Back to the 70s

Larry Lindsey looks at a proposal by New York's Senator Chuck Schumer, and isn't amused:

One leading proposal is a bill called S. 1299, offered by Sen. Chuck Schumer of New York. .... His proposal represents a regulatory and litigious approach to mortgage-market reform.

The bill requires that each mortgage originator act with "reasonable skill, care, and diligence" and in "good faith and fair dealing." It also requires that all loans are "reasonably advantageous to the consumer." Surely these are noble sentiments. But they are also vague and ill-defined legal requirements that open up the mortgage industry to endless litigation in an environment where juries comprised of homeowners must decide between families in the process of losing their homes and mortgage brokers, investment bankers and other financial intermediaries.

....The legislation also prescribes some regulatory tightening that will block access to mortgages for some key segments of the population, or at least make those mortgages more expensive and less appropriate. The bill would require that all borrowers qualify for a mortgage at the fully indexed long-term rate that would apply when a variable-rate mortgage converts to its long-term level.

Many borrowers choose to take out loans that have a lower rate for the first two to 10 years, which then rises to a higher rate for the duration of the loan's 30-year life. Sen. Schumer would require everyone to qualify at the higher rate, arguing that it is wrong for mortgage lenders to put people into mortgages that they "cannot repay."

Yet former Federal Reserve Chairman Alan Greenspan publicly recommended that people take out variable rate mortgages that may ultimately lead to higher rates. Why? Because they are cheaper.

....Whatever the merits of the idea in the long run, this is precisely the wrong time to add this requirement. Three-quarters of the subprime mortgages issued in 2006, along with other variable rate mortgages, will reset in 2008. Borrowers who had planned on refinancing then may be stopped by the requirements in S. 1299. Unable to pay the new reset rate and barred by law and regulation from easy access to refinancing, many or most of these borrowers could have little choice but to give up their homes. This in turn would put further downward pressure on all home prices.

The home mortgage industry has certainly been guilty of excesses in the past few years. It may be that Sen. Schumer's approach of restrictive regulation and turning the trial bar loose on the industry is the only way to reverse these excesses. But the cost of his approach to every existing homeowner and would-be homeowner is potentially staggering.

We already have an excess supply of homes on the market, and credit standards have been toughened. Reductions in demand already have pushed total home sales--existing and new--down 15% in the last year. The Schumer bill would depress demand still further.

Forty percent of all the loans issued last year by dollar volume were either subprime or Alt-A. If these two categories of loans reverted to their more traditional levels, one-third of the 2006 level of home demand would disappear (some already has). The Schumer bill would exacerbate this problem. The current inventory of unsold homes would jump further from its current record of five million homes. The effect on home prices would be disastrous.