Capital and mortgage financing rules being drafted in Washington and elsewhere raise the possibility that the United States will become increasingly split between affluent home owners and less affluent renters, because lenders will be constrained to stay within tight mortgage underwriting rules that many households won’t be able to penetrate.
That’s the grim assessment of a meeting of several dozen housing, consumer, and other organizations in Washington last week to look at the regulations coming down the pike as a result of the housing bust several years ago.
The meeting of the Coalition for Sensible Housing Policy, hosted by NAR at its Washington offices, heard from a panel of some of the country’s most highly regarded banking and mortgage financing experts, including Lew Ranieri, one of the creators of the mortgage-backed securities (MBS) market, Gene Ludwig, the U.S. Comptroller of the Currency under President Bill Clinton, and Jim Millstein, a Treasury official who oversaw the restructuring of insurer AIG in the aftermath of the mortgage crisis.
“We’re going to look back at these regulations five years from now and wonder, ‘What the heck did we do?’” said Millstein.
The regulations that have so many in the industry worried are two from the Dodd-Frank Wall Street Reform Act enacted two years ago: QM and QRM. QM stands for “qualified mortgage” and the rule would set standards for lenders to ensure they only make loans to borrowers who have the ability to repay them. The rules would apply to all mortgage loans. QRM refers to “qualified residential mortgage” and the rule would set minimum underwriting standards for loans that are packaged into securities and sold to investors. QRM applies only to securitized loans, with the exception of Fannie Mae and Freddie Mac loans, although once those two companies are out of U.S. conservatorship, their loans would be subject to QRM as well.
A third rule that is now on the horizon is known as Basel III, a set of proposed international banking standards being written in Basel, Switzerland, that would include requirements on how much capital banks must hold on their books based on the type of loans they make. In previous Basel iterations (Basel I and Basel II), the rules apply only to the largest banks, but there is concern that aspects of Basel III could apply to regional and community banks as well. The rules don’t have the force of law unless countries choose to adopt and enforce them. Banks in countries that have not adopted the rules might still have to abide by them, though, if they do business in countries that have adopted them.
Against these proposed rules are other factors that threaten to dramatically change the home ownership landscape: what to do with the two secondary mortgage market companies, Fannie Mae and Freddie Mac, which are now into their fourth year of conservatorship, and what to do with FHA, which has seen its market share soar since the housing bust but has analysts worried about its exposure.
Panelists and other financial specialists at the meeting said each one of the proposed rules, if not done right, will close down the mortgage finance market for a large portion of home buyers. For example, if the ability-to-repay rules of QM are written too narrowly, lenders will only make loans within tightly specified parameters, closing the door to financing for many first-time buyers unless they use FHA financing, which would put further pressure on that agency.
A similar risk exists with QRM. If that rule requires a minimum down payment, such as 20 percent, much of the first-time buyer market outside of FHA would disappear.
Among the Basel III proposed standards that are troubling are finely detailed risk-weighting requirements that would force banks to hold more capital for all but the most conservative loans.
All three of these new rules becoming final in their current form would effectively create a have and have-not market in the U.S., “creating disparities outside of FHA that are very uneven,” said David Stevens, president and CEO of the Mortgage Bankers Association and 2009-2010 FHA Commissioner.
There’s some irony there, Stevens suggested. Because HUD and the new Consumer Financial Protection Bureau (CFPB) are writing “disparate impact” rules that would penalize lenders for loan practices that widen the disparities between borrowers. Thus, lenders face the possibility of adhering to QM, QRM, and Basel III and getting slapped with disparate impact penalties as a result. “This is leading to a real challenge around fair lending,” said Stevens.
There’s another irony as well, and that’s a delay in the day when Fannie Mae and Freddie Mac can be taken out of conservatorship and possibly replaced, paving the way for the development of a fully private mortgage market, which both the federal government and industry participants say they want. Right now, Fannie, Freddie, and FHA comprise the lion’s share of the mortgage market—by some estimates, more than 90 percent. If QRM rules are too tight, the federal government will face pressure to keep Fannie and Freddie under conservatorship rather than let their loans become subject to the new rules.
Thus, the industry finds itself on the horns of a dilemma: On the one hand, overly tight regulations will force all but a few borrowers into government-backed loans, delaying the development of a private market, while on the other, even when a private market is developed, it will be a sharply divided one, catering only to wealthy households that can meet the tight standards while everyone else must use FHA (or Fannie and Freddie, if they remain in some form), or be forced to stay in the rental market.
“What I see now is a turn away from home ownership in America,” said Sen. Johnny Isakson (R-Ga.), who provided closing remarks at the meeting, “an inability to finance home ownership. And a rental America is weaker than a home owner America, I can tell you that. We’re a nation of owners and not tenants, and that’s one of the great differences between the United States and many other countries. So, we’ve got to be really outspoken. Otherwise, if these rules start coming down after the election on Nov. 6, the administration is going to face not only a protracted unemployment of 8 percent, but a draconian drop in consumer confidence as housing becomes out of reach for almost everybody.”
Other presenters at the meeting were Jim Parrott of the National Economic Council, Michael Calhoun of the Center for Responsible Lending, Ray Natter, former counsel with the OCC and Federal Reserve, Susan Wachter of the University of Pennsylvania, and Brian Gardner, a Washington policy analyst with Keefe, Bruyette & Woods.