A new financial regulation defining “qualified mortgages” is due to take effect in January 2014. It would make the approval process for a mortgage stricter, both in the United States and Puerto Rico. Local banks are convinced that as a result of this new regulation, many mortgage applications will be denied. They are right. They argue that the regulation is bad for Puerto Rico. They are wrong.
We are still experiencing the collapse of the construction industry and property prices in Puerto Rico. During the 2000s, local banks participated in the whirlwind of real estate speculation. They were so aggressive that they incurred in glaring accounting mistakes related to mortgage loans. The “interest only strips” fiasco and accompanying losses were the first signal of a system gone out of control.
Mortgages were issued at a 100 prcent loan-to-value ratio and with no principal payments over the first few years (“balloon payments”). Income tax returns were disregarded in favor of self-reported financial statements. Construction loans were issued in the expectation that consumers, instead of buying a house more in line with their means, would rather borrow to the hilt to buy ever more expensive units.
In 2008, partly due to misguided credit policies by the banks and partly due to the economic contraction, thousands of new housing units in Puerto Rico stood unsold. Then, the Puerto Rico Bankers Association organized the media campaign “El momento de comprar es ahora” (“The moment to buy is now.”) During 2009, sales continued at a snail’s pace and property prices declined significantly.
Early in 2010, the Bankers Association claimed that the local banking industry was well capitalized. Meanwhile, the federal government was buying preferred stock from local banks to shore up their weak capital bases. Weeks later, the FDIC closed down three banks in one of the largest banking collapses in the history of Puerto Rico. The crisis in the banking sector deepened the island’s ongoing economic recession.
Now the federal government is going to implement stricter regulations in the mortgage market. The regulations will force families to slow down on credit card purchases and delay buying new cars to access mortgage loans. It is going to force individuals in the informal economy to report income in their tax returns to qualify for mortgage loans. A repetition of the collapse of property prices will become more difficult because buyers will have a better financial footing to pay for their mortgages.
This is not only good for the United States, but also for Puerto Rico.