The anti-risk-retention lobby’s bizarre logic

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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