Edward M Gramlich: HMDA data and their effect on mortgage markets
Remarks by Mr Edward M Gramlich, Member of the Board of Governors of the US Federal Reserve
System, to the National Association of Real Estate Editors, Washington DC, 3 June 2005.
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Thank you for the invitation to speak today. I am particularly pleased to accept an invitation to address
the National Association of Real Estate Editors. Journalists are critical in helping the public understand
the economics of the mortgage market, which has become more accessible, yet also more complex
than ever. Your ability to demystify the mortgage market and identify trends greatly improves the
public's understanding of the housing market - the market for one of the most important financial
transactions an individual will ever undertake.
I also note that your readership includes real estate professionals - another group of individuals who
play a crucial role in the efficient operation of the housing market. Homeowners often rely on
recommendations from their realtors when looking for financing. Realtors must understand the role
they play in making credit markets work, and in promoting sustainable homeownership opportunities
for individuals.
In our society, homeownership is the most common step one can take toward accumulating wealth.
Home equity, built over time, has also become an important source of cash for other investments,
including educational expenses. Moreover, homeownership strengthens communities by turning
residents into investors with an ownership interest in the places they live. Recently, homeownership
rates have reached record levels, thanks, in large measure, to technological innovations that allow for
risk-based pricing of loans, along with the rapid growth of the subprime mortgage market.
This brings me to the topic I want to discuss today: the recent release of pricing information collected
under the Home Mortgage Disclosure Act (HMDA). As you are aware, HMDA requires that large
mortgage lenders report their lending activities to the Federal Reserve Board and its sister agencies.
The Board validates and ultimately compiles the data into a format that is made available to the public.
The public can then use this information to evaluate whether lenders are serving their communities,
enforcing laws prohibiting discrimination in lending, and providing private investors with information to
guide investments in housing. Generally, for-profit lenders that have offices in metropolitan areas and
that have more than $34 million in assets, or whose mortgage lending represents 10 percent of their
lending originations, must report under HMDA.
In my remarks today, I will first review the history of HMDA as a backdrop for the new HMDA pricing
data. The Federal Reserve is still editing these data, but I will also provide a preview of what they are
likely to show.
HMDA history in brief
The regulations implementing HMDA require that lenders disclose aspects of their home mortgage
application and lending activities, including the applicant's or borrower's race, ethnicity, sex, and
income. Also reported are characteristics of the loan, such as the amount and purpose, and the
location of the property securing the loan. But it was not always this way.
When HMDA was originally enacted in the mid-1970s, the only information required to be reported
was the number and dollar amount of loans, by census tract. Congress, concerned about the role that
financial institutions' lending policies might play in the deterioration of our cities, designed HMDA to
combat the practice known as "redlining," in which institutions took deposits but did not lend in their
local communities. Initially, HMDA data simply helped the public and regulators track where an
institution was lending and, more important, where it was not.
Not until the late 1980s did the data collection expand to include race, sex, and income levels for each
loan application, along with whether the application was approved or denied. By then, the issue was
whether minority borrowers were denied mortgage loans more frequently than white borrowers and
whether those disparities reflected discrimination in mortgage underwriting.
Today, after significant changes in the mortgage market brought on by technological advances,
deregulation, and financial innovation, the credit availability question is no longer limited to whether
minority borrowers have access to credit but, rather, at what price that credit is available. Moreover,
there are new questions about whether the price of credit always reflects the lender's risk or cost, or
whether it is tied in any way to the race or sex of the borrower.
The technological changes have led to strong growth in the subprime mortgage market. In general,
this growth appears to be a positive development. Homeownership is at record highs among
low-income and minority borrowers, many of whom would not have qualified for mortgages several
years ago, and most of whom have been able to make their mortgage payments. At the same time,
the increase in mortgage lending among lower-income and minority borrowers has been accompanied
by reports of abusive, unethical, and, in some cases, illegal lending practices. I am sure you are aware
of the concern about whether consumers have the ability to shop for mortgages and to avoid unfair or
deceptive lending arrangements.
Taking these concerns and public comments into consideration, the Federal Reserve determined that
information on loan prices was critical to gaining insight into the functioning of the higher-cost
mortgage market. In the Board's amendments to the regulation that implements HMDA, Regulation C,
we attempted to expand the HMDA data to permit evaluation of this market. The same amendments
also required recording of information about the lien status of the loan, whether it was for
manufactured housing, and whether it was subject to the Home Ownership Equity Protection Act.
