Reducing mortgage defaults starts with beefing up housing supply

The coronavirus pandemic has revealed a distressing fact in the housing world: Federal home-loan policies that promote “responsible, affordable mortgage credit access” for minorities are instead setting them up for an increased risk of failure.

Sadly, structural barriers for people of color do exist in housing. Rather than being the result of inadvertent discrimination by lenders, it mostly stems from misguided government policies. At the state and local level, zoning and building codes have created a supply shortage that is most pronounced at lower price points, where minorities tend to buy and which helps to drive up prices.

At the federal level, policymakers and advocacy groups have been trying to promote greater buying power for marginalized groups in a futile attempt to increase access. However, lowering lending standards or interest rates only works when there is ample supply.

In today’s constrained market, the unintended consequence is that marginalized borrowers mainly bid against one another for scarce homes. The additional buying power is thus quickly capitalized into higher home prices, which means stretched budgets for marginalized borrowers. During economic hardship, this translates into higher default risk.

A new analysis by the AEI Housing Center shows that because of these federal policies, today the single best predictor (per ZIP code) of a change in delinquency rate due to the pandemic has become the share of minority borrowers residing in it. The higher the minority share, the larger the increase in the delinquency rate. The outcome is a fundamental injustice that runs counter to the 1968 Fair Housing Act, which not only prohibits discrimination in housing, but legally requires federal agencies to further the goal of fair housing.

These heightened delinquencies are occurring mostly in the same neighborhoods that were devastated a decade ago in the aftermath of the Great Recession. The only difference is that it is happening despite all the purported safeguards of the 2010 Dodd-Frank Act, which stopped the most egregious underwriting practices, and the U.S. government securitizing about three in four of all mortgages.

But there is a second issue. These affordable federal housing policies, which enable minorities to buy especially during a boom when houses are more expensive, expose them to greater default risk during a bust. This also creates greater home price volatility in less affluent communities — a phenomenon that is greatly attenuated in more affluent ones with less risky lending and greater borrower resources to fall back on.

While it is often argued that buying a home early in life is the key to building wealth, it is when and where you buy that matters most. Ultimately, nothing strips wealth faster from borrowers of color than purchasing a home in high-risk neighborhoods late in a housing up-cycle. Unwittingly, borrowers end up speculating in land (since the structure value of the home is mostly fixed). In many areas of the country with high levels of minority homeownership, land prices over the last 25 years have been much more volatile than the Dow Jones Industrial Average.

Wild home price cycles and risky lending discriminate against unwitting borrowers of color that get their timing of the purchase wrong. Stable home price cycles and safe lending, on the other hand, allow borrowers to build lasting wealth.

To achieve this, there needs to be more supply. Places such as Minneapolis or Portland, Ore., have already eased burdensome local zoning codes, which will ultimately enable new home construction.

Another place, Palisades Park, N.J., a suburb of New York City, which did away with its restrictions long ago, was able to add 24% to its housing stock between 2000 and 2013. While this process will take time, the AEI Housing Center estimates that gradually replacing a small portion of one-unit homes with two-to-four-unit ones has the potential of adding about 8 million homes over the next two decades — or about 6% to the current stock.

In the meantime, federal policies should limit risky lending practices, especially during a boom, instead of encouraging them. Unfortunately, this message has not reached everyone. The Consumer Financial Protection Bureau’s new QM (qualified mortgage) proposed rule would enable borrowers to get even riskier loans, setting up people of color, once again, for failure.

Even if the effects of COVID-19 do not result in a full-fledged housing recession, the current delinquency data warns us that unless federal home loan policies change quickly, communities of color will again be the ones that will shoulder the most pain. This is the definition of systemically unfair housing.