Regulators Back Away From Tougher Mortgage Rules

From: The Wall Street Journal

A Win for Housing Lobby, But Critics Warn of Toxic Loans

By ALAN ZIBEL  And NICK TIMIRAOS

WASHINGTON—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 a broad exemption: it would not apply to securities containing most mortgages made today. Lenders have sharply tightened lending standards since the 2008 financial crisis, so most home loans made are of relatively low risk. 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.

The proposed rules would still severely limit the types of toxic loan products, such as loans with low “teaser” rates that reset at higher levels, that contributed to the financial crisis. The rules effectively prohibit “a number of the problematic practices that contributed to the recent mortgage crisis,” said Martin Gruenberg, the FDIC’s chairman.

The move was a disappointment for proponents of tighter rules. They had said that during the housing boom, lenders made too many risky loans without regard for borrowers’ ability to repay them because the lenders could quickly resell the loans to Wall Street. They said lenders would be more careful only if they had to keep a chunk of the loans on their books, giving them more to lose if borrowers default.

Some regulators agreed with that criticism. SEC Commissioner Daniel Gallagher issued a 3,000-word dissent, saying the proposed exemption was “unrealistic and dangerously broad” and would impede the development of securitized lending with risk retention.

“We are delivering exactly the type of implicit endorsement that led to the massive expansion of subprime” mortgage-backed securities before the crisis, he wrote in his dissent.

The proposal would affect the market for mortgage-backed securities–pools of loans that are packaged by banks and sold to investors. During the crisis, the value of those securities dropped as millions of homeowners lost their homes to foreclosure, sending shock waves through the financial system. That market has been slow to recover in the wake of the housing bust, with most securities issued through Fannie Mae, Freddie Mac and other government entities.

The new proposal drops the regulators’ earlier plan to exempt only those loans with at least a 20% down payment. Instead, the new rules largely adopted a separate mortgage definition put forward earlier this year by the Consumer Financial Protection Bureau that outlines steps banks must take to demonstrate that a borrower has the ability to repay a mortgage.

Under the new proposed rules, banks would have to retain 5% of the risk for many of the types of loan products that fed the housing bubble, such as those in which borrowers only make interest payments or allow the principal balance to increase. They also would require banks to ensure that borrowers’ total monthly debt doesn’t exceed 43% of their income.

The new proposal marked a win for a coalition of mortgage lenders, real-estate agents, home builders, civil rights groups and consumer advocates. They formed a group, called the Coalition for Sensible Housing Policy, that lobbied heavily against the tighter rules proposed earlier.

“Adding additional layers of regulation would have contracted credit for first time home buyers and borrowers without large down payments, and prevented private capital from entering the market,” said David Stevens, chief executive of the Mortgage Bankers Association.

Regulators sought comments on the proposal by Oct. 30. They also asked for comment on an alternative definition that would add a 30% down payment to the exemption requirement.

Government officials have grown more concerned in recent months that the combined weight of mortgage regulations could further constrain lending at a time when mortgages are still available only to the most creditworthy borrowers.Earlier this year, the Federal Reserve dropped a separate proposal to require banks to hold more capital for certain mortgages with low down payments.

The change in the risk-retention plan reflects widespread concern that “there is just too much uncertainty around how risk retention would have worked in this already credit-constrained market,” said Jim Parrott, a former White House housing policy official now with the Urban Institute.

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