Proposed mortgage standard would have discriminatory impact

 

Whether or not one believes that the Qualified Residential Mortgage (QRM) should be narrowly defined or more broadly construed is an important question to resolve.  However, a key concern of the civil rights community is that no matter whether QRM risk retention represents a very narrow space so that the standard mortgage falls outside the scope of QRM or whether QRM represents a more broad space which would encompass the standard mortgage – the criteria for determining risk retention should not be based on something that is so closely connected to the race of the borrower.

The reality is that certain Asian populations, American Indians, Latinos and African-Americans have very low net worth when compared to Whites.  A 20% down-payment criterion has a significant negative disparate impact on communities of color.  The QRM standard should not be predicated on a criterion that poses such huge discriminatory outcomes especially when there is absolutely no need to select that criterion when other, less discriminatory alternatives exist.  That is the key point of the civil rights community.  It is never proper to select a criterion for such an important policy that would exclude the majority of borrowers of color when less discriminatory criterion exists.

The civil rights community does not wish to return the market to its pre-crisis position. Indeed, the civil rights community has worked long and tirelessly hard to change the financial marketplace.  The civil rights community never pushed for lax and imprudent underwriting standards, unsafe and substandard mortgage products and loose regulatory oversight.  We pushed for the exact opposite.  Our position, however, often got misrepresented in the media and in debates.

The reality is that a very high down-payment reflects how much net worth a borrower has much more than it reflects how risky the mortgage loan will be. There are myriad criteria that impact risk.  Loan-To-Value (LTV) or down-payment is only one of the components of risk.  And it is not the most important criteria.  In fact, many of the subprime loans that went into default had low LTVs or high down-payments.

Indeed, one of the major scams of predatory lenders was to target senior citizens who had amassed a lot of equity in their homes and put those homeowners into cash-out refinance products that had abusive terms and conditions.  In many cases, the appraisal super-inflated the true value of the home in order to maximize profits for the mortgage broker and originating lender.  These loans were deemed to be less risky by the industry because of the low LTV on the loan and the relatively high FICO score of the borrower.  Yet, because of the problematic underwriting, appraisal quality issues and abusive loan terms, these loans turned out to be extremely risky.

Another major scam was to target homeowners in the Habitat for Humanity and other community development lending programs for cash-out refinances.  In the Midwest, it is more common than not for homes to come with garages.  However, in many Habitat programs, the homes were built without garages.  It is easy to imagine how hard it is to not have a garage in places like Michigan, Ohio, Pennsylvania, Illinois and Indiana.  Winters are quite harsh.  Predatory lenders would routinely target Habitat borrowers to give them a cash-out refinance so that the homeowners could build a garage.  These loans typically featured very low LTVs, yet they were very risky – again – because of the abusive features of the loans – not because of the borrowers’ characteristics.

There are many homeowners who receive mortgages with low down-payment amounts who perform just fine on their mortgages.  Those loans pose very little risk.  Indeed, most borrowers put relatively little money down.  Moreover, there are a number of projects around the country which typically feature low or even no-down-payment programs.  Some of these programs have had no mortgage defaults; others have very low default rates.

The point is that there are factors that impact risk – some of them are more important than LTV or down-payment.  Regulators have many criteria from which to select.  Those factors include, among many others:

• low or no-doc versus full documentation
• appraisal quality
• loan terms and conditions
• loan type
• quality of underwriting verification process
• pre-payment penalty terms and conditions
• ability of the borrower to repay the loan
• strength of regulatory oversight

Indeed, an analysis of many loan portfolios would reveal that down-payment amount registers very little in terms of the performance of the loan and therefore the risk that the loan poses.  And therein lies a major concern of the civil rights community.  There is not enough transparency in the data analysis the regulators have undertaken to develop the proposed QRM rule.  There is a lot of data out there that tells us much about what really impacts risk.  We wonder whether that data has been adequately analyzed.

A major contributor to the financial crisis was the lack of real data analysis and quite frankly a regulatory scheme that did not promote transparency when it came to making data and information available to the public.  The government needs to assure the public that it is looking at the right data and analyzing that data accurately and fairly before it proposes such an important regulation that will have strong reverberations throughout the marketplace.

Moreover, the government should not contradict itself.   On the one hand, the government has strong anti-discrimination laws and policies.  Our government has stated over and again that it does not want America to be a society where arbitrary discrimination can be practiced.  We are a nation that believes firmly in promoting equal opportunities for everyone – especially for under-served communities.  Indeed, federal laws mandate that all government entities that have anything to do with housing and economic development implement their programs, regulations, rules and guidelines in a manner that affirmatively furthers fair housing.

The government should not be about the business of promulgating regulations that have such a strong discriminatory impact on communities that have already been affected by discrimination.  The government, should, however, be about the business of promulgating regulations that achieve their prescribed purpose – without the unnecessary discriminatory impact.  The purpose of the QRM regulation is to highlight factors that strongly impact the risk of the loan for the purposes of identifying which loans should spark the risk retention requirement.  The truth is there are many factors that impact risk more than down-payment.  Many of these requirements do not have the discriminatory effect that the down-payment requirement holds. These are the requirements we should be concerned about with QRM standards.