Fed’s New Mortgage Rules: Not Much Impact, Just a Few Unintended Consequences

The Fed is proposing new rules regarding mortgages.  The new broad rules that apply to all mortgages (see the Fed’s announcement for details) are reasonable, but probably covered by current fraud statutes.  I’m not a lawyer, but they seem to be rules implementing common law standards.

The other rules that apply to subprime mortgages are a different story. To a large extent, they require practices that used to be skipped, but which mortgage investors have already figured out should be used.  For instance, the new rules would require underwriting loans based on a person’s ability to repay the loan out of income–sounds like a good idea.  Similarly, verifying incomes of borrowers seems like a good idea.  The Fed’s new rules are mostly unnecessary, because the mortgage industry has already figured out that it should be doing this.

So why not have federal rules in place?  Because there will be some adverse impacts of these new rules.  Not huge, end-of-civilization impacts, but negative impacts none the less.

For instance, suppose a borrower wants a loan that is a stretch out of current income.  Should it be illegal for the borrow to stretch, and for the lender to take the risk that it’s too big a stretch?  Do we really want a federal marshal with a gun on his hip policing these transactions?  With rules you get gray areas.  Suppose a borrower wants a mortgage, and the lender thinks the guy is good for it.  They’ll have to also run numbers to see if they conform to federal guidelines.  If they don’t, well, maybe the lender will risk an exception; maybe not.

Example: a newly-minted MD is heading into a residency program.  Her mortgage will be a real stretch based on her income.  But she’s used to being a poor student, and she’ll soon be making very big bucks as a surgeon.  Should it be illegal for her to get a mortgage?  The Fed will probably say that their regs will allow exceptions.  But that sounds like it would be illegal to set up a business targeting such customers, even if they would be profitable, in the aggregate.

Example: a young stripper works for tips.  She receives no salary, no W-2, no 1099.  All of her income comes in cash.  But she’s making a good income and wants to buy a house.  Because she has a limited credit history, she’s subprime.  There’s no way to verify her income without sending someone into the strip club where she works to record her tips.  Now it shall be illegal, a federal offense, to lend her money for a house.

Unintended Consequences: What happens with other lending "protections" aimed to help consumers?  A recent study by economists at the Fed of New York looked at two states that banned expensive "payday loan" operations.  Those states had increases in bounced checks and Chapter 7 bankruptcy, relative to other states, after they banned the payday lenders.  Maybe they weren’t helping consumers after all.  (Hat tip to Steve Buckstein.)