Lending standards and credit availability have tightened significantly since 2008. The authors quantify the changes using their Credit Availability Index. They believe that the regulatory landscape being contemplated under the Dodd–Frank Act will worsen the situation because the interaction among the act’s various rules will have a chilling effect on credit availability.
Credit availability from 2005 to early 2007 was very loose. Because of guarantor and originator overreaction, the situation has reversed and now credit availability is too tight. It is increasingly difficult for borrowers to qualify for a mortgage, and according to the authors, the many confusing and conflicting rules in the Dodd–Frank Act will make the situation worse. They focus on four mortgage reform changes as a result of Dodd–Frank: the Qualified Mortgage (QM) rule, the Qualified Residential Mortgage (QRM) rule, the new high-cost mortgage changes to the Home Ownership and Equity Protection Act (HOEPA), and the "disparate impact" rule.
How Is This Research Useful to Practitioners?
The authors use their Credit Availability Index to show the change in credit availability, which may be a metric of interest to market participants and regulators. Origination standards were very loose in 2005–2007, and after the financial crisis, guarantors and originators overreacted with excessive tightness. The authors find that despite historically high affordability, housing market activity remains very weak.
The QM rule requires lenders to ensure that borrowers have the ability to repay their loans. The authors contend that a broad QM standard and a safe harbor is necessary to promote credit availability. Additionally, Dodd–Frank requires securitizers to retain 5% of the risk on securitizations, unless the loan is a QRM. But the QRM rules are extremely restrictive. A Federal Housing Finance Agency study shows that from 1997 to 2009, only 19.8% of the government-sponsored enterprise (GSE) loans would have been eligible to be a QRM.
The changes to HOEPA further restrict the likelihood that credit will be available to weaker borrowers at a higher rate. These rules make risk-based pricing for what the authors call "less-than-pristine borrowers" more difficult to implement and thus cut off their access to credit. Under the disparate impact rule, liability can arise when the outcome of a lender’s operations can be correlated with race, national origin, or sex, even if neutral credit standards are uniformly applied. By adhering to one provision of Dodd–Frank (on loan standards), the banks may wind up violating another provision on equal opportunity lending. For example, if potential borrowers of one race are rejected for a mortgage at a different and statistically significant rate from the rate for borrowers of another race, the lender is vulnerable to potential lawsuits.
How Did the Authors Conduct This Research?
The authors conduct a historical review of credit availability. Using their Credit Availability Index, they quantify changes in credit availability over time. The index measures the standards and market share for the four major categories of originations: GSE loans, Federal Housing Association/Veterans Administration (FHA/VA) securitization, bank portfolios, and private label securitization. Very high average FICO scores for new originations, a low proportion of adjustable-rate mortgages, and a lack of such affordability-enhancing products as interest-only loans indicate tighter credit. The authors use data from CoreLogic, Amherst Securities, Freddie Mac, Fannie Mae, Ginnie Mae, and the National Association of Realtors, among others.
The authors make a compelling argument that lending standards and credit availability have tightened significantly and show that inadequate attention is being paid to the interaction among the various rules under the Dodd–Frank Act. Policymakers have to be very careful about the unintended consequences of laws. This study is very useful to policymakers and market participants because it highlights previously overlooked problems that are likely to arise from the interaction of Dodd–Frank rules that are administered by different regulatory agencies.