The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was approved in the aftermath of salient abuses against consumers, and in times of pressure from public opinion and the media. This pressure might have reduced the ability of Congress to foresee all the possible consequences of the new legislation.
In recent research, we find that after Dodd-Frank mortgages to middle-class households decreased by 15 percent, whereas wealthy households increased by 21 percent. In the context of mortgages, Dodd-Frank changed lenders’ origination behavior because it increased the expected costs of originating mortgages.
{mosads}Lenders faced the higher expected costs of origination and the costs of compliance before the date of the execution of Dodd-Frank, when banks had to be compliant. This announcement effect of regulation is often overlooked by lawmakers.
Cutting mortgage loans to middle-class households and increasing it to wealthy households should have been more pronounced for larger lenders for at least three reasons. Large loans cannot be sold to Fannie Mae or Freddie Mac. Large lenders find it less costly to keep originated mortgages on their balance sheets, because they have a larger amount of deposits.
Large lenders can also offer a larger set of financial services than smaller institutions, and hence acquiring wealthy customers is more profitable to them than to smaller institutions. Large lenders operate in several counties, which makes it easier for them to change their origination to cater to the demand for larger loans. Consistent with these explanations, we find that the drop in mortgage originations and dollars lent to middle-class households was largest for large banks.
All our analyses compare U.S. counties with similar demand for mortgages. We explicitly keep constant the effect of individual applicant characteristics, such as their reported income and race, as well as county-level house prices and share of properties foreclosed.
Whereas our results are consistent with an effect of Dodd-Frank on mortgage origination, they are not consistent with potential alternative explanations. Anecdotal evidence suggests that after the financial crisis, wealth has polarized, that is, middle-class households have moved lower or higher.
If wealth polarization explained our results, the drop in origination should be stronger in counties with a higher share of middle-class households before the crisis. Instead, drop in origination was higher in counties with a lower share of middle-class households before the crisis. The results are also similar for counties with a high or low share of government employees, and counties with a high or low share of households investing in stocks.
One concern for our interpretation is that the financial crisis of 2008 change the mortgage market in ways that determined the reduction of loans to the middle class. For instance, after the crisis large banks changed the way they serve counties across the country, and moved out of counties with more in which originations have decreased after the crisis.
To tackle this problem, we looked at counties based on the pre-crisis share of large banks. Whether a county was served more or less by large banks cannot have been determined by the financial crisis, or by any other shock that affected counties differently after the crisis.
We also only compare counties with similar demographic characteristics, but different shares of mortgage originations by large banks. Even in this setting, we confirm that large banks cut their mortgage originations to middle-class households substantially, and instead increased originations to wealthy households.
Proponents of financial regulation aim to help vulnerable consumers. But regulators often neglect the changes in the incentives of private organizations, which react based on their own objective function. In the case of Dodd-Frank, many middle-class households did not obtain cheaper mortgages, but were cut out of the mortgage market altogether.
Alberto Rossi and Francesco D’Aunto are assistant professors of finance at the Robert H. School of Business at the University of Maryland.
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