by Adam Tempkin
NEW YORK, June 7 (IFR) - Last week's intense backlash against U.S. regulators' proposed risk retention requirements for residential mortgage-backed securities (RMBS) united an unusual group, namely mortgage bankers, consumer advocates and nearly 200 elected officials.
The furore has left commentators wondering whether anyone, even a member of the government, was still willing to defend the proposal to instill lending accountability in the form it was originally written.
The original deadline for market feedback and commentary on risk retention rules and the related carve-out for ultra-safe "qualified residential mortgages" (QRMs) was this Friday, but has now been extended until Aug 1.
The debate unleashed a formidable, outspoken lobby of mortgage and banking trade groups, consumer activists, and dozens of members of Congress strongly opposed to the regulation.
But amid the outcry, the voices of those who support the proposed rule going ahead in its current state were curiously missing; in fact, the silence was deafening -- especially from the regulators that crafted the proposal.
Some market experts were either perplexed by the baffling alliance of bankers, consumer groups, and politicians -- insisting that their claims were often exaggerated -- or else they believed that the protesters were misinterpreting the QRM proposal and avoiding the real issue at hand: what will the future of US housing finance look like?
"These histrionics are way out of line," said Dean Baker, economist and co-director of the Center for Economic and Policy Research in Washington, DC, referring to the pushback from the anti-risk retention lobby over the last several weeks.
"When risk retention was first discussed, it was proposed in the 10% to 20% range, and then it went down to 5%. That is a relatively small stake in the scheme of things. What you could have ended up with could have been more restrictive; [these groups] are just pushing back because they can."
At a press conference last Thursday, members of groups as diverse as the Mortgage Bankers Association (MBA), Center for Responsible Lending, National Community Reinvestment Coalition, and the Consumer Federation of America joined forces in a rare display of solidarity to convey the message that the proposed risk retention regulations will irreversibly reduce credit options, even for qualified borrowers.
"We believe that the proposed rule implementing these provisions goes beyond what Congress intended and would drastically limit affordable mortgage financing options for moderate-income families, first-time borrowers, minorities, and many others," said a brochure distributed by the collective groups.
Moreover, in the past two weeks, more than 160 bipartisan lawmakers from the House of Representatives, and separately, nearly 40 Senators, wrote to regulators (including the FDIC, Federal Reserve Board, and Department of Housing and Urban Development) urging a dilution of the risk retention rule and broadening of the QRM definition to avoid constricting access to credit and impeding the housing market's recovery.
The problem, they say, is that QRMs -- or the very safest mortgages exempted from the risk retention rule -- will demand a 20% down payment from borrowers. According to critics, this proposed down payment, as well as prescribed loan-to-value and debt-to-income requirements, is unnecessary and "not worth the societal cost of excluding far too many borrowers from the most affordable loans", according to the MBA.
Baker noted that as a result of risk retention, borrowers would have to pay only about one-tenth of a percentage point higher interest, "if even that", he said. "It seems crazy to me. Banks are convinced that this is going to be a horrible thing, but it's not as if [issuers] will be holding on to the 5% and putting it under their mattress: they will have interest payments on that," he added.
But both sides of this debate may be missing the point, says Michael Barr, a professor at University of Michigan Law School and former Assistant Secretary for Financial Institutions of the US Treasury Department, who helped to develop and pass the Dodd-Frank Act.
"The real question is, 'will there be government-guaranteed mortgages or not?'," he said. The answer to that will drive the cost and structure of the system.
"If not, it means much higher cost for mortgages, a shift away from 30-year fixed-rate to short-term adjustable-rate mortgages, as well as much more bank balance sheet lending and less securitization, and more concentration in mortgage origination.
"But I don't think that regulators [in the draft rule] intended the QRM to be what a 'conforming mortgage' would look like in the future."
So-called conforming mortgages, according to Barr, are mainstream mortgages that are now guaranteed by Fannie Mae and Freddie Mac, but don't involve a blanket rule of 20% down payment.
The GSEs still finance more than 90% of the mortgages in the country, so the risk retention rules won't have much of a short-term impact; but in the long term, as Fannie and Freddie are wound down, it's not clear whether there will be another method for guaranteeing these conforming loans.
In Barr's view, the proposed QRM is an extremely narrow exception to the risk retention rule, and not the "gold standard" for what a typical conforming mortgage would look like.
However, Barr admits that if the requirements for conventional conforming mortgages -- something akin to Freddie Mac and Fannie Mae-eligible mortgages in the past -- require a 20% down payment, and people begin to think of the current-draft definition of QRMs as conforming mortgages, "then yes, there is a real risk of knocking a lot of [borrowers] out of the mortgage market", he said.
The debate about whether 5% risk retention is appropriate seems to have only just begun given the new deadline for comment.
"Assuming there is a profitable business opportunity presented in the context of the 5% risk retention requirement, I think that large money-centered banks will be more likely to take advantage of that opportunity, but for smaller banks, it will be a real cost," said Patrick Dolan, a partner at Dechert LLP.
Some critics say that risk retention is not needed at all, and that increased transparency is the only thing that might have helped to avoid the crisis. But the clamor for reversing the proposal made some wonder whether the reason for imposing a strict risk-retention rule in the first place has now been forgotten.
"What we saw in the financial system was a breakdown in standards for securitization driven by the misalignment of incentives," said Professor Barr. "Increased transparency is an important corrective, but if incentives are still out of line, transparency won't be enough to correct the market."
(Adam Tempkin is a senior IFR analyst; Tel: 1-646-223-8841)