Peter Wallison defends positions on housing, warns of new crisis


A realtor's sign hangs in front of a house for sale in Portland, Oregon, December 29, 2005.

Article Highlights

  • Vast numbers of low-income Americans lost their homes as victims of lending practices fostered and encouraged by HUD.

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  • Qualified mortgages, as defined by the CFPB, will have enormous failure rates.

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  • The ability to afford a particular mortgage on the date of closing does not protect against a fall in housing prices or other external events.

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Jim Carr's response to my Senate testimony contains a major misconception about the 2008 financial crisis that is at the bottom of the left's mistaken view of the crisis. Unfortunately, that mistake has also shaped the Consumer Financial Protection Bureau's definition of the Qualified Mortgage (QM), so that-unless QM is changed--we will again bring about a collapsed housing market at some time in the future.

The left's fundamental mistake is to believe that the low quality mortgages that became delinquent and failed in 2007 and 2008 were the result of predatory lending. We don't have a very good definition of predatory lending--some think it is defined as a high cost loan--but we can pretty well characterize what is not predatory lending.

A loan to someone who has a 580 FICO score is not predatory; a loan to someone who makes a 3% downpayment is not predatory; and a loan to someone who has a 50% debt-to-income ratio is not predatory. Yet loans like this--which are currently insured by FHA--have claim rates through the normal credit cycle of 8-10 years of 27%.

These, and loans like them, were the mortgages that accounted for most of the losses in the mortgage meltdown. This is shown clearly by the insolvency of Fannie Mae and Freddie Mac, both of which made efforts to avoid buying mortgages that could be classified as predatory.

Mr. Carr's article cites all the efforts of various organizations that have "worked tirelessly to create a consumer-focused agency [that] would have the ability to prevent the kind of reckless and irresponsible lending that triggered the crisis." I agree that these organizations have worked hard to prevent predatory lending; they should; it is a disgraceful practice that should be stamped out.

However, the losses of Fannie and Freddie show that their lending was--although not predatory--"reckless and irresponsible" by any reasonable definition; vast numbers of the mortgages they bought, either as whole mortgages, directly from the likes of Countrywide, or as mortgage-backed securities from Wall Street, ultimately failed.

That means that vast numbers of (primarily) low-income Americans lost their homes, not as victims of predatory lenders but as victims of lending practices--fostered and encouraged by the Department of Housing and Urban Development--that were "flexible." Mr. Carr's argument that "flexible" underwriting was different from "loose" underwriting also founders on the Fannie and Freddie example, because they did not buy the "designed-to-fail" loans with resets that were apparently, in his view, the loans that were "loose."

Fannie and Freddie were enjoined by HUD--along with many private originators such as Countrywide that joined HUD's National Homeownership Strategy--to be "flexible" in their underwriting, and Fannie and Freddie became insolvent because of this flexibility.

These flexible loans were, then, almost by definition, "reckless and irresponsible." And this is looking only at Fannie and Freddie, not the pain that was caused to the victims of this flexible underwriting--the families that lost their homes, or the taxpayers who had to pay the bill.

In deluding itself into believing that the financial crisis was caused by predatory lending, the left thinks that it can prevent another financial crisis by outlawing such practices as negative amortization, interest-only loans, and no-or-low doc loans.

All that is necessary, for the left, is to make sure that a loan is not high-priced and a borrower can afford the loan at the time of commitment or time of closing. The down-payment, the borrower's FICO score, and a low DTI that leaves room for the vicissitudes of life are not relevant in QM.

This, however, takes no account of the things that happen after the closing--like recessions, injuries, illnesses, housing price declines, divorces and other ills that flesh is heir to.

These chance occurrences are what a downpayment of 10-20%, a solid 660 or higher FICO score, and a DTI in the 30s were designed to address. These standards, however, are all irrelevant in QM, as long as the mortgage is affordable at the commitment or closing. That's why QM mortgages, as the CFPB has defined them, will have enormous failure rates in the future and why we are risking another financial crisis if QM is left as it is.

Indeed, this sentence in Mr. Carr's article makes clear that the ability to afford a mortgage on the day of closing is not the key to a sound loan: "Communities of color suffered catastrophic losses from the housing meltdown; Latinos experienced a drop of nearly 70 percent of their net worth and Asians and African Americans lost more than half their wealth largely as a direct result of foreclosures and lower home prices."

The losses that were experienced by communities of color, Latinos and Asians were the result of a housing meltdown, not something they or anyone else could control.

Their ability to afford a particular mortgage on the date of the closing, as QM requires, would not protect these victims against another fall in housing prices or any other serious external event.

Finally, there is the question of who wants these risky mortgages to be made. In my testimony, I said it was the realtors, the homebuilders and the community activists, and that when these mortgages fail these groups do not take the losses (which are eventually taken by the taxpayers).

Mr. Carr defends the community activists, although they are the ones that moved HUD to push "flexible" underwriting, and pushed the CFPB to structure QM so that downpayments and FICO scores are irrelevant.

Nevertheless, they have made common cause with the realtors and homebuilders, who profit from more home sales and thus will push mortgage quality to the lowest level they can achieve. In a free market, mortgages of such low quality would not be widespread and mortgage failure rates would be low.

But because they can influence Congress, and because Congress influences what kinds of mortgages are made, these three horsemen will produce another apocalypse.

-- Peter Wallison, American Enterprise Institute.

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