Stern: On Bank Reform, Risk Retention Harms Competition
In an effort to avoid another meltdown of the mortgage market, the U.S. Senate is currently considering legislation to reform the regulatory structure of the banking and finance industry.
Buried inside the staggering 1,136 pages of the bill is a series of “risk retention” provisions which would require that mortgage companies retain a portion of the risk on each loan they write and sell into the secondary market. The belief is that if lenders are forced to retain risk on the loans they sell, they will be less likely to put borrowers into loans they can’t afford, thus preventing future mortgage market meltdowns.
On its face, increasing the “skin in the game” sounds appealing, but the fact is that it would have a devastating impact on mortgage lenders and, in turn, mortgage rates, cost and availability.
By setting risk retention requirements at each step of the process, the very legislation intended to avoid a housing crisis could drastically reduce liquidity and cripple the ability of the secondary mortgage market to deliver hundreds of billions of dollars of low cost mortgage credit needed each year.
Consider this: If a community lender closes $100 million of loans each year, and under the proposed legislation, is required to retain 10 percent of the loan amount, after only five years, it will be required to have $50 million in cash on hand – half of its annual loan volume.
This would be impossible for most lenders, and would surely cause many lenders to go out of business. The larger companies that remained would be forced to dramatically increase margins, resulting in skyrocketing rates for consumers.
The impact on local independent lenders cannot be overstated, as they currently account for more than 40 percent of all mortgage loans.
These companies rely heavily on their ability to sell these loans into the secondary market and are not structured to retain layers of credit risk. The resulting market consolidation would lead to the consolidation of the mortgage marketplace into a handful of the largest institutions — an ironic result for legislation intended to mitigate “too big to fail” concerns.
In addition to the negative impact of risk retention requirements, consider the following:
- Risk retention requirements are unnecessary, as lenders already retain the risk of their loans going bad. When a lender sells a loan to investors, it has to comply with standards set by the investor. If the loan does not meet the standards, the lender has to buy the loan back.
- Mortgage companies follow the underwriting guidelines that are developed by the investors on Wall Street, whose loose underwriting guidelines and risky products created the mortgage problems.
- Non-depository mortgage lenders are already heavily regulated by federal laws, such as the Truth in Lending Act, the Home Ownership and Equity Protection Act, the Fair Credit Reporting Act and the Real Estate Settlement Procedures Act.
The Federal Reserve, HUD, and other federal agencies provide oversight. Most states have enacted their own regulatory legislation, and each state has its own regulator, which conducts comprehensive audits of its licensed non-depository mortgage lenders’ practices and provides a mechanism for handling consumer complaints. In addition, state Attorney General offices provide oversight and enforcement. Non-depository lenders are also scrutinized by consumer watchdog and advocacy groups, plaintiff’s attorneys and consumer-based websites. Non-depositories are regulated and held accountable.
Since the problems in the mortgage industry began to surface in 2007, several changes have taken place addressing many of the issues policymakers are concerned about. For example, the sub-prime and non-traditional loans (e.g. no documentation loans) no longer exist and underwriting standards on all loan types are considerably tougher.
The heightened desire by policy makers to fix the complicated mortgage industry problem via risk retention requirements carries significant risk — namely the risk that the “solution” of risk retention would make the problem worse. Simply put, the risk retention provisions contained in proposed legislation are overreaching and will have a devastating impact on thousands of mortgage companies and the consumers who rely on them.
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Scott Stern is the President of Lenders One, an alliance of 150 of the nation's leading independent mortgage bankers. Collectively, Lenders One members comprise the third largest source of retail mortgage lending in the US, originating more than $60 billion in mortgage loans to families in every state.