Risky mortgages primed for comeback under Senate reg relief bill
Now that we’re at the top of the business cycle, it’s about time for amnesia to set in about the last financial crisis. Sure enough, that’s what’s happening with the Senate’s latest attempt to roll back key financial reforms.
The Economic Growth, Regulatory Relief, and Consumer Protection Act, by Sen. Mike Crapo, R-Idaho, has made it to the Senate floor and is poised for a vote, with Republican and some Democratic support.
This bill, if enacted, would make a terrible mistake by paving the way for another financial meltdown. When Congress passed the Dodd-Frank Act in 2010, it required lenders to first determine that loan applicants are able to repay before making them home mortgages. Lenders who fail to make this assessment can be liable to borrowers.
Congress did provide lenders with some legal protection by insulating them from ability-to-repay claims by borrowers for loans meeting certain safety requirements set out in Dodd-Frank. These so-called “qualified mortgages” have important guardrails against a future spike in defaults, including stricter underwriting and safer loan terms. Congress carefully designed these protections to prevent a repeat of some of the biggest lending lapses culminating in the 2008 financial crisis.
The Senate bill waters down these safeguards for banks with total assets of up to $10 billion by permitting them to make unaffordable mortgages, with no liability to borrowers, so long as the banks hold the loans on their books.
If the bill becomes law, Congress will excuse over 97% of U.S. banks from having to verify applicants’ income, assets and debts for mortgages they keep on their books. This is a recipe for unmanageable monthly payments for consumers. Further, under the bill, these smaller banks can make toxic balloon loans and adjustable-rate mortgages without ever confirming that the borrowers can afford the higher monthly payments in future years. This raises a serious concern because both of these abuses contributed to the 2008 financial crisis.
The Senate bill poses another, less obvious risk. If smaller banks don’t have to play by the same rules as big banks, we face a race to the bottom in lending standards. Smaller banks will lure away business from big banks by offering borrowers loans that appear to be cheap, but are filled with nasty surprises. The result: Smaller banks will load up their balance sheets with risky mortgages to pursue lucrative fees, while ignoring the peril to their solvency.
The bill’s sponsors pooh-pooh any problem, saying that banks will not make unsafe loans if they retain those mortgages. But that is a myth. FDIC data reveal that, by year-end 2012, banks, both big and small, held a whopping $238 billion in bad home mortgages on their books. Many of those banks were so insolvent that they required taxpayer bailouts to stay afloat.
Similarly, the bill’s sponsors blame the Dodd-Frank Act for crimping economic growth and hurting smaller banks. Once again, they are wrong. Since Congress enacted Dodd-Frank, bank revenues and lending have grown, the S&P 500-stock index has more than doubled, wages are rising, home mortgages to minority borrowers are up and full employment is in sight. Since Dodd-Frank became law, smaller banks have enjoyed rising income and loan volumes. And while the number of small banks has declined, that trend began many decades ago and long before enactment of the Dodd-Frank Act.
If the Senate had held hearings on the bill, it could have addressed the myths advanced by the sponsors. Instead, the Senate Banking Committee rushed the bill through markup, with no hearings or amendments, before sending it to full Senate. In the process, the Banking Committee cut off any serious examination of the risks the bill presents. While several prior Banking Committee hearings touched on small-bank lending, witnesses for consumers were noticeably excluded and the senators had not yet seen the language of the bill.
Bottom line, the bill will wreak havoc by allowing small banks to “sell” homeowners loans they cannot afford, triggering rising defaults and foreclosures. The bill, if passed, will also set off bank failures. In 2008, we saw how that movie turned out and it wasn’t pretty. To prevent a repeat of the last crisis, the Senate should reject this bill.