Dodd-Frank creates a bizarro world of housing finance

Foreclosure by Gina Jacobs / Shutterstock.com

Article Highlights

  • A Bizarro World of home finance is being created by the Consumer Financial Protection Bureau and Dodd-Frank.

    Tweet This

  • The Dodd-Frank Act was enacted after a mortgage meltdown, but promotes the same policies that made the meltdown.

    Tweet This

  • In Bizarro World a prime loan has little to do with borrower qualifications or the actual riskiness of the loan.

    Tweet This

  • The Dodd-Frank Act did little to restrict excessive borrower or government mortgage guarantor leverage.

    Tweet This

In Superman comics there exists a Bizarro World where the inhabitants do the opposite of all things normal. For example, a salesman does a brisk trade selling Bizarro bonds: "Guaranteed to lose money for you".

A Bizarro World of home finance is being created by Dodd-Frank Wall Street Reform and Consumer Protection Act's new enforcement agency, the Consumer Financial Protection Bureau (CFPB). In this world a loan with little or no money down, a FICO credit score of 580, and a total debt-to-income-ratio of over 50% is defined as a prime loan, even though it has a nearly 30% likelihood of ending in foreclosure. Like the bond salesman in Bizarro World, this sets up for failure working-class families striving to achieve the American dream. In the real world a prime loan with 20 percent down, a FICO score of 720 (the average score of all individuals in the U.S.), and a 40% debt ratio has a 1.5 percent chance of foreclosure.

The Dodd-Frank Act was enacted following a mortgage meltdown, but perpetuates the same policies that made the meltdown inevitable. It was passed in 2010 with the stated purpose of "promot[ing] the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail', to protect the American taxpayer by ending bailouts, [and] to protect consumers from abusive financial services practices." Like the 1992 act that promised to protect taxpayers from a bail out of Fannie Mae and Freddie Mac and did the opposite, the Dodd-Frank Act will lead to a similar perverse outcome.

One of the CFPB's core functions is to assure "that responsible, affordable mortgage credit remains available to consumers." This is not the first time Congress has attempted to legislate the availability of "affordable mortgage credit." Recall Fannie Mae and Freddie Mac's affordable lending mandates, the Department of Housing and Urban Development's (HUD's) National Homeownership Strategy with its goal of doing away with downpayments, and the Community Reinvestment Act (CRA) with its "flexible" underwriting. This increase in leverage allowed HUD to trumpet a self-described "revolution in affordable lending", ignoring the resulting in boom in home prices, thereby making them unaffordable

This time, we have the CFPB relying on the same affordable lending nostrums. These placate community activists still eager to make sure that low-income borrowers have access to mortgage credit with little regard for the failure rate, and a National Association of Realtors still interested in assuring that there's no shortage of credit for any marginal buyer who can be made eligible to buy a home.

In Bizarro World a prime loan has little to do with borrower qualifications or the actual riskiness of the loan. Irresponsible loans setting families up to fail are called qualified so long as they are approved by a government-sanctioned underwriting system.

In the real world a prime borrower puts sufficient money down so as to have skin-in-the game and demonstrates willingness and ability to pay.

In Bizarro World the government does not price for risk; instead credit is allocated by government agencies based on political goals. Here, the Federal Housing Administration (FHA) charges the same to insure a loan with 5% down, a FICO credit score of 580, and a total debt-to-income-ratio of 55% as for a loan with 20% down, a FICO credit score of 740, and a total debt-to-income-ratio of 30%.

In the real world lenders allocate credit by charging borrowers different interest rates based on risk, and protect their shareholders by operating at safe levels of leverage.

In the Bizarro World of Dodd-Frank Act, borrowers are deemed incapable of making a responsible decision and all financial institutions are presumed evil. Thus thousands upon thousands of pages of mind-numbing regulations are required to "protect" consumers. Beyond being complex and confusing, at times these regulations conflict. The evil financial institutions are presumed staffed by employees who never make a mistake. The resulting gotchas assure that the tort bar has plenty of opportunity make evil institutions pay. This favors ‘‘too big to fail'' institutions which Dodd-Frank vowed to end.

In the real world borrowers would be expected to act responsibly and risky lenders would be allowed to fail, regardless of size.

In Bizarro World home loans are another form of entitlement, where unqualified borrowers stamped "prime" by government underwriting systems allowed to avoid making monthly payments for 1, 2, or 3 years or more.

In the real word lending is a business based on credit standards and markets are permitted to correct.

The Dodd-Frank Act did little to restrict excessive borrower or government mortgage guarantor leverage. Instead it provided a clear path for the government to expand both, laying the foundation for the next bust and taxpayer bailout.

AEI Resident Fellow Edward Pinto was an executive vice president and chief credit officer for Fannie Mae until the late 1980s. He has done groundbreaking research on the role of government housing policies in the lead-up to the financial crisis.

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Edward J.
Pinto
  • American Enterprise Institute (AEI) resident fellow Edward J. Pinto is the codirector of AEI’s International Center on Housing Risk. He is currently researching policy options for rebuilding the US housing finance sector and specializes in the effect of government housing policies on mortgages, foreclosures, and on the availability of affordable housing for working-class families. Pinto writes AEI’s monthly Housing Risk Watch, which has replaced AEI’s FHA Watch. Along with AEI resident scholar Stephen Oliner, Pinto is the creator and developer of the AEI Pinto-Oliner Mortgage Risk, Collateral Risk, and Capital Adequacy Indexes.


    An executive vice president and chief credit officer for Fannie Mae until the late 1980s, Pinto has done groundbreaking research on the role of federal housing policy in the 2008 mortgage and financial crisis. Pinto’s work on the Government Mortgage Complex includes seminal research papers submitted to the Financial Crisis Inquiry Commission: “Government Housing Policies in the Lead-up to the Financial Crisis” and “Triggers of the Financial Crisis.” In December 2012, he completed a study of 2.4 million Federal Housing Administration (FHA)–insured loans and found that FHA policies have resulted in a high proportion of working-class families losing their homes.

    Pinto has a J.D. from Indiana University Maurer School of Law and a B.A. from the University of Illinois at Urbana-Champaign.

  • Phone: 240-423-2848
    Email: edward.pinto@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: 202-419-5212
    Email: emily.rapp@aei.org

What's new on AEI

image The Census Bureau and Obamacare: Dumb decision? Yes. Conspiracy? No.
image A 'three-state solution' for Middle East peace
image Give the CBO long-range tools
image The coming collapse of India's communists
AEI on Facebook
Events Calendar
  • 14
    MON
  • 15
    TUE
  • 16
    WED
  • 17
    THU
  • 18
    FRI
Wednesday, April 16, 2014 | 10:00 a.m. – 11:00 a.m.
Calling treason by its name: A conversation with Liam Fox

Join us at AEI as the Right Honorable Liam Fox sits down with Marc Thiessen to discuss and debate whether America’s intelligence agencies have infringed on the personal privacy of US citizens.

Thursday, April 17, 2014 | 4:00 p.m. – 5:00 p.m.
The curmudgeon's guide to getting ahead

How can young people succeed in workplaces dominated by curmudgeons who are judging their every move? At this AEI book event, bestselling author and social scientist Charles Murray will offer indispensable advice for navigating the workplace, getting ahead, and living a fulfilling life.

Event Registration is Closed
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled today.
No events scheduled this day.
No events scheduled this day.