By David Dayen, a lapsed blogger, now a freelance writer based in Los Angeles, CA. Follow him on Twitter @ddayen
There’s no way to possibly count the various ways in which Dodd-Frank rules have been watered down, even from their already waterlogged original intent. But we got another example of it yesterday, the product of a corrupt bargain between the mortgage industry and so-called “progressive” housing groups.
If everything written in Dodd-Frank were actually implemented as far as mortgage origination standards, we would certainly have a safer system. The problem is that the plain legislative language often doesn’t match the reality of what the regulators produce. This is exactly the case with the “qualified residential mortgage,” or QRM, rule. To make this completely confusing, there already is a qualified mortgage (QM) rule promulgated by the CFPB, which actually retained at least some, though not all, of its teeth. The QRM rule was in the hands of six different financial regulators, and it was supposed to create “risk retention,” where the originator of the loan would have to hold a 5% stake in the loan on its own books, disabling them from distributing the entire risk. Only “qualified residential mortgages” would escape the risk retention requirements.
After the proposed rulemaking, it appears that the QRM will deliver risk retention in name only.
Six regulators—including the Federal Reserve, Federal Deposit Insurance Corp. and Securities and Exchange Commission—on Wednesday issued new proposed rules that would require banks and other issuers of mortgage-backed securities to retain 5% of the credit risk of the bonds on their books, as mandated by the 2010 Dodd-Frank financial-overhaul law.
However, the proposal carries an exemption so broad it wouldn’t apply to securities containing most mortgages made under today’s stricter lending standards, which are of relatively low risk. Rather, the rule would apply to the types of higher-risk loans that were popular before the 2008 financial crisis. The rule effectively sets boundaries for what kind of loans might be offered, and on what terms, once lending standards relax.
Had the rule been in effect last year, at least 98% of loans would have been covered by the exemption, according to Mark Zandi, chief economist at Moody’s Analytics.
There’s an “alternative rule” that would include a 30% down payment for the exemption, but that’s so out of left field that it’s obviously been placed in there as a red herring. The elimination of the down payment is the one that will get implemented for sure.
The FDIC, desperate to maintain some form of dignity through the process, claim that the rules would still ban certain types of teaser rate loans. But this was all in the CFPB rules already. Risk retention was the killer app here. And the regulators basically discarded it, despite the plain reading of the law which authorized it.
For those wanting the technical details, regulators basically took away the downpayment requirement in the risk retention rule, replacing it with CFPB’s “ability to pay” rule, which doesn’t require a down payment. There’s really been only one line of argument on the side of the mortgage industry, which enabled them to decisively win this round. That’s the claim that forcing a 5% risk retention would “contract credit for first time home buyers and borrowers without large down payments, and prevented private capital from entering the market.” As James Kwak points out, this is precisely the rationale for the last housing bubble, that actually putting regulations on the go-go mortgage market would disrupt credit, and you just don’t want to do that. We’ve seen decisively that whatever economic benefits come from the disposition of runaway credit are far outweighed by the risks.
Cheerleaders have touted a housing recovery that will usher in a full economic comeback. The watering down of these origination rules shows the darker side of that happy talk, and all the dangers inherent with the idea that housing can lead a turnaround again. That puts weak-kneed regulators in the situation where they don’t want to take away the punch bowl, and they write rules that back away from any consumer protections for home loan borrowers. We’re not far away from the same kind of lending proposals that proliferated during the crisis. It’s just a matter of time that exemptions get carved out for, say, interest-only or negative amortization loans.
As for regulation inhibiting private capital, it’s really quite the opposite. The wild west show that is private label securitization has kept private investors away from the market for the last five years. Further deregulation will only cement that wariness.
The scummiest part of all this is the willing participation of housing groups like the Center for Responsible Lending, which bought the argument that forcing originators to hold a small sliver of a loan would inhibit all lending. I wrote about this two years ago:
Let’s be clear about this. Banks could still sell other loan products. And they could pass off 95% of those other loan products to investors. if they want to sell all 100% of the loan, they need to use a qualified residential mortgage (QRM) with a 20% down payment. Unless you believe that loan originators will not sell anything but a QRM, nobody will be locked out of the market. That’s further underlined by the fact that this rule does not apply to loans sold to the FHA or Ginnie Mae. There’s a good possibility that this will be extended to Fannie and Freddie as well. At that point, you’re pretty much talking about all new mortgage loans, since the securitization market outside of those public buyers is dead.
And let’s keep going on this. The terrible burden placed on these non-QRM home buyers is something on the order of twelve bucks a year… Do affordable housing groups have a problem with risk retention? Do they think that banks shouldn’t have to hold any piece of the loans they originate, so they at least have a small stake in the downside, which might weigh on their ability to rip off customers? Would they rather the banks not care about the ripoff because they’ll feel no pain if the loan fails to perform?… they’re acting as human shields for bad policy that will allow the banks to run the same kinds of dangerous originate-to-distribute shops and cut the same corners they did in the run-up to the bubble. Making sure that affordable housing gets into the hands of low and moderate-income people is not the same as making sure banks can rip off those same people.
I appreciate the work of SEC Commissioner Daniel Gallagher, who in a long dissent argued that the near-blanket exemption from risk retention rules was “unrealistic and dangerously broad,” and that “We are delivering exactly the type of implicit endorsement that led to the massive expansion of subprime.”
The full rule is here. You can submit public comments by October 30 by visiting Regulations.gov and searching under “Docket ID OCC-2013-0010.” Usually all these agencies hear from are bank lobbyists, so you can shake things up a bit just by your presence.