A recent article in the Washington Post noted that the Obama administration is engaged in active discussions to create a regulatory commission "that would have broad authority to protect consumers who use financial products," including mortgages.
This story was reported a few days after the publication of a piece in the New York Times entitled "My Personal Credit Crisis," in which the author (Edmund Andrews, a Times economics reporter) outlined how his willingness to aggressively obtain financing for a home he couldn't afford led him to sabotage basic underwriting practices while driving himself into insolvency. (Basically, he violated a fundamental rule of self-preservation: "When you find yourself in a hole, stop digging.")
It would be very easy to let the appearance of these two articles within days of each other precipitate another round of finger-pointing and debates on the relative evils of predatory lending vis-a-vis predatory borrowing. The discussion should not obscure the central questions of what mortgage lending practices should be in the future, and what practices should be proscribed. Given the importance of the housing market to the economy and the financial system, this question is of critical importance. A useful regulatory framework should not be constructed to "protect" one side from the other, but rather as a means of ensuring the availability of mortgage funds to qualified borrowers that can reasonably be expected to service their obligations.
In this context, residential lending practices need to be codified in order to ensure both the borrower's ability to afford the property being purchased and the accuracy and truthfulness of communications between borrower and lender. The first element means that lenders should be obligated to ensure that borrowers are able to afford their mortgage payments by requiring the full reporting of income and associated income ratios. While it's appealing to pretend that consenting adults should be allowed to borrow as much as they can fit into their pockets, this practice ultimately led to disastrous consequences for the world financial system. Despite its overtones of paternalism, lenders have a responsibility to the safety and soundness of the financial system to ensure that borrowers don't overextend themselves.
The other key element is that the accuracy, truthfulness and completeness of data provided by applicants needs to be assured. As the Times story documents, the reporter willfully made a series of untruthful statements on his loan applications. However, his ability to avoid accurately reporting his financial position was facilitated by both the absence of laws specifically governing his representations, as well as the laxity of the mortgage lenders, securitizers and investors that knowingly packaged and/or bought securities backed by such loans.
The information exchanged between a lender and borrower needs to be treated as the legal equivalent of a contract. The misstatement of facts by either party is fraud and should be treated as such. Lenders should be responsible for providing an accurate and comprehensive summary of a loan's terms and fees. In turn, borrowers should be required to accurately represent their income, assets and employment status, as well as whether the underlying property represents a primary residence or a speculative investment. The ability to provide accurate income and property data to investors evaluating securitizations would be an important additional benefit.
While it's easy to look at the current market and conclude that these changes have already been made, there is nothing to stop either borrowers or lenders from reverting to their old, bad practices. Backsliding to the old system, the financial system's equivalent of "don't ask/don't tell", would be a disaster. If it accomplished nothing else, a national mortgage regulator would serve a useful purpose if it prevented this from happening.
Bill Berliner is a mortgage and capital markets consultant based in Southern California. His Web site is www.berlinerconsulting.net
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