Regulators, please don't tear off the QM patch
Last month, the Trump administration proposed legislative and administrative changes that have the potential to dramatically alter the mortgage industry — potentially to the disadvantage of consumers. Chief among these is the Consumer Financial Protection Bureau's announcement of its plans to overhaul key post-crisis mortgage regulations, including ability-to-repay and the exemption to the qualified mortgage rule, better known as the QM patch.
The patch essentially allows lenders to make mortgage loans that otherwise would fall outside of the QM rule, primarily those that exceed the 43% debt-to-income limits. This important exemption, which expands the QM safe harbor, helped ensure robust credit availability while maintaining important consumer protections.
Experts predict that anywhere from 10%-20% of the loans made now would not be originated if the patch is completely repealed. According to the Urban Institute, as of 2018, roughly 25%-29% of the purchase loans guaranteed by the government-sponsored enterprises had a DTI above 43%.
This has aligned consumer advocates and industry executives who worry about the prospects for market dislocation if the patch disappears. Writing as the CEO of one of the largest independent lenders, we are very concerned about the immediate impact of losing the QM patch, which will certainly result in substantially reduced lending volumes and access to credit for borrowers that don't fit under the 43% DTI test.
But while the impact to the consumer may be especially burdensome, the proposed reforms will also result in significant market shifts that may further entrench large money center banks. The financial regulators managing this process have stated that they want to “level the playing field” when it comes to mortgage originations between the private sector and government.
It is important to understand, however, that the GSEs today serve to provide an alternative to the considerable market power of the large banks. The ability to turn to the GSEs on competitive terms allows community financial institutions and independent mortgage banks to access the secondary market without a large bank intermediary. This market access provides the consumer with a more affordable and competitive mortgage rate than would be available in the absence of this secondary market. Limiting the activities of Fannie Mae and Freddie Mac will only increase the considerable market power of the top-five money center banks.
If the QM patch is reformed or eliminated, industry analysts expect significant mortgage origination flow to shift from the GSEs to the private-label securitization market. A big part of the reason for concern about this shift is that private investors may not be prepared, or have the wherewithal, to step in to replace the GSEs. Although the market for non-GSE loans is slowly growing, investors remain very cautious about taking risk on loans that are outside of the QM legal safe harbor contained in the Dodd-Frank law.
This shift will result in an increased market presence for large banks. Community financial institutions and independent mortgage banks will have to turn to them for secondary market access and liquidity previously provided by the GSEs. This will not only increase concentration risk among those large banks, but could result in increased transaction costs, which will be largely borne by consumers.
There are nine senators, including Sherrod Brown of Ohio, the top Democrat on the Banking Committee, and presidential candidate Elizabeth Warren, D-Mass., who are concerned about the CFPB's possible plans to eliminate both the QM rule and the ATR standard. They called on the CFPB to be cautious in revising the QM patch, but the same warning applies to the Federal Housing Finance Administration, which can unilaterally impose the change on the GSEs at any time.
"Based on the CFPB's own analysis, if lenders remain unwilling to originate loans for average families without full liability protection, this could further restrict access to credit for borrowers of color, who represent a disproportionate share of QM patch loans and remain underserved by conventional mortgage credit," the nine senators wrote. "Further restricting borrowers’ access to affordable mortgage credit that is properly underwritten was not the intent of the ATR or QM statutory provisions, nor should it be the intent of the bureau."
As policymakers consider these significant reforms to the mortgage rules, it is important for them to understand that banks, which currently hold one in four of the nation's mortgages in their portfolios, are focused primarily on larger, prime mortgages with credit scores in the top third of the U.S. population, to whom the banks can cross-sell their other financial products.
In addition, these banks are constrained by regulatory capital rules from expanding their holdings of mortgages. Independent mortgage banks, on the other hand, have provided a significant source of affordable mortgage credit for borrowers across the country. Without the QM patch, many independent firms will see their ability to serve non-prime consumers severely constrained, which may result in many American households being effectively cut off from mortgage credit, either because they cannot qualify for a loan or the payment on the loan is too high.
A decade ago, when policymakers fashioned the QM patch, the rule was rightly seen as a compromise that sought to balance the need for mortgage credit with protecting the taxpayer from risk. Since 2008, the $10 trillion mortgage industry has grown accustomed to having the government play a central role in encouraging and facilitating home ownership. Before the Trump administration simply "rips off the patch," we all should be very sure that we understand the implications for the mortgage industry, both immediately and longer term. Caution, to put it mildly, should be the watchword for this important process.