The risk retention proposal drafted by federal regulators is likely to hinder the development of a private securitization market and make it harder to wind down Fannie Mae and Freddie Mac, according to a new paper by Moody's Analytics.

As proposed, the regulators would require MBS issuers to retain 5% of the credit risk on mortgages that don't meet a "qualified residential mortgages" (QRM) test and carry downpayments of less than 20%.

The regulators should "soften the rules," lower the downpayment requirement for QRM loans and eliminate the premium recapture provision on private securitizations, according to Moody's Analytics chief economist Mark Zandi.

The premium recapture rule is "unlikely to prevent securitizers from avoiding the 5% retention requirement, but it is likely to raise mortgage rates and make credit less available," Zandi said in a paper, Reworking Risk Retention, he co-authored with Cristian deRitis.

The Moody's Analytics economists estimate non-QRM borrowers would end up paying mortgage rates 75 basis points to 100 bps higher than QRM borrowers if the regulators move ahead with their risk retention rule.

As an alternative, Zandi suggests regulators could revive confidence in private securitizations by tightening loan standards at the point of origination and strengthening representations and warranties.

The current risk retention proposal "risks raising the costs to securitization so high it will make it more difficult to come back," the Moody's Analytics' paper said.

"Until private mortgage securitization is reborn, it will be difficult for the government to reduce its current outsized role in the mortgage market," Zandi said.

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