Dodd-Frank Creates a Bizarro World Of Housing Finance
In Superman comics there exists a Bizarro World where the inhabitants do the opposite of all things normal. For example, a salesman does a brisk trade selling Bizarro bonds: "Guaranteed to lose money for you".
A Bizarro World of home finance is being created by Dodd-Frank Wall Street Reform and Consumer Protection Act's new enforcement agency, the Consumer Financial Protection Bureau (CFPB). In this world a loan with little or no money down, a FICO credit score of 580, and a total debt-to-income-ratio of over 50% is defined as a prime loan, even though it has a nearly 30% likelihood of ending in foreclosure. Like the bond salesman in Bizarro World, this sets up for failure working-class families striving to achieve the American dream. In the real world a prime loan with 20 percent down, a FICO score of 720 (the average score of all individuals in the U.S.), and a 40% debt ratio has a 1.5 percent chance of foreclosure.
The Dodd-Frank Act was enacted following a mortgage meltdown, but perpetuates the same policies that made the meltdown inevitable. It was passed in 2010 with the stated purpose of "promot[ing] the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail', to protect the American taxpayer by ending bailouts, [and] to protect consumers from abusive financial services practices." Like the 1992 act that promised to protect taxpayers from a bail out of Fannie Mae and Freddie Mac and did the opposite, the Dodd-Frank Act will lead to a similar perverse outcome.
One of the CFPB's core functions is to assure "that responsible, affordable mortgage credit remains available to consumers." This is not the first time Congress has attempted to legislate the availability of "affordable mortgage credit." Recall Fannie Mae and Freddie Mac's affordable lending mandates, the Department of Housing and Urban Development's (HUD's) National Homeownership Strategy with its goal of doing away with downpayments, and the Community Reinvestment Act (CRA) with its "flexible" underwriting. This increase in leverage allowed HUD to trumpet a self-described "revolution in affordable lending", ignoring the resulting in boom in home prices, thereby making them unaffordable
This time, we have the CFPB relying on the same affordable lending nostrums. These placate community activists still eager to make sure that low-income borrowers have access to mortgage credit with little regard for the failure rate, and a National Association of Realtors still interested in assuring that there's no shortage of credit for any marginal buyer who can be made eligible to buy a home.
In Bizarro World a prime loan has little to do with borrower qualifications or the actual riskiness of the loan. Irresponsible loans setting families up to fail are called qualified so long as they are approved by a government-sanctioned underwriting system.
In the real world a prime borrower puts sufficient money down so as to have skin-in-the game and demonstrates willingness and ability to pay.
In Bizarro World the government does not price for risk; instead credit is allocated by government agencies based on political goals. Here, the Federal Housing Administration (FHA) charges the same to insure a loan with 5% down, a FICO credit score of 580, and a total debt-to-income-ratio of 55% as for a loan with 20% down, a FICO credit score of 740, and a total debt-to-income-ratio of 30%.
In the real world lenders allocate credit by charging borrowers different interest rates based on risk, and protect their shareholders by operating at safe levels of leverage.
In the Bizarro World of Dodd-Frank Act, borrowers are deemed incapable of making a responsible decision and all financial institutions are presumed evil. Thus thousands upon thousands of pages of mind-numbing regulations are required to "protect" consumers. Beyond being complex and confusing, at times these regulations conflict. The evil financial institutions are presumed staffed by employees who never make a mistake. The resulting gotchas assure that the tort bar has plenty of opportunity make evil institutions pay. This favors ‘‘too big to fail'' institutions which Dodd-Frank vowed to end.
In the real world borrowers would be expected to act responsibly and risky lenders would be allowed to fail, regardless of size.
In Bizarro World home loans are another form of entitlement, where unqualified borrowers stamped "prime" by government underwriting systems allowed to avoid making monthly payments for 1, 2, or 3 years or more.
In the real word lending is a business based on credit standards and markets are permitted to correct.
The Dodd-Frank Act did little to restrict excessive borrower or government mortgage guarantor leverage. Instead it provided a clear path for the government to expand both, laying the foundation for the next bust and taxpayer bailout.