The recent firestorm in the press over the qualified residential mortgage proposal, risk retention — and the unlikely alignment of mortgage financiers and consumer groups — make for amusing reads, but largely miss the point as it relates to the secondary markets.
Amid the overt cynicism, trite claims of corruption and the apparent need of big lenders to mercilessly nickel-and-dime potential homeowners, the meat of the commentary on QRMs and risk retention are right-minded yet misguided.
In a blog post Wednesday, Reuters contributor Felix Salmon charges CNBC's John Carney did not go far enough
when taking some mortgage industry trade groups to task. Salmon looks to complete the lap
, and he does, but it's ultimately on the wrong racetrack.
By stating, as financial commentators, that any opposition to risk retention is counter intuitive to mortgage lending there is an implication of being in favor of risk retention. In opposition to the so-called "homeownership mob," the journalists themselves fell into a pack mentality. Call it the "risk-retention mob."
Salmon offers the simplest explanation as to why risk retention is a good idea. He states, "And most importantly, we’re talking about 5% of the loan here." It's clear he thinks that is not a lot of risk to hold, so why not go ahead and hold it?
A $225,000 mortgage would ultimately cost a homeowner about $12 more a year, Salmon said, when the lender retains 5%.
Yet, it is important to note that risk retention is not an issue in relation to homeownership. It is an issue related to securitization.
The new federal mandate is meant to reduce risk for the secondary markets, not to increase costs of homeownership.
The draw of securitization, to that end, is that it can be done often and cheaply. That's not going to be the case with Dodd-Frank reforms, as well as with other market fundamentals, such as the disappearance of cheap insurance.
"It's not that risk retention hasn't happened or doesn't happen, so it shouldn't be a shock to the secondary markets," said Ed Kramer, an executive vice president at Wolters Kluwer Financial Services
. Kramer is a former deputy superintendent at the New York State Banking Department, in charge of the consumer services division. He tried to push through similar skin-in-the-game initiatives and met similar industry resistance. Clearly, Kramer wasn't successful in this initiative, but he notes risk retention is the secondary market's bad penny.
In the case of real estate investments trusts, risk is often retained by the REIT. This is not so much an issue, because of the related capital versus costs structure. REITs can raise money on the stock market, and as long as they reinvest at least 90% of proceeds in real estate, they don't pay taxes.
Bankers don't operate in this environment, of course.
"When you retain risk, you have to have capital to put aside. But only the risk flows to the investors," said Kramer. "In fairness to bankers, the cost sticks with them. That's a cost they may have to pass on via higher interest rates."
So this is the reality of risk retention.
In seeking to establish a "gold standard" for mortgage origination, the Federal Deposit Insurance Corp.
derived 20% down payments for QRM. By its admission, the FDIC says $8.5 trillion in outstanding mortgages in year's past would not qualify under the QRM today. So that's where risk retention would fill the gap in mortgage finance.
"For mortgage originators pursuing securitization as part of their basic business, they will be required to retain 5% of the non-QRM collateral they are securitizing on their balance sheet," writes structured products analyst John Jay of financial consultancy firm Aite Group
Jay's June 2011 impact note spells out the real impact of risk retention on the mortgage market and highlights the missed points summarily: Risk retention is nothing new and won't greatly impact the secondary markets. It has been used for quite some time, and it did nothing to prevent the financial crisis.
"As appealing as this proposal might appear for general consumption, market participants feel that this proposal is more political in nature than in substance," Jay said. "After all, prime quality mortgages account for only 5% of the overall mortgage market, and the skin in the game can be sold or transferred to a separate subsidiary — or a synthetic derivative or something such as that can be created to mitigate the negatives of retention."
"To the general public, risk-retention requirements may sound reasonable," he added. "But to think it can act as a cornerstone to risk management is a bit much."
Write to Jacob Gaffney
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