In recent years, we have heard complaints of how difficult it is for many of us to get a mortgage loan.  The flagship example was Fed Chairman Ben Bernanke’s difficulty obtaining a mortgage – a credit denial that is difficult to explain.  A review of bank and credit union behavior reveals that banks have pulled back from extending consumer credit, but credit unions have increased their mortgage loans.  One explanation for banking’s reduced profile in consumer credit may come from Dodd-Frank regulations that seek to eradicate the risk of “too big to fail.”

The Urban Institute reports that mortgage loan approval now takes a much higher FICO score than it did before the great recession.  Although there is no “cutoff” score, the best chances apply to those scoring above 750.  US home ownership peaked in 2004 at 69% and slumped to 64.5% at the end of 2014.  Former owner-occupied homes did not just disappear – they were converted into rental properties.  The Urban Institute suggests that if credit had not been tightened, another 1.2 million first mortgage approvals would have taken place in the post crisis period.

Looser credit may help keep the housing market buoyant, but many know that before the great recession, mortgage issuance was too lax.  Those in the loan business saw the problem when they applied the term “liar’s loans” to the low-documentation and no-documentation mortgage applications that were popular in the run up to 2007.  While some loans were based on fraudulent assertions, other loans were being made with little or no down payment required, leaving lenders with scant security in the housing price collapse that cratered in 2009.  Fannie Mae is trying to re-introduce those high risk thrills with its proposed 3% down payment loans.

By the end of 2014, the assets of US chartered banks totaled $12.36 trillion total and assets of credit unions were $1.12 trillion.  Banks’ share of consumer credit had declined by 11% since 2010, but since bank’s assets actually grew by 27% over the 2008 to 2014 period, banks were clearly shifting assets away from consumer credit into other uses.

Credit unions, on the other hand, had its share of consumer credit rise since 2010.  Today, credit unions provide 9% of consumer outstanding credit.  Over the 2012 to 2014 period, credit union new car loans increased 36%, used car loans were up 25% and real estate mortgages increased 19%.  New and used auto loans represent $230 billion of the credit union portfolio and mortgages account for another $292 billion.

Despite an asset base twelve times that of credit unions, banks provide just 34% of total consumer credit.  They provide $2.04 trillion in residential mortgages but their mortgage holdings increased a scant 0.5% in the year ending February 2015.  Bank automobile loan portfolio stands at $359 billion, just 56% more than auto loans from credit unions. Credit unions punch far above their weight in consumer credit. They tend to be smaller, safer, and provide lower interest rates and higher interest on deposits.  In the last financial mess, they did not need a bailout.  Meanwhile, big banks keep getting bigger and small banks are disappearing.

One explanation for bank behavior is the regulations that prevent “too big to fail” banks.  The regulations reduce banks’ riskiness by increasing their equity and decreasing their risky loans.  This reduces leverage, and thus limits the earnings available for a given amount of equity.  In this calculus, “risk” is measured as the amount of equity needed to offset that risk.  Assets such as treasury bills score a zero risk; typically, corporate loans score 8%; residential mortgages score 4%; and mortgage backed securities (MBS, government agency insured) score 1.6%.

A bank needs to devote less of its equity to offset treasuries or mortgage backed securities than to offset residential mortgages.  For a given equity, it can carry 2.5 times more MBS than residential mortgages.  Since MBS yields are only slightly lower than residential mortgages, after adjusting equity levels, it can be more profitable for a bank to borrow at near zero interest and buy MBS than to buy residential mortgages.  If repeated over a few years, that will change the bank’s profile in the consumer credit market.  Sentiment in the Federal Reserve provides extra incentive – if banks don’t reduce their risk, they might be dismantled.

Alan Daley is a retired businessman who writes for The American Consumer Institute Center for Citizen Research