OPINION:
A working market economy depends on lending.
If an economy were based entirely on the cash available today, innovation and investment would be impossible. A lender and a borrower have a pretty simple relationship; the lender takes a risk that the borrower will meet the terms of the loan and pay the money back. The lender and the borrower negotiate with each other based on the cost of the risk involved.
Lower risk means a lower interest rate, and a bigger risk means a bigger ask. The more friction involved in this relationship, the slower an economy grows. The rules of this relationship are immutable from playgrounds to prisons and from bodegas to boardrooms. But when it comes to housing and mortgage lending, there is resentment and grievance. Some people aren’t able to borrow as much for mortgages as others.
A recent story in The Washington Times about changes to credit score requirements and interest rates charged for mortgage loans has people buzzing. According to the story, the Federal Housing Finance Agency is going to set loan rates and fees in a way that will mean people with higher credit scores will be charged more to subsidize people with lower credit scores. I have yet to substantiate or even understand whether this is true.
As of May 1, the agency is set to implement different rates, and a table has been released that almost nobody but a mortgage banker could understand. The changes were announced in a similarly impenetrable “fact sheet” released by the FHFA. What’s going on?
The coming changes were prompted by the passage almost five years ago of Senate Bill 2155, legislation aimed at “improving consumer access to mortgage credit.” Section 310 of the bill directs the FHFA to establish standards and criteria for processes used by Fannie Mae and Freddie Mac to “validate and approve credit-scoring models in accordance with the bill.”
That means that the government-sponsored enterprises, or GSEs, that back most American mortgage debt, Freddie Mae and Freddie Mac, will, “when determining whether to purchase a residential mortgage … consider a borrower’s credit score only if certain procedural requirements are met with respect to the validation and approval of credit-scoring models.”
The mandate was for the FHFA to redefine the kinds of loans that the GSEs would back with an eye toward improving equity in mortgage lending. The best articulation of all this is from the National Fair Housing Alliance: “Our current credit scoring systems have a disparate impact on people and communities of color. These systems are rooted in our long history of housing discrimination and the dual credit market that resulted from it. Moreover, many credit scoring mechanisms include factors that do not just assess the risk characteristics of the borrower.”
If you watch the two-hour video of FHFA’s public process, you can watch all sides argue this issue. I watched it, so you don’t have to.
Lenders worry that abandoning the classic FICO scoring system for giving out mortgages in favor of an array of other measures will muddle things, creating friction in the relationship between lender and borrower and, not surprisingly, make things worse for people with thin or bad credit. Social justice advocates argue on the other side that credit scores don’t fairly represent a person’s ability to keep their promise to pay. A person might have a bigger debt but make payments consistently, for example, and this is considered bad using traditional credit measures.
Changing the rules to favor a specific outcome twists the basic ligature between markets and freedom. When the government says that the rules don’t produce the outcome it wants — in this case, more people of color getting mortgages — and then it puts its fingers on the scale to produce that outcome, people who have worked hard to follow the rules are betrayed. After paying bills on time for years and keeping their debt low, the idea that others who haven’t been as disciplined would get the same treatment erodes social cohesion, creating more resentment.
More importantly, the figures don’t lie: People of color, especially Black borrowers, don’t get access to capital for the generational wealth afforded by buying a home. That’s a fact. Fixing that by qualifying people who can’t pay back loans distorts the market, pushing many lenders out of the market because they want to avoid the risk and causing others to make reckless loans counting on the taxpayers to solve the problem if the loan fails.
Neither of these outcomes benefits borrowers who are facing an uphill climb for their first mortgage. In the first case, the supply of money will fall (the Federal Reserve has already tightened supply with interest rate increases), resulting in higher rates with loans granted. In the second case, backing loans to families that can’t support them will result in foreclosures that make the underlying problem of credit worse. It is true that traditional credit scores might institutionalize age-old assumptions about lenders who are riskier or not so risky, and these might perpetuate racial bias. But abrogating long-standing measures isn’t the answer.
What is the answer? First, the FHFA must be very careful in adjusting the rules, and the effort shouldn’t be to favor outcomes but opportunity.
Yes, it is true that Black families don’t get mortgages as easily as White ones, but this brings up the second point. How can we create a dynamic in the economy that creates better credit and more financial sustainability among Black families and households? That should be our focus.
We’ve already seen in 2008 and 2009 what happens when lending becomes profligate. Judiciousness in amending the rules isn’t racist. Neither is rewarding people who have made the effort to keep up their end of the lending bargain. Risk is risk. Our goal should be to measure and quantify hard work and persistence and measure that in a way that truly offsets risk and facilitates the free flow of credit in our economy.
• Roger Valdez is director of the Center for Housing Economics and a research fellow at the Foundation for Research on Equal Opportunity.
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