Eye on Washington

Democratic lawmakers want to hold lenders’ and securitizers’ feet to the fire so they won’t originate and sell mortgages that burn consumers and investors.But the mortgage industry fears legislation currently under consideration could stifle a recovery in the private-label securities market, which has been dormant since the credit crisis began.Senate Banking Committee chairman Christopher Dodd, D-Conn., has drafted a bill that would require sellers of mortgage-backed securities to retain 10% of the credit risk."To restore confidence in our markets and encourage investment, we will require companies that sell products such as mortgage-backed securities to keep ‘skin in the game’ so that they won't sell worthless securities to unsuspecting investors," Sen. Dodd said.The 1,100-page bill is designed to revamp regulation of the financial services industry and safely shut down firms that are currently considered "too big to fail."In the securitization section of the bill, the Connecticut senator provides a "total or partial" exemption for government-guaranteed mortgages as well as mortgages purchased and securitized by Fannie Mae and Freddie Mac.The bill carves out government-guaranteed loans and provides flexibility for other exemptions, according to Scott Talbott, the Financial Services Roundtable's top lobbyist.The Securities and Exchange Commission and the federal banking regulators can approve a total or partial risk retention exemption for other MBS and allocate risk retention between securitizers and the lenders.But to issue a private-label MBS, the securitizer would have to make a case for the regulators to reduce the 10% retention requirement."We think 10% is too high as a starting point," Mr. Talbott said. "We think 5% is the right place to start."Independent mortgage bankers also want risk retention reduced to 5%.But Glen Corso, managing director of the Community Mortgage Banking Project, is wary of the exemptions in the Dodd bill.He pointed out that the way securitizers are defined it could "rope in" Ginnie Mae issuers and make them subject to risk retention."We are not 100% convinced that the way it is worded the exemptions will be effective," Mr. Corso said.Back in May, the House of Representatives passed a subprime lending bill (H.R. 1728) that requires lenders selling and securitizing subprime mortgages to retain 5% of the credit risk.House Financial Services Committee chairman Barney Frank, D-Mass., drafted the bill and he wants to attach (H.R. 1728) it to a regulatory legislation his committee is working on.But in drafting a regulatory reform bill, Chairman Frank bumped up the risk retention requirement to 10%. He also excluded the exemptions for government-guaranteed loans and other "qualified mortgages" that industry groups liked in H.R. 1728.This week, the Financial Services Committee resumes markup of its regulatory reform bill. Industry groups are supporting an amendment that will reduce the risk retention requirement to 5%."We want 5% to be the ceiling not the floor," Mr. Talbott said.Industry groups also want exemptions added to the bill. "The amendment will try to reinstate the provisions of H.R. 1728 with regard to qualifying mortgages," Mr. Corso said.American Bankers Association executive vice president Bob Davis is concerned 5% or 10% risk retention will restrict the availability of credit.Banks and other leveraged lenders already hold capital and requiring them to hold more has the "potential to choke the system," Mr. Davis said. "My great fear is that the markets won’t operate with a 10% risk retention requirement because it has to be capitalized by leveraged lenders."The ABA executive said there are a lot of other ways to "instill better discipline and more prudence in the underwriting process."He noted there is recourse as well as representations and warranties that lenders have to provide to investors.In addition, the Federal Reserve Board has strengthened Home Ownership and Equity Protection Act rules to limit prepayment penalties and prevent another subprime lending debacle. Lenders must assess the borrower's ability to repay the loans and fully document the loan under the new HOEPA rules that went into effect Oct. 1.These changes will put the brakes on lenders mass-marketing higher-cost alt-A loans as well as 2/28 and 3/28 subprime adjustable-rate mortgages.Lenders will not be making those "wild high risk" loans again, Mr. Davis said.