Part of the story about subprime mortgages during the U.S. banking economy of the 1990s and 2000s centers on the Community Reinvestment Act — through which Congress required lending institutions lend more in poor neighborhoods.
There is a question as to how much this drove lenders to extend credit to people who couldn’t afford it.
Late in the subprime game, FNMA and FHLMC (Fannie Mae and Freddie Mac), the two government-sponsored mortgage giants, began buying up subprime mortgages from banks, further encouraging this type of lending. How much or how little these two programs mattered can be endlessly debated. What we know for a fact is that both things existed, so when the housing market blew up there was some rationale for laying part of the blame at the feet of government.
Those days are long gone… or at least, they were.
While FNMA and FHLMC are now under the conservatorship of the U.S. government, the programs aren’t dead. In fact, these two entities still purchase mortgages made in the U.S. but with a new overseer and under new regulations.
The watchdog that keeps the two entities in line is the Federal Housing Finance Agency (FHFA), which was created for this purpose. Since the financial crisis, the head of the FHFA was Edward DeMarco. He believed it was his job to preserve as much value as possible for the American taxpayers who had bailed out these two giants.
Part of his approach was to keep as much interest from mortgages flowing into the two companies while staying away from risky lending. For a banker, these sound like good ideas.
But then Mr. DeMarco was replaced. Apparently his conservative approach to the business didn’t fit with the plans of the administration, which wanted Fannie Mae and Freddie Mac to offer a slew of mortgage changes to underwater homeowners, many of which would’ve cost taxpayers money.
As is the prerogative of the administration, Mr. Mel Watt was installed as the head of the FHFA in January of this year, and he has declared that the mortgage giants under his control should do more to help struggling homeowners. Part of this help is encouraging banks to assist more low-income borrowers to not only refinance their homes, but also purchase homes, just like during the housing boom.
FHFA encourages such behavior by changing the mix of loans the two entities will buy from banks. When Fannie and Freddie offer to buy more low-income loans, if banks don’t have the right mix, then the banks are missing out on some almost free money.
I say “almost free” because the new regulations for mortgages in general are now making themselves known. Part of the fallout from the new Consumer Finance Protection Bureau (CFPB) is that banks can be held liable if they make a loan to a person whom later defaults, but it’s determined that the bank should have known the borrower was most likely not able to pay in the first place.
Take a minute to digest that.
Banks are at fault if they make a conforming loan (one that meets all the guidelines of Fannie Mae or Freddie Mac), but the loan defaults at some point and the borrower can show the bank “should have known” that the borrower wasn’t good for it.
Is it any wonder that banks are choosing to make only the most cautious lending decisions with that kind of liability hanging over their mortgages? Who in their right mind would make subprime loans that had even the most remote chance of defaulting?
There is no question that CFPB regulations are stemming the flow of loans, which is one of the many things that are holding back the economy. But in this particular instance, it’s better for the nation that the loans never get made.
While we won’t sell as many homes, at least fewer people will be taking on mortgages they potentially can’t pay, and taxpayers won’t have to eat the cost of default.
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