Regulation and the mortgage market

September 5, 2014

As readers know, I have a major concern about the regulatory response to the financial crisis. An unintended consequence of regulation is that it can raise costs, reduce competition, and choke off access to legitimate sources of credit for consumers. And yet, it has been used over and over again in the United States.

It is ironical that in ratcheting up so-called consumer protection regulation, advocates end up pushing consumers out of the mainstream financial system and into the fringe lending market, which is precisely where the most vulnerable consumers are often exposed to the potential for fraud. The most notorious example, of course, is the resurgence of loan sharks in response to strict usury ceilings on interest rates. But examples abound, not just in consumer credit, but also in areas such as occupational licensing.

Some news reports in recent days have suggested that one of the cornerstones of the Dodd-Frank consumer financial protection scheme — heightened regulation and enforcement of rules regarding residential mortgages — is starting to have exactly this effect, at least in that major players are quitting the field. A report in the Financial Times said that according to Wells Fargo CEO John Stumpf, the bank is considering leaving the home mortgage market for lower-income borrowers as a result of the regulatory and liability risk:

“If you guys want to stick with this programme of ‘putting back’ any time, any way, whatever, that’s fine, we’re just not going to make those loans and there’s going to be a whole bunch of Americans that are underserved in the mortgage market,” Mr Stumpf told the Financial Times.

Nor is he alone — the article also quotes the CEO of JPMorgan Chase, Jamie Dimon, as saying that his bank also is exiting this space because of excessive regulatory and liability risk.

Why does it matter if Wells Fargo and JP Morgan decide to leave the mortgage industry? It matters because people still want to buy houses. And according to The Wall Street Journal, non-bank lenders are stepping in to fill the void created by banks exiting the market. According to the WSJ, the market share of nonbank lenders (such as Quicken Loans and lenders that most readers have never heard of) has doubled in the past two years from 11 percent to 23 percent, almost completely among those who are not premium borrowers.

Now, this could be a good thing. First, they are obviously meeting a demand that at least some big banks have decided is too risky to meet. Second, competition in consumer credit markets typically produces lower prices and higher quality service, just as in other markets.

But is this good competition since the bigger banks are not competing in this area? And are these companies that no one has ever heard of (as one guy in the WSJ article admits) providing fair rates to consumers, while not penalizing them for the greater risk?

More information is needed about these smaller lenders. Perhaps they are simply more nimble and better able to bear the regulatory and liability risk than the big banks. But most economists believe that it is larger firms that tend to have a comparative advantage in regulatory compliance (indeed, I confess that I had thought the large banks would come to dominate mortgage lending because they would be the only ones that could bear the regulatory cost and risk).

As we get to know more about these new or smaller players, we may find out that they are providing a much-needed service that does benefit consumers. Or the end result could be an increase in the incidences of fraud against precisely those consumers who are the supposed beneficiaries of Dodd-Frank.

Update: It has been called to my attention that a reader could infer that I was suggesting that the growing market share of non-bank lenders was only in the subprime market. I didn’t intend to say that. Quicken Loans, for example, is not a subprime lender. I should have been more clear on that point and have corrected the post to eliminate that reference to Quicken Loans. My apology for any erroneous impression that I created.

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