The Future of Mortgage Finance

2013 Banking Outlook Conference: Navigating the New Banking Landscape, February 28, 2013

Donna Fay: I'm Donna Fay with the Federal Reserve Bank of Atlanta at the Banking Outlook Conference, and I want to welcome Jay Brinkman, senior vice president and chief economist of the Mortgage Bankers Association.

Jay, welcome, and thank you for joining for us today.

Jay Brinkman: Thank you Donna. It's a pleasure.

Fay: Jay, a Washington Post article recently wrote that "how qualified mortgages are defined under Dodd-Frank will essentially set the boundaries of the U.S. mortgage market." Do you agree or disagree, and if so, why?

Brinkman: I completely agree that it is going to set the boundaries for all sorts of lenders, and even within the qualified mortgage, what's called a "safe harbor mortgage," where you are pretty well protected against the provision that essentially says, "Did you have an adequate estimate of the borrowerâ??s ability to repay?" That is a tremendous liability on a lender if that loan then goes bad at some future point, then they say, "Well, did you have adequate knowledge that the plant may have shut down or that they would have had some other problem, potentially, come up in their life given their level of reserves?" So that even within what is a qualified mortgage, it is even a tighter boundary for this safe harbor legally.

Here is the issue: when loans go bad, we can look at this incidence of—ok, what is a default incidence. But what we have seen is this tremendous growth in your loss when a loan goes bad. We've got longer foreclosure timelines. We've got higher servicing costs. We've got all the other things that have, sort of, added to these foreclosure costs. Now under QM [qualified mortgage], if you do something outside these boundaries, you have tremendous legal costs because the borrower, through attorneys that will go out and solicit them, can say, "Let's try to get some of this money back from the bank. Let's put these penalties on them." And even if you win the case, the legal costs are just tremendous. When you look at the legal costs for one defaulted loan versus what your profitability is on that loan to begin with—not all that much—they are going to operate very much within that qualified mortgage boundary.

Fay: My next question for you: Having said that, what suggested changes to the definition of "qualified mortgage" would you advocate in order to sustain a healthy mortgage industry?

Brinkman: One of the complaints that we have had with the approach with the qualified mortgage is these defined ratios of saying that your debt-to-income ratio can't be above this amount, or other credit measures can't be above that amount, when in fact it is a judgment call on the part of—well we've got trade-offs, multi-dimensional, in these different characteristics, and if what you are saying is each one of these then can be an individual trigger that would cause you then to have a nonqualified mortgage, you are going to do two things. One is you are going to cut off people that otherwise would qualify. But you are also going to lend inside of that because you then don't want to run the risk that in a subsequent calculation of what is truly income relative to the debt payment, were you over by a few dollars, that suddenly kicks you over into the nonqualified and all sorts of bad things happen. So that by spelling it out the way it is spelled out—and of course we will still have to see what the enforcement on it looks like—that we are just going to have people lending inside of that for safety reasons, and we think there really needs to be a little more leeway and some understanding about what the tradeoffs are in some of these different risk factors.

Fay: So, lastly, looking into the future, can the current momentum in the housing market be sustained given the net effects of regulatory reform and the current dynamics in the mortgage industry?

Brinkman: I would say that the market as we are now seeing it probably can be sustained for the near term because of the heavy reliance on FHA; that until something happens to sort of pull back on FHA's growth—that that has been an outlet in terms of—if there is not the private appetite, if Fannie and Freddie have pulled back on their credit, it's really driven a lot of the riskier business now to FHA. I don't know how sustainable that is in the long term (there are a number of people looking at that), but that would be, sort of, the first drawback. But, in general, what we have to decide as a society is what is, sort of, an acceptable level of loss in the mortgage business because with any credit model that you set up, you establish "this is the point at which I'll lend and not lend" and the cost is you are going to not make loans to some people that are perfectly able to pay them back. But then you do that because then you want to limit your losses in the people that then do default, that's been true of lending for centuries, and then trying to decide how you set that credit.

What we are seeing now is the government injecting itself into setting these credit definitions. And to the extent the government definitions are tighter than where the market otherwise would be, you get dislocations. You get artificially constrained markets. And I think that is going to be, on a long-term basis, unhealthy. To me, long term is "What is the market appetite?" Let's take a look at some of the things that really caused our problems in the past—whether it was stated income loans, some of these teaser ARM loans to people that just had no clue what they were doing, overbuilding in markets, multiple speculation of buying multiple properties somewhat fraudulently—all these things we know were key drivers, not necessarily what a particular debt-to-income ratio was or some other cutoff that people had been able to do very well, particularly new people coming into the market, buying their first home, struggling to get that down payment. They're going to be the ones most affected by having an overly tight credit box imposed on the market by the government.

Fay: Jay, thank you so much for your insight today, and thank you so much for being with us.

Brinkman: Thank you.