The Consumer Financial Protection Bureau's Qualified Mortgage rules and the agency's intention to pursue disparate impact claims expose mortgage lenders to enormous regulatory and legal risk.
Without clear guidance from the CFPB, the natural response by lenders will be to reduce credit availability and/or raise prices.
Nowhere has the piecemeal approach to postcrisis regulation of the mortgage industry been more apparent than with the CFPB's implementation of the Qualified Mortgage rules followed by its announcement it will take a more aggressive stance on the fair-lending doctrine of disparate impact. The agency has essentially ceded sound economic principles to untested legal doctrine and in the process may wind up stalling the emerging housing recovery.
Let's face it: QM was a response to the mortgage industry's lack of underwriting discipline in the years leading up to the crisis. The heavy price to be paid came in the form of the federal government dictating to lenders what the standards for high-quality mortgages would be. The cornerstone of QM is the ability-to-pay doctrine, codified in the 43% maximum debt-to-income ratio for QM eligibility. While the industry has reconciled itself to a QM world, it did not bargain for the double whammy that came in the form of vigorous enforcement of disparate impact. Under this doctrine of discrimination, a lender can be charged with violating the Fair Housing Act if it engages in practices that impose a disparate impact on a protected class, even if the effect was unintentional.
In contrast, many mortgage fair-lending cases focus on proving a disparate treatment effect of intentional acts to discriminate against a protected class. In the case of disparate impact a lender would need to demonstrate a business necessity for the practice. However, the Department of Housing and Urban Development and the CFPB this year raised the stakes for lenders in disparate impact cases by asserting their intention to pursue practices as discriminatory even if the practice is unintentional but creates a disparate impact on a protected class. The Office of the Comptroller of the Currency took the disparate impact doctrine to new heights by issuing an enforcement action against Community First Bank in Maryland recently. The agency contended the community bank engaged in a form of disparate impact in its lending practices against white males.
In the past, legal attacks on those lenders with what Nobel Laureate Gary Becker would claim have a "taste for discrimination" have helped root out instances of intentional discrimination. However, this new legal campaign to combat discrimination based on disparate impact regardless of whether such practices are intentional or not in all likelihood will crash head-on with the QM rules, eventually harming the very borrowers it aims to protect.
How? Consider a lender that conforms to the QM rule limiting debt-to-income ratios at 43% for all creditworthy borrowers. It isn't much of a stretch to show using publicly available data that a disproportionate share of minorities would have debt ratios over 43% compared to nonminorities. So complying with the QM rule could invite a disparate impact challenge by the regulatory agencies.
A lender could try to defend itself by demonstrating that the differences in debt-to-income ratios result in statistically higher levels of defaults for minorities than nonminorities, controlling for all other risk attributes. Therefore, the lender could argue that it indeed has a legitimate business justification for setting the DTI threshold at 43% (in addition to complying with the QM rule, that is). But that logic may not matter, given the stance taken publicly by the CFPB and HUD.
Anticipating such actions and in the face of regulatory uncertainty, lenders have a couple of options. One option is to simply reduce their lending. Another would be to relax underwriting standards and accept higher risk to reduce fair-lending scrutiny and price that risk via higher mortgage rates. In effect, economic theory falls victim to a legal doctrine that winds up reducing the availability of credit, raising its price for those who need it the most for housing, or both.
Lenders find themselves in a policy vise with little maneuvering room as a result of QM and agency assertiveness around disparate impact theory. We found out the hard way that despite the best of intentions, not everyone is ready for homeownership and strong underwriting standards are there to protect the lender and the borrower.
That is not to say that intentional discriminatory acts should be at all condoned, but where there is a clear business justification for those underwriting practices to exist, then they should be permitted and mortgage markets should be allowed to operate according to the dictates of fundamental economics. (The
Dictating mortgage standards while pursuing an aggressive stance on disparate impact threatens to disrupt an otherwise stabilizing housing market.
Clifford Rossi is the Professor-of-the-Practice at the Robert H. Smith School of Business at the University of Maryland.