The new data were first reported for loans originated in 2004. Although the edited aggregate HMDA
data will not be available until September 2005, lenders, as of March 31, are required to make their
individual data available to anyone who submits a request. Some community organizations have
already obtained and analyzed the data of some large lenders and have published reports indicating
they believe that the data reveal discrimination in pricing. Simultaneously, the Federal Reserve,
together with the other agencies that make up the Federal Financial Institutions Examination Council
and the Department of Housing and Urban Development, has been explaining to financial institutions
and to the public the uses and limitations of the pricing data and how these data will be used by bank
examiners.
General data issues
The collection of HMDA data is premised on two distinct assumptions. The first is that the mortgage
markets work more efficiently when information is publicly available. HMDA data have been used to
identify credit demand that might otherwise have been overlooked. The analysis and conclusions
drawn from the data have also encouraged the establishment of partnerships between lenders and
community organizations to meet credit needs.
The other assumption is that data improve compliance with, and enforcement of, fair lending and
consumer protection laws. The HMDA data are the first point of reference for fair lending examinations
conducted by the Federal Reserve and the other banking regulators. Government agencies use
HMDA data to assist in evaluating lender compliance with anti-discrimination laws - particularly the
Equal Credit Opportunity Act (ECOA) and the Fair Housing Act (FHA) - as well as other consumer
protection laws. The data help examiners identify institutions, loan products, or geographic markets
that show disparities in the disposition of loan applications by race, ethnicity, or other characteristics
that require investigation under the fair lending laws. With the addition of price data for higher-priced
loans, the agencies will be able to more easily identify price disparities that require investigation. If
disparities are found to violate the ECOA or FHA, certain federal agencies are authorized to compel
lenders to cease discriminatory practices and, among other remedies, obtain monetary relief for
victims.
The public disclosure of price information under HMDA - in the form of spreads between the annual
percentage rate (APR) on a loan and the rate on Treasury securities of comparable maturity - is
designed to ensure that the data continue to be useful in improving market efficiency and legal
compliance. The APR represents the cost of credit to the consumer and captures the contract-based
interest rate on a loan as well as the points and fees that consumers pay up front, converted to a
percentage rate. But since these fees have to be amortized over the term of the loan to calculate the
APR, and since interest rates vary over time, even the APR can be difficult to use as a basis of
comparison across loans.
Because of interest-rate fluctuations, the HMDA rules require lenders to report the difference between
the APR and the rate on Treasury securities of comparable maturity for any loans with rate spreads
that exceed prescribed thresholds. For first-and second-lien loans, the thresholds are 3 percentage
points and 5 percentage points above the Treasury security of comparable maturity, respectively.
These particular thresholds were chosen to exclude the reporting of the vast majority of prime-rate
loans and include the vast majority of the subprime-rate loans, minimizing the burden of the data
collection on lenders while providing information on that portion of the market where concern about
consumer abuse is most prevalent.
Although the addition of the price data significantly increases the robustness of HMDA data, the data
alone do not prove discrimination. Instead, the data will be used as a screen to identify any aspects of
the higher-priced end of the mortgage market that warrant closer scrutiny. The new HMDA data are
clearly limited: they do not include credit scores, loan-to-value ratio, or consumer debt-to-income ratio
- all factors relevant to the cost of credit. Because these important determinants of price are missing,
one cannot draw definitive conclusions about whether particular lenders discriminate unlawfully or take
unfair advantage of consumers based solely on a review of the HMDA data. The new data will be
useful to examiners in identifying particular loan products or geographic areas with significant pricing
disparities and establishing one or more focal points for a pricing analysis that would include a review
of all the factors relevant to a particular institution's pricing decisions.
The Board did consider adding other data elements relevant to pricing to the HMDA collection. For
each possible new data item, we weighed the potential benefits and costs. On the basis of that
analysis and careful consideration of public comments, we decided not to add more factors. In addition
to the cost to lenders of collecting additional data, more data being made publicly available would
create very real privacy concerns. As it stands, many of the HMDA data fields are unique and can be
matched with other information to determine the identity of individual borrowers. Given the costs and
limitations of collecting additional data, we felt that the potential for further privacy losses outweighed
the usefulness of the additional data.
