Will Rising Rates + Looser Regs = Excess? Possible, But Doubtful
In past cycles, when interest rates rose and origination volume was harder to come by, mortgage lenders relaxed underwriting criteria, undercut each other on price, or both, hurting loan quality.
Rates are rising again. Moreover, a new president who campaigned on a platform of reduced regulation is about to take office, and his administration seems poised at the very least to temper the recent zeal for enforcement. It's only natural to wonder if the combination could put the industry back on the path to the excesses that led to the financial crisis a decade ago.
Answer: It's unlikely, but not impossible.
Since the crisis, tight regulation and oversight have resulted in very conservative loan origination practices. The consensus is that the mortgage underwriting pendulum is now firmly on the conservative side, leaving plenty of room to loosen criteria without reverting to the unsound practices that caused the subprime meltdown.
"When you have a straitjacket on, it doesn't affect your ankles. You can still walk around," said Daniel Jacobs, executive vice president and managing director of MiMutual Mortgage, Port Huron, Mich.
Lenders can "squirm about to get where we need to go, but we still don't have the use of our arms," he said. "In the past bubble, we had full use of all of arms and our hands and our fingers and we don't right now."
Of course, the rules that Jacobs considers straitjackets — the qualified mortgage and ability-to-repay rules — are products of the Dodd-Frank Act, which Trump vowed to repeal.
Among those who are worried is Phil McCall, chief operating officer at Aces Risk Management, a quality control and audit technology provider in Pompano Beach, Fla.
"We can't forget why we got to where we are," he said. During the height of the mortgage boom, there was "very little regulatory oversight and we saw how it got out of control."
In his view, Dodd-Frank and the Consumer Financial Protection Bureau brought a lot of good processes and procedures into the industry.
"Rules and guidelines were established. There are pros and cons to how it all works," McCall said.
"As the pendulum goes back and forth, we've seen it go too far due to the heavy-handedness of the CFPB. Now with the new administration, how far will we see that pendulum go the other way?" he asked.
Few if any predict a full-blown return to the exotic products of the pre-crisis era.
Investors "got burned pretty badly in the last round and so did mortgage bankers," said John Robbins, chairman of the Mortgage Collaborative, a San Diego-based co-operative.
"Companies have long memories when it comes to the repurchases that were required by Fannie and Freddie, plus the Department of Justice's lawsuits over FHA warranties and representations. So my sense is that this is going to remain a very conservative lending environment," said Robbins, a former chairman of the Mortgage Bankers Association.
And a Republican administration does not mean a free-for-all, Robbins said. Many conservatives feel that "mortgage lending should be consumer driven — consumers should be put first and profits second. I don't think they are going to stop punishing the bad doers. Easing regulation is not necessarily a signal that all of a sudden mortgage bankers can run amok again," he said.
There is no doubt that "some of the over-the-top enforcement has hurt access to credit and it's time for that to stop and be looked at," said Bill Cosgrove, CEO of Union Home Mortgage Corp. in Strongsville, Ohio.
But being able to provide more consumers with credit should not mean a return to bad practices.
"At the end of the day, you've got to underwrite loans in a responsible manner, no matter what the market conditions, because if the borrower cannot repay the loan, no one wins," said Cosgrove, another former MBA chairman.
This will be a difficult year for a lot of lenders.
"There may be more loan officers and more lenders than there are loans" and it's been more than a few years since that situation arose, Cosgrove said.
Cutthroat competition was a major factor that caused lenders to expand their criteria in the past.
Union Home has not dropped its lending standards to originate more loans and it "never will," Cosgrove said. "And I would say most, if not all, the lenders out there feel the same way. History has shown us when we lower our underwriting standards, nothing good comes from that long-term."
But to survive, no matter what administration happens to be in power, with a tick up in interest rates and a reduction in business, lenders are going to start pushing the boundaries a little bit, McCall said.
Some might go to desperate lengths to close loans.
"Without a doubt in 2017 we will have more fraudulent activity than we had in 2016," McCall said.