Dodd-Frank and Mortgage Reform at Five

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The Department of Treasury has issued a report, Dodd-Frank at Five Years: Reforming Wall Street and Protecting Main Street. The report is clearly a political document, trumpeting the achievements of the Obama Administration. It is interesting nonetheless. It opens,

When President Obama took office in January 2009, the U.S. economy was in crisis. The nation was shedding more than 750,000 jobs per month, and confidence in our financial system had been shaken to its core. The worst financial crisis since the Great Depression exposed a toxic mix of excessive risk-taking, shoddy lending practices, inadequate capital levels, unstable funding, and weaknesses in regulatory oversight. A collapsing financial system choked off credit to consumers seeking to purchase a car, a home, groceries, or to finance an education. Nearly 9 million Americans lost their jobs, and over 5 million lost their homes. Nearly $13 trillion of families’ wealth was destroyed, wiping out almost two decades of gains.

In response to the crisis, the Administration released a proposed set of reforms in June 2009. Congress held numerous hearings and crafted legislation based on the Administration’s proposal, incorporating ideas from both Republicans and Democrats throughout the process. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law, a historic and comprehensive set of financial reforms, which put in place critical new protections for consumers, investors, and taxpayers. Five years later—as a result of Dodd-Frank and other Wall Street reforms—our financial system is stronger, safer, more resilient, and more supportive of sustainable economic growth. Regulators also have better tools to deal with financial shocks when they occur, to protect Main Street and taxpayers from Wall Street recklessness.

Critics of reform have claimed that Wall Street Reform would deter lending and choke off the recovery. But, today it is clear that the opposite is true. Reform has served as a building block for economic growth, providing Americans with safe places to invest their savings and enabling banks to lend to individuals, businesses, and communities. Only a financial system strong enough to withstand a major financial shock is capable of promoting sustainable economic growth. Five years after the President signed Wall Street Reform into law, nearly all of the major elements of financial reform are in place. Today, our financial system is safer and stronger as a result of these hard-won reforms, and our economy is in a far better position to continue growing and creating jobs. (1)

I was struck by the fact that the report does not address the biggest financial reform failure of the last five years, the lack of reform of the housing finance system.  Fannie and Freddie remain in conservatorship, putting the housing finance system at risk of another crisis.

I was also struck by the following passage:

In the run-up to the financial crisis, abusive lending practices and unclear underwriting standards resulted in risky mortgages which hurt consumers and ultimately threatened financial stability. Wall Street Reform bans many of the abusive practices in mortgage markets that helped cause the crisis, and requires lenders to determine that borrowers can repay their loans. (2)

My recollection from academic conferences over the course of the last six or seven years is that many leading academics denied the link between abusive lending practices and systemic risk. It seemed pretty clear to me, but I was in the minority on that one. I am glad to see that at least the Treasury agrees with me.

Friday’s Government Reports Roundup

Foreign Funding for Real Estate Projects

Jeanne Calderon and Gary Friedland have posted A Roadmap to the Use of EB-5 Capital: An Alternative Financing Tool for Commercial Real Estate Projects. The paper provides a great overview of a relatively new source of funding for real estate deals. The introduction opens,

From an immigrant’s perspective, the EB-5 Immigrant Investor Program (“EB-5” or the “Program”) represents merely one of several paths to obtain a visa.  The EB-5 visa is based on the immigrant’s investment of capital in a business that creates new jobs. However, from a real estate developer’s perspective, the immigrant’s investment to qualify for the visa creates an alternative capital source for the developer’s project (“EB-5 capital” or “EB-5 financing”).

Despite the Program’s enactment by Congress in 1990, for many years EB-5 was not a common path followed by immigrants to seek a visa. However, when the traditional capital markets evaporated during the Great Recession, developers’ demand for alternate capital sources rejuvenated the Program. Since 2008, the number of EB-5 visas sought, and hence the use of EB-5 capital, has skyrocketed. EB-5 capital has become a capital source providing extraordinary flexibility and attractive terms, especially to finance commercial real estate projects. Consequently, many developers routinely consider EB-5 capital as a potential source to fill a major space in the capital stack. As the financing tool becomes more widely known and understood, this source of capital should become even more popular.

