An Unlikely Couple

It's hard to think of two groups more deeply in conflict with one another right now on financial issues than consumer advocates and mortgage lenders. Financial institutions didn't just sabotage millions of borrowers with overvalued and now unpayable loans; since the housing crisis began, the institutions have been stunningly inflexible in helping homeowners modify their mortgages, even when the outcome would be better for both lender and borrower.

So it was a curious turn of events last week when the Mortgage Bankers Association, the national trade group for lenders, joined consumer organizations at a Washington, D.C., press conference on financial reform. It was even more striking to see those consumer groups -- the Center for Responsible Lending, National Community Reinvestment Coalition, Consumer Federation of America and the National Housing Conference -- taking a stand against a key Obama administration proposal for financial reform.

Under the Dodd-Frank financial-reform bill, passed by Congress last year, issuers of mortgage-backed securities must keep the equivalent of at least 5 percent of the value of those securities on their own ledgers, as a kind of inoculation against reckless lending. This "risk retention" was a response to a driving cause of the 2000s financial bubble and bust: Lenders originated mountains of bad mortgages and sold them to investment banks, which in turn packaged those mortgages into securities and sold them to investors, thus passing on the liability to them. If the issuers are financially exposed to the risk of their own products, the reasoning goes, they will be much less likely to package toxic debts to sell to investors.

A privileged class of ultra-safe loans -- called "qualified residential mortgages" (QRMs) in Dodd-Frank -- will be exempt from the risk-retention requirement. Among other qualifications, borrowers must have a minimum 20 percent down payment and cannot have had a mortgage payment that was more than two months late or debt bills greater than 36 percent of monthly income.

The idea behind exempting the safest mortgages from the skin-in-the-game rule is that that it's inefficient -- that translates into "costly" -- for financial institutions to keep inherently safe loans on their books instead of selling them to investors. Now consumer advocates fear that the exceptions will create two classes of borrowers with wildly different experiences in the market: those with the resources and credit scores would get relatively inexpensive loans exempt from risk retention, while less wealthy borrowers would, through higher interest rates, effectively foot the cost of lenders' compliance with the risk retention rules -- if they could get mortgages at all. As James H. Carr of the National Community Reinvestment Coalition wrote in the Prospect last month, the proposed new rules "will set the standard for conventional mortgages and determine the loans that will most widely be available to consumers at the lowest costs."

The securities industry is further stoking advocates' concerns by suggesting that bankers are likely to focus disproportionate resources and offer more favorable terms on QRM-compliant loans. For instance, the Securities Industry and Financial Markets Association's primer on risk retention states: "Loans which meet QRM standards are likely to carry lower interest rates, and generally be more available than loans that do not."

The possibility that borrowers who fall short of the QRM standards might not have access to credit is what has the Mortgage Bankers Association aligning with consumer groups. In a survey last week, a credit-counseling organization found that half of respondents would not be able to come up with a 20 percent down payment. Last year, four in 10 mortgages issued had down payments of less than 20 percent. That's a lot of potential customers to lose, and a lot of consumers without access to financing for a home.

"Mortgage bankers" are a breed apart from the Chases and Goldmans of the world, with only a fraction of the major institutions' money and power. The Mortgage Bankers Association membership consists of thousands of small institutions, many of which are dependent on the big banks for lines of credit with which they make home loans. Their own future depends on their ability to reach diverse groups of consumers via flexible lending standards.

The association's new leader is former Obama administration Federal Housing Administration chief David Stevens, and he is waging a public fight against the rules. Why would the Obama administration advance a rule so widely condemned that even its former homeownership czar says it goes too far? The administration may have painted itself into a corner. In place of the former system of government-sponsored enterprises, including Fannie Mae, that offset risk, operated under strong regulation, and had a chartered mission to expand access to credit, the Treasury/HUD proposal for housing-finance reform seeks to hand the home-credit business over to the big financial institutions that issue mortgage-backed securities. Dodd-Frank also provides a thin-to-nonexistent safety net. In the future, consumers will largely carry the price of policing the new, all-private housing-finance marketplace, through the rationing of credit and much higher interest rates. The risk-retention rule is one of the few, blunt tools available to make sure securities issuers act responsibly.

As I wrote in the June issue of the Prospect, extensive research shows that high-risk borrowers can succeed with low down payments when the mortgages are designed to be affordable. True mortgage-market reform would target government support to make sure that credit is available on stable terms that ensure those borrowers succeed, and not only within the constraints of the Federal Housing Administration insurance program. But regulators are loath to give lending institutions any leeway.

Federal banking regulators published the proposed risk-retention rules earlier this spring, and opposition escalated as the deadline for comment loomed for this Friday, June 10. Three dozen senators have signed a letter by the authors of the risk-retention rules declaring that the proposed regulations "swing the pendulum too far and reduce the availability of affordable mortgage capital for otherwise qualified consumers." Amid the swirls of criticism, the agencies have now pushed back the comment deadline to Aug. 1.

Securities-industry lobbyists, unhappy with Dodd-Frank from the beginning, have a clear motive to sound the alarm about a looming credit drought: Under the current, strict risk retention rules, securities firms stand to lose business and shoulder new costs of compliance. In effect, the costs of managing financial risk that were once born by the government are now moving to the private sector. But that means consumers are ultimately paying the price -- and quite understandably, they're fighting back.

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