The push by banks and consumer advocates to expand the "qualified residential mortgage" exemption to pending risk-retention requirements ultimately boils down to this: it should be the rule, not the exception.
While regulators have said Congress meant for the QRM to be a narrow category of super-safe loans, the industry and consumer groups fundamentally do not see it that way, arguing that it will be, in effect, the new normal that shuts out or penalizes other creditworthy borrowers.
They liken it to conforming mortgages, which most borrowers aspire to obtain because they feature lower interest rates, while lenders know they can sell them to Fannie Mae or Freddie Mac.
"If the government says these are good mortgages, then the market will take notice," said Ethan Handelman, vice president for policy and advocacy at the National Housing Conference. "It could become an unintended focal point. No one today is calling these conforming loans, but that easily could happen as we figure out what's going on with the rest of mortgage finance."
But while the industry and consumer groups are calling for expanded QRM criteria — easing tough requirements such as a 20% down payment and certain debt-to-income thresholds — many others observers see this as a dangerous proposition. They say if most mortgages are QRM, that means lenders do not have to retain any risk in loans they sell to the secondary market, raising questions about the purpose of a risk-retention requirement in the first place.
"Debt-to-income and loan-to-value are real factors affecting the probability of default," said Josh Rosner, managing director of the research firm Graham Fisher & Co. "What you have are mortgage banks and mortgage insurers who want to obscure that reality and consumer groups arguing the same thing along the lines of racial and ethnic impact. But that is silly. They want to bring us to a world that looks like the world before the crisis."
Much of the argument turns on what Congress meant by calling for QRM loans in the first place.
In their proposal, regulators clearly interpreted Dodd-Frank as mandating a narrow QRM exemption, and their proposed 80% LTV would force the vast majority of private-label securitizations to retain credit risk.
Yet in letters and hearings, lawmakers have attempted to clarify that they did not envision such a limited definition. (The proposal initially included a comment period until June 10, but many have pushed the agencies to extend that to August.)
Tom Deutsch, the executive director of the American Securitization Forum, said the language in Dodd-Frank — establishing the QRM treatment for loans with a "lower risk of default" — left regulators with enough room to broaden the definition.
"The next question you have to ask is: Lower than what?" Deutsch said. "The law indicates that there is a wide berth of interpretation, but it seems very clear by statements of those who wrote the law such as" Rep. Barney Frank "that the proposed QRM definition is not nearly as wide as he intended."
But others involved in the legislative process said everyone had a different view at the time the law was being drafted. "In the legislative process, there was a lot of opposition to risk retention. When the qualified residential mortgage provision was put in, different people viewed that different ways," said Michael Barr, formerly the assistant Treasury secretary for financial institutions and now a law professor at the University of Michigan.
"Treasury viewed QRM as a narrow exception to the risk-retention standard. The industry thought of QRM as being a broad exception so that only the riskiest loans would be subject to risk retention.
"A third way of thinking about QRM was … that it would be the new standard in the mortgage market going forward, akin to a new conforming mortgage — the standard loan in the future that, if there is a government guarantee, that guarantee would adhere to."
Many observers have been surprised at how QRM now overshadows other provisions of the risk-retention proposal.
"What people are trying to do is create the QRM as the standard mortgage product in the industry, and it's not," said D. Anthony Plath, a finance professor at the University of North Carolina at Charlotte. "It's not designed to be a plain-vanilla mortgage product for everyone. The standard should be the 5% risk retention, not 0% risk retention."
Under the law, lenders would have to retain 5% of the credit risk of any loan they securitize — unless it fits QRM criteria. Plath said such "skin in the game" requirements make the system safer.
"We're being schizophrenic about the mortgage market," he said. "We're talking out of both sides of our mouth. On the one hand, we want mortgages to be harder to get because we want to eliminate a speculative asset-pricing bubble in the housing market. On the other hand, we're going back to the days when we're putting people in homes that don't qualify for the lowest-risk mortgage in the marketplace."
To a large extent, the outcome for finalizing the QRM standard is tied to the broader debate about the uncertain future of U.S. housing finance. Various proposals are on the table for a new financing structure once the conservatorships of Fannie Mae and Freddie Mac are wound down.
In the short term, loans backed by Fannie and Freddie are fully exempt from the risk-retention requirements, as long as the mortgage giants are supervised by the government.
But in the long term, when loans backed by the government-sponsored enterprises would be subject to risk-retention rules, observers said a QRM standard could be viewed as criteria for GSE support, similar to the current conforming loan limits restricting the size of mortgages held by Fannie and Freddie.
"Your view of QRM depends a lot on your vision of the future of the housing finance system," Barr said.
As regulators work on defining the QRM, they also have yet to finalize another category known as the "qualified mortgage." Mandated by Dodd-Frank, the QM — which applies both to securitized mortgages and those kept on the balance sheet — is a separate category of features that exempts loans from new ability-to-repay requirements. The Federal Reserve Board's proposal for QM criteria omitted DTI and LTV as factors.
Many industry representatives have urged regulators to align the two standards.
QRM "should be much closer to the QM," said Joseph Pigg, vice president and senior counsel of mortgage finance for the American Bankers Association. "The QM is a more workable standard in the way that it approaches underwriting. The QRM takes so much discretion away from the underwriter. The QM leaves some of that discretion in place, which is after all what underwriting is about."
He said risk-retention and a minimum down payment may ultimately be unnecessary with the underwriting standards required by the QM rule and already adopted by many institutions.
"If the goal of all of this was to improve underwriting, we've thrown a number of tools out there that have improved underwriting. Layering an additional tool on top of it it may be somewhat superfluous," Pigg said.
But others countered that risk retention is a more effective defense against a repeat of the crisis in which securitization played such a huge role.
Lawrence White, a professor at New York University, said if the regulations mean most securitized mortgages will require risk retention, the market will adapt.
"If there are creditworthy borrowers who cannot come up with the 20% down payment and therefore their mortgages don't qualify for QRM treatment, … the market will figure out a way to handle their mortgages in a way where the 5% holding ends up with natural holders like depository institutions and maybe even insurance companies," White said.
Barr said depending on how the future of mortgage lending plays out, housing advocates concerned about the effects of a limited QRM definition on lower-income borrowers may have a valid point.
"If it does become the new standard for mortgage lending, then I would agree with the critique: it's way too narrow. … That's not what the regulators intend, but it has the danger of morphing into that if people are not careful," he said.