“We say hypocrisy because these rules from the banking regulators have been marketed since the 2010 Dodd-Frank law as a way to reduce risks by ensuring that everyone has “skin in the game.” The concept was that borrowers and the people who sell these mortgages to investors have to be on the hook for losses…
…so that they cannot simply bundle all the risks into mortgage-backed securities and then pass them on to the muppets who run government pension funds. But now regulators have enacted rules that you can call the “No-Skins Game.” Mortgage borrowers don’t have to put down a nickel and can have a debt-to-income ratio up to 43%.”, “More Risky Loans Allowed”, Wall Street Journal
More Risky Loans Allowed
The feds ease rules for mortgages but tighten them for business.
Washington has settled on a perfect credit-allocation strategy to stunt economic growth. Step One: Hand out mortgages with little or no money down. Step Two: Discourage loans to businesses.
Last week we told you about Federal Housing Finance Agency Director Mel Watt ’s plan to bring back down payments as low as 3% to Fannie Mae and Freddie Mac , the two government mortgage monsters that helped create the last financial crisis. Along with Mr. Watt’s other initiatives to expand credit, it could lead to another boom and bust housing cycle.
Now the Federal Reserve and other banking regulators have approved new rules for private mortgage-backed securities that don’t require the underlying loans to have any down payments at all. But this latest move may be less immediately damaging than it sounds. As a general matter, the bureaucrats shouldn’t be setting the terms of private contracts. And until a new Congress enacts serious reform, the government—via Fannie, Freddie and the Federal Housing Administration—will likely continue to dominate this market anyway.
Therefore, in contrast to the fate that awaits taxpayers in the government mortgage programs, in the near term participants in the fully private market probably won’t have the chance to come to much harm—even if they’re foolish enough to follow the regulators’ advice on what constitutes a “qualified mortgage.”
So this may be the rare occasion when we can laugh at the hypocrisy of Washington without having to pay for the privilege. We say hypocrisy because these rules from the banking regulators have been marketed since the 2010 Dodd-Frank law as a way to reduce risks by ensuring that everyone has “skin in the game.” The concept was that borrowers and the people who sell these mortgages to investors have to be on the hook for losses, so that they cannot simply bundle all the risks into mortgage-backed securities and then pass them on to the muppets who run government pension funds.
But now regulators have enacted rules that you can call the “No-Skins Game.” Mortgage borrowers don’t have to put down a nickel and can have a debt-to-income ratio up to 43%. The creators of mortgage-backed securities can assemble entire pools of such questionable loans, sell them to the muppets and retain not one dime of credit risk. The regulators even had the gall to keep calling them “risk-retention rules,” though they codified that mortgage risks won’t be retained.
Whenever Congress gets around to reform, it should eliminate this part of the law before real damage is done. Absent reform, investors could get fooled into thinking that risk is being retained by the sellers of mortgage bonds, and that “qualified mortgages” really are safe.
Another part of the new rules demands more immediate attention. Perhaps in an effort to justify the title of their rule-making, the regulators did force risk retention on the market for so-called leveraged loans. These are bank loans made to heavily indebted companies that certainly do carry risk. And that risk does not disappear when slices of these loans are bundled together in what’s called a collateralized loan obligation (CLO).
But get this—the regulators put a mandate to retain 5% of a deal’s credit risk on the buyers, not the sellers, of these loans. Rather than putting new requirements on the banks that make these loans or the businesses that borrow, the bureaucrats somehow decided to lay the burden on CLO managers, who act essentially like the managers of mutual funds in selecting which pieces of loans to buy on behalf of investors. It’s as if Fidelity or Vanguard had to accept losses whenever your bond fund declines in value.
Leveraged loans had little or nothing to do with the financial crisis. But discouraging risky loans to businesses serves two purposes for the Fed. Along with justifying the “risk retention” campaign, this new regulatory burden might partially offset credit-market distortions from the Fed’s experiments in monetary policy. Fed officials no doubt get worried that they are creating a corporate debt bubble when they consider the gargantuan bond issuance of recent years and low credit spreads.
The solution is to start raising rates for everyone, not to single out asset classes that bureaucrats have decided shouldn’t receive additional funding. There’s also a role for judges here in making sure this provision of Dodd-Frank isn’t applied to CLO managers in a way that Congress did not intend.
All of which should give the next Congress even more incentive to rewrite Dodd-Frank, starting with a repeal of the “risk retention” provisions that have become the biggest joke in the Washington bureaucracy.