules at first blush, your complaint reeks of the total ignorance you have brought to this subject. You never had any business commenting on mortgage lending by training or temperament, as the saying goes.

    • In the original ‘normal course’ of events, the lender did manual underwriting and made a determination as to whether or not the person asking for a loan was (a) able to repay the loan (assets/income) and (b) trustworthy enough to repay the loan (risk). If both (a) and (b) were met, then Party A and Party B entered into a binding legal document that laid out the terms and the repayment of the loan. If Party B couldn’t meet the terms of the contract, Party A acted according to the contract.

      Then the Government came along. They sure fixed that problem, didn’t they.

      • “In the original ‘normal course’ of events, the lender did manual underwriting and made a determination as to whether or not the person asking for a loan was (a) able to repay the loan (assets/income) and (b) trustworthy enough to repay the loan (risk). If both (a) and (b) were met, then Party A and Party B entered into a binding legal document that laid out the terms and the repayment of the loan. If Party B couldn’t meet the terms of the contract, Party A acted according to the contract.

        Then the Government came along. They sure fixed that problem, didn’t they.”

        The problems weren’t caused by switching to automated underwriting. Anyone who tells you that is lying.

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