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Clifford Rossi is the Professor-of-the-Practice at the Robert H. Smith School of Business at the University of Maryland.
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Mortgage Markets Will Pay Price for CFPB’s Contradictory Policies

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The Consumer Financial Protection Bureau's Qualified Mortgage rules and the agency's intention to pursue disparate impact claims expose mortgage lenders to enormous regulatory and legal risk.

Without clear guidance from the CFPB, the natural response by lenders will be to reduce credit availability and/or raise prices.

Nowhere has the piecemeal approach to postcrisis regulation of the mortgage industry been more apparent than with the CFPB's implementation of the Qualified Mortgage rules followed by its announcement it will take a more aggressive stance on the fair-lending doctrine of disparate impact. The agency has essentially ceded sound economic principles to untested legal doctrine and in the process may wind up stalling the emerging housing recovery.

Let's face it: QM was a response to the mortgage industry's lack of underwriting discipline in the years leading up to the crisis. The heavy price to be paid came in the form of the federal government dictating to lenders what the standards for high-quality mortgages would be. The cornerstone of QM is the ability-to-pay doctrine, codified in the 43% maximum debt-to-income ratio for QM eligibility. While the industry has reconciled itself to a QM world, it did not bargain for the double whammy that came in the form of vigorous enforcement of disparate impact. Under this doctrine of discrimination, a lender can be charged with violating the Fair Housing Act if it engages in practices that impose a disparate impact on a protected class, even if the effect was unintentional.

In contrast, many mortgage fair-lending cases focus on proving a disparate treatment effect of intentional acts to discriminate against a protected class. In the case of disparate impact a lender would need to demonstrate a business necessity for the practice. However, the Department of Housing and Urban Development and the CFPB this year raised the stakes for lenders in disparate impact cases by asserting their intention to pursue practices as discriminatory even if the practice is unintentional but creates a disparate impact on a protected class. The Office of the Comptroller of the Currency took the disparate impact doctrine to new heights by issuing an enforcement action against Community First Bank in Maryland recently. The agency contended the community bank engaged in a form of disparate impact in its lending practices against white males.

In the past, legal attacks on those lenders with what Nobel Laureate Gary Becker would claim have a "taste for discrimination" have helped root out instances of intentional discrimination. However, this new legal campaign to combat discrimination based on disparate impact regardless of whether such practices are intentional or not in all likelihood will crash head-on with the QM rules, eventually harming the very borrowers it aims to protect.  

How? Consider a lender that conforms to the QM rule limiting debt-to-income ratios at 43% for all creditworthy borrowers. It isn't much of a stretch to show using publicly available data that a disproportionate share of minorities would have debt ratios over 43% compared to nonminorities. So complying with the QM rule could invite a disparate impact challenge by the regulatory agencies.

A lender could try to defend itself by demonstrating that the differences in debt-to-income ratios result in statistically higher levels of defaults for minorities than nonminorities, controlling for all other risk attributes. Therefore, the lender could argue that it indeed has a legitimate business justification for setting the DTI threshold at 43% (in addition to complying with the QM rule, that is). But that logic may not matter, given the stance taken publicly by the CFPB and HUD.

Anticipating such actions and in the face of regulatory uncertainty, lenders have a couple of options. One option is to simply reduce their lending. Another would be to relax underwriting standards and accept higher risk to reduce fair-lending scrutiny and price that risk via higher mortgage rates. In effect, economic theory falls victim to a legal doctrine that winds up reducing the availability of credit, raising its price for those who need it the most for housing, or both.

Lenders find themselves in a policy vise with little maneuvering room as a result of QM and agency assertiveness around disparate impact theory. We found out the hard way that despite the best of intentions, not everyone is ready for homeownership and strong underwriting standards are there to protect the lender and the borrower.

That is not to say that intentional discriminatory acts should be at all condoned, but where there is a clear business justification for those underwriting practices to exist, then they should be permitted and mortgage markets should be allowed to operate according to the dictates of fundamental economics. (The Supreme Court is expected to hear a case challenging the disparate impact doctrine in the fall.)

Dictating mortgage standards while pursuing an aggressive stance on disparate impact threatens to disrupt an otherwise stabilizing housing market.

Clifford Rossi is the Professor-of-the-Practice at the Robert H. Smith School of Business at the University of Maryland. 

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Comments (4)
The current process of borrower and saver protection resembles the Sopranos protection rackets with competing gangs protecting different parties with conflicting interests, but without the syndicate to impose order and discipline.
Posted by kvillani | Monday, August 19 2013 at 11:38AM ET
I agree with Professor Rossi. I am not a professional economist but I know that stabilizing the housing markets is important for overall economic stability. In the west, where I live, housing accounts for a significant percentage of all economic activity. FDIC studies reported that housing provided 20% of all jobs in the western region in 2006. Later studies showed that housing starts declined about 75% from 2006 to 2010 due to the disruption in the supply of mortgages. That, in a nutshell, was the Great Recession. Today housing starts in my state (Utah) are still only half of the volume in 2006, and that explains in large part why the economy remains anemic. In some ways that is a good thing. Housing was out of control prior to 2007 and we don't want to go back to essentially unregulated or ineffectively regulated mortgages. Unfortunately, the current environment has become a prime example of how political dynamics, which are running at fever pitch right now, are disconnected from market dynamics. Fair housing is a critically important public policy issue but as applied now lenders find it very hard not to violate the myriad and often changing standards and agendas being enforced. In this environment, making mortgages is likely to result in lawsuits and regulatory sanctions regardless of a lender's efforts to comply with the laws. Housing will not get back to a healthy normal until legislators and regulators establish fair, permanent and effective mortgage standards.
Posted by gsutton | Monday, August 19 2013 at 1:01PM ET
Bravo Professor Rossi. If lenders must sing, dance and juggle all at the same time, then perhaps the policy folks will realize that the requirements of Dodd-Frank don't support fair housing. A possible solution to fair housing just might be changing the traditional mortgage to a contract of sale where lender holds title to the property until the homeowner pays the loan off. Eviction is cheaper and faster than foreclosure. The homeowner can have most of the benefits of homeownership and at least the lender is an a somewhat safer position,j The California Veterans Administration has a great record of success with this approach.
Posted by aschweiger | Monday, August 19 2013 at 6:24PM ET
Right on, Professor Rossi
Posted by Westernbanker | Tuesday, August 20 2013 at 5:36PM ET
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