Giving Investment Banks Another Pass?
Politics and mortgage lending are making for some strange bedfellows and, as usual, the biggest winners will be the big banks. In fact, when all is said and done and Dodd Frank is fully implemented it may end up that we love the sin of reckless mortgage lending; it’s just the sinners — those arrogant investment banks that brought us to the brink of a depression — that we don’t like.
First a little trip down memory lane. In the aftermath of the Mortgage Meltdown it seemed that everyone agreed that we had to do something about investment banks that were so anxious to cobble together mortgage-backed securities (basically bonds comprised of mortgages) that originators could sell them just about anything. The investment banks marketed these ticking time bombs which exploded when people defaulted on their mortgages. The solution was to mandate that securitizers have skin in the game. If they wanted to pawn off mortgages to investors then they should bear some risk.
As you all should know by now, Dodd-Frank requires lenders to underwrite to Ability to Repay Standards (ATR) . A special category of Qualified Mortgages (QM) gives lenders whose loans meet certain specific standards protection from lawsuits and foreclosure defenses. One acronym I haven’t talked about is the Qualified Residential Mortgage. Under Dodd-Frank, securitizers that purchase mortgages that aren’t Qualified Residential Mortgages (QRM) are required to keep 5% of the investment. These regulations are slated to take effect in final form in January of 2014.
Financial regulators, not including the CFPB (what a coincidence), are charged with defining what a QRM mortgage is. The first draft they came out with was surprisingly strict. For example, to qualify as a QRM mortgage borrowers would have to put 20% down on their mortgage loans and total monthly debt to income ratios could not exceed 36%.
This is where the strange bedfellows come in. Groups ranging from the National Community Reinvestment Coalition to the American Bankers Association have argued correctly that if these regulations take effect, they might devastate the home buying market. They argue that the QRM standards will become the de facto underwriting standards for lenders wishing to sell mortgages to the secondary market, so many qualified borrowers will be precluded from getting a house. It appears that regulators have heard the message loud and clear.
According to the Wall Street Journal, regulators are considering final regulations that dramatically scale back the QRM requirements. However, in one final twist, since Dodd-Frank requires that QRM standards cannot be looser than the CFPB’s lending standards for qualified mortgages, my guess is that the regulators will take several hundred pages to explain that if a mortgage is good enough for the CFPB, it’s good enough to qualify as a QRM mortgage.
This is probably the most logical solution and the safest way to protect the housing industry, but it does mean that virtually every major component of Dodd-Frank meant to curtail the excesses of the big banks has either been gutted or delayed by the regulators. If you believe in moral hazard, the idea that if you don’t hold people accountable for their misconduct you are effectively telling them that they’ve done nothing wrong, then this is yet another troubling example of the power that finance has come to hold over the American economy. This may not seem like a big deal, but think about all the regulations that credit unions are struggling to implement and ask yourself is the consumer really any safer today than he or she was five years ago.