The risk retention proposal drafted by federal regulators has stirred such widespread opposition—and controversy—that it may take years before it is finally implemented.
Of late, both parties in Congress have been highly critical of the proposal. And in addition, industry and consumer groups are up in arms about the narrow exemption regulators are providing for MBS that can escape the rule’s stringent underwriting requirements.
Opposition is now coming from all sides—and for different reasons, according to Edward Mills, a research analyst at FBR Capital Markets. He expects it will take several years for regulators to craft a final rule. And by statute, the rule cannot go into effect until one year after finalization.
Meanwhile, the comment period on the rule ends June 10. In short, regulators will be deluged with comment letters, which may take several weeks to digest, sort and analyze. "The complexity of the opposition will make it very difficult for a small tweak to the rule one way or another to make it palatable to the various interest groups," Mills and fellow analyst Steve Stelmach say in a FBR Capital Markets report.
"During this time, should opposition continue, we would expect Congress to consider action to change, delay or prevent implementation," according to the two.
Congress passed the risk retention provisions as part of the Dodd-Frank Act of 2010. The rule is designed to encourage strong underwriting and stop the securitization of risky loans by requiring issuers of mortgage-backed securities to retain 5% of the credit risk.
Initially, industry groups were expecting regulators to require safe and sound underwriting standards on a category of loans known as "qualified residential mortgages" that would be exempt from risk retention. But it soon became known that the regulators—led by the Federal Deposit Insurance Corp. and Federal Reserve Board—were moving toward a very narrow QRM exemption.
As proposed, only mortgages with downpayments of 20% could meet the QRM exempt test. Other QRM requirements include strict debt-to-income ratios and no 30-day delinquencies on any obligations at the time of closing.
Industry and consumer groups are now clamoring for the regulators to lower the downpayment to 10% or 5% with a requirement for private mortgage insurance.
Various trade groups are busily talking with congressmen and senators about risk retention, urging them to register their concerns with the regulators.
One risk retention letter circulated by Reps. Brad Sherman, D-Calif., and John Campbell, R-Calif., has garnered the signatures of six other members of the House Financial Services Committee. The sponsors are trying to get more members to sign the letter before it is sent to the regulators.
The letter points out that a 20% downpayment would reduce the availability of affordable mortgage credit to creditworthy borrowers and reduce demand for housing at a time when the housing market is already facing challenges.
"We urge you to revise the proposed rule to reflect the intent of Congress by including prudently underwritten privately insured loans within the QRM definition," the letter says.
At a recent Senate Banking Committee hearing, Sen. Jeff Merkley, D-Ore., noted that Congress has outlawed predatory lending practices, teaser rates, undocumented loans and steering payments. "We are trying to reclaim the standard amortizing mortgage as a wealth-building instrument," Merkley told housing secretary Shaun Donovan.
"So there is tremendous concern about the possibility of the QRM and 20% downpayment requirement," the Oregon senator said. It will impose an "unreasonable disadvantage" on potential homebuyers who are in no position to provide a 20% downpayment, he noted.
Donovan said that the downpayment is only one element in evaluating risk and loan performance. He pointed out the proposed rule does seek comments on an alternative that would only require a 10% downpayment. (Donovan was instrumental in getting the 10% alternative included in the proposed rule.)
FDIC chairman Sheila Bair is the leading force for the high downpayment requirement. However, her term at the FDIC ends in June. FDIC vice chairman Martin Gruenberg is expected to replace her. Some industry officials believe Gruenberg may be supportive of a broader QRM definition with a lower downpayment.
"With her departure, it may be easier for the regulators to have a clearly defined role of private mortgage insurance and a less strict rule overall," the FBR analysts say.
