U.S. securities regulators has adopted a rule designed to avert another financial crisis, but two officials dissented, saying it did not do enough to discourage banks from lending to borrowers with shaky credit and then passing the mortgage risk to investors.
The Securities and Exchange Commission (SEC) approved the so-called “risk retention” rule by a 3-2 vote, while the U.S. Federal Reserve unanimously adopted it later in the day in a public board meeting. The rule requires banks to keep at least 5 percent of the risk on their books when they securitize loans. This “skin in the game” is aimed at aligning the bank’s interest with investors that buy the loans.
But two commissioners said they could not support the rule in part because they believe its exemption for low-risk mortgages is too broad and does not sufficiently crack down on lax underwriting standards. They also said the rule perpetuates the dominant role of government-sponsored enterprises like Fannie Mae in the housing market. Before the financial crisis, banks pumped up lending volumes, little concerned about the risks since they planned to unload the loans. The system imploded when subprime mortgage borrowers started defaulting.
The Department of Housing and Urban Development also adopted the rule last Wednesday, following three other agencies which had given their nod. The six regulators were required by the 2010 Dodd-Frank Wall Street financial reform law to implement the rule. Their concerns, however, reflect the broader public debate about the delicate balance between mortgage lending standards and the need to protect investors.
The most hotly contested issue centers on the scope of an exemption for ordinary “qualified” residential mortgages. In 2011, regulators originally proposed defining qualified mortgages as those requiring borrowers to make hefty down payments. Regulators scrapped the plan after the industry pushed back, saying it would stifle the housing market for lower-income buyers. In the new rule, the definition of a qualified mortgage is much looser than first proposed in 2011, and aligns with a definition in a separate rule by the Consumer Financial Protection Bureau.
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