Opinion: The Fed’s Mortgage Fix Risks Repeating 2008’s Mistakes

Here’s a sign of the times: Where are you sending your mortgage payment? In days of yore, it was most likely a big, familiar bank. These days, it’s more likely to be a nonbank lender like Rocket.

That has led to a rather odd landscape of major financial institutions not being heavily involved in one of the nation’s key economic engines. Now the Federal Reserve is aiming to course-correct, and get major banks more committed to home lending again.

How they’re baiting the hook, as outlined in a recent speech by Michelle Bowman, the Fed’s Vice Chair for Supervision: Offering to lower capital requirements that came into effect after the financial crisis to cover potential losses. 

Not the craziest notion to adjust policy based on evolving societal needs. And the motives are sound if we are trying to free up capital and expand mortgage access to subprime borrowers in particular. 

But this is a potential minefield with much at stake. We need to pick our way through it carefully — and make sure everyone benefits, not just bank profitability. 

To understand what’s happening, just look at how the playing field has changed: In 2008 the banks originated 60% of mortgages and serviced 95% of them, according to the Fed. Now those numbers are down to 35% and 45%. That’s seismic.

It also has real-world implications when banks are taking their marbles and going home. The key point, as Bowman stated: “By requiring disproportionately high capital, we reduce a bank’s ability to deploy capital to support the needs of their community.”

Fair enough. But we should be very careful about upending a system that has been serving us well, for a couple of different reasons.

In 2008, banks originated 60% of mortgages and serviced 95% of them. Today, they originate 35% of mortgages and service 45%.

First, we learned our collective lesson about financial reserves the hard way back in 2007/8. There is rock-solid rationale for those capital rules that were put in place to protect us all.

For the sake of the economy — and our 401(k)s — we should be wary of making the same mistake all over again. If the housing market runs into serious trouble, would those eased capital requirements swamp the system with more losses than it could handle?

Second, if we loosen the handcuffs on the banks, do we really trust them to make choices that will benefit society at large? 

One ostensible goal of this proposal would be to widen mortgage access to a broader swath of the population, in particular subprime borrowers. That cohort faces obvious challenges in getting loans, and rewriting capital rules could help them do so.

It could also provide some support to the housing market, whose foundations are looking a little rickety. Right now sellers outnumber buyers by more than 600,000 nationwide, representing one of the largest gaps on record.

Where the rubber meets the road here, is whether the big banks actually start catering more to underserved communities as a result.

To play devil’s advocate: The banks could conceivably use that freed-up capital to take risks elsewhere in their portfolios. Or they could simply focus more on prime borrowers, to keep their own risk low while juicing profits. 

That would certainly make shareholders smile. But from a consumer standpoint, it would defeat one of the proposal’s core purposes. 

That’s why any such changes should come with guardrails or commitments about how much mortgage access will be extended to the subprime space.

The Federal Reserve enjoys some bargaining power here, and it shouldn’t just give it away without any follow-up. If banks desire more freedom to deploy their capital, then it’s fair to expect real, measurable progress for consumers who have few options.

The point Bowman made was an accurate one: Banks have more weapons in their arsenal when it comes to navigating choppy economic periods, compared to nonbank rivals.

Those include having the size and scale and resources to offer temporary forbearance to struggling borrowers, or to seek government aid when necessary.

Banks have more weapons in their arsenal today to navigate choppy economic periods.

It’s understandable that the banks might be reluctant to commit more resources to the subprime space. They probably still have some PTSD from the financial crisis, with clips from “The Big Short” playing on a loop in the back of their heads.

But long-term, it’s not a sustainable solution to just dump more and more risk onto nonbank lenders. It’s a sensible thing to want big banks to have more skin in the game, and for borrowers to have sturdier consumer protections as a result.

More competition in the marketplace couldn’t hurt, either, to put downward pressure on the rates being offered.

But let’s design a fix that doesn’t entirely scrap what has been working. Any revisions on capital requirements should be thoughtful, and come with real accountability, and attach repercussions if commitments aren’t met. 

Otherwise, when the next economic storm comes, we may have to take a remedial class on the importance of financial reserves all over again. The second lesson might be even harder than the first.