Reining in the Regulators

There's debate brewing over what loans to exempt from a lender risk-retention requirement.

February 1, 2011

When lawmakers were hammering out major Wall Street reform legislation last year, one of the key debates was over a skin-in-the-game provision for residential mortgage lenders. The bill called for lenders to align their interests with those of borrowers and investors by retaining on their books at least 5 percent of the value of the mortgage loans they originate. With 5 percent of their own money at stake, the thinking went, lenders wouldn’t be quick to make loans that weren’t in the borrower’s interest.

The NATIONAL ASSOCIATION OF REALTORS® supported the intent of the idea but wanted to be sure the requirement didn’t choke off the availability of safe, affordable financing. So NAR sought and won an exemption for conventional residential mortgage loans—the kind of loans that were never considered a systemic risk to the economy.

But now, as regulators write the rules for the Wall Street reform law, there are questions about whether the hard-won exemption for so-called "qualified residential mortgages" will be as effective at keeping markets liquid. That’s because regulators are considering narrowing the definition of these loans to include only those that exceed the minimum down payment and other standards imposed by Fannie Mae and Freddie Mac in the conventional market and by the FHA, VA, and USDA in the government market.

FDIC Chairman Sheila Bair expressed regulators’ tough stance in public statements last year. "If [there are] good, strong lending standards that the new mortgages adhere to going into the securitization pools, we won’t have to have the 5 percent," Bair said in an interview with CNBC in October.

It’s not clear exactly what the stronger standards might include, but some industry analysts say regu­lators are taking seriously the idea of requiring at least a 20 percent down payment for so-called qualified residential mortgages, even if loans with lesser down payments have mortgage insurance.

And it’s not just regulators who are thinking in these terms. Wells Fargo in December came out with a statement supporting the idea of a minimum 30 percent down payment for qualified residential mortgages that are eligible for the exemption. "Risk retention is a good idea," John Gibbons, an executive vice president with Wells Fargo Home Mortgage, said in a Dec. 14 Financial Times article about this proposal.

In addition to NAR, there are other groups who want to see the exemption applied more broadly. Many other lenders and the American Bankers Association have said the exemption should apply to all plain-vanilla conventional and government-backed loans being underwritten today.

In a letter in December to the six banking regulators, NAR President Ron Phipps said defining a qualified residential mortgage as something more than what’s required by the secondary mortgage market entities and government backers would make financing, already too hard to get for even creditworthy borrowers, too costly. "Many borrowers would simply be forced to pay much higher rates and fees for safe loans that nevertheless did not meet too narrow QRM criteria," he said.

Regulators could come out with their proposed rules this month. Depending on what those rules say, NAR could be pressing hard for changes.

"Fannie Mae, Freddie Mac, the FHA, and the others already have good, sound lending standards," says J. Lennox Scott, head of the Pacific Northwest regional brokerage John L. Scott Real Estate, based in Seattle. "These loans are not the problem, and they should not have the retained risk premium."

Robert Freedman

Robert Freedman is the former director of multimedia communications at NAR.