Lawmakers: Risk Retention Proposal Could Spark Credit Crunch

WASHINGTON — Lawmakers from both political parties sharply criticized the banking regulators on Thursday for their risk-retention proposal, arguing it will lead to a credit crunch.

Members of the House Financial Services capital markets subcommittee focused mostly on the plan's definition of "qualifying residential mortgages," which are exempt from the risk-retention requirements but must meet strict underwriting criteria, including a 20% down payment by borrowers. While regulators maintain that QRM loans are meant to be a small slice of the market, lawmakers said the result could be a loss of access to credit for worthy borrowers and a concentration of lending power at the largest banks.

"Before the crisis we were over here with very lax standards … and now we've gone over here where it's become very difficult to get a loan," said Rep. Carolyn Maloney, D-N.Y. "Many people are questioning the 20% down in the draft rule."

Lawmakers also complained about the inclusion of limited servicing standards in the risk-retention plan and an exemption for Fannie Mae and Freddie Mac while they are in conservatorship.

"There are aspects of the rule that I think raise questions and concerns," said House Financial Services Committee Chairman Spencer Bachus. "For example, the regulators have proposed extraneous issues which are beyond the scope of the Dodd-Frank Act, including mortgage servicing standards, as part of the risk-retention requirement. Also, the broad exemption provided to loans purchased by Fannie and Freddie. I think it's problematic."

Top Democrats also took issue with the exemption for the government-sponsored enterprises.

"I agree that we should not be exempting Fannie Mae and Freddie Mac from the legislation," said Rep. Barney Frank, the full panel's ranking member.

The Massachusetts Democrat added that a 20% down-payment standard was too tough.

"I am persuaded by a number of people that 20% is too high. … There is a very good argument that you don't have to get to 20%," Frank said.

Others worried about the potential competitive impact of the plan. Rep. Brad Sherman, D-Calif., said community banks would not be able to offer non-QRM mortgages, leaving the market dominated by the largest banks.

"The larger banks would have the capacity to make non-QRM loans, while the community banks with a higher cost of funds will not be able to do so at a cost effective and competitive rate," Sherman said. "One of the consequences of a narrow QRM standard may be to force community banks to become agents or supplements to the larger institutions."

Under a proposal released March 29, lenders must retain 5% of the risk of a loan they sell into a securitization unless it meets certain underwriting criteria spelled out by the banking agencies, including a 20% down payment by borrowers and compliance with certain debt-to-income ratios. The QRM test is one of the most important pieces of the risk-retention plan because many lenders are hoping to offer mortgage credit exclusively according to that definition.

Under the plan, the GSEs are exempt because they offer a 100% credit guarantee for any loan they purchase, and retain it when that loan is sold as a mortgage-backed security. Regulators insist that there is no need to force the GSEs to retain a 5% stake in a MBS when they already take the entire credit risk.

"The 100% risk retention by the enterprises on their guaranteed MBS is obviously the maximum possible and far exceeds the 5% retention requirement by Section 941," Patrick Lawler, chief economist for the Federal Housing Finance Agency, said during the hearing. "Therefore, the NPR does not classify all of the enterprises' loans as qualified residential mortgages, but rather acknowledges that the risk retention by the enterprises on almost all of their securities is already complete. Furthermore, since the risk retained by the enterprises is itself backed by the Treasury through senior preferred stock purchase agreements and not by private capital, it is stronger than any other form of 100% risk retention by a private corporation."

But Frank said this may be considered favored treatment.

"There is a lot of concern about special treatment for Fannie and Freddie," Frank said. "Please give it up. There is no real harm here. It almost becomes a matter of turf. … It can't add to the taxpayer risk if you are already 100% covered. I would urge you to go along with the risk retention."

Julie Williams, first senior deputy comptroller and chief counsel for the Office of the Comptroller of the Currency, warned that forcing the GSEs to hold an extra 5% stake in MBS would, ironically, make them bigger at a time the government has said they should be wound down.

"Requiring the enterprises to retain a 5% interest in each [asset-backed security] they sponsor would significantly increase their holdings of mortgage-backed securities at a time when there is strong interest in reducing such holdings," she said.

The subcommittee has already passed a bill by Rep. Scott Garrett, the panel's chairman, which would prohibit the GSEs from being exempt from the risk-retention plan.

"The rule before us today allows for the GSEs to be exempt by claiming that their guarantee functionally acts as a formal type of risk retention," Garrett said. "This will severely hinder ongoing efforts by the administration and Congress to encourage more private capital in our mortgage markets and reduce taxpayer risk. By a 34-to-0 unanimous vote last week, this subcommittee passed legislation that I introduced which attempts to ensure that the government and private sector are treated equally with regards to this risk-retention proposal. … So, this should be a clear indication to you that Congress believes you need to alter your rule and follow the clear intent of Dodd-Frank on this topic."

But Scott Alvarez, general counsel of the Federal Reserve, said forcing the GSEs to follow risk retention would not be beneficial.

"The alternative of requiring the GSEs to hold back and fund 5% of the MBS they issue would simply expand their portfolios," he said. "This would not reduce the burden on the government capital support agreements, and would require the GSEs to issue more corporate debt without having any material effect on the economics of their securitization or their incentives as sponsors."

Lawmakers also pushed regulators to lower the 20% down-payment requirement.

"We should not allow a proposal by any agency that would subject minority or first time home borrowers to the same predatory lending that contributed to the recent economic crisis," said Rep. Ruben Hinojosa, D-Texas. "Requiring a 20% down payment might have that affect."

Even the acting commissioner of the Federal Housing Administration, Bob Ryan, said the requirement could cut off access to credit.

"We are concerned about 20% being too high," he said. "This definition has the potential to create false situations that deny creditworthy borrowers affordable loans in this class."

But Michael Krimminger, the general counsel of the Federal Deposit Insurance Corp., defended the requirement.

"The agencies' analysis of the data show, historically, that loans with the high standards chosen for QRM loans had lower rates of default," he said. "In fact, many of the underwriting standards proposed for the QRM loans precisely address the layered risks that were often ignored during the housing boom that led to increasingly higher delinquencies as housing prices declined."

Krimminger emphasized that the QRM criteria were not intended to become the standard for the entire market.

"The QRM exemption is meant to be just that — an exemption from the regulatory rules," he said. "Under the proposed rule, not all homebuyers would have to meet the higher QRM standards to qualify for a mortgage. On the contrary, we anticipate that loans meeting the QRM exemption will be a small slice of the market, with greater flexibility provided for loans securitized with risk retention or held in portfolio."