Mortgage Companies and Regulatory Arbitrage

Abstract

Mortgage companies (MCs) do not fall under the strict regulatory regime of depository institutions. We empirically show that this gap resulted in regulatory arbitrage and allowed bank holding companies (BHCs) to circumvent consumer compliance regulations, mitigate capital requirements, and reduce exposure to loan-related losses. Compared to bank subsidiaries, MC subsidiaries of BHCs originated riskier mortgages to borrowers with lower credit scores, lower incomes, higher loan-to-income ratios, and higher default rates. Our results imply that precrisis regulations had the capacity to mitigate the deterioration of lending standards if consistently applied and enforced for all types of intermediaries. Yuliya Demyanyk is at the Federal Reserve Bank of Cleveland, and she can be reached at ydemyanyk@clev.frb.org. Elena Loutskina is at the University of Virginia, and she can be reached at eloutskina@virginia.edu. The authors thank Jennifer Bray, Mark Dobbins, Tom Fitzpatrick, Mark Greenlee, Chris Henderson, Paul Kaboth, and James Thomson for sharing their knowledge about the supervision and regulation of mortgage companies. They thank

Regulatory space and the flow of funds across the hierarchy of money

“…In the context of the creation of housing credit more than anywhere else, the severity of the regulatory tax on traditional banking entities has arguably pushed these activities beyond the perimeter of financial regulation into the world of 'murky finance' (see for example, Demyanyk and Loutskina, 2016). Figure 8 illustrates the large volumes of mortgage origination by regulatory agency over the two decades that marked the largest rise and fall of house prices in modern US financial history.…”