It is always possible that banks could disclose additional information on their own, but even this is
questionable from a legal standpoint. The recent Fair Credit Reporting Act limits financial institutions'
ability to share consumer reports (such as credit scores) with third parties.
Regardless, the new data still offer the public and supervisory agencies charged with enforcement of
the fair lending laws a better screening tool than was previously available. Until now, in determining
whether a lender is discriminating in its pricing decisions, examiners have relied on several factors: the
relationship between loan pricing and compensation of loan officers or brokers; lender policies giving
loan officers broad pricing discretion; the use of empirically based and statistically sound risk-based
pricing systems; disparities among prices quoted or charged to applicants who differ in their protected
characteristics (such as race); and consumer complaints alleging price discrimination. These data will
still be used, but the APRs will make the high-cost loan assessments much more precise.
Although discussions of the new HMDA pricing data have just begun, some outcomes should be
anticipated. First, a debate will continue about what the HMDA data say about the lending practices of
individual institutions. Some community groups have already publicized their analysis of the data
provided by individual institutions, and those institutions have responded. The attorney general for
New York is also reviewing the data of several institutions. I anticipate that these inquiries and the
conclusions drawn from them will continue for several months.
Second, lenders can gain an increased awareness of the lending and pricing practices of their
organizations, and of their competitors, through analysis of HMDA data. As a result, lenders may take
opportunities to compete in areas where the data show concentrations of high-priced lending.
Competitive pressures in such markets should increase efficiency in pricing, ensuring that prices for
mortgages are commensurate with risk and do not just reflect an absence of competition.
Third, new and strengthened collaborations should emerge among lenders, community groups,
realtors, and other participants in the real estate market. As lenders seek to enter new markets, or to
better serve their existing markets, the groups that have an intimate knowledge of their communities
will be viewed as valuable partners.
Finally, increased importance will be placed on the value of financial education to help consumers
shop for and obtain the mortgage loan that represents the best price and terms for their financial
situation and needs. The broad array of mortgage loan products makes choosing difficult, even for
those with financial savvy. The choices are substantially more confusing for those with credit-impaired
histories or those who are unfamiliar with the different types of financial service providers and
products. Consumers are often bewildered by the mortgage credit process, and the consequences of
poor choices or misunderstanding or misinformation can have lasting effects on their financial
wellbeing.
An early look at the data
As I said earlier, as of March 31, lenders have been required to make their individual HMDA data
available. Many press reports have discussed these data and there is already a vigorous debate about
what the data do, and will, show.
The Federal Reserve is now editing the data, and its reports will not be complete until September.
Until then, we can only provide a broad preview of the overall picture. In 2004, some 8,800 lenders
reported 37 million loan applications, compared with 8,100 lenders with 42 million loan applications in
2003. The drop in the number of loan applications reflects the slowing of the refinance market last
year. The increase in the number of lenders is partly the result of the expanded coverage of the
Board's amendments, but it could also suggest increasing competition in the home mortgage industry.
Regarding subprime lending, back in 1994 the subprime market, defined as high-cost mortgage loans,
amounted to $35 billion, or 5 percent of total mortgage originations. By 2004, the subprime market had
exploded to $530 billion, or 19 percent of total mortgage originations. The annual subprime market
growth rate over this time was a whopping 27 percent.
The initial data also suggest that prevalence of higher-priced loans differs notably across racial and
ethnic groups. As some press accounts have implied, the data indicate that blacks and Hispanics are
more likely to take out higher-priced loans than non-Hispanic whites, and that Asians are the least
likely to have higher-priced loans. These preliminary data also seem to indicate that the actual prices
paid by those taking out higher-priced loans are about the same for different racial groups.
Until the editing process is complete, more details cannot be provided. Needless to say, everyone will
have an opportunity to review the final data when they are released in September.
Conclusion
In closing, I cannot emphasize enough the importance of your role. By understanding the potential
usefulness and limitations of the data, and conveying those messages clearly, we can promote a more
efficient market and compliance with anti-discrimination laws without unfairly tarnishing the reputations
of particular lenders. No one will be served if lenders are unwilling to enter, or remain in, certain
higher-priced segments of the market. The most effective way to lower the cost of credit to higher-risk
borrowers is to promote a competitive marketplace. And one of the most effective ways of ensuring
competition is to make data available.