Commercial Real Estate Finance

For decades government policy has been to encourage lenders to provide mortgage loans to lower-income families. When mortgage brokers refused to make such loans because the risk was too high compared to the interest rates they could charge and still expect repayment, they were accused of discrimination. Now low-income borrowers, enabled by the policies of the federal government (I fall into this category with my 96.5% loan to value FHA loan), are in a bind. As has become expected of this administration, politicians are seeking to punish the lenders.

In the Sunday edition of the New York Times an article title “U.S. To Pressure Mortgage Firms For Loan Relief” quotes Treasury’s assistant secretary for financial institutions as saying, “The banks are not doing a good enough job. Some of the firms ought to be embarrassed, and they will be.”

Is this the Treasury, or a group of thugs? What should mortgage firms be embarrassed for? Should they be embarrassed to have made loans to low-income borrowers? Nope, the government should be embarrassed for this. As is discussed below, it is the government that both forced banks to make loans to low-income households and created the environment where banks could charge higher rates for those loans. The government’s purpose is to promote the public’s interest. The purpose of mortgage firms is to make a profit. If mortgage firms decide that they can make more profit by continuing to charge the mortgage contract interest rate after they have accounted for the increased risk of default, then they should. If the government decides that it is in the public’s best interest to stem the number of foreclosures, they should not try to shame mortgage companies into lowering the monthly payment. Instead, they must offer mortgage companies an economic incentive to lower the monthly payment.

It gets better; Mr. Barr said that the government “would try to use shame as a corrective, publicly naming those institutions that move too slowly to permanently lower mortgage payments.” The government forced lenders to offer loans to people with low-income. Not surprisingly, low-income people jumped at the opportunity to get a piece of the American dream. This easy credit helped fuel a housing bubble, and now dropping prices coupled with increasing variable rate mortgages now make loan payments unaffordable for many people.

Fortune Magazine reports that “neither the expansion of the subprime market nor the proliferation of exotic interest-only or option-ARM mortgages would have been possible without federal laws passed in the 1980s.”

Two key pieces of legislation helped enable the current mortgage crisis: the Depository Institutions of Deregulation and Monetary Control Act of 1980 (DIDMCA) and the Alternative Mortgage Transactions Parity Act of 1982 (AMTPA). In short, DIDMCA abolished interest rate caps, a good thing. Interest rates are how risk is priced and compensated for. However, the 1980 act allowed banks to make riskier loans because they could price for the risk. Prior to 1982, banks could only make conventional fixed-rate, amortizing mortgages. AMTPA ended those restrictions and gave birth to exotic mortgages.

AMTPA and DIDMCA by themselves are positive pieces of legislation; the problem arises from the incentives created by the Community Reinvestment Act of 1977. This act encourages commercial banks to meet the needs of borrowers in all segments of their communities, including low-income neighborhoods. CRA forces banks to loan to low-income borrowers and AMTPA and DIDMCA allowed the creation of the exotic mortgages that have gotten so many borrowers into trouble.

This is another example of how government meddling can really screw things up. First banks are shamed for not making loans to low-income families, now they are being shamed for trying to collect on a legally binding obligation. Shame mongering is a sign of poor governance.