A story by Bloomberg anticipates the arrival of a new version of the Qualified Residential Mortgage (QRM) rule. Coordination with the CFPB‘s Qualified Mortgage (QM) rule, issued in January, is expected. It is essential that these two rules agree, but are they going in the right direction?The motivation for both rules is a section of the Dodd-Frank Act (941, if you want to look it up) that requires lenders to keep ‘skin in the game’ with the intent that this commitment of capital to a loan would act to curb many of the abuses seen in the loan markets leading up to the financial crisis. The amount of ‘skin’, 5%, is not at issue. Instead, all the action has been in deciding what loans can be exempted from the rule. A ‘qualified’ mortgage loan is exempt, and the bank making the loan can securitize 100% of the loan, instead of 95%.
The initial proposal of a QRM rule back in 2011 was quite strict. According to one analysis, only 6% of loans made in recent years would qualify. The proposal had a 20% down payment requirement, and 20% debt to income (DTI) ratio. This proposal met strong criticism, and the rulemakers went back to the drawing board.
Step forward two years. The new proposal expected today will have no down payment requirement, and a 43% DTI requirement.
Are we headed in the right direction, or are we going back to the bad old days of allowing too many mortgages to be written to unqualified applicants?
Lets look at the big picture. American public policy has long been twisted to support the goal of widespread ownership of single family homes. Owning a home is seen as an objective good.
Looked at more clearly, this is highly questionable. The average family size in the US is dropping, and fits as well into a two bedroom apartment as a four bedroom house in the suburbs. Aging empty-nesters don’t that house any more.
The suburban single family home is also not the ‘greenest’ lifestyle possible. Urban or semi-urban living that groups people into larger buildings and allows the use of mass transit is much more energy efficient. That is good for personal economics, the country and the planet. There is a big disconnect between housing and energy policy, here.
(Full disclosure: The author lives in an apartment, takes the train into NYC and drives a hybrid.)
So part of the unquestioned policy background here that should be questioned is whether the US government should be pushing people into buying homes. From there we can go on to looking at this particular regulatory proposal.
I believe the glass is half full on the subject of whether the 0% down, 43% DTI proposal is a good one. According to the analysis done in 2011 by the pro-housing for everyone NCRC.org, lowering the requirements made the rule fairer with respect to income levels and ethnicity, while only changing foreclosure rates of QRM loans by a negligible 0.14 to 0.24%.
The half empty view would say that that change isn’t negligible, it is 58%!
The half full view responds that that is the wrong comparison. What the rule is trying to do is let safe mortgages become securitized. Under either the strict or loosened proposals, most loans that did get foreclosed would not have been QRM loans.
An entirely different perspective is provided by the comment letter of FICO to the 2011 proposal. FICO provides credit scoring services, and their letter points out that the whole process of setting percentages for down payment, DTI and other factors is just creating a poor proxy for the consumer credit score – an instrument that has been statistically validated by academic studies and commercial use over decades. In addition, credit scores are inherently fair and efficient, attributes that could be lacking in any new system.
I find this approach the most persuasive. It is in general agreement with the NCRC.org analysis, but takes advantage of a much longer view of the data. The takeaway I have is that a credit score of 620-640 would be a better determinant of whether a loan should be a QRM than other possible determinants.
We live in the age of Big Data and stress tests. I would love to see any proposal backed up by clear analysis, not only of past loans and loan experience, but by ‘stress test’ modeling of multiple scenarios of rule parameters, markets and economics. This kind of rule is too important to be left to the lawyers alone.