Keeping Credit Flowing to Consumers in Need

Regulators and policymakers are debating the best ways to revamp our damaged system of consumer and housing finance. The problem: turning the regulatory spigot too tightly could shut off the flow of needed credit to millions of lower-income Americans. A discussion with professor Nicolas P. Retsinas. Key concepts include:
  • The economy will continue to depend on large numbers of low-wage workers. If lenders tighten credit too stringently, millions of Americans will be barred from borrowing.
  • The challenge is to recalibrate the country's access to credit so that more responsibility for making good loans lies with lenders, and so that the burden is not almost entirely on borrowers.
by Sean Silverthorne

The credit crunch and subsequent collapse of the nonprime mortgage market claimed many victims, including hundreds of thousands of low- and moderate-income Americans who lost their homes and savings. Today, regulators and policymakers are debating ways to reform the housing finance industry and strengthen consumer protections.

The risk they run is that too stringent regulation could make it harder for borrowers in need to get money. In today's challenging economic climate and with high unemployment, "many Americans borrow to live," notes Nicolas P. Retsinas, a senior lecturer in real estate at Harvard Business School, and director emeritus of Harvard's Joint Center for Housing Studies. In addition, the American economy depends on consumers having access to credit. "The challenge is to avoid the temptation of overcorrecting," he says.

To begin to study some of these issues, the Joint Center held a symposium in February 2010 on Moving Forward: The Future of Consumer Credit and Mortgage Finance." A new book, co-edited by Retsinas and Eric S. Belsky, managing director of the Center, collects papers presented at the symposium that deal with, among other topics, rebuilding the housing finance system, the credit needs of low-income consumers, mortgage finance alternatives, and the regulation of consumer financial products.

In this e-mail Q&A, we asked Retsinas to discuss some of the issues covered in the book.

Sean Silverthorne:: What is the root of the credit crunch?

Nicolas P. Retsinas: In 2007 the nonprime mortgage market crumbled. Many of these products were predicated on ever-rising home values, which would enable owners to sell, pay off, buy again-a cycle toward ever-bigger, ever-more expensive homes, regardless of income or assets. This cycle could not continue. That erosion spread to nonprime consumer credit and commercial mortgages.

Those factors helped spark a global financial crisis. Credit markets were seizing up. The US government was spending billions of dollars to thwart a complete collapse of the financial system. Millions of families lost their homes, personal bankruptcies soared, and it seemed that every weekend one financial firm after another failed. There was substantial doubt about the ability of the financial system to return to any kind of "normalcy"; pundits, editorial writers, and economists, like modern-day doomsayers, referred to the specter of another Great Depression.

This was not total hyperbole. While different analysts weighted the "fundamental" causes of the crisis differently, most recognized that the increased complexity of both financial products and markets, coupled with an inability of the regulatory structure to keep pace with the changing market, shared the blame.

Q: What are the implications today for low- and moderate-income consumers?

A: As we lurch toward a recovery, the economy will continue to depend on large numbers of low-wage workers. For many workers, employment will be sporadic, and they will have difficulty making ends meet. If lenders tighten credit, they will of course reduce their risk; but at the same time millions of Americans, barred from borrowing, will be unable to leverage their incomes to buy either a car or their first home. Many Americans borrow to live. Weekly paychecks cannot cover the predictable but sporadic need for increased spending-for instance, medication for a sick child or new brakes for an old car. The challenge is to avoid the temptation of overcorrecting.

Q: How has the government reacted to the credit crisis so far?

A: While the Dodd-Frank Act outlined a broad blueprint for a revamped federal regulatory structure, the details have yet to be determined. The legislation created a new Consumer Financial Protection Bureau to better protect consumers. However, to date, a permanent director has not been identified, and it appears that statutory deadlines for new regulations will not be met.

The challenge will be to balance the trade-offs between preserving affordable credit to low-income families, protecting consumers, and ensuring the safety and soundness of our financial system. This journey to a new regulatory architecture has barely begun. Rather than merely tightening credit, the challenge is to recalibrate the country's access to credit so that more responsibility for making good loans lies with lenders, and so that the burden is not almost entirely on the borrowers.

Q: Looking ahead, what are the major issues you are thinking about?

A: We are at the doorstep of a transformation of residential mortgage finance in the United States. During the past year, over 90 percent of all mortgages have been supported/insured/securitized by the federal government. There is a consensus that the government should not be the sole credit source. But how will private capital respond to a diminished federal role?

Given the collapse of the housing market, what terms will private capital require to reenter the mortgage market-and at what price? Will there be (or should there be) a federal presence to preserve liquidity and affordability? What will be the implications for young families, particularly low- to moderate-income families? Is the American dream of homeownership to be abandoned?

In the midst of partisan debate, I hope to add an analytical perspective.

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    • Murray Kenney
    • Credit analyst, Raven Asset Management
    The credit crisis occurred because too much money was lent to too many people who had no ability to pay the money back, based upon their income and job prospects. The loans were purely asset- based, and were made on the assumption that asset values, i.e. housing prices, would not decline. Lending more money that cannot be repaid is not the answer. The key question is whether our economy is creating too many jobs with inadequate incomes to sustain aggregate private demand, in the absence of sub prime credit. Real income growth in the last 30 years has been concentrated among a smaller group of consumers with very low marginal propensity to spend. Unfortunately, financial innovation and government guarantees will not fix a problem that is created by stagnating real income for a very large sector of the population. In fact, it's pretty clear that financial innovation (sub prime lending and securitization) and government guarante
    es (Fannie and Freddie) were the two main causes of the financial crisis.
    • Derek Coleman
    We need second market mortgage companies like Fannie Mae and Freddie Mac to be revamped, and for government to understand its place in the mortgage market. The unemployment rate is down and home prices are finally turning around, now is the time to execute. But if banks and homeowners don't share equal risk/reward and interest in the quality of the loans, it will not work.
    • India property
    • real estate,
    It is clear that financial innovation (sub prime lending and securitization) and government guarante es (Fannie and Freddie) were the two main causes of the financial crisis.
    • G Thibodeaux
    • Broker Associate, First Team Real Estate
    As a real estate professional that bought my first home at the age of 21, and a property owner for 35 years, I have to admit that I have never qualified for a loan under today's standards. In 2003-2006, it's my belief that the banks were offering a faulty product. The criteria normally used for getting a loan being income, money down or personal investment and a good credit rating was being ignored. The banks exacerbated the problem by not reining themselves in until they made a crisis. Then, they punished the same people they previously made their money off of by going back to the old criteria exclusively. If the banks would go to a more realistic model based on ones reasonable ability to pay, and not based on a standard of unrealistic perfection, the real estate market would be able to recover.