Last week, a procession of federal financial regulators led by the Federal Reserve Board issued a draft rule and request for comments on what Congressman Barney Frank (D-MA) called the most important part of his namesake legislation, namely the provisions requiring “skin in the game” for issuers of mortgage securities.
The reference to “skin in the game” is an economic metaphor that refers to a tax on investors and home owners which Barney Frank and other liberals in the House of Representatives included in the Dodd-Frank Wall Street Reform Act. Frank and his colleagues apparently thought that they were protecting investors by making sponsors of mortgage bonds retain 5% of the economic risk in a given deal.
Another MA liberal, Senator Elizabeth Warren, also supports the idea of skin in the game, again thinking that this tax on investors and consumers will make events like the subprime bust less likely. As I’ve noted before, the rules in Dodd-Frank requiring a 5% retained interest in non-agency mortgage bonds — paper that is not eligible for guarantees from Uncle Sam – exist because nobody in Congress has the guts to enforce existing securities laws.
But it gets better. Liberals like Frank and Warren, and most of Congress to be fair, don’t even understand the real world impact of their own actions. After former House Financial Services Committee Chairman Frank included the skin in the game language in the Dodd-Frank legislation, the Senate adopted an exception to the 5% retained interest, an exception that was meant to be narrow. Instead, last week the Fed, FDIC and other agencies punted and said any Fannie Mae, Freddie Mac or Ginnie Mae eligible mortgage backed security will be exempt from the QRM rule.
“What regulators proposed last week was instead broad, allowing any loan that meets basic underwriting requirements to qualify for QRM status, American Banker reports. “That is fueling criticism that regulators are undermining a Dodd-Frank mandate in the face of pressure from the Obama administration, the housing lobby and community groups.
“It’s the exception that ate the rule,” Edward Pinto, a fellow at the American Enterprise Institute, told American Banker. “The new proposal really turns the whole thing on its head. For single family mortgages, risk retention becomes a non-event.”
But sadly my friend Ed Pinto is not quite right about the impact of the “skin in the game” provisions of Dodd Frank and the broad exemption proposed by the Fed et al on American families. The whole idea of skin in the game as proposed in the rule last week is to keep a capital buffer inside the trust created for a given mortgage bond to protect investors from loss. If the “qualified mortgage” or QM rule issued by the Consumer Financial Protection Bureau is about safeguarding consumers, the “qualified residential mortgage” or QRM rule proposed by the Fed, FDIC et al with the 5% risk retention requirement is meant to shield bond investors.
The trouble is, with the broad interpretation of Dodd-Frank in the QRM proposal, the vast majority of home owners who qualify for a mortgage guaranteed by Uncle Sam are paying nothing to mitigate the risk of another subprime crisis. Meanwhile, the portion of the population who can’t qualify for an agency loan, both good credits and bad, will carry the full load of the Dodd-Frank tax. My colleagues in the bond analytics world think that the disproportionate impact on below-prime and non-conforming borrowers could be worth between half a point and a full point annually in higher loan costs.
While liberals like Frank and Warren pretend to be compassionate defenders of low-income Americans and consumers more generally, in fact their “skin in the game” rule is putting the screws to the poorest, most vulnerable members of our society. Just add the “skin in the game” directive to a long list of provisions in Dodd-Frank that deprive American families with access to credit. The only “winners” here are the big Wall Street banks that dominate the market for agency mortgages.
Lower income American families and others who cannot qualify under the QRM standard will find non-agency loans are far more expensive. The credit risk retention requirements of Dodd-Frank are as regressive and anti-consumer as any provisions of this badly flawed legislation. Frank, Warren and their ilk in Congress pretend to have solved the issue of risky securities by taxing below prime borrowers, but they are mistaken.
By exempting most of the market from responsibility, the Fed is placing the full load on a relatively small group of low-income borrowers. Prime borrowers who for whatever reason cannot qualify for an agency guarantee are also taxed. Keep in mind that federal housing agencies are getting ready to yet again reduce the maximum size of mortgages eligible for federal loan guarantees from Fannie, Freddie and the FHA, meaning even more Americans will pay the Dodd-Frank “skin in the game” tax.
Sad to say, Barney Frank, Liz Warren, and most members of Congress don’t understand what we have just discussed in the most cursory fashion in the paragraphs above. The retained interest provisions of Dodd Frank prove, yet again, that attempts by a financially illiterate Congress to regulate the financial markets usually creates more problems than it solves.