How Texas’s consumer protections helped banks

April 1, 2010

Alyssa Katz has a very long piece in The Big Money today about the housing market in Texas:

It’s one of the great mysteries of the mortgage crisis: Why did Texas—Texas, of all places!—escape the real estate bust?

I didn’t think it was a mystery at all: Mike Konczal had a compelling blog entry in April 2009 explaining that it was a function mostly of banning prepayment penalties, along with other consumer protections such as banning balloon repayments, banning negative-amortization mortgages, and banning loans based only on collateral value without regard to the borrower’s ability to repay the loan.

But Katz ignores all of those things, and says that the heart of the matter is another part of Texas law: the bit about Helocs and cash-out refinancings.

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 can’t total more than 80 percent of a home’s appraised value… And when a borrower refinances a mortgage, it’s illegal to get even $1 back…

“Delinquency and foreclosure rates are significantly lower in Texas,” boasts Scott Norman, the president of the Texas Mortgage Bankers Association. “The 80 percent loan-to-value limit—that’s the catalyst for a lot of this.”

I’m not convinced. Yes, the rules on Helocs and cash-out refinancings were good things, at the margin. But I don’t think it makes sense to concentrate solely on them, while ignoring all the other consumer protections that Texas implemented in the mortgage space.

The point here is that Texas had a set of strict restrictions on mortgage lending, all of which emerged naturally from an overarching philosophy which was generally suspicious of banks and leverage. In the language of rules vs principles, we can say that the rules were put into place in order to express a relatively simple principle.

As a result, I don’t think that Katz is right when she suggests that simply adopting Texas’s restrictions on Helocs and cash-out refis is an easy and obvious way to prevent future housing bubbles nationwide. As we saw over the past few decades, it’s easy to repeal rules if there isn’t a strong set of principles underlying them. And I think that what we saw in Texas wasn’t one rule having a large effect; rather, it was a large set of rules, including crucially a ban on prepayment penalties, having a large cumulative effect.

In any case, I think that the example of Texas does go to show that rules put into place to protect consumers are likely to help, rather than harm, the safety and soundness of banks. Texas didn’t think that giving consumers access to mandated cheap credit would help them, as John Dugan seems to fear. Instead, the state put limits on how much credit they could take out. And that worked out very well, in the end.

Update: Katz has a really good follow-up on her personal website. Let’s have more, please, of journalists continuing the conversation after their piece appears! She’s less impressed by the prepayment ban than I am, since it applied only to “high cost” mortgages and that was a loophole it was easy to get around. I’m not completely convinced, since there’s no evidence that lenders did manage to get around that loophole in practice. So I still think it was the big philosophy which really mattered here, rather than any individual rule. Also, there are some great comments below, and elsewhere in the blogosphere: see Konczal, Drum, and Avent.


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