Editor: David Reiss
Brooklyn Law School

April 13, 2018

The Costs and Benefits of A Dodd-Frank Mortgage Provision

By David Reiss

Craig Furfine has posted The Impact of Risk Retention Regulation on the Underwriting of Securitized Mortgages to SSRN. The abstract reads,

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 imposed requirements on securitization sponsors to retain not less than a 5% share of the aggregate credit risk of the assets they securitize. This paper examines whether loans securitized in deals sold after the implementation of risk-retention requirements look different from those sold before. Using a difference-in-difference empirical framework, I find that risk retention implementation is associated with mortgages being issued with markedly higher interest rates, yet notably lower loan-to-value ratios and higher income to debt-service ratios. Combined, these findings suggest that the implementation of risk retention rules has achieved a policy goal of making securitized loans safer, yet at a significant cost to borrowers.

While the paper primarily addressed the securitization of commercial mortgages, I was particularly interested in the paper’s conclusion that

the results suggest that risk retention rules will become an increasingly important factor for the underwriting of residential mortgages, too. Non-prime residential lending has continued to rapidly increase and if exemptions given to the GSEs expire in 2021 as currently scheduled, then a much greater fraction of residential lending will also be subject to these same rules. (not paginated)

As always, policymakers will need to evaluate whether we have the right balance between conservative underwriting and affordable credit. Let’s hope that they can address this issue with some objectivity given today’s polarized political climate.

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  • John T Maher says:

    I see a future class action lawsuit based on the conclusion on p. 22 “Since vertical risk retention is held by sponsors and horizontal risk retention is sold to outside investors, it could be that sponsors chose vertical risk retention for pools with higher interest rates, lower LTVs, and higher DSCRs. That is, sponsors may have chosen the shape of retention in such a way that they ultimately retained risk in higher quality pools.”

    How different is that from the 2008 lawsuits for MBS and RMBS securities where the issuer cherry picked asset pools it held on account or steered to preferred customers?

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