David Dayen: Regulatory Apparatus To Provide Full Employment For Chroniclers of Future Bailouts, as Useless Mortgage Origination Rules Introduced

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.

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About David Dayen

David is a contributing writer to Salon.com. He has been writing about politics since 2004. He spent three years writing for the FireDogLake News Desk; he’s also written for The New Republic, The American Prospect, The Guardian (UK), The Huffington Post, The Washington Monthly, Alternet, Democracy Journal and Pacific Standard, as well as multiple well-trafficked progressive blogs and websites. His has been a guest on MSNBC, CNN, Aljazeera, Russia Today, NPR, Pacifica Radio and Air America Radio. He has contributed to two anthology books, one about the Wisconsin labor uprising and another on the fight against the Stop Online Piracy Act in Congress. Prior to writing about politics he worked for two decades as a television producer and editor. You can follow him on Twitter at @ddayen.


  1. psychohistorian

    Nice bit of reporting.

    My public comment will be about the purpose of government. Is it to insure profit for the plutocrats or a reasoned functioning economy that supports the non plutocrats (rest of us)?

    Seems like it should be pretty basic social morality and rule of law to me but I digress……..

  2. taunger

    Pretty Orwellian that the Center for Responsible Lending is advocating against down-payment requirements. Although, they are located out of Durham NC. I seem to remember a regional influence in the lending sector there near there . . .

    1. DolleyMadison

      CRL is nothing but a bank lobbying group – its a front for the banks and funded by them.

    2. LifelongLib

      OK, but you could save a downpayment living in your parents’ basement and never paying for anything. A history of paying rent and other bills on time is also a good indicator of financial responsibility. None of that really has anything to do with what’s done with the mortgage after it’s originated though.

  3. chicagogal

    Geez, only government could write something that’s 500 pages long that’s impossible for ordinary people to decipher! What’s wrong with just saying something like: “Mortgage originators must retain x% of any loan that deviates from a Qualified Residential Mortgage (QRM) if they choose to securitize or sell it on the secondary market, should one exist.” There doesn’t need to be wishy washy language that creates loopholes big enough to drive a truck through.

    Wasn’t Glass-Stegall something like 33 pages?

    1. ZadoofkaFlorida

      Why? Well, it worked so well the first time around: elevated appraisals, no doc loans, securitization of empty bags of wind, then foreclosing with faked documents, then for all those who suffered the above a $500.00 check that was mailed to the wrong address. OF COURSE THEY’RE GOING TO DO IT AGAIN!

  4. TY

    “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.”

    I find this kind of argument so unpersuasive. Interest-only and negative amortization loans wouldn’t be allowed under either QM or QRM, and the scary “exemptions” you’re warning about are non-existent. If you want to debate the substance of the proposed rule, then do that. But don’t just make up hypothetical future “exemptions,” assert that regulators will OBVIOUSLY accept your scary hypothetical exemptions in the future, and claim victory. It’s beneath you.

    Also, you can’t simultaneously praise the QM rule and claim that the new QRM rule is toothless, since the regulators essentially decided that the CFPB has already set appropriate underwriting standards with QM.

  5. Conscience of a Conservative

    Anyone who trades, invests or follows mortgages knows, LTV is the single biggest predictor of loan performance, specifically with regards to default. High LTV loans all else bein equal are simply more prone to default and some of those other attriutes such as FICO, loan purpose etc are not that trust worthy, so I have to agree with the Republican dissentor Daniel M. Gallagher, a Republican member of the Securities and Exchange Commission who wrote that the new standards were so lax that they would allow lenders to escape retaining risk on many loans that will probably default.

    On a side note, I can just hear Larry Summers getting behind this one, as he recently wrote that we won’t be having another mortgage crisis anytime soon, so lower mortgage standards would have the benefit of helping housing with none of the risk.

    We’ve learned nothing since 2008.

  6. ChrisPacific

    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.”

    Isn’t that tantamount to an admission that they are deliberately understating risk? Why else would a requirement to retain 5% of the risk contract credit?

  7. Lyle

    Here is an alternative take that takes the postion that the new rules are to harsh in particular the 43% total debt and property tax+insurance limit. That clearly excludes the old 100% debt to income loans as made in Ca, and requiring documentation for them, also kills off that No Doc and Alt-A mortgage. The article is at: http://homes.yahoo.com/news/tighter-mortgage-rules-will-soon-squeeze-these-groups-even-more-005538769.html
    So perhaps given that both sides think the rules are wrong by going to far in one direction or the other, the might be just right.

    Of course I don’t see why anyone in his right mind would loan money on a 30 year fixed rate mortgage anyway. (Given few mortgages make it that long, its really a disguised way of not calling it a ballon payment). I could see a 5/30 ARM that adjusts once ever 5 years however. (With a years warning on the increase by telling folks at 4 years what the current estimate of the new rate is)

  8. Percy

    I could not retrieve this item today on this blog by going back to August posts (but only by Goggling David Dayen and the topic). I hope there is nothing sinister about why I can’t get to it on the blog. Anyway, to repeat here in the right place what I now have under another post by Mr. Dayen on 8/28/13, my comment (typos corrected) is:

    August 31, 2013 at 11:57 am

    This is a late comment on David Dayen’s piece on the proposed Risk Retention Rules for lending (8/29/13 of this blog),a draft of which uncomfortably disappeared just as I was about to put it up, but lost, to my disappointment, when the Dayen piece was moved to “old news.” That piece is very much worth reading and contains a link to the joint agency release proposing the new rules — rules that should, but I fear will not (because they are so long, so boring, and so hard to take in), evoke general outrage. The piece articulately criticizes the new definition of a “QRM,” which type of loan would be exempt from the “skin in the game” measures and attendant creditworthiness requirements otherwise applicable to home and commercial loans. It also praises, as I do, SEC Commissioner Gallagher’s excellent dissent from the proposals (which can be found only separately on the SEC’s site because not published with the offending risk retention rules release itself). The points I meant to make, in summary, were these. First, the multi-agency QRM definition will reignite the practice of issuing low quality loans, meant to be stopped by Section 941 of the Dodd-Frank Act; swallow whole the underlying risk retention idea; and dilute the stiff qualifying principles otherwise required for home and commercial lending. (The discussion of QRM can be found buried in the tediously long, multi-agency release at about page 248, as I recall.) Second, the reasons offered for putting forward this bad QRM idea bear an uncanny and uncomfortable resemblance to the diffuse, unpersuasive, attention-deflecting, “no-one-was-to blame” reasons for the financial crisis offered by the majority in the Majority Report of the Financial Crisis Inquiry Commission two years ago. These, you will recall, were debunked convincingly by Peter Wallison in his own dissent from that thing. (Wallison offers a much more convincing, if politically unpalatable, alternative based on governmental interference with sound lending, resulting predictably in a great, costly, and frightening mess.) The multi-agency joint risk retention rules, if adopted as proposed, will plunge us once again into unsound lending — lending to those too stupid to know they cannot afford the loan and to risk-taking speculators. These loans again will be mixed with others in securitized pools offered to investors, all this to the delight of real estate agents, banks, and politicians everywhere. Haven’t we been here before? Do we learn nothing? I meant to conclude my lost comment, and do this one, with “Happy Days Are Here Again!”

    Read more at http://www.nakedcapitalism.com/2013/08/44836.html#xjdU14VpTlx8cWd1.99

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