Tag Archives: Qualified Residential Mortgage

Access to Sustainable Credit

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Reid & Quercia have posted Risk, Access and the QRM Reproposal. This document is intended to influence the most recent proposed rulemaking for the Qualified Residential Mortgages (QRMs). The rulemaking process for the QRM has been controversial and the stakes could not be higher for the health of the residential mortgage market. The first  proposed rulemaking in 2011 would have required QRMs to have substantial down payments. A broad coalition of lenders and consumer groups believed that this requirement would excessively restrict credit and so the regulators responsible for the QRM rule issued an new proposed rulemaking in 2013 that removed the requirement for down payments from the QRM definition.

Reid & Quercia argue that the more restrictive 2011 proposed QRM rule only provided marginal benefits over the 2013 proposed QRM rule, while significantly restricting credit particularly for households of color. They note that the “objective of weighing the marginal benefit of stricter QRM requirements against the costs of cutting off access to the mainstream mortgage market is an important one.” (7) They have created simple metrics “for evaluating the tradeoffs of reducing the number of defaults against the number of successful borrowers who would not be able to obtain a QRM loan as a result of stricter down payment and credit score requirements” (7)

While Reid & Quercia do not say so explicitly, I believe that their metrics, such as the benefit ratio, should be explicitly worked into the final QRM rule so that regulators are constantly considering the two sides of credit: availability and sustainability. There is a lot of pressure to increase access to residential mortgage credit by a range of players — consumer advocates, lenders and politicians to name just a few. But credit that cannot be sustained by homeowners leads to mortgage default and foreclosure. We will be doing new homeowners no favors by letting them take out mortgages with payments that they cannot consistently make, year in and year out.

 

Benefit Ratios for Qualified Residential Mortgages

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As I had noted previously,

the long awaited Proposed Rule that addresses the definition of Qualified Residential Mortgages has finally been released, with comments due by October 30th. The Proposed Rule’s preferred definition of a QRM is the same as a Qualified Mortgage. There is going to be a lot of comments on this proposed rule because it indicates that a QRM will not require a down payment. This is a far cry from the 20 percent down payment required by the previous proposed rule (the 20011 Proposed Rule).

The Proposed Rule notes that in “developing the definition of a QRM in the original proposal,” the six agencies [OCC, FRS, FDIC, FHFA, SEC and HUD] responsible for it “articulated several goals and principles.” (250)

First, the agencies stated that QRMs should be of very high credit quality, given that Congress exempted QRMs completely from the credit risk retention requirements.

Second, the agencies recognized that setting fixed underwriting rules to define a QRM could exclude many mortgages to creditworthy borrowers. In this regard, the agencies recognized that a trade-off exists between the lower implementation and regulatory costs of providing fixed and simple eligibility requirements and the lower probability of default attendant to requirements that incorporate detailed and compensating underwriting factors.

* * *

Fourth, the agencies sought to implement standards that would be transparent and verifiable to participants in the market.” (250)

After reviewing the comments to the 2011 Proposed Rule, the agencies concluded that “a QRM definition that aligns with the definition of a QM meets the statutory goals and directive of section 15G of the Exchange Act to limit credit risk, preserves access to affordable credit, and facilitates compliance.” (256)

I was somewhat disturbed, however, by the following passage. The agencies are

concerned about the prospect of imposing further constraints on mortgage credit availability at this time, especially as such constraints might disproportionately affect groups that have historically been disadvantaged in the mortgage market, such as lower-income, minority, or first-time homebuyers. (263)

While it is important to make residential credit broadly available, the agencies will be doing borrowers no favors if their loans are not sustainable and they end up in default or foreclosure. The agencies should come up with a metric that balances responsible underwriting with access to credit and apply that metric to the definition of a QRM.

Quercia et al. have developed one such metric, which they refer to as a “benefit ratio.” The benefit ratio compares “the percent reduction in the number of defaults to the percent reduction in the number of borrowers who would have access to QRM mortgages.” (20) A metric of this sort would go a long way to ensuring that there is transparency for homeowners as to the likelihood that they can not only get a mortgage but also pay it off and keep their homes.

Regulating the Distribution of Home Equity

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Ian Ayres and Joshua Mitts have posted Three Proposals for Regulating the Distribution of Home Equity which brings welcomed attention to the systemic risk implications of consumer protection regimes.  In particular, they argue that the proposed Qualfied Residential Mortgage “rules do not effectively address the systemic consequences of mortgage terms which in aggregate can exacerbate market volatility.” (4) They also argue that the new and proposed regulations governing residential mortgages are too static and that they have too many bright line rules that could needlessly reduce variation and innovation for mortgage products.

The authors apply cap and trade to the residential mortgage market in a novel way — one that is is worthy of exploration.  They propose that the government sell mortgage lenders licenses to originate a range of low downpayment mortgages, with the total number capped so as not to pose a systemic risk to the mortgage market.

This is not to say that the paper is flawless.  I find the modeling of the mortgage market overly simplistic.  For instance, its discussion of circuit breaker gaps (an empty range “of equity levels  that can absorb small decreases in prices by keeping homeowners above the range in positive equity”) assumes that LTV ratios at origination will somehow be carried over even when a mortgage is seasoned. (14) That would not be the case.

Its proposal to require that debt-to-income ratios be increased from the 5 years in the proposed regulation to the life of the loan does not seem to take into account the fact that it would kill just about the entire market for ARMs. (32) Given that many ARM products (5/1s ,7/1s, 10/1s) are legitimate and important products, this proposal seems off. (32)

Finally, there is something a bit “turtles all the way down” about the cap and trade proposal. (see 34) The proposal does not let us know how regulators would come up with the optimal (from a systemic risk perspective) distribution of licenses.  Until we know how to answer that question, it will be hard to determine the value of this proposal.