Patrick Lawler, the Chief Economist for the Federal Housing Finance Agency (FHFA), the group responsible for the conservatorship of Fannie Mae and Freddie Mac, made a speech on the proposed qualified residential mortgage rules to the House Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises.
The risk retention rules are required under the Dodd-Frank financial reforms, and are aimed at ending, or at least minimizing the risk involved with the “originate-to-distribute” model that was at least partially responsible for the housing bubble. Under the model, mortgages of dubious quality were originated, packaged, securitized, and sold to investors. The originator had little incentive to make sure the loans were of a high quality, and many were not.
Under the new rules, originators will be required to retain 5% of any loan that is not considered a “qualified residential mortgage” (QRM). To be considered a QRM, a loan must have a 20 percent down payment (25 percent and 30 percent home equity are required for, the home must be owned-occupied, the borrower cannot have delinquencies of 60 days or more on their credit report, and the borrower’s debt-to-income ratio can be no higher than 28 percent. Government backed loans such as VA, USDA, or FHA loans are exempt from the requirements. Fannie Mae and Freddie Mac loans are exempt so long as they are in conservatorship.
The QRM rules are causing considerable controversy in the mortgage industry because many feel these guidelines are overly restrictive. Last week we learned that as many as 25 million current homeowners would be precluded from refinancing due to the QRM requirements. Additionally, QRM could significantly shrink the pool of eligible home-buyers, which would be very harmful to home values in a market that already suffers from an extreme lack of demand for homes and a huge oversupply of them.
Lawler addresses the availability of credit under the risk retention guidelines for non-QRM borrowers thusly:
“While the proposed QRM standard requires a 20 percent down payment and does not recognize mortgage insurance as a source of meaningful reductions in mortgage defaults, FHFA expects that securitizers and investors will continue to recognize the value of mortgage insurance and other credit enhancements as a vehicle for the reduction of loss severity in the event of default. Therefore, borrowers should continue to have access to mortgage credit without making a 20 percent down payment.”
As to how much more non-QRM mortgages will cost, Lawler equates these mortgages to jumbo mortgages, for which there is no (significant) securitization currently. These loans go, on average, for about 60 basis points over securitized loans. Lawler says that risk-retention would “have a much smaller effect on mortgage rates because it would only prevent lenders from securitizing five percent of their loans.”
The trouble is that Lawler seems to be comparing apples to oranges. Jumbo mortgages are generally safe loans with relatively strict underwriting guidelines because originators frequently retain these loans for their own portfolios. By definition, non-QRM loans are riskier than the jumbo loans Lawler cites. I suspect the cost of non-QRMs will be significantly higher than 60 basis points above the QRM rate.
Another interesting factoid from the speech is that only 31 percent of mortgages owned by the GSEs in 2009 would have been QRMs, and only 10 percent during the boom years qualified. I think this serves to illustrate just how bad many of the loans that were originated during the bubble were, and also shows just how few people qualify.
While I like the QRM rules, I feel as though they are about a decade or two too late. That said, I think it would make a lot of sense to phase in some of the requirements, particularly the down payment requirement, over time. Maybe raising the minimum down payment one or two percent per year until we get to 20 percent. The housing market is in such a weak state right now that I fear quickly enacting these requirements could kill it. I’m not sure why there is such a rush to close the barn door when the horse left a couple of years ago. What do you think about the proposed rule? Let me know in the comments section below.
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Russ Wetherill
April 19, 2011 @ 2:17 pm
In general, I agree with the proposed QRM rules. I just don’t think they go far enough. For example, they fully exclude all government agencies from both the QRM guidelines and the 5% risk retention requirement.
The theory with exempting the GSEs, VA, and FHA is that since they retain 100% of the risk via government guarantees, then they should not be subject to heightened mortgage lending requirements.
In other words, QRMs are intended to protect the securitization market, and not the taxpayer. Why shouldn’t the taxpayer have the same quality assurances as the investor?
20% down is especially important in the case of default. While the NAR and others claim that 20% down imperceptibly affects default rates, what they fail to consider is the consequence of default when loans are let out with less than 20% down. Consequence of default and probability of default are two different animals. The consequence of default is a loss of ~20% of the value of the asset through transaction related expenses. Realtor commissions eat up 6% of the market value to sell a foreclosed property. There are also carrying costs (sometimes years), back taxes, etc. All of these costs are paid by the guarantor (taxpayer). A 20% pad is necessary to make either the investor, or the taxpayer whole.
The discussion about months to save for a 20% down payment is colored by self interest. The time period is highly variable depending on the underlying assumptions. For instance, the NAR in a white paper claims that it will take 9 years to save 10% down, and 14 years to save 20% down. My first reaction is: my god, at that rate it will take 5*14=70years to buy a home! Or, alternatively, 10*9=90years! If it’s really that hard to save a down payment for a home, how in the hell will they be able to afford the property taxes, mortgage interest, and maintenance? Does the NAR even think before they publish this? The fact is that they assume a 6% savings rate, and that current prices won’t fall after the QRM is implemented. Of course prices will fall. This is why the NAR is so concerned (not to mention sales volume).
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Russ Wetherill
April 19, 2011 @ 2:42 pm
One more thing: it shouldn’t take more than 4 years to save up 20% down, at 20% savings rate. If a house is really that important to you, than you will find a way to make it happen. for the typical family earning 50k a year, they should buy a home at 4xincome =200k. 20% of this is 40k. @20% savings rate 40k can be saved in 40k/.2*50k=4years. Live at home rent a small apartment and put your useless crap in storage, double up with another homeowner wannabe. It’s not that hard.
The reward for 4 years of living on less is twofold: a stable housing market which protects your 20% investment, and good savings habits that will last a lifetime.
What became infinitely clear in the housing bubble is that Realtors, Mortgage bankers, and government regulators don’t give a rat’s ass about homeowners. Their chief concern is keeping the game alive, and a constant stream of suckers coming in through the door.
I fully expect the QRM to be significantly watered down. The reason they released this for public comment was to provide political cover. Due diligence is not required, the mere perception of due diligence will suffice. Obama’s 10% down recommendation he made for reforming the GSEs will be implemented. With the exemption of government agencies, who fund 90% of mortgages, from QRM retention requirements, the impact to the market will be minimal. And yet, there will be the expected outcry from the mortgage industry that they are being driven out of business. Well, if your business model is based on 4%ysp, then good riddance!
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