Just as the Obama administration seeks to reduce the government’s role in housing, reliance on Fannie Mae and Freddie Mac may be reinforced by a rule growing out of the Dodd-Frank regulatory overhaul.
The Federal Deposit Insurance Corp. and the Federal Reserve yesterday released for public comment a proposed rule requiring lenders and bond issuers to keep a stake in some home loans they securitize.
The proposal would require securitizers to retain as much as 5 percent of an issue if it is based on mortgages whose borrowers have imperfect credit and make down payments of less than 20 percent.
The rule includes a key exemption from those standards: Lenders could avoid keeping a share in riskier mortgages if they get them insured by federal agencies or sell them to Fannie Mae and Freddie Mac, the government-sponsored enterprises now under U.S. conservatorship.
The GSEs and the Federal Housing Administration own or insure more than 96 percent of home loans now being originated. Making their loans exempt from the rule would maintain the government as the main holder of mortgage-market risk, said Karen Shaw Petrou, managing partner of Federal Financial Analytics in Washington.
“If finalized as proposed, which we doubt, the regulation would memorialize U.S. mortgage finance in the hands of Fannie, Freddie and the FHA,” Petrou said. “So much for all the talk about bringing back private capital.”
If the housing market recovers and private capital becomes available for mortgages, the rule’s biggest beneficiaries could be the largest lenders, including Wells Fargo & Co. and JPMorgan Chase & Co. Large institutions can more easily afford to hold loans on their books. Community banks, which generally need to sell their loans in order to keep originating new mortgages, would find it harder to meet the new standard if they couldn’t get government backing for riskier loans.
The risk-retention rule is mandated by the 2010 Dodd-Frank regulatory overhaul and is designed to prevent the shoddy underwriting practices that fueled the housing bubble.
During the debate on the Dodd-Frank bill last year, some housing interest groups applauded the amendment allowing exceptions for qualified residential mortgages, or QRMs, assuming that regulators would carve out many if not most home loans. Some said today they weren’t expecting the regulators to set such a high bar. Senator Kay Hagan, a North Carolina Democrat who sponsored the amendment, said regulators went too far when they defined a qualified mortgage as one with a 20 percent down payment.
The rule reflects the wishes of some of the largest banks, which lobbied for the 20 percent because it would have relatively little effect on their ability to originate mortgages. The Mortgage Bankers Association and small banks had been pushing for a more flexible down-payment threshold.
The proposed rule was released as the Obama administration and Congress are considering plans to wind down Fannie Mae and Freddie Mac, and possibly replace them with a different entity. The exemption would continue under a new government mortgage entity as long as there was a federal guarantee.
The Securities and Exchange Commission, the Federal Housing Finance Agency and other regulators are preparing to consider the risk-retention rule this week. Battle lines already are forming among participants in the mortgage market.
Groups including small banks expressed relief that the rule wouldn’t prevent them from continuing to sell most of their loans to government-backed agencies.
“We’re very glad to see that the regulators are proposing to exempt loans sold to Fannie and Freddie,” said Ann M. Grochala, vice president of lending and accounting policy at the Independent Community Bankers of America. “In that regard, it should have a minimal impact on community banks.”
Jerry Howard, president of the Washington-based National Association of Homebuilders, questioned whether Fannie Mae and Freddie Mac would have the capacity to finance any more mortgages. Loan limits are set to be reduced in October and the administration and congressional Republicans are seeking to cut the companies’ portfolios, meaning they won’t be able to hold as much debt.
“The ability of the GSEs to continue to do their jobs is going to be greatly impeded,” he said.
Beyond the exemption for loans backed by the government, analysts and stakeholders said, requiring a 20 percent down payment for easily securitizable loans could have a deep impact on the housing market.
“Its impact on access to homeownership would be hard to overestimate,” said Susan Wachter, professor of financial management at the Wharton School at the University of Pennsylvania.
Many mortgages now being originated don’t meet the 20 percent down-payment standard. More than a fifth of the nearly 464,000 loans issued in 2010 had down payments of less than 15 percent, according to Corelogic Inc., a data company based in Santa Ana, California.
Redwood Trust Inc., a Mill Valley, California, real estate investment trust, is the only company since 2007 to offer non-government backed mortgage debt. In its two offerings, totaling about $500 million, the company retained five percent of the risk and its home loans averaged 40 percent cash down payments, according to company prospectuses.
Regulators designed the new rule “around mortgages in the Redwood trusts. Do the math. You’ll see how many mortgages will get done under QRM,” said Glen Corso, managing director of the Community Mortgage Banking Project, a coalition of smaller lenders.