One of the striking features of the housing bubble was the excessive origination of toxic mortgages. Government incentive programs—and the global savings glut's search for yield—directed too much credit towards housing and only temporarily juiced prices. It is all but certain that whatever reforms come for the housing market, there will be less credit available for mortgages than during the past decade.
But that is okay.
While we don't know exactly how much credit the housing market needs in an unencumbered market, supply and demand signals will necessarily determine this constantly evolving figure. We do know, though, that there was too much during the credit period. So it makes sense that there will be less credit available in the future. We can't return to unsustainability. We need to accept that a sustainable market will look different.
This is a politically unpopular message, though. And interested parties in the reform debate often talk about trying to ensure access to mortgages for Americans and promoting home ownership. If fixing Fannie Mae and Freddie Mac (with a silver steak) and an overhaul of housing finance is going to work, though Congressmen will have to change their way of thinking on this.
In someways, they already have. In the Dodd-Frank Act, Congress eliminated federal preemption for mortgage lenders that are subsidiaries of national banks. In the current market, large national banks can avoid having to deal with 50 different sets of regulatory requirements when operating in the 50 states because federal law preempts state law. With that provision going way, banks are now faced with a choice:
They can keep their mortgage subsidiaries as such, which would subject them to a patchwork of state consumer-protection laws. Alternatively, they can roll up their subsidiaries, retaining the federal preemption shield but losing the practical benefits of keeping the mortgage business in a stand-alone unit.
Industry lawyers expect most institutions to go the roll-up route, partly out of fear that sooner or later the states would try to force operating subsidiaries — and, potentially, their individual loan officers — to get state licenses. The burden of satisfying 50 state regulators would outweigh the cost in legal fees of restructuring.
While this reduction of mortgage lending operations doesn't necessarily mean there will be less mortgages originated, it certainly won't increase them. There will likely be private mortgage brokers that step into the void, but at least in the short-term this law is likely to mean less access to credit for home buyers on some level.
Even if the reduction in credit is marginal, lawmakers have shown their willingness to potentially decrease access to mortgage credit if they think it is for the right reason. The preemption provision in Dodd-Frank unnecessarily complicates an already uncertain marketplace, and shouldn't have been passed. But at the very least, lawmakers should recognize what it means to access to credit.
When the housing finance reform battle heats up early next year, lawmakers should recognize that they have a price for reducing mortgage interest: a perceived beneficial law. And if getting the government out of the housing finance market reduces access to credit that shouldn't matter—as long as the benefit is a more sustainable and stable housing market. Certainly that is worth less mortgages originated.