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Bank Regulations Miss the Point

Story, Rob Jr., CMB

(Editor's Note: This Op-ed piece by MBA Chairman Rob Story Jr., CMB, appeared in the Washington Times.)

Modernizing the regulation of our financial institutions will play a critical role in restoring confidence in our financial system and facilitating the recovery of our national economy. For almost two years, the financial services industry has been working with legislators and regulators to improve oversight and protect consumers without restricting consumers' access to affordable financial products.

An often overlooked concept found in both House and Senate reform bills seeks to ensure that loan originators have an additional financial interest in the long-term success of the loan by requiring lenders to retain a portion of a loan's risk on their books if they sell the loan to the secondary market. Though well-intentioned, this approach to risk retention has the potential to have unintended consequences stifling the recovery of both the residential and commercial real estate markets. More important, it would be duplicative of the current risk-retention requirements and require lenders to put aside large amounts of capital, limiting the credit available to consumers.

As it pertains to real estate financing, the principle, known as "skin in the game" or "risk retention," is built on the fallacious notion that residential and commercial mortgage lenders can make reckless loans with no regard for the long-term performance of those loans because once a loan is sold to the secondary market, the lender is free of any responsibility for how the loan was underwritten.

This couldn't be further from the truth. When I sell a loan, whether it is secured by a residential or commercial property, to a secondary market investor, I make representations and warranties to the buyer with respect to the borrower, the underwriting of the loan, the documentation and the property securing the loan.If the loan fails - that is, if it goes into foreclosure - because of an error or oversight on my part, I am required to buy back the loan or reimburse the buyer. Investors, now more than ever, enforce those warranties to hold me accountable for the loans I have made.

Enacting broad risk retention, requiring lenders to keep a portion of the original loan on their books, has the potential to eliminate a sizable percentage of the mortgage-lending capacity in this country. There is an entire segment of the residential mortgage-lending industry that only does mortgages and does not take deposits from customers. Those lenders make loans to borrowers, sell the loans into the secondary market (with representations and warranties) and then use the money they receive from the sales of the loans to make the next mortgage to another borrower.

Requiring these independent mortgage lenders--many of which are small businesses--to retain a portion of every mortgage they sell would render their business model unsustainable. Elimination of this critical segment of the market - often smaller lenders that serve underrepresented areas and borrowers -would limit capacity and choice for consumers, driving up borrowing costs or limiting access to mortgages altogether, which is the last thing we need in a real estate market that is just beginning to see signs of recovery.

Additionally, elimination of these businesses ultimately would mean job losses, which, again, would not be helpful in the current economic environment. Mortgage banking companies that would be forced out of business by this provision employ between 45,000 and 55,000 people.

In order to avoid this, legislators should provide explicit exemptions from additional risk-retention requirements for qualified residential loans that have particular features and meet certain underwriting guidelines. For example, a fully documented, fully amortized mortgage with a 30-year fixed rate has well-understood risk characteristics.

The market for residential real estate already contains mechanisms that serve to ensure that risk is appropriately accounted for.Consumers are best served by a marketplace that gives them choices and competition. Driving competition and liquidity from the residential mortgage market with broad, one-size-fits-all risk-retention requirements is not the means to bringing back confidence and stability to our markets.