FDIC Chair Casts Doubt Over "Risk Retention" Exemptions

by devteam June 14th, 2011 | Share

Federal Deposit InsurancernCorporation Chair Sheila Bair recently took issue with the “Qualified Residential Mortgage” rule in a wide ranging interview conducted by New York Times editor Andrew Ross Sorkin at the Council on Foreign Relations seminar last Thursday. This was surprising feedback fromrnBair, a Bush appointee whose term of office ends on July 8, as she has been onernof the stronger voices pushing back against anti-regulationrnforces.  </p

The Dodd-Frank financial reform act requires the originator of a residential mortgage to retain at least a 5 percent interest in that mortgage when selling it into the secondary market, a provision commonly referred to as “skin in the game.”  Loans backed by FHA, VA, USDA, Fannie Mae and Freddie Mac will however be exempt from risk retention regs. For non-agency loans to meet the QRM definition and avoid being subject to risk retention regs, they must have down payments of 20% or more and a DTI of 28%/36% or less.  MORE DETAILS</p

Bair said that requiring securitizers tornkeep a 5 percent slice of loan packages “can do a lot to tame underwriting standardsrnin a way that we regulators don’t have to get into micromanaging what thernstandards are.” However, the industryrnpushed the QRM exception into the bill so regulators now must definernthe new gold standard in mortgages “and these are just such great standards...we’rernjust so sure against default that nobody would really need to retain anyrnrisk.”  Now there is a huge push back,rnshe said, because people think that this is going to become the new normal,rn”and I think people are right to the extent that it is going to createrntwo-tiered pricing for securitized loans.”</p

“So the risk retention loans willrnprobably be some incrementally higher. rnIt’s more like 10 or 15 basis points, not some of the other numbers thatrnpeople are throwing around.  If we couldrnjust get rid of it it’d be fine with me, just making sure everybody keeps 5rnpercent, I would love that; that statute has this direction.”</p

It is unclear whether Bair’s comments reflect a growing opinion among regulators to forego QRM definitions and simply apply the 5 percent rule to all securitized loans including those backed by government agencies,  but we do know there has been a push-back from consumer advocates and politicians on the issue: FULL STORY</p

Bair commented on a number ofrnother FDIC-related issues concerning  the economic downturn as well as thernrecovery.  Besides risk retention regulations, here are a few of the areasrnshe touched upon in the discussion with Sorkin and the audience Q&A thatrnfollowed.</p


“I think it’s up to Congress to decide how much they want governmentrninvolved in mortgage finance. I do think there’s a difference betweenrnsubsidizing mortgage finance and supporting home ownership.  And so I think they need to look at policiesrnthat actually promote home ownership; not a lot of leverage with people who ownrnhouses.”</p

She suggested an FDIC model for supporting secondary mortgage finance; arngovernment-run agency that charges premiums for this and prefunds a reserve torntake losses if the loans go bad rather than a hybrid model of a private-sectorrnentity with a government backstop.  “If Irnwas going to continue a U.S. government presence, I would continue it (inrnhousing for low and moderate income people) before I would continue itrnanyplace.” </p

The foreclosure process, she said, isrnbecoming dysfunctional.  There is anrnoverhang of delinquencies and inventory and increasing litigation that willrnalso be slowing things down.  Early on,rnshe said, she had suggested a two part process; for retroactive problems therernwould be a bank-funded pool to provide a nominal settlement to waive claims andrna process for those who were wrongfully foreclosed and going forward a streamlinedrnmodification that would write down loans below appraised value, give homeownersrna year to perform before refinancing them with a bit of equity or they wouldrnagree to turn in their keys.  Something dramaticrnmust be done rather than the current incremental fixes. Instead, she said, shernsees modifications becoming more and more complicated.</p

She is quite angry with the servicers. “We saw this coming for years. Werntalked about ramping up their staff, putting assistance in place for workout,rnbut it wasn’t done. Now we have poor quality servicing plus litigation andrnissues around poor documentation. </p

