Making Mortgage-Backed Securities Safer
One of the hard-learned lessons from the global financial bust is that home lenders should not be allowed to pawn off their risk on investors indiscriminately. In a process Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) has decried as "securitization gone wild," banks and others made sloppy loans which, with Wall Street's help, they then diced up and packaged together into a bewildering array of securities. When those mortgages went bad, everyone from U.S. college endowments to European banks took a hit—except, all too often, the institutions that issued the toxic paper.
Lawmakers in Washington want to make sure that doesn't happen again. One seemingly straightforward fix would be requiring mortgage lenders to retain a slice of the loans they write. If they must shoulder some of the risk, lenders will be more discerning about whom they lend to, the thinking goes. The idea also is gaining traction across the Atlantic, where investors were badly stung after gorging on U.S. mortgage securities. At the recent Group of 20 summit in London, the leaders of the world's major economies called for applying the principle worldwide.
A House bill that seeks to crack down on mortgage abuses would require institutions to retain at least a 5% stake in all but the most plain-vanilla home loans. Dodd has voiced support for the concept in the Senate.
Banks and other lenders are wary, however. Retaining pieces of loans will require them to keep more capital on hand to cover potential losses, they say. That, in turn, will reduce the pool of funds available for new lending. What's more, companies that specialize in mortgage lending without taking deposits also may be shut out of the market altogether, as they are poorly capitalized to begin with.
Industry's Proposals to Avert Regulation
The industry's biggest worry, though, is that regulators may require lenders to set aside funds to cover the entire loan, not just the sliver they keep on their books. "We're trying to put the genie back in the bottle and recreate the lending environment of the 1970s," says Diane Casey-Landry, chief operating officer of the American Bankers Assn. "It's not going to work the way the market has evolved."
In fact, forcing banks to put skin in the game may not in itself ward off another debacle. After all, some banks did keep part of the loans they securitized, but profited enough from selling the rest to compensate for any losses that resulted when the underlying mortgages soured. That's why some in the industry are instead pushing for better disclosure, to give those who buy mortgage-backed securities more information about the underlying assets. There's also talk of beefing up protections for investors in the event of fraud or other irregularities in the mortgage origination process. The industry is hoping that these voluntary initiatives will be enough to satisfy policymakers and head off tougher regulations from Washington. "We're all for trying to clean up the parts of the business that went astray," says Christopher R. Dunn, chief operating officer at South Shore Savings Bank in Weymouth, Mass. "I'm concerned about the longer-term unintended consequences [of legislation]."
Congress will conduct hearings on the House bill in coming weeks. Many observers expect the legislation to be tweaked to address at least some of the concerns voiced by lenders. Steven Adamske, spokesman for House Financial Services Committee Chairman Barney Frank (D-Mass.), one of the bill's sponsors, acknowledges that no amount of new rules can protect investors from making bad judgments "when you have a gold-rush mentality." The ultimate goal, he says, is to make sure that mortgage brokers, home lenders, and others can't "instantly absolve themselves of responsibility."