Here's the question to ask, as the House and Senate negotiate a financial reform bill: Will the new law prevent another meltdown in mortgages and real estate?
Reckless lending fueled the housing bubble, and the housing bubble fueled reckless lending. The two phenomena operated in a vicious circle. To prevent another meltdown, a circuit breaker needs to be installed. The House-Senate conferees want to install a circuit breaker that might not flip in time.
Congress wants to create an "ability-to-repay" standard. That's a start. An ability-to-repay standard needs to be there, but it's insufficient.
By requiring lenders to assess borrowers' ability to repay, Congress signals that it believes that adjustable-rate mortgages drove the housing bust. For the most part, an ability-to-repay standard addresses borrowers' ability to make monthly payments after the rates on their ARMs adjust.
I'm not convinced that ARM rate adjustments were the culprit in the housing bust. Rate adjustments played a role, but I don't think they stood at center stage.
No, the problem was that lenders underwrote mortgages that were too affordable at the outset. They offered ARMs with low introductory rates, combined with low or no down payments. Congress is addressing the first part of that equation, but not the second.
An effective circuit breaker would link minimum down payments with changes in home prices. Fast-rising home prices would automatically trigger a requirement for bigger minimum down payments.
For example (and I'm just throwing numbers around; I haven't researched what the numbers should actually be), the minimum down payment might be 5 percent when house prices are rising at an annual rate of 3 percent. But if prices begin to rise at an annual rate of 6 percent, the minimum down payment might automatically rise to 7 percent.
Combine that with an ability-to-repay standard, and you'll reduce the supply of hot air that's available to inflate the next housing bubble.