The anti-risk-retention lobby’s bizarre logic

By Felix Salmon
June 2, 2011
John Carney doesn't go far enough in his attack on what he calls the Home Ownership Mo

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John Carney doesn’t go far enough in his attack on what he calls the Home Ownership Mob. Whenever you see the Mortgage Bankers Association getting into bed with the Center for Responsible Lending, you know something funny is amiss, and in this case it’s their joint opposition to the bit of Dodd-Frank which says that if banks securitize mortgages, they have to keep a modest 5% slice on their own balance sheet.

So far so sensible, right? What can there possibly be to object to there? Well, it turns out that there’s an exemption to that rule. If the mortgages being securitized count as QRMs — that is, “qualified residential mortgages” — then the banks don’t need to keep 5% for themselves, and can go ahead and securitize the whole thing.

The Home Ownership Mob has taken QRM as a rallying cry, and has decided that far from being the exception to the rule, QRM is the new benchmark which all Americans should aspire to. They have a brochure, and a detailed presentation, showing that most mortgages will fail to qualify for the QRM exemption — which of course is exactly the point. But then they go much further: MBA president David Stevens says that failing to throw many more mortgages into the QRM bucket will “withhold credit from tens of thousands of qualified borrowers”.

But the fact is that Stevens hasn’t the foggiest notion whether or not that’s true. The rhetoric of the Home Ownership Mob is entirely based on the unexamined premise that if banks can sell off 100% of their loans, rather than just 95%, then the loan rates will be cheaper.

But there’s no good reason to believe that to be the case. Will banks be able to sell that last 5% of the loan for more than they can book it for on their own balance sheet? I can’t see why they would — and if they can’t, then QRM loans wouldn’t be any cheaper than any other loans. More to the point, investors, burned during the financial crisis by the originate-to-distribute business model, are going to require a risk premium on any securitized paper where the underwriting bank doesn’t retain at least 5%. For that reason, too, it seems reasonable to believe that QRM loans would if anything be more expensive than other loans, rather than cheaper.

And most importantly, we’re talking about 5% of the loan here. Let’s say that the Home Ownership Mob is right, and that banks will require a premium of say 15bp to hold loans on their own balance sheet rather than selling them off in the market. If the market rate is 4.9%, the bank is going to require 5.05% to keep its own bit of the loan in-house.

Now say you’re buying a typical $250,000 home, with 10% down, and you’re getting a standard 30-year fixed-rate mortgage. If the whole thing was sold off into the market, then the monthly payments on a $225,000 mortgage at 4.9% are $1,194.14. On the other hand, suppose that just 95% of the mortgage was sold off into the market at 4.9%, and the other 5% was retained in-house at 5.05%. In that case, you end up paying a whopping 4.9075% instead, overall. And your monthly mortgage payments soar to $1,195.16 — a whole dollar more! That’s more than twelve dollars a year!

That buck a month, of course, is money well spent: it reduces the amount of fraud and tail risk in the system, and forces banks to be honest about their underwriting. Meanwhile, the Home Ownership Mob is trying to return us all to the bad old days when banks felt no need to actually own any part of the mortgages they were underwriting.

It’s becoming very obvious that the QRM, far from being an attempt to push banks to improve their underwriting standards, is in fact going to act as a way for the banking lobby — helped by its friends at the Center for Responsible Lending — to try to get around the rules requiring them to hold on to one dollar of every twenty that they lend out. Let’s hope they fail.


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If the new regulation doesn’t “withhold credit” from anyone who would otherwise get it, it isn’t working.

Posted by dWj | Report as abusive

You could go a lot further. Say the cost of that 5% is 10% not 5.05%. An extra 5% interest on 5% of the loan would be $47/month. Granted, a lot more than $1/mo, but still not a prohibitive cost.

No bank would need 10% to hold the loan either…

Posted by winstongator | Report as abusive

Is 5% enough to prevent the mortgage mess from reoccurring?

I thought the ABS originators made enough money off each issue to simply write-off the 5% they’d end up holding.

I could imagine them holding back either the *best* 5%, or the *worst* 5% depending on whether the market was chasing safety or yield.

Posted by AndyGarbage98 | Report as abusive

I can’t recall exactly who pointed this out, it may have been Elizabeth Warren, but mortgage brokers and securitizers didn’t want mortgages insured because, on average, it opened up as much as 95bp in profit on a mortgage.

Hey, it’s all about booking a commission today isn’t it, and forget you once it’s in their checking account?

Bring back some form of insurable interest. Lending banks need to have some skin in the game up front, if for no other reason than the next time they collectively screw the pooch, that’s 5% taxpayers don’t have to insure.

Posted by Beezer | Report as abusive

The idea of keeping skin in the game may, of course, backfire because banks will continue to make loans that go bad and they’ll now have more of that on their books. Just pointing out it seems impossible to craft to a genuinely effective system. If I were a bank, I’d be more interested in what I can do with the value on my books. Can it be used to offset other capital requirements? Can its value be used to make my books look better than they are?

Posted by jomiku | Report as abusive

5% retention is a very small amount. The old standard was closer to 20-25% being kept “on the books,” just because of the cashflow issues of securitized mortgages (most especially–as has become a problem now–that the servicer continues to make payments as if they came in on mortgages that are slightly delinquent).

Posted by klhoughton | Report as abusive

What jomiku said. Felix’s unexamined premise is that if the 5% retention rule goes into effect, unchanged, over the bankster’s objections, that they’ll necessarily be “forced to be honest about their underwriting”. I’m not nearly as sanguine.

The way to force better underwriting is to do so directly. Regulate that area of activity with clear rules and standards, backed up by random, intrusive audits. If greedy banksters with their eye on this quarters bonus check are found to have violated the standards, then file civil lawsuits and/or criminal actions against them as individuals.

Posted by Strych09 | Report as abusive