In his recent note to shareholders, Jamie Dimon includes a startling number: $500 billion more mortgage credit a year would flow if the rules recognized that many lower-income borrowers aren’t also high-risk borrowers. JPMorgan Chase & Co. cares about this in part because it wants to make these mortgages, but we should care about it because we should want JPMorgan and other regulated lenders to provide the urgently-needed loans essential for reversing U.S. economic inequality. It’s not often we find a win-win policy — more credit without more risk — but the few, easy changes that would sharply increase mortgage opportunity are an example.
The Dimon letter doesn’t tell us how this $500 billion figure is derived, but it’s not improbable given that the U.S. last year originated $3.8 trillion in new mortgages. However, even in these boom times for mortgage finance, the average credit score for borrowers backed by Fannie Mae and Freddie Mac was 775. Given that the top score is 850, it’s clear that getting a mortgage is flat-out impossible for many of those who most need a mortgage. The Federal Housing Administration (FHA) does many lower-score mortgages for families with higher debt-to-income ratios, but huge segments of the market remain under- or wholly-unserved.
This is true for mortgages used to purchase a home across the board, but even more so for mortgages used to refinance a loan to take advantage of the Fed’s low rates. It’s also a good deal harder for African-Americans — whose homeownership rate is now below where it was in the 1960s — to obtain a refinancing.
The Dimon letter doesn’t go on from its startling fact showing the need to reform mortgage finance to provide any specifics about how in fact to reform mortgage finance. There are, though, an array of options readily at hand that would make an immediate meaningful difference.
First, it’s past time to erase barriers to getting low-balance (i.e., small-dollar) loans. In many urban and rural neighborhoods, house prices are far below the national median, $346,800, recorded at the end of last year. For example, in Detroit, many neighborhoods have thousands of houses with values of as low as $60,000. Because borrowers looking to live in these communities are often first-time homeowners and minority households, barriers to credit are already high. Add in the small balance on a mortgage — which adds a lot of lender cost — and there’s no hope of loans that promote community improvement that then create economic opportunity.
Solution? Regulators can and should create positive incentives to offset the cost of small loans by, for example, reducing the cost to capital against each such loan when the mortgage is part of a bigger portfolio of low-balance loans that, by virtue of its size and the communities served, effectively diversifies risk and reduces origination and servicing cost. Government-sponsored enterprises (GSEs) and Ginnie Mae should buy these portfolios instead of going loan-by-loan, creating new products for the secondary market and, at the same time, better serving their statutory mandates.
Another obstacle to equitable mortgage finance is to be found in the risk-based capital rules that govern each bank’s business decisions. Crafted in the wake of the 2008 great financial crisis and premised on the view then held about “subprime” borrowers, the capital construct is very punitive to borrowers who lack a pristine credit score.
However, research makes it clear that subprime borrowers who took out mortgages to buy a home were far better credit risks than prime borrowers who used their loans to invest in speculative housing or purchase second homes. Still, to this day, these high-risk prime borrowers find it far easier to get mortgages than borrowers castigated as subprime.
Regulatory assumptions about risk are rooted in mistaken data, discriminatory assumptions and a desire to protect lenders and guarantors at all costs — even if the lenders are willing and the guarantors are able. Indeed, when the guarantors are the federal government or its agencies, they are not just able, but also chartered to back these loans.
There’s nothing about mortgage finance that should make home ownership just a dream for many lower-income households. Given the importance of home ownership to economic equality and racial equity, there’s also nothing we shouldn’t hesitate to do to increase credit availability as long as we don’t also increase predatory lending or speculative risk-taking.
Karen Petrou is managing partner of Federal Financial Analytics and author of ”Engine of Inequality: The Fed and the Future of Wealth in America.”