The EB-5 investor’s motivation for making the investment accounts for the relative flexibility and favorable terms afforded by EB-5 capital compared to conventional capital sources. Unlike that of the conventional capital providers (such as banks, private equity funds, REITs, life insurance companies and pension funds), the EB-5 investor’s reason for making the investment is to secure a visa. Thus, his primary objective at the time of making the investment is to satisfy the EB-5 visa requirements. Consequently, so long as the investor believes that the investment will qualify for the visa and result in the safe return of his capital, he is willing to accept a below market, if not minimal, return on the investment. Furthermore, the investor might not require some of the other protections that more sophisticated, conventional real estate investors typically seek.

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Simply stated, the Program requires that the immigrant make a capital investment of $500,000 or $1,000,000 (depending on whether the project is located in a “Targeted Employment Area”) in a business located within the United States. The business must directly create 10 new, full-time jobs per investor. Thus, the number of jobs that a project will create is a key determinant of the amount of the potential EB-5 capital raise. (3-4)

This once exotic funding technique is now becoming quite mainstream. Of interest to some readers of this blog, the paper describes at various points how EB-5 funds have been used in residential projects. The paper is a useful introduction for those who want to know more about this program.

Wednesday’s Academic Roundup

Friday’s Government Reports Round-Up

Reiss in CSM on Rental Policy

The Christian Science Monitor quoted me in Census Outlines ‘Poverty Areas’: Which States Hit Hardest? It reads in part,

The number of US residents living in “poverty areas” has jumped significantly since 2000, according to a Census Bureau report released Monday.

According the 2000 Census, less than 1 in 5 people lived in poverty areas. But more recently, 1 in 4 residents have lived in these areas, according to census data collected from 2008 to 2012.

The Census Bureau defines a poverty area as any census tract with a poverty rate of 20 percent of more.

Sociologists and other analysts point to the Great Recession, in particular housing and job challenges, as well as slow and uneven growth since the recession.

“With the advent of the financial crisis and the bursting of the housing bubble, many people lost their homes and thus needed to rent or move in with relatives,” says Cheryl Carleton, an economics professor at Villanova University near Philadelphia. “[I]ndividuals need to move where they can afford to live … which is going to be in areas where public housing is available or housing prices and rental rates are low, which is more likely to be in a ‘poverty area.’ ” Professor Carleton made her comments via e-mail.

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Law professor David Reiss suggests that changes to homeownership policies could help.
“Federal and state housing programs could do more to support a market for well-maintained rental units for low-income households,” e-mails Professor Reiss, who teaches at Brooklyn Law School. “Many low-income households have difficulty maintaining homeownership because of irregular incomes and low wealth.”

Preserving NYC’s Affordable Housing Stock

The housing folks in the De Blasio Administration may want to take a look at a recent article in the Journal of Affordable Housing by Sullivan and Power.  Coming Affordable Housing Challenges for Municipalities After the Great Recession (also on SSRN) provides an overview of some modest ways to protect the existing affordable housing stock. Policies such as these can inform the Mayor’s overall affordable housing strategy which will have to emphasize preservation as much as new construction.

The authors note that for “low-income individuals who are to find employment, the disparity between wages and housing affordability is stark.” (298) They also note that while “housing prices have fallen approximately 30 percent since 2006, adjustments in value have done little to ease the financial burden of rental housing.” (2) The article then looks at various opportunities that local governments have to stem the loss of rental units to conversion, demolition and abandonment.

The authors identify three cost-effective and ways that states and local governments may be able to  “curtail the ongoing loss and conversion of affordable housing units . . ..” (308) They can adopt “no net loss” policies that could, for instance require that downzonings of residential communities be matched by upzonings . They can implement “rights of first refusal” that grant governmental and not-for-profit housing agencies “the right to notice of an owner’s intent to sell within a certain time frame and an opportunity to purchase expiring or opting-out affordable housing units.” (310) And local and state governments can amend their building codes to make it easier and cheaper for providers of affordable housing to maintain their properties.

NYC already does some of these things, but it is worth it for the new Mayor to take a fresh look at the City’s approach to preservation to ensure that there are no missed opportunities.