Virtually every section of HR 1728 bears
the fingerprints of consumer groups and/or mortgage lenders. Legislators
and their staffs operate under the illusion that by adjudicating between
these groups, they can achieve a balance between the interests of
borrowers and those of lenders. This is an illusion because most of the
policies espoused by consumer groups further the interests of consumer
groups, not those of consumers.
The tragedy is that neither lenders nor
consumer groups want to make the market work more effectively. Lenders
don’t want it because a well-functioning competitive market would force
down prices. Consumer groups don’t want a well-functioning competitive
market because it would reduce the need for consumer groups. They prefer
to entangle lenders in a maze of complex rules and potential
liabilities, which provide opportunities to counsel and litigate for
borrowers, and make special deals with selected lenders.
The mortgage market works poorly because
borrowers know so little relative to the loan originators they deal
with. Economists call this the problem of information asymmetry. There
are two major tools for over-coming information asymmetry: mandatory
disclosures and transaction-simplification rules, which are discussed in
turn.
Mandatory Disclosures
Under mandatory disclosures, Government
mandates by law that lenders must disclose what borrowers need to know
to negotiate on an equal basis. We have had mandatory disclosures for
three decades, however, and it has not helped borrowers in the
slightest. Mandatory disclosure has raised lender costs, lengthened
transaction periods, but for the most part has left borrowers as
confused and overwhelmed as before. Indeed, judging from the many
hundreds of letters I have answered on the subject, the required
disclosures in many cases have created more rather than less confusion..
The reasons are well known to everybody
familiar with the process, including many of the consumer groups. The
total volume of disclosures is excessive, overwhelming borrowers; a
large proportion of disclosed items is garbage of no value to borrowers;
some disclosed items are irreconcilable with others because they
originate with different agencies; and none are abreast of the current
market.
The major source of these problems is
the early decision by Congress to make itself the source of many of the
items subject to disclosure. The
garbage disclosures all come from Congress. As just one example of
many, the requirement that every transaction must show the sum of all
scheduled monthly payments over the term of the loan, which is a
completely useless number, is in the law.
Congress is also responsible for
entrusting the two most important disclosures, Truth in Lending and Good
Faith Estimate of Settlement, to two different agencies (HUD and the
Federal Reserve Board), which have never succeeded in reconciling them.
And of course, there is no possible way to keep disclosures up to date
when substantive changes require new legislation.
The remedy is obvious. Congress should
remove itself from disclosure operations and eliminate all existing
Congressionally-mandated disclosures. Sole responsibility for all
mortgage disclosures should be entrusted to one agency, which would have
the legal authority to set and revise the rules as needed. This is the
approach taken a few years ago, to good effect, in the
The approach taken by HR 1728, in
contrast, leaves the current disclosure system in place, adding a new
set of mandatory disclosures to the pile. Under one of them, lenders
will be obliged to disclose “the comparative costs and benefits of each
residential mortgage loan product offered, discussed or referred to by
the originator.” Compliance with this rule alone, ignoring extensive
other new disclosures stipulated in 1728, would probably double the size
of the garbage pile dropped in the lap of hapless borrowers. Needless to
say, none of the existing garbage disclosures are eliminated.
The cardinal sin of any disclosure
system is over-load, because borrowers have limited time and limited
attention span. Disclosing too much is the same as disclosing nothing
because nothing is absorbed. Adding even a badly-needed and
well-designed new disclosure to an existing pile of garbage disclosures
does nothing but increase costs. An agency whose sole business is
disclosure would quickly learn this, but Congress never will.
Transaction Simplification Rules
Transaction-simplification rules are
needed to separate third party service transactions from the mortgage
transaction; to sharply reduce the number of lender charges that can
vary from loan to loan; and to assure the validity of price quotes.
These rules would empower borrowers to protect themselves from abuse by
loan providers.
Rule 1,
as simple as it is obvious, is
that any third party service required by lenders must be paid for by
lenders. The cost of these services would be embedded in the mortgage
price, in the same way that the cost of automobile tires is embedded in
the price of an automobile. But the price would be much lower because
lenders can buy the services for less than borrowers, and it would no
longer needlessly complicate the mortgage transaction.
Rule
2 would limit lender charges to points, expressed as a percent of the
loan amount, which are traded off against the interest rate; and one
fixed dollar fee, that must be posted and the same for all transactions.
This rule would eliminate fee escalation, which is common practice.
Rule
3 would require that the prices that lenders lock be the same as the
prices they quote to a borrower shopping the identical loan on the same
day. This rule would eliminate low-ball price quotes, which pervade the
market.
Not surprisingly, none of these rules
are found in HR 1728, which is aimed not at empowering borrowers to
protect themselves, but at replacing private decision-making by lenders
with Government-imposed rules.
Some of the rules in HR 1728 are
sensible, such as the requirement that mortgage originators be licensed.
It would also prohibit the sale of single-premium credit insurance,
which would be barred by my more comprehensive rule 1. But other rules
in HR 1728, knee-jerk reactions to abuses that arose during the go-go
years prior to the crisis, are toxic.
One involves mandating detailed
underwriting rules and procedures, the Congress in effect telling
lenders how they must assess risk. This is the same kind of legislative
over-reach that Congress embedded in Truth in Lending, where it itemized
the specific items that had to be disclosed, with the disastrous results
discussed above.
A second toxic rule requires that
lenders be responsible for assuring that borrowers who refinance obtain
a “tangible net benefit.” As shown in
The Tangible Net Benefit Rule, the net benefit in every refinance
transaction depends at least in part on something known only to the
borrower. Making the lender liable for what is in the borrower’s head is
bad policy.
A third rule would require that all
mortgage lenders retain 5% of the credit risk on any loan they sell. I
am not sure if this rule will prove toxic or not, but it will raise
costs, especially those of the smaller lenders who sell all the loans
they write. A major consequence of this rule is discussed below.
HR 1728 provides an escape hatch from
these three rules. The rules are in effect waived on “qualified
mortgages.” A qualified mortgage is one that has an annual percentage
rate (APR) no more than 1.5% above that of a “prime” transaction, on
which the borrower’s total payment obligation does not exceed some
maximum to be prescribed by regulation, has a 30-year term, and fully
documents the borrower’s financial status.
The qualified mortgage escape hatch from
these rules will divide the market between qualified and non-qualified
mortgages. The non-qualified group will be larger, since it will include
all loans with terms other than 30 years, loans with debt-to-income
ratios above the level deemed prime by the regulators, loans to
borrowers having FICO scores below about 660, which pay a rate premium
of about 1.5% in the current market, most loans to self-employed
borrowers, most loans for investment purposes or on other than
single-family houses, and all loans with risk variables that in
combination require a risk premium of more than 1.5%. In the current
market where risk premiums are extremely high, that covers a lot of
ground.
HR 1728 says nothing about the down
payment, the most important risk variable of all. If prime loans are
viewed as having down payments of 20% or more, which is consistent with
the concept of “prime”, mortgage insurance on loans with smaller down
payments will increase their APRs, pushing many of them into the
non-qualified sector as well.
Borrowers taking non-qualified loans will pay a price increment charged by lenders to cover the additional liabilities they assume under HR 1728. This will be an addition to the large risk premiums they already pay in a highly risk-averse market. Prime borrowers get a pass.