Atlantans continue to navigate the least affordable housing market in the metro’s history. Home prices today are 75% higher than the 2007 bubble peak, outpacing overall inflation substantially. Now, a regulatory change proposed by the Federal Reserve could make things even worse — to the tune of $900 annually for a typical Atlanta-area home.
Although regulators appear poised to revise their initial proposal as public outcry over the changes continues, prospective homebuyers should remain on alert.
Credit: Handout
Credit: Handout
So, what happens if regulators arbitrarily reclassify all mortgages as riskier loans? This would require banks to obtain more capital from investors to protect themselves from this illusory risk of loss. Attracting more capital from investors comes at a cost — typically in the form of dividend payments to shareholders. To recoup costs, banks lower interest rates on deposits, charge higher fees and increase interest rates on loans. With interest rates on deposits near historic lows, we could expect higher mortgage rates as banks seek additional revenue to compensate investors for providing additional capital.
Here’s how this change would affect Atlanta homeowners. The median-priced home sells for slightly more than $408,000. Under current regulations, a bank financing 90% of the purchase price would need to set aside close to $19,300 in capital to protect against possible default. If investors require a 5% annual return on their capital, the annual cost to the bank exceeds $950 annually. Doubling the required amount of capital to $38,600 means doubling the annual payouts to investors. To recoup this expense, a bank might adjust the interest rate accordingly — saddling the new homeowner with $950 additional annual costs.
Lending is inherently risky — both for the shareholders and depositors. Many depositors forget that their savings aren’t stored on-site. Banks lend out these deposits, pocketing the difference between the interest rates earned on the loans and paid to depositors. The classic movie “It’s a Wonderful Life” illustrates this. As the bank struggled to collect on loans as the economy collapsed, a “run on the bank” ensued as community members feared their deposits would vanish.
Protecting depositors is the primary reason regulators require banks to maintain a capital buffer. However, some loans are less risky for a bank than others. For this reason, the amount of capital required to protect depositors against loss varies widely depending on the type of loan. Credit card loans are among the riskiest of loans. If a borrower fails to repay, the bank cannot simply seize the property of the borrower to make good on the debt.
Home mortgages are among the least risky of loans. A bank can foreclose on a house and sell the property to cover some or even all of the mortgage balance owed. Mortgage insurance also mitigates this risk. Independent analysis of historical losses from the 2005 to 2008 housing market collapse indicate a capital requirement far less than the one proposed is amply sufficient even if a crisis of similar severity occurred now.
The Federal Reserve is rightfully promising to revise its proposal to dramatically increase the amount of capital banks must set aside for mortgage loans. Let’s hope the new proposal more accurately reflects reality. Irrationally restricting the ability of lenders to meet the needs of families seeking a home needlessly worsens the most unaffordable housing market in Atlanta history.
Joel Griffith is a research fellow in the Thomas A. Roe Institute for economic policy studies at the Heritage Foundation.
About the Author
