The problem with serving the “underserved”

The Senate Banking Committee today postponed its vote on whether to establish the Federal Mortgage Insurance Corporation, a new federal housing insurer to replace Fannie Mae and Freddie Mac. The move may be a sign that the plan merits serious skepticism, not only for continuing to expose taxpayers to potential mortgage market losses, but for a still more fundamental problem: enshrining in law the idea that certain places and people have been and will, inevitably, be “underserved” by financial markets; and that government, in turn, must address this.

The proposal, authored by Sens. Tim Johnson (D-S.D.) and Mike Crapo (R-Ida.), defines underserved market segments quite expansively, “including rural and urban areas; manufactured housing; small balance loans; low- and moderate-income creditworthy borrowers; and affordable rental housing.”

{mosads}Thus would the new law preserve an unfortunate principle of U.S. housing regulation, beginning with 1977’s Community Reinvestment Act (CRA) and later expanded with affordable housing mandates imposed on Fannie and Freddie (1992).

Such regulation should not continue indefinitely—but not merely because it’s costly to banks (though it is); nor because of its role in the financial crisis (significant); or the fact that contemporary credit markets are now so competitive it’s hard to imagine the credit-worthy going unserved. Rather, the Johnson-Crapo bill must be opposed on moral grounds, for the potential harm posed to its intended beneficiaries: the low-income poor and their neighborhoods. 

Serving the underserved certainly seems a noble goal. For instance the National Community Reinvestment Group, a leading advocacy group, describes its mission as seeking “to increase fair and equal access to credit”. In practice, however, “equal access” is enforced by regulators not simply in terms of the availability of credit to the qualified, but by the numbers of loans actually made.

Consider the Office of the Comptroller of the Currency’s (OCC) analysis when assessing JP Morgan Chase’s CRA compliance (i.e. whether the bank made enough loans in areas where it accepts deposits): “We [OCC] noted three states where the home mortgage product’s in/out ratio was less than 50.0%. Mitigating factors were present in these rating areas that aided in explaining the low ratios.” 

The logical conclusion? Loans to various underserved constituencies make for a better rating. Indeed, such a system gives lenders more incentives to make loans (correctly viewing them as a cost of doing business), rather than carefully underwriting loans and, later, collecting on them. Under the former, when bad loans invariably accumulate, existing homeowners in low-income communities suffer most: a neighborhood littered with foreclosed and abandoned properties is not, after all, a good thing for the home values of residents who remain.

That well-intentioned affordable housing goals can devastate poor communities is hardly idle theorizing. In the wake of the 2008 housing crisis, for example, the Kansas City Federal Reserve Bank chronicled the concentration of foreclosures that struck poorer areas. The foreclosure rate in low-income neighborhoods in its own district, the Bank found, reached 13 percent— over four times higher than the comparable figure in mid- and high-income areas (3 percent). 

As Edward Pinto, a former executive vice president and chief credit officer for Fannie Mae, has noted, “from 1993 to 2008, the GSE’s [government-sponsored enterprises] acquired $2.78 trillion more in low-income loans than they would have acquired under their pre-1992 baseline…” The Johnson-Crapo bill would, in effect, continue the same mandates which led to such purchases, even as it privatizes—albeit with a new federal backstop—the country’s secondary mortgage market.

But why perpetuate an incentive for less-than-careful lending, in neighborhoods which most need to avoid default and delinquency?

Not all property, of course, need be owner-occupied. Indeed, investor-owners of rental property suffered fewer foreclosures during the financial crisis, according to the Kansas City Fed. Market conditions, moreover, are quite different than they were when the Community Reinvestment Act was first enacted—which preceded the advent of interstate banking; internet mortgage lenders; and widespread credit scoring (allowing lenders to distinguish between good and bad risks, no matter the zip code).

In fact, the aforementioned tools—which have become increasingly subtle and can even be used to predict which delinquent debtors will wind up paying their bills—are the natural allies, not enemies, of the upwardly mobile poor. For unless one believes that sustainable poverty eradication can be achieved by making credit available, willy-nilly, to lower-income people and places, such “discrimination” is actually desirable.

Simply stated, the inclusion in ostensible reform legislation of a never-ending mandate to serve the allegedly underserved is likely to harm, not help, the mandate’s intended beneficiaries. Even if the Johnson-Crapo bill leaves committee and passes the Senate, let’s hope House Financial Services chairman Jeb Hensarling derails the bill — and, instead, opens a conversation on the wrongheaded first principles which continue to guide government housing policy. 

Husock, vice president for policy research at the Manhattan Institute, is the author of “America’s Trillion-Dollar Housing Mistake: The Failure of American Housing Policy” (Ivan R. Dee, 2003).