A constant narrative of the financial crisis is that banks out-smarted the government by taking excessive risks, and that if only we had empowered regulators, the whole crisis would have been avoided. The truth, however, is that government was often the driver of excessive risk-taking, and nowhere is that more true than in the mortgage market.
One of the worst offenders has been the Federal Housing Administration (FHA). Even today, one can get an FHA backed loan with only a 3.5% downpayment. After the financing of seller concessions, the borrower can leave the closing table with zero, or even negative, equity. FHA will even offer these low equity loans to subprime borrowers, those with the worst credit history. If there’s anything to be learned from the financial crisis, combining high risk borrowers with low downpayment loans is asking for default.
Despite FHA’s loose standards, several lenders have responsibly chosen to impose higher underwriting standards than FHA. Sadly instead of being praised for being slightly more responsible than FHA, these lenders are being attacked by so-called consumer advocates for not taking enough risk.
The Washington Post reports that a coalition of advocates is planning to file complaints against lenders who have higher standards than FHA, claiming that higher standards discriminate against minorities, since minorities on average have lower credit scores. It seems some have learned nothing, continuing to push the very same policies that contributed to the crisis. If anything, FHA should start moving in the direction of the more responsible lenders and improve its woefully weak underwriting standards. Congress should also move in the direction of requiring meaningful downpayments on FHA loans, as well as shifting some of the credit risk back to the lender.