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The Dodd-Frank Act and Housing: The Debacle Continues

The financial crisis of 2008 began with housing: after decades of misguided government policy based on the mistaken idea that everyone should own a house—and that government should do everything within its power to make homeownership possible, even if the homeowner couldn’t afford to pay the mortgage—credit markets seized up as people began to realize that when you lend money to those who are not creditworthy, who may have fudged their credit applications, against inflated home prices, you might not get repaid. Rather than let the market find its own equilibrium, government rushed in with bailouts and programs to stave off the inevitable write-offs and fall in housing prices and succeeded only in making matters worse.

The government’s policy was, at all costs, to keep the market from finding its bottom in order to re-inflate the housing bubble: prop housing prices up, in order to rescue homeowners who had borrowed too much and financial institutions who had loaned too much. The government’s strategy of immunizing financial institutions from the consequences of their poor lending decisions through bailouts and government subsidies, and offering homeowners false hope through poorly designed foreclosure mitigation programs, has been a singular failure.

The Dodd-Frank Act compounds the government’s disastrous foray into housing policy. First, the Dodd-Frank Act simply overlooks the proximate cause of the financial crisis: the government’s efforts to support an affordable housing policy through the government sponsored enterprises Fannie Mae and Freddie Mac. Hundreds of billions of dollars into the GSE bailout without end, there is nary a word about the GSEs in the two-thousand plus pages of the Dodd-Frank Act.

So while the Dodd-Frank Act goes to great lengths to regulate every single facet of the financial system, including many things that had nothing to do with the financial crisis, the single biggest contributor to the collapse of the financial system went unaddressed.

The GSEs continue as wards of the state, underwriting virtually all of the mortgages in the United States: Fannie Mae, Freddie Mac and Ginnie Mae account for 97% of mortgage-backed securities issuance in the United States.
As the Financial Times columnist Gillian Tett put it on July 1, “By the time you read this column today, a fascinating shift will almost certainly have occurred in the nature of US finance: for the first time the government will be the biggest source of outstanding home mortgage and consumer credit loans in the US, eclipsing private sector banks or investors.” And yet, the Dodd-Frank Act trains its 2,000 pages and hundreds of rule-makings and studies not on the government, but on the private sector.

While government becomes the biggest source of consumer credit in the United States, the Dodd-Frank Act hobbles the private mortgage market through onerous regulations with unintended consequences, thereby ensuring that housing will remain in limbo for some time to come, as investors, securitizers, and lenders try to navigate its cumbersome and unworkable rules.

The negative consequences of the Dodd-Frank Act on housing markets could not come at a worse time. As home prices continue to fall, the only hope for a sustained recovery is if creditworthy borrowers can take advantage of lower housing prices and the large inventory of foreclosed properties on the market.
When this happens, housing starts will begin again, and a recovery in the housing market will power a broader economic recovery, as it always has. Given the tremendous importance of the housing industry to the U.S. economy, a broader economic recovery will not take place until the housing industry stabilizes.

Of the hundreds of new requirements contained in the Dodd-Frank Act, perhaps none is more cumbersome than the “risk retention rule” and the exception to that rule for “qualified residential mortgages.” Because most mortgages will fail to meet the overly stringent standards to qualify as a “qualified residential mortgage,” most mortgages will fail to qualify for the exception.

As a result, thousands—if not millions—of qualified borrowers may find themselves shut out of the mortgage market, which means that housing prices will continue to fall and the overhang of unsold and foreclosed properties will persist.

Although the requirement that securitizers retain some of the risk of the loans they bundle and sell off seems relatively straightforward, the Federal Reserve found in a study that the issue is anything but straightforward. As the Federal Reserve put it, “simple credit risk retention rules, applied uniformly across assets of all types, are unlikely... to improve the asset-backed securitization process and protect investors from losses associated with poorly underwritten loans.”

The risk-retention requirement thus has a lot in common with the rest of the Dodd-Frank Act: a complex rule, pressed into the service of a benefit that is unlikely to materialize, all with a cost to consumers, homeowners, the financial services industry, and the broader economy. As foreclosures mount, home prices continue to plummet, and the government has all but taken control over the issuance of mortgage credit in the United States, it is time to step back and think about whether the Dodd-Frank Act has put us on the wrong track.


Who presided over this insane law? One Barack Hussein Obama.
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