U.S. home finance in limbo a year after Dodd-Frank

July 18, 2011

By Agnes T. Crane
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

A year after the Dodd-Frank Act, the $10.5 trillion U.S. mortgage market is still in limbo. One big reason is that the law scarcely touches Fannie Mae, Freddie Mac and the Federal Housing Authority — the collection of government-run lenders that these days dominate the home loan market.

The consequences of lax mortgage lending were central to the 2008 financial crisis that Dodd-Frank was intended to make unrepeatable. But rather than tackle the huge and highly political issue of Fannie, Freddie and the FHA, the law is narrowly focused on one part of the market. That’s the private-label mortgage-backed securities area, dormant since the crisis but the source of more than $3 trillion worth of mortgage bonds between 2002 and 2007.

The most significant new rule could require private-sector financial institutions to hold at least 5 percent of securities they create by repackaging loans. Giving them some incentive to ensure the securities are creditworthy isn’t a bad idea. But it reinforces the notion that the private sector is at a competitive disadvantage to government lenders if and when it returns to the MBS business. That’s because Fannie, Freddie and other government agencies would be exempt from this requirement logically so, since their credit, which stands behind their mortgage securities, is in turn backed by Uncle Sam’s.

The risk retention rule plays into another Dodd-Frank initiative: the creation of new standards for safe-as-houses home loans known as qualified residential mortgages. QRMs, in which the proposal is that homeowners must put 20 percent down, among other criteria, would be exempt from risk retention requirements. Banks, in addition to real estate lobbyists and consumer groups, want the standards to be looser since mortgages that don’t qualify could be costlier, by up to a percentage point on interest by one estimate. That hardly seems catastrophic for borrowers when 30-year mortgage rates are as low as 4.5 percent. But it’s easy to see the banks’ point when federally backed housing agencies sometimes allow homeowners to borrow 96.5 percent of the value of their homes.

In short, the reform effort so far seems to have widened the gap between public and private sector mortgage lending, making it harder for the latter to re-establish itself and entrenching the cost, and risk, to taxpayers from the former. Congress and regulators need to assess housing finance as one market. Until the hulking government mortgage lenders’ future is mapped out, the worthy goals of Dodd-Frank don’t mean much.

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