Regulators ease mortgage securities rules

Mortgage securities have caused a lot of problems in the past, but regulators don’t seem to be too worried about today’s lending standards. The new proposed rules requiring banks to hold 5 percent of the credit risk on mortgage bonds has a broad exemption.

Here’s the story from the Wall Street Journal:

Federal regulators retreated from a proposal that would have toughened rules for the mortgage securities market, a defeat for advocates of tighter standards and a victory for the housing lobby.

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.

The decision by regulators represented a major concession to the real-estate industry and consumer groups that had worried the 5% requirement would hurt the housing recovery by limiting credit.

Bloomberg reported that the new guidance aligned rules to protect investors with those covering more risky home loans. It also points out that loans backed by Freddie Mac and Fannie Mae would be exempt from the retention requirements:

The draft would align the qualified residential mortgage rule, designed to protect investors, with similarly named guidance governing risky home lending: the qualified mortgage, or QM rule, designed to protect borrowers. That regulation, issued by the Consumer Financial Protection Bureau in January, contains no down payment requirement. It offers legal protections to banks that make loans defined by the rule as non-abusive.

Both rules, mandated by the 2010 Dodd-Frank Act, will reshape who can lend and who can borrow because banks will probably make only those loans that conform to the new standards.

The new plan marks a victory for a coalition of Realtors, bankers and consumer advocates who lobbied for the two rules to be aligned.

“We’re very thrilled because we think it’s a victory for home buyers and future homeownership in the country,” Gary Thomas, president of the National Organization of Realtors, said in a telephone interview.

Loans guaranteed by Fannie Mae and Freddie Mac, the mortgage financiers operating under U.S. conservatorship, would automatically be exempt from risk-retention requirements for as long as the companies remain in federal control. The two companies, which would be eliminated under proposals in Congress, currently guarantee about two-thirds of all new home loans.

Daniel M. Gallagher, a Republican member of the Securities and Exchange Commission, one of the regulators issuing the proposal, said in a written dissent today that the new standards were so lax that they would allow lenders to escape retaining risk on many loans that will probably default.

Reuters reported that a main concern for regulators was to not suppress the housing recovery:

Lawmakers also intend to overhaul U.S. housing finance in response to the market collapse that forced the 2008 takeover of Fannie Mae and Freddie Mac, a process that could take years.

The risk retention rules are aimed at preventing banks from writing risky loans with impunity. In the years leading up to the crisis, banks used shoddy underwriting standards under the assumption that they could sell loans off to securitizers and avoid harm if the borrowers defaulted.

Dodd-Frank called for lenders and bond issuers to hold 5 percent of those loans on their books, giving them more incentive to make better loans.

The law called for some mortgages to be exempt but did not require a downpayment. When regulators decided “qualified residential mortgages” would need a 20 percent downpayment, critics said that could hamper credit and hurt the economy.

“The reaction was fairly extraordinary and unanimous from consumer advocates, industry experts and housing stakeholders – all aligned around the fact that the rule as proposed could have had an adverse impact on the housing recovery,” said David Stevens, chief executive of the Mortgage Bankers Association.

No matter what you think of the new rules, it does seem a bit suspect that those guaranteed by the largest federal agencies are suspect. These stories are also complicated and don’t actually explain the implications for banks and investors well. If banks don’t have to hold part of the risk on their books, then that frees up more capital to lend, which is a good thing for the economy. But as we’ve already seen, too much of a good thing isn’t always what’s best.