Adding insult to injury: How regulators are making homebuying even more expensive

By Rod Alba and Dan Brown
ABA Viewpoint

A key challenge for Americans today, especially for millennials and Generation Z, is housing affordability. A recent Redfin survey found that 20 percent of millennials believe they will never be able to own a home. Figure 1 illustrates the decoupling between home prices and wages that accelerated at the start of the pandemic. Although the Biden administration speaks with some urgency about the negative impacts of housing affordability, federal banking regulators have unveiled major regulatory changes that will only make purchasing a home even more expensive. These new proposals will increase the cost of mortgage financing and further drive mortgage origination from highly regulated banks to less regulated lenders. This ABA Viewpoint examines recent trends in mortgage origination and summarizes the regulatory proposals that could have a severe negative impact, individually and cumulatively, on housing affordability and financial stability more generally.

Figure 1: Home Prices and Wage Growth: 1994-2024

Source: BLS, Average hourly earnings of production and nonsupervisory employees; FHFA, Purchase Only House Price Index for the U.S. Note: Index, January 1996 = 100.

Revenge of the nonbanks: What is past is prologue

This is the third article in a series examining the cumulative impact of multiple regulations on the U.S. economy and businesses. Read other entries in the series on credit card users and small business lending.
Regulation, particularly the increase in regulation that followed the 2008 financial crisis, has steadily pushed more financial services activity outside the highly regulated banking sector. In 2007, insured depository institutions provided roughly 80 percent of the residential mortgage loans in the United States. Today, depositories’ mortgage origination market share has declined to about 39 percent (Figure 2). Since the 2008 financial crisis and the passage of the Dodd-Frank Act, nonbank mortgage companies have significantly increased their market share in the mortgage origination business. Post-crisis regulations make it more expensive for banks to originate mortgages and have impacted their ability to compete on equal footing in what used to be a core market for banks across the nation. In fact, according to data from Stratmor and the Mortgage Bankers Association, the cost for banks to originate a mortgage roughly doubled from $4,800 in 2008 to approximately $9,000 in 2018.

Figure 2: Mortgage Originator Market Shart: 2012-2022

Source: CFPB and Federal Reserve

Nonbank mortgage companies generally face less regular and rigorous oversight than banks and, among other things, hold thinner capital buffers. The thin capital structure of mortgage companies should set off financial stability risk alarms. Typically, mortgage companies quickly sell newly originated mortgages in the secondary market. When the mortgage market deteriorates, these companies get stuck holding illiquid (and potentially loss-inducing) mortgages, which can quickly increase the risk of company failures. This is exactly what happened to many nonbank mortgage companies in the mid-2000s. While nonbank mortgage companies were a smaller component of the mortgage market at that time, there was a 32.6 percent reduction in mortgage companies reporting Home Mortgage Disclosure Act data from 2005 to 2009, compared to just a 3.7 percent decline in bank HMDA reporters. The cumulative effect of the proposed regulations will only accelerate these trends and magnify financial stability risks.

The CRA rule penalizes banks, ignores nonbank mortgage lenders

As mentioned in a prior ABA Viewpoint on small business lending, the new Community Reinvestment Act rule requires the evaluation of certain “large” banks’ (defined as those with $2 billion or more in assets) lending — including mortgage lending — outside of their traditional facility-based assessment areas, or FBAAs. Under the new rule, any large bank that does not conduct more than 80 percent of its retail lending within its FBAA must designate a Retail Lending Assessment Area, or RLAA, where the bank originated at least 150 closed-end mortgage loans in each of the prior two years. A bank’s lending in that RLAA will be evaluated against other lenders serving that community, including lenders that have a physical presence in the area.

While the rule may be well-intentioned, it will disincentivize banks from lending outside of their branch footprint or growing into new markets, thereby reducing the supply of mortgage capital in those locations. Moreover, mortgage originations are a key component of a bank’s CRA examination, yet nonbank mortgage companies and credit unions are not subject to the CRA. Ultimately, this means that policymakers are failing to fully assess the extent to which the majority of participants in the mortgage market are serving low-to-moderate-income individuals and communities — while simultaneously creating a disincentive for banks to supply mortgage capital to underserved areas located outside of their branch footprint. The end result: fewer banks will choose to offer home loans, and banks’ share of the mortgage market will continue to shrink.

Basel III: More capital, less mortgage lending

The proposed Basel III “endgame” capital standards would require higher capital ratios for impacted banks and higher risk weights for single family mortgages, particularly for mortgages with high loan-to-value ratios. A wide variety of stakeholders, including a group of well-respected consumer advocacy organizations, have expressed concern that these various provisions would harm homebuyers, particularly borrowers with lower income and first-time homebuyers by making bank mortgages more expensive to fund. Higher capital ratios and changes to risk weights for mortgages would accelerate the post-financial crisis trend of bank regulation forcing banks to retreat further from mortgage lending and incentivizing less-regulated mortgage companies to fill the void.

FHLB reform needs to limit unintended consequences

The Federal Home Loan Banks provide a key liquidity facility to assist banks’ housing market activities. Recently, the FHLBs’ regulator, the Federal Housing Finance Agency, outlined potential reforms for the FHLB system. Several provisions within the report would add to the mounting disincentives for bank mortgage lending.

For instance, restricting membership would simultaneously hamper the ability of some banks to contribute to the housing market (through multiple channels, such as mortgage-backed securities investment, loans to mortgage companies and homebuilders, direct originations) and would make FHLB advances more expensive because of the system’s need for scale to ensure affordability of advances. Any changes to collateral policy would have a similarly restrictive effect on the ability of banks to aid the housing market.

Therefore, FHFA needs to be aware of all the ways banks help facilitate mortgage lending (including lending a significant amount of capital to mortgage companies) and consider whether the new proposals will produce unintended consequences. In particular, FHFA and the administration need to consider how changes that make the FHLBs less reliable sources of liquidity could lead to reduced member usage of the system and thus reduced profits that the system can devote to affordable housing initiatives.

Conclusion

We agree that the U.S. has a housing affordability crisis. We are concerned, however, that the wave of new regulations will only exacerbate that crisis, leaving consumers with higher costs and fewer options, especially those who trust their local bank more than an online mortgage company. Policymakers need to recognize that their actions are creating market distortions where non-bank mortgage players play by a different set of rules and economics, driving banks out of the origination business.

This reduces consumer choice — not just customers’ ability to shop around on price, but also their option to trust their local banker with the most consequential investment of their lifetime. Adding new regulations to the mortgage market without accounting for what these cumulative changes will do to the mortgage business will inevitably hurt the people who need help the most. We join the recent call by housing advocates across the political spectrum that “striking the right balance in regulatory policy is not just a matter of academic debate; it’s a pragmatic necessity.”

With these new regulatory changes, that balance is off. Would-be homebuyers will pay the price and wait even longer for their chance to participate in the American dream of homeownership.

Rod Alba is SVP for real estate finance at ABA. Dan Brown is an economist and senior director on ABA’s economic research team.

ABA Viewpoint is the source for analysis, commentary and perspective from the American Bankers Association on the policy issues shaping banking today and into the future. Click here to view all posts in this series.

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