Is risk retention the least intrusive regulation?

Thoughts on Barney Frank's latest speech

Today, I am at the ABS conference in Las Vegas with almost 7000 other finance professionals. 

Barney Frank is one of the headline speakers at the convention this year and has already talked to HousingWire here about what may be one of his best known legislative acts that also bears his name- the Dodd-Frank Wall Street Reform Act.

It’s not inconsequential to stand before an audience of industry professionals who have been directly impacted by this legislation, but if anyone can do it gracefully it’s Mr. Frank, who immediately disarmed the crowd with his trademark wit.

As Trey Garrison reported in the HousingWire interview, one of Mr. Franks biggest concern with the implementation of Dodd-Frank has been with regard to the risk retention rules. In particular, the alignment of the Qualified Risk Mortgage with the Qualified Mortgage that, in Mr. Frank’s opinion, makes the QRM regulation force a set of rules on what can and can’t be originated without requiring any risk retention.

In Mr. Frank’s address to the audience he focused many of his comments on the role of regulation in the first place as context for Dodd Frank and his concern with the lack of risk retention in the residential mortgage market. 

As an economist, it was wonderful to hear Mr. Frank describe the role of regulation as necessary to fix negative externalities that are not in the best interest of the public. 

The private sector should be free to innovate and the public sector should set rules that prevent the negative externalities with minimum impedance of the private sector. In my opinion, this is an excellent doctrine for the public sector to follow when creating regulation. Don’t fix what (the market) didn’t break.

Easily said, but much harder to do! Have you heard of the saying that a good regulation is one where nobody is happy with the result? 

By that measure, maybe Dodd-Frank is wildly successful! More seriously, this is why risk retention is, as Mr. Frank describes, the least intrusive regulation that could have been designed. The regulation, as intended by Mr. Frank, would have implicitly recognized that the private sector knows better how to manage and “take” risk than any set of rules the public sector could require. This is in keeping with the role of regulation to mitigate the negative externality, no incentive to manage risk, without undue burden on the private sector to innovate.

For those who argue that any risk retention would cause the wheels of housing finance to come off the proverbial bus Mr. Frank points out that loans originated and held in portfolio are “100%” risk retained so lending would still happen with modest retention requirements.

Agree or disagree with Dodd-Frank and specifically the risk retention rules, it’s nice to know that the policies embodied in the regulation come from a thoughtful doctrine of why the public sector should regulate in the first place. 

It helps that it appeals to my economic sensibility. Would we have preferred a set of regulatory rules that hamper our ability as industry participants to innovate and create new products that serve the ever-changing housing needs of our nation? 

Risk retention, as intended by Mr. Frank, could have been the least intrusive way to create a stronger incentive to manage risk. 

An incentive the market may well have adopted on it’s own accord.

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