The new risk retention rules proposed by regulators today are far more stringent than major banks had hoped they would be.
The FDIC today revealed a new set of rules that would implement a provision of the Dodd-Frank financial reform law mandating that banks maintain at least 5 percent of the risk of mortgage securities they package.
Banks had pushed for regulators to adopt an expansive definition of the “qualified residential mortgage” that would be exempt from the requirement.
Regulators rejected the most expansive versions of a qualified residential mortgage, which would have exempted virtually every mortgage that banks are now making. Instead, only very conservative, traditional mortgages will qualify.
The purpose of the risk-retention provision of Dodd-Frank was to ensure that banks have “skin in the game” when they securitize mortgages—with the hopes that this will incentivize them to police the quality of mortgages that get bundled and sold to investors.
Many lawmakers believe that the ability of banks to distribute the risk of mortgages to investors led to loose underwriting, bad loans, and contributed to the severity of the financial crisis.
The rule proposed today would only exempt securities entirely composed of very high quality home loans. The tests for quality include a requirement for a 20 percent down-payment, a maximum loan to value ratio of 80 percent, a very strong borrower credit history, and a low ratio of borrower debt-to-income. No interest-only loans are allowed, and adjustable-rate mortgages are strictly limited.
The rules are so strict, in fact, that a single loan to a homebuyer who had missed a single credit card payment in the past two years could disqualify a bundle of thousands of mortgages. Such loans would have to be excluded from the securitization.
Bank lobbyists argue that these rules will constrict mortgage lending, make non-qualifying mortgages more expensive, prevent a revival of the mortgage securitization market, and hurt the housing market.
Sheila Bair, the chairman of the Federal Deposit Insurance Corporation, believes that the rules will actually help securitization by instilling investor confidencein the quality of the underlying loans.
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