How deregulation can improve bank safety
By Scott Sumner
Alan Goldhammer directed me to a very interesting article on the Texas housing market (which avoided the worst of the housing boom and bust):
A cash-out refinance is a mortgage taken out for a higher balance than the one on an existing loan, net of fees. Across the nation, cash-outs became ubiquitous during the mortgage boom, as skyrocketing house prices made it possible for homeowners, even those with bad credit, to use their home equity like an ATM. But not in Texas. There, cash-outs and home-equity loans cannot total more than 80 percent of a home’s appraised value. There’s a 12-day cooling-off period after an application, during which the borrower can pull out. And when a borrower refinances a mortgage, it’s illegal to get even a dollar back. Texas really means it: All these protections, and more, are in the state constitution. The Texas restrictions on mortgage borrowing date from the first days of statehood in 1845, when the constitution banned home loans.
“Delinquency and foreclosure rates are significantly lower in Texas,” says Scott Norman of the Texas Mortgage Bankers Association. “The 80 percent loan-to-value limit — that’s the catalyst for a lot of this.”
Right after the housing bust I suggested that we ought to discourage loans of more than 80% of a home’s appraised value. One way to do this is to have FDIC insurance only apply to banks that refuse to issue mortgages of greater than 80% of the appraised value of a home.
Other institutions are free to make those sorts of loans, and if there is a market for them then presumably the loans will be made. But with my proposal the taxpayer would no longer be exposed to the risk of default on low down payment mortgages. It also reduces the government’s role in the economy, by restricting the reach of FDIC.
Some worry that these sorts of restrictions would discourage homebuilding. I doubt it—at least not very much—as Texas has the most vibrant homebuilding industry in the entire country. In 2016 Texas built far more homes than any other state, despite being hit hard by the oil price bust. Although limiting the scope of FDIC would have little impact on homebuilding, it would reduce moral hazard and protect taxpayers.
PS. Here’s a FT article on the return of subprime mortgages, now called “nonprime”.