Elizabeth Warren</p

While Bair didn’t exactly throwrnElizabeth Warren, the person designated to establish the new Consumer FinancialrnProtection Bureau, under the bus, she didn’t provide much support for herrnappointment as permanent CFPB Director.  Itrnis critical there be a presidentially appointed and Senate-confirmed head, Bairrnsaid she hopes that the administration and the Senate “come together and forrnthis and other jobs “find quality people to serve.”</p

Sorkin quoted William Cohen’s suggestionrnthat it was Warren’s duty as a citizen of this country to get out of the way;rnthat there was no way to move the agency forward with her in the mix.   Bair responded, “Elizabeth is a veryrntalented person who had a wonderful career prior to this and there’s a lot ofrnwonderful things she can do, and there are — you know, there’s a goodrnreservoir of candidates out there, but I think it’s important for the presidentrnto make a decision on this and to move forward and engage the Senate andrnhopefully in a way that can move these nominees to confirmation, because atrnthis point it’s looking like they’re all going to get bogged down and I thinkrnthat’s a very difficult situation for the country right now.”</p


Asked about the need for accountability for what happened in the financialrnindustry prior to the collapse, Bair said, “We obviously can’t put people inrnjail. We are certainly being very vigorous in suing directors and officers whornwe feel did not exercise the appropriate duty of care in running their banks;rntry to recoup some of the losses we suffered as part of the failed banks.”  “Instead of just going after the (D&O)rninsurance proceeds; I think you need to have some pain be felt by people.  So I think you can — you know, can havernfinancial pain without sending somebody to jail, and maybe it’s appropriaternthat some people should go to jail too.”</p

I think at the origination level I think there was a lot of fraud going on,rnand I think the question is how much of it begs — are there larger financialrninstitutions funding this stuff, did they know about it and it was just a matterrnof looking the other way, not having appropriate controls or did they actuallyrnknow about that.”</p

Banking Regulation</p

Early in the discussion, Sorkin askedrnBair about CitiBank CEO Jamie Dimon’s recent remark that most of the bad actorsrnand the exotic derivatives are gone; standards are higher, banks have morernliquidity and capital, boards and regulators are tougher and more regulationsrnare coming. The cumulative effects of regulation are the reason banks aren’trnlending and unemployment hasn’t gotten better. </p

Bair responded that we need to berncareful to ensure that regulations are efficient, understandable, and presentrnthe desired outcomes “But on basic things, obvious thingsrnlike higher capital standards, I say full speed ahead and the higher thernbetter.”</p

Arnlot of research, she said, challenges that notion that higher capitalrnrequirements have much impact on lending. rn”Lending is really just another way of funding your balance sheet, andrnit’s more expensive than debt. But it can influence losses in a crisis. Andrnthen you have financial institutions, especially large ones, that are toornhighly leveraged. If you get into a crisis, they don’t have that lossrnabsorption capability, so they have to quickly reduce their balance sheet tornmaintain solvency, and that’s what we saw during the crisis.”</p

Now there is better regulation,rnhigher capital standards, rules that prevent regulatory arbitrage.  There will always be cycles, she said, but werncan help ensure these are normal cycles not economic cataclysm.</p

Too Big to Fail</p

Sorkin asked if regulations to preventrntoo big to fail will work or will create risk, and lead to political favorrntrading.</p

Bair said she did worry about the government’srnwill to use the new tools, but not about favoritism.  FDIC has always had resolution authority forrnmember banks and has tools to resolve banks and get the assets back into thernprivate sector quickly; rules that don’t allow favoritism.  Under Title II of Dodd-Frank that resolutionrnauthority now applies outside of insured banks</p

She said that large complex entities, especially those with multinationalrnoperations, will be difficult but not impossible to resolve. Banks are fundamentallyrntoo big if they cannot demonstrate that they can be resolved, than they are toornbig and need to be downsized now.  Unlessrnthose large banks think that FDIC and the Fed is serious about using thatrnauthority, we won’t get credible resolution plans; we’ll get “nice paperrnexercises to sit on the coffee table somewhere”.</p

Bair said the FDIC could have easily resolved Lehman Brothers under the newrnrules.  There were ready buyers who hadrndone due diligence, there was a lot of time for planning.  It might not, she said, have even gotten tornresolution – the FDIC’s authority provides strong incentives for bankrnmanagement and bank boards to right their own ship. 

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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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