The same goes for the bill’s mandate that borrowers have a “reasonable ability to repay” a mortgage. Banks have incentives to loan to borrowers who are reasonably likely to repay, because banks do not want to foreclose. Contrary to popular impression, banks almost never make money on foreclosures and can lose 30 to 60-percent of the outstanding loan value because of legal fees and property expenses, according to a 2003 Federal Reserve study.
But neither lenders nor borrowers can see into the future with certainty. A layoff, medical expenses, or a divorce could be what’s called a “trigger event” that results in a default and a foreclosure. A broad “ability to repay” mandate for making loans could force lenders to inquire about things far further into the personal lives of consumers; Banks might require such information as the details of a borrower’s diet and exercise regimen, and the stability of a borrower’s marriage (aren’t bankers nosy enough as it is?!). Even more likely, the mandate would result in a massive cutoff in credit for many deserving borrowers who fit a certain risk profile.
A sharp cutoff in credit is even more likely due to Frank’s methods of enforcement. Not only does the bill give vast new powers to regulatory agencies, it also lets the trial lawyers get in on the game. Borrowers could sue, alleging that their loan had no “net tangible benefit” and they had no “reasonable ability to repay” it, and they and their lawyers could be awarded up to three times a lender’s gain. Needless to say, the losers would not just be the lenders who had to pay, but other borrowers who will not get the home loans this law has discouraged.
One would think that this bill’s limiting the freedom of homebuyers, and empowerment of the trial bar, would make opposition a no-brainer for GOP House members. But amazingly, Rep Spencer Bachus, R-Ala., ranking member of the House Financial Services Committee that Frank now chairs, endorsed the bill last week after very minor changes. In a tortured explanation, Bachus stated, “The answer is that we have a choice between curing problems after they have caused severe damage to our economy…or taking preventive actions to ensure the problems do not occur.”
Hopefully, Bachus’s GOP colleagues, and maybe even some Democrats who believe in the American Dream, will see that the “problem” he speaks of is, in fact, freedom. Yes, freedom can result in some economic disruption, but without it, the only “problem” is economic stagnation. Opportunities for getting ahead also mean opportunities for failure. And as Eli Lehrer and I point out in a new Competitive Enterprise Institute study, a lot more people have gotten ahead than have failed in the mortgage boom.
As a result of new mortgage innovations, homeownership has risen to an all-time high of almost 70-percent, most recently standing at 68.4-percent — and the vast majority of those mortgages are being paid off. The “record number of foreclosures” the media breathlessly reported are shocking only when separated from the “record number” of homeowners. Though they have increased, foreclosure rates are well within historical norms at just .58-percent of mortgages, according to the industry’s most recent National Delinquency Survey. Even the foreclosure rate for the dreaded subprimes was below 4 percent.
There are indeed problems in the credit market, but they are problems of uncertainty. Methods of valuing mortgage-oriented securities have proven to be flawed, and a repricing of these securities is taking place. As Washington Post economics columnist Robert J. Samuelson has written, “The real problem is the unanticipated nature of the losses which has triggered a broad reappraisal of risk. Investors don’t know who holds the bad subprime loans.”
By all means, let’s discuss ways to increase transparency, or to lift barriers to transparency in this market. But paternalistic mandates that result in a sharp reduction in home loans would simply add more uncertainty, and stall the credit market even further.
– John Berlau is director of the Center for Entrepreneurship at the Competitive Enterprise Institute.