The Unintended Consequences of the Dodd-Frank Act

Understanding the housing paradox
By Christopher Thornberg

In many ways, the current new home market looks fairly robust. Prices for new and existing homes continue to rise at a steady pace, but also remain affordable due to low interest rates. The number of single-family building permits and starts has been trending upward, even while the supply of new and existing homes on the market remains low. Overall housing vacancy rates have finally drifted back down to normal levels.

The demand side of the picture looks solid as well. Despite slower than normal GDP growth, labor markets remain tight with headline unemployment sitting at five percent, one of the reasons that wages have been rising at a faster pace. Household formation has been picking up after running slower than normal for many years. The stock market remains at a high level, and data from the Federal Reserve’s Flow of Funds shows average home equity is back to pre-bubble levels. With all this good news, there is little wonder that the NAHB/Wells Fargo Homebuilder confidence level has returned to heights seen prior to the great housing crash.

But these positive trends are undermined by the stark reality that new home construction is running well below where it should be given the strong indicators from other parts of the economy. Single-family housing starts are running below 800,000 per year, when the right number should be in the 1.2 to 1.3 million-unit range. And while the trends are upwards, they are slow enough to suggest that it will be years before the market is operating at what might be called full-capacity, if it ever reaches that point.

One explanation for this new home conundrum is that the market is supply constrained. On the existing home side, the argument says that potential sellers are ‘afraid’ to list their homes for sale because they may not be able to find another available to them, or they are locked into a low mortgage rate. These arguments make no sense. Potential sellers can list their homes for sale without having to actually sell and interest rates are still near rock bottom levels—with little sign of any major surge in supply (and hence demand). Lastly, existing home sales have actually been fairly good—running at a 5.4-million-unit pace per year. This may be lower than it should be, but it is far closer to normal than new home sales and single-family construction.

If it isn’t supply, the only logical explanation is that the slow pace of new home construction is being driven by a lack of demand. This lack of demand is not being driven by economic problems, but by financial ones.

The last mega-housing bubble was caused by the collapse of credit standards in the mortgage lending business in the early part of the decade, with predictable results. Given the damage to millions of homeowners and the economy overall, new rules needed to be enacted to prevent something similar from happening again.

But instead of pursuing logical reforms, the hyper-partisan nature of U.S. politics turned the process of regulation making into a political witch-hunt, framing lenders as the problem and borrowers as victims. The Dodd-Frank Act largely amounted to pushing the liability of a foreclosure from the borrower to the lender. Not surprisingly, lenders have responded to these new rules by sharply reducing the pace of lending to higher-risk borrowers.

In doing so, Dodd-Frank largely threw the baby out with the bathwater. For many decades there has been an active higher-risk mortgage lending market. This market allowed many people an opportunity for homeownership even if their circumstances weren’t optimal. That opportunity no longer exists for millions of households. The best data on this comes from the New York Federal Reserve Consumer Credit Data Panel. The data shows that the overall pace of credit origination for high credit score households (Fico > 720) remains at levels similar to what they were before the new rules passed. But for those with credit scores under 720, the pace is less than one-third what it was prior to the downturn, and there is little sign of improvement. This explains why homeownership rates are still falling.

The lack of available credit has profound implications. One is that the housing construction market will be largely constrained. The last year has been better for builders—recent data indicates that 2015 was the first year since before the bubble that there were more new home-owning households than renting households. This jump, however, was due strictly to better economic conditions among some households. Most new construction is at the higher end of the market—where credit is still available. But this market is in danger of being over-saturated, given a lack of new owners at the bottom end of the market.

More importantly, freezing so many potential buyers out of the market has left them unable to pursue one of the most important strategies Americans use to save for the future—building equity. Those who fought so vigorously for Dodd Frank, in many ways, ended up hurting the very population of consumers they were ostensibly protecting. Ultimately, the housing market, and the economy overall, will be better off if these rules are reformed in a more logical way. This is possible, even in this hyper-partisan environment, if policymakers understand the negative impact of the current legislation.

Christopher Thornberg, PhD is Founding Partner of Beacon Economics and Director of the UC Riverside School of Business Center for Economic Forecasting and Development. For more information visit

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