At the beginning of 2009, the U.S. economy was in the grip of one of the worst financial crises in our history. Home lending practices, which played a big part in that crisis, naturally assumed a prominent place on the agenda of financial reform. And now, five years later, groundbreaking new mortgage-lending rules have gone into effect, thanks to the diligent work of the Consumer Financial Protection Bureau.
To understand the new rules, it is useful to recall what they were designed to prevent – the kind of abusive loans and loan-marketing tactics that dominated the market in the pre-crisis years, leaving a trail of devastation from which homeowners, communities and the country are still struggling to recover.
Under one of the new regulations, a mortgage lender must verify a borrower’s ability to repay. That might seem to be an unnecessary rule; why would lenders need to be told to worry about getting repaid? And yet, in the run-up to the crisis, mortgage lenders made millions of loans that borrowers could not possibly afford to repay – except, in some cases, by riding an endless wave of increases in housing prices, further inflating a bubble that was bound to burst.
Subprime and other risky lending led to alarming levels of equity-stripping and foreclosures, and then, after the bubble burst, to a massive housing crisis and an economic depression. Since the crisis, both investors and homeowners and communities (especially low-income communities and communities of color) have paid a terrible price. Between 2007 and 2011, an estimated 10.9 million homes went into foreclosure. And the spiral continues, with millions more families enduring the economic challenges of owing more on their mortgages than their homes are worth.
The Bureau’s rules implementing new mortgage laws in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 went into effect on January 10 of this year. The law and rules are intended both to make the housing market safer for homebuyers and to protect communities and the economy from the kind of bubble and burst we just experienced. These rules have two ingredients. The first is straightforward — an "Ability to Repay" standard, which requires all lenders to reasonably determine the ability of a borrower to repay their loan. The second ingredient is a Qualified Mortgage standard (often referred to as QM) that will give lenders an incentive to originate safer and more transparent and affordable loans.
To qualify as QM mortgages, loans have to meet a number of affordability criteria, including a borrower debt-to-income ratio of less than 43 percent. For an adjustable-rate mortgage to qualify, it will have to be underwritten to the highest possible payment in the first five years; in other words, a borrower cannot be approved purely on the basis of the ability to handle a low initial payment that has been engineered to increase sharply a few years later. New QM standards will also limit points and fees to no more than 3 percent of the loan amount (for loans above $100,000), while prohibiting negative amortization and interest-only loans, among other abusive practices.
A Qualified Mortgage will be presumed to meet the Ability to Repay requirement. This part of the rules reflects a compromise between differing interests; prime loans that meet QM standards will enjoy legal protections from challenges to their affordability, while higher rate subprime QM loans have a rebuttable presumption of affordability.
The new rules do not ban any particular form of mortgage. Instead, they provide an incentive – in the form of greater legal protections for lenders – for safer, more standardized and lower-fee loans.
In drafting these, the Bureau weighed the views of a wide range of stakeholders, including industry, civil rights and consumer organizations, and its final rules reflect compromises on a number of key issues. When the rules were announced last January, many industry players responded with praise both for the rules themselves and for the care and thoughtfulness of the bureau’s deliberations.
More recently, however, the applause has faded, and segments of the banking and lending world have ramped up a campaign of obstruction. Meanwhile, some in Congress have responded to the pleas of a powerful industry (and a prodigious source of campaign money), by calling for delays and exemptions, based in large part on an old, tired and thoroughly discredited line of argument that the new rules will restrict access to credit. This is, of course, the very same claim that the lending industry used to fend off regulation in the housing-bubble years. In the short run, the conduct that led to the bubble brought enormous profits to the worst elements of the lending industry. But the end result was a much wider disaster, with an epidemic of foreclosures and massive losses of homes, jobs and household wealth.
Access to credit is a legitimate issue, and lending standards are in some regards very tight right now. But while this is a question that needs to be addressed, the QM standards that just went into effect are not the source of the problem. These rules are clear standards designed to save borrowers and the rest of us from another wave of dangerous and unsustainable loans — the types of loans that took advantage of families, stripping them and their communities of much needed equity.
The crisis devastated families and communities, and has cost this country many trillions of dollars in lost wealth. It is critical that new rules and standards inhibit banks, lenders, and other self-interested parties from the ability to return to pre-crisis business as usual. While these protections and standards are important in protecting families, investors, and the economy, work remains to be done. The focus in the months and years ahead should be on making sure we have rules that accomplish the critical goals they are designed to meet, including identifying and closing gaps that could permit abuses to continue.