Opponents of risk retention are beginning to sing the praises of transparency as an alternative to requiring securitizers of mortgage-backed securities to have "skin in the game."
At a recent congressional hearing, several witnesses testified that requiring securitizers to retain 5% of the credit risk would increase the cost of mortgage credit. However, transparency—through timely and accurate disclosures of loan level data and standardized representations and warranties—would protect investors and reduce the cost of credit for borrowers.
This was music to the ears of Rep. Patrick McHenry, R-N.C., who chairs the House Oversight and Government Reform Subcommittee on TARP, Financial Services and Bailouts. "The most market-based tool to address this problem would be transparency," McHenry said at a subcommittee hearing.
McHenry is concerned the risk retention proposal issued by federal regulators will make it harder for families to obtain an affordable mortgage if they can't come up with a 20% downpayment. The subcommittee chairman also expressed concerns that the risk retention rule favors large well-capitalized banks over smaller institutions.
During the hearing, the witnesses agreed with the North Carolina congressman's concerns about risk retention. However, they also made it clear that transparency in the mortgage market is not easily achievable and could take years.
Former House Financial Services Committee chairman Barney Frank, D-Mass., pushed for risk retention in the Dodd-Frank Act to hold securitizers accountable for the bad loans they packaged into MBS. Supporters of risk retention claim it will lead to better underwriting and steer issuers away from securitizing risky mortgages that precipitated the 2008 financial crisis.
Anthony Saunders, a real estate professor at George Mason University, told the subcommittee that strengthened representations and warranties are the "ultimate skin in the game." If a bank misleads investors, "they can sue to get their money back," the professor said.
"You will see a different market going forward” if there is enforcement of representations and warranties along with other laws and regulations on the books, he said.
Joshua Rosner, managing director at the independent research firm Graham Fisher & Co., said the key to transparency is standardization of pooling, servicing and R&W agreements that spell out the rights and obligations of the various parties.
This is one management item that Fannie Mae and Freddie Mac handled well, he noted. The GSEs used standard contracts that were identical for each MBS deal. But in the private-label MBS market there were 300 different pooling and servicing agreements with different “reps and warranties.” When investors got spooked by rising defaults on subprime loans, they didn’t have time to read the documents. There was a stampede to sell and the "housing finance system came to a grinding halt,” Rosner said.
"Amazingly, three years after the crisis, there is still no single standard accounting or legal definition of either delinquency or default," he said.
The Federal Housing Finance Agency launched a project earlier this month to standardize the mortgage data used by the GSEs. “The two-year project will produce a uniform set of definitions and means of reporting data—so regardless of who the originator or the securitizer is, the data will be standardized," said FHFA acting director Edward DeMarco.
The GSE regulator agreed with McHenry that transparency is essential to bringing private capital back to the mortgage market. "This uniform data program is actually the foundation for this transparency," DeMarco said.
Janneke Radcliffe, executive director of the University of North Carolina Center for Community Capital, argued that transparency and risk retention are complementary.
"Transparency is only part of the solution," she testified. Risk retention is better at aligning the interests of borrowers and investors with the MBS issuer. "For no one to take any risk on the loans is not going to help," she said.
Radcliffe also took issue with the federal regulators' proposal to place a 20% downpayment requirement on "qualified residential mortgages" that are exempt from risk retention.
"Our research suggests that a broad QRM definition will better balance the value of risk retention with the goal of reducing the government role in the mortgage market from current levels and projecting the taxpayer over the long run," she said.
Meanwhile, 15 industry and consumer groups are urging federal regulators to extend the June 10 comment period on the risk retention proposal.
The 400-page proposal includes 150 questions, which will require data development and analysis, the 15 groups say in a letter to the six regulatory agencies working on the risk retention rule. “For this and other reasons, we respectfully but strongly request” an extension of the comment period until July 22.
The signers, including the American Bankers Association and Center of Responsible Lending, also are pressing regulators to hold a series of regional hearings to solicit public input on the proposal.
The Federal Reserve Board and Department of Housing and Urban Development have held public hearings during other important rulemakings. “We believe such an approach is clearly warranted here as well,” the trade groups said.
Separately, American Securitization Forum executive director Tom Deutsch told the Senate Banking Committee last week that one provision in the risk retention proposal could shut down large down swaths of the residential and commercial MBS market.
The regulators added a "premium recapture" provision to the proposal to prevent an erosion of the 5% risk retention requirement. If finalized, this provision would require securitizers to place any excess spread received at closing into a premium cash recapture account, which would be used to absorb first losses on the underlying mortgages.
Currently, securitizers pocket this excess spread. "This provision would ultimately make the securitization business a not-for-profit business," Deutsch testified.
Considering the complexity of the proposed rule and the thousands of pages of expected comments, regulators should solicit another round of comments before finalizing the risk retention, he said. "They should re-propose the rule to ensure they get it right," the ASF executive director said.
