This post is the fifth in a 10-part series on reform proposals for the Consumer Financial Protection Bureau. See below for previous posts.rulemaking agenda for Spring 2019. While there weren’t too many surprises in the agenda, which mainly involved implementing statutory requirements or completing ongoing initiatives, there was one important new reform that jumped out: assessing the necessity of a provision known as the Qualified Mortgage “patch.” This is an incredibly important step for the bureau to take, as the QM patch has allowed the federal government to continue to engage in the kind of risky behavior that led to the financial crisis over ten years ago.
A key congressional response to the 2008 housing crisis was the Mortgage Reform and Anti-Predatory Lending Act under Title XIV of Dodd-Frank. In short, Title XIV required the bureau to establish a Qualified Mortgage rule to define certain minimum mortgage terms. Those criteria as defined by the bureau include assessing a borrower’s “ability to repay” a loan, such as requiring a debt-to-income (DTI) ratio of 43 percent or less, prohibiting “risky features” such as negative amortization or interest only payments, and prohibiting large points and fees.
However, while the bureau established punitive regulations on the private mortgage market, it instituted an exemption to the QM rules for loans eligible to be purchased by the government-sponsored enterprises Fannie Mae and Freddie Mac, as well as loans eligible to be insured by other government agencies such as the Federal Housing Administration (FHA). As American Enterprise Institute scholar Edward Pinto has written, “true to the government’s long history of promoting excessive leverage, [the QM rule] sets no minimum down payment, no minimum standard for credit worthiness, and no maximum debt-to-income ratio” on the loans that the GSEs can purchase. This exemption, established for seven years, is known as the QM “patch.”
The QM rules are, therefore, simultaneously too strict on private lending and too loose on government-backed lending. This is the worst of both worlds: heavily regulating loans made by the private market, or those with “skin in the game,” while encouraging the government, or those without “skin in the game,” to back more and more risky lending—something my colleague John Berlau has discussed in the past. This will increase the cost and crowd out private mortgages while perpetuating the government’s outsized role in the mortgage market.
It is unfortunate that Title XIV, like the rest of Dodd-Frank, completely missed the fact that the federal government’s mortgage meddling played the primary role in the financial crisis. Sound underwriting practices did not need to be forced on private lenders by the government. Instead, sound underwriting practices would have followed by eliminating the perverse incentives that the federal government creates. As Mercatus Center scholars Hester Peirce and James Broughel put it:
Lax underwriting standards were a symptom of the government-backed mortgage-finance system and the government-encouraged emphasis on increasing homeownership. The symptoms can best be addressed by using market mechanisms to make the institutions that decide to extend credit face the consequences of their decisions and by allowing individuals to decide for themselves whether to make the sacrifices necessary to buy a home and how best to finance that purchase.
As we saw from the last crisis, the inability to control the government’s credit quality is a recipe for disaster. There is strong evidence to suggest that the QM patch has led to a proliferation of risky mortgages and another house price boom. Housing prices are higher today than before the 2006 crisis, and measures of risk in the mortgage market, such as the National Mortgage Risk Index, have been growing dramatically over the years. As AEI and Heritage Foundation scholars concluded in a recent analysis of the patch, the exemption has “led to the needless and risky proliferation of high DTI loans by government agencies,” “put minority borrowers at greater risk,” and “helped fuel a house price boom.”
Unfortunately, much of the QM rule’s restrictions on private lenders are statutorily required. They cannot be meaningfully altered without legislative change. But the QM patch, on the other hand, is not. It was designed to expire on January 10, 2021. It is encouraging, therefore, that the bureau is conducting an analysis of the patch’s impact on the mortgage market.
Once completing the “look back” review, the bureau should immediately announce that it will not renew the patch in 2021. It should then coordinate with the relevant government agencies, such as the Federal Housing Finance Agency, to achieve a smooth transition away from the market’s reliance on the patch. Eliminating the QM patch will go a long way to helping limit the disastrous impact of the federal government on the mortgage market.
Previous posts on reform proposals for the Consumer Financial Protection Bureau:
- Regulators Should Rescind 'Small-Dollar' Loan Rule (5/22/19)
- Reform Fair Lending Laws to Uphold Rule of Law (5/23/19)
- Narrowly Address Fair Lending Requirements to Spare Impact on Small Business (5/28/19)
- Consumer Financial Protection Bureau Should Drop Flawed Enforcement Actions (5/29/19)