The Risk of Excess


If there is one thing that this past decade has taught us, it’s that excess and layering of risk without objective and balanced oversight can lead to systemic failure. We have learned this painful lesson resulting in an approximate 34% peak to trough home price decline.

The combined impact of the actions, or lack of action, by lenders, investors, realtors, borrowers, regulators, rating agencies and legislators has destroyed trust, eradicated personal wealth, and brought the economy to the brink of complete failure.

The fact is that this lack of trust is what has motivated the most extensive intervention in all aspects of housing finance that the nation has ever seen. Multiple regulators, legal agencies, legislators, states attorneys, private class action lawyers, and more have all decided to respond to the mistakes of the past with their own interventions. Legal action, mass settlements, new regulations relating to literally every aspect of the housing purchase process are being addressed. The result will be an entirely changed system; one that is still uncertain, but one that will certainly involve greater disclosure, more oversight, and stiffer enforcement…..

And tighter credit resulting in less access to homeownership.

The qualified mortgage rule as written in the Dodd Frank legislation requires lenders to prove “ability to repay” or be faced with the most costly penalties on a per loan basis ever enacted. With the potential per loan penalties so high, lenders of the future from community banks to credit unions will have one rule: don’t make any loan that could be determined by any court as violating the “ability to repay” provision or you will face costly fines.

So, what determines “ability to repay”? Right now the CFPB is trying to define that. I do know that wealthy borrowers with lots of assets and big down payments – the 1% – will certainly be able to prove that ability. They have disposable income after expenses, lots of money in reserve just in case something arises, and likely a good credit history.

But what about the rest of America? Middle class workers who didn’t get an inheritance, families with stable jobs who want to own a home but don’t have the large monthly residual income, or non traditional households with multiple income sources or cash income or variable income? Will banks lend to these families and face the risk that if one family defaults in the future a court could rule that they did not meet ability to repay provisions required by law, and slap the lender with an enormous penalty?

The Kennedy school at Harvard released their “state of the nations housing” and forecasts approximately 14 million new households in the next decade. Much of this growth will come from the Hispanic community and first time homebuyers. The question is whether the rules being created to protect these future borrowers will elimante their ability to buy at all.

Excess. We let the pendulum swing too far and created too much risk and we are all sharing that outcome. Excess works both ways. We need strong consumer protection and clear transparent disclosure. The question is will we simply end up with homeownership for the wealthy? In the end we cannot force banks to lend. They won’t lend if the risks of penalties are too great. Creating accountability is critical but so is maintaining access to homeownership itself.

Excess works both ways and systemic impacts occur on either side.