NCPA - National Center for Policy Analysis

Economy Suffers from Government-Directed Lending Policies

March 17, 2014

Without checks and balances, governments will use their financial systems to carry out political goals that lead to losses and crises, says Paul Kupiec, a resident scholar at the American Enterprise Institute.

The Dodd-Frank Act (DFA) was marketed as a set of comprehensive reforms that would keep the financial sector stable. Unfortunately, the law does not make the types of reforms that are truly needed and actually increases the ability of the government to carry out social policies through banking institutions.

The financial crisis was caused by overleveraged consumers who were able to overleverage themselves based on government housing policies that weakened mortgage underwriting standards. Today, government housing policy still aims to stimulate mortgage borrowing, including subprime borrowing.

  • Regulators have started enforcing anti-loan-discrimination statutes by comparing the characteristics of an institution's actual borrowers to its potential borrowers.
  • If those characteristics differ, the government can threaten disparate impact litigation.
  • This threat has forced banks to restructure their lending processes.
  • Even when banks use objective financial criteria, they can be accused of lending discrimination if it results in an "unbalanced" distribution of credit.
  • If a plaintiff shows evidence of "statistical discrimination" (simply showing that loans using a certain underwriting standard affect the ability of a protected class to access credit), the bank is given the burden to prove its own innocence.

How are banks to avoid disparate impact charges? They can engage in "reverse discrimination" (reducing the credit granted to nonprotected classes until they end up with even numbers between both groups). Or, they can extend loans on unfavorable terms to borrowers that do not meet neutral standards and increase loan rates on well-qualified borrowers to subsidize that risk.

Ultimately, disparate impact litigation threats are likely to hinder the ability of nonprotected Americans with good credit to get loans, because extending loans to those with poor credit hurts bank profits.

Additionally, the new Qualified Mortgage (QM) rule in the DFA is intended to prevent predatory lending, but it does no such thing. The QM underwriting standards are so lax that neither borrowers nor banks will be protected either from predatory lending or discrimination charges.

Moreover, government policies that force banking and other institutions to offer loans at unprofitable rates essentially impose a tax on financial activity. Resources will leave the financial sector, which means that economic growth will suffer.

Source: Paul H. Kupiec, "When Governments Direct Bank Credit, the Economy Suffers," American Enterprise Institute, March 4, 2014.


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