Treasury Report Targets Dodd-Frank
In February of 2017, President Trump issued Executive Order 13772, which gave the Secretary of the Treasury 120 days to create a report reviewing financial laws and regulations with respect to seven “Core Principles”. Those principles are generally related to streamlining the financial markets and, in the President’s opinion, reducing constraints that hinder economic growth.
The mandated Treasury report, issued on June 12, takes dead aim at regulations enacted as part of the Dodd-Frank Act of 2010. Republicans tend to characterize Dodd-Frank regulations as an unnecessary drag on the economy, while Democrats consider them necessary to avoid a repeat of the financial conditions that led to the housing crisis and subsequent recession.
As a potential homebuyer or seller, how will these policy changes affect you? That depends on how many, if any, of the Treasury report changes are adopted. The executive branch may directly apply some changes, while others require legislation by Congress. However, both paths meet in one spot – the Consumer Financial Protection Bureau (CFPB).
Loosen It Up
The CFPB was created by Dodd-Frank to act as both a watchdog on financial institutions and as an educational resource and protective agency for consumers. The organization enjoys an unusual – and arguably unconstitutional – degree of independence. Agency appropriations are independent of the Congressional budget, and the President may only remove the director before the ten-year term for “inefficiency, neglect of duty, or malfeasance” – not on whim or preference.
The CFPB can affect the housing market through adjusting regulations on qualified mortgages. To establish qualified mortgage criteria, lenders are required to make a good-faith effort to determine that the borrower meets ability-to-repay (ATR) standards, minimizing the chances of default.
One primary qualification standard is the debt-to-income (DTI) ratio, a borrower’s total debt compared to gross income. Current qualified mortgage rules for banks and private lenders require a DTI of 43% or less. The government-sponsored enterprises Fannie Mae and Freddie Mac currently allow a 45% maximum DTI, and will raise the cap to 50% for mortgages issued after July 29.
The gap gives lenders incentive to channel loans through Fannie and Freddie or other guarantee programs instead of directing them toward private capital. To close this gap somewhat, the Treasury report proposes raising DTI to the 45% maximum currently used by Fannie and Freddie.
Other Treasury report proposals affecting the mortgage market include raising caps on certain fees and points for qualified mortgages and allowing larger banks to receive reduced qualified mortgage requirements currently available to smaller banks. Smaller community banks tend to operate in rural areas where loans don’t always fit the typical mold – such as farm loans where income is less predictable. While these loans are inherently more risky, they do serve a valuable purpose.
Lending standards are already loosening, as with the DTI limit expansion of Fannie Mae. However, accelerated loosening of credit combined with other recent factors – namely, Federal Reserve interest rates and a shortage in starter homes that are driving prices disproportionately high in some markets – could set up a dangerous combination. Motivated buyers will be tempted to overspend, and relaxed laws and CFPB rules will make it easier for them to do so.
House Republicans: We’re Not Waiting
Republican leadership in the House of Representatives did not wait for the Treasury report to act. With the President’s core objectives in mind, they recently passed the Financial Choice Act (FCA) on an almost unanimously partisan vote. The FCA removes or adjusts many Dodd-Frank provisions – including bringing CFPB under federal budget control and allowing the President to fire the director at will.
The FCA may not pass the Senate as constructed, but if it does, the CFPB would almost certainly be under new leadership that would loosen lending and mortgage oversight regulations. Banks would be free to offer riskier loan products, opening up the market while increasing risk.
Even with failure of the FCA, looser mortgage restrictions are probably in CFPB’s future. President Trump could simply wait until CFPB Director Richard Cordray’s term expires in 2018 — but waiting is not Trump’s strong suit.
Since the original implementation of Dodd-Frank, the credit market for mortgages has been slowly loosening, as expected. Dodd-Frank was in response to an extraordinary situation. Lending rules should drift over time and reach equilibrium between prudent risk-based lending restrictions and the extension of credit to those who really want to buy a home but can’t afford one – if for no other reason, politicians will accelerate the process to address unhappy constituents on the fringes of the housing market. Trump’s directives would certainly accelerate moves toward easier credit and riskier lending practices.
However, you make the final decision on whether or not you can afford to buy a home, or what size of home is within your reach. No lender has ever forced a homebuyer to sign a mortgage at gunpoint. Trump administration policies are likely to put more responsibility on you as a homeowner to understand your own financial limitations and resist the urge to overspend.
These policies may also increase the risk of a future housing crisis. If your area appears to be nearing a housing bubble, take extra care to reduce your overall debt and increase savings – you may need it to handle a local or national economic downturn.