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QRM's Missed Opportunities for Financial Stability and Servicing Reform

posted by Adam Levitin

There are three major new regulations shaping the housing finance market:  QM (qualified mortgage), QRM (qualified residential mortgage) and Reg X.  QM is a safe harbor from the statutory ability-to-repay requirement that applies to all mortgages.  QRM is a safe harbor from the statutory risk retention requirement that applies to mortgage securitization.  And Reg X are the new mortgage servicing regulations.  It's important to understand how these three regulations interact and how they're going to affect the housing finance market.  (There's also new TILA/RESPA disclosure stuff, but I don't think that's particularly impactful, in part because I don't think disclosure regulation is especially effective in most real world circumstances.) 

QM and Reg X are consumer protection rulemakings by the CFPB.  QRM is an investor protection rulemaking by SEC, Fed, FDIC, OCC, FHFA, and HUD...but not the CFPB (although CFPB does have a seat on the FDIC board).  We learned early this week that QRM just means QM.  Thus, any mortgage that is QM is also QRM and is exempt from sponsor/originator credit risk retention in securitizations.  

QM is about ensuring that consumers' are able to repay their mortgages, meaning that they are not going to default.  Accordingly, it includes all sorts of requirements about the consumer's income, but nothing about downpayment.  Nor should it.  Downpayment relates to loss-given-default, not probability of default.  Downpayment is about investor protection, not consumer protection. Because QM is an ability-to-repay rulemaking, downpayment has no place in QM. 

The entire ability-to-repay requirement (and QM) might have some effect constraining credit. The early evidence doesn't show much effect, but if ATR/QM is restraining credit a bit, I'm not too concerned, as it it probably should--borrowers who can't repay loans shouldn't be getting them. In the good old days when banks held loans on their books, ability-to-repay was a basic assumption of lending. But that assumption no longer holds universally in the days of risk transfer through securitization and sweat-box lending models that care about extracting enough fees to make a profit before a default. Hence a statutory requirement was necessary to restore some common sense to mortgage lending. 

Similarly, Reg X is a consumer protection regulation. Let's acknowledge that mortgage servicing is an absolute mess.  It is a failed industry.  Reg X doesn't fix things, however. It actually exacerbates problems by requiring a whole lot of procedural steps from a mortgage servicer engaged in loss mitigation.  This is a problem because servicers' compensation for existing loans doesn't cover these additional costs.  What's more, Reg X adds procedural costs, but it doesn't mandate any substantive outcomes. The added costs from the procedural steps required by Reg X might well shape substantive outcomes, but that's not guaranteed. In fact, the added servicing costs from Reg X might well make lenders shy away from lending to riskier borrowers because the likelihood that those borrowers will produce added loss mitigation costs is higher.  So Reg X might have an effect of constraining credit on the margin to riskier borrowers.  Anecdotally this is what I hear, but anecdote≠data. 

The problem, is that to some degree or another QM and Reg X (plus all of the various servicing settlements) are likely to have some effect restricting housing credit. And politically that's really problematic in two ways. First, there are affordable housing concerns--people of lesser means should still have decent housing, and there are real social benefits to home ownership. Second, and much less commented on, is that a constriction in credit affects existing home prices, which are already fragile.  We've had a weak housing price recovery despite a long period of incredibly low interest rates. Housing is so important politically because of its shelter and investment/retirement savings and homebuilding/selling/furnishing economy aspects that no one wants to do anything that will put downward pressure on home prices.  

QRM and Missed Opportunities

Which brings us to QRM. The original QRM proposal quite sensibly included a downpayment requirement. One might quibble about just what that requirement should be, but the original proposal was essentially saying that someone ought to have some skin in the game:  if not the securitizer, then the borrower.  100% leveraged assets shouldn't be sold unless the seller is also taking the risk.  But the QRM downpayment proposal resulted in a total freak-out. The affordable housing and the general "must protect home prices" concerns came together against it. There could have been an affordable housing carve-out for smaller mortgages or the like, but it was easier to junk the entire downpayment requirement.  Notably downpayment requirements exist for risk retention exemptions for commercial mortgages and auto loans.  It's not like this was a principled change in QRM.

Missed Financial Stability Opportunity:  current housing prices again long-term trump financial stability.

So we're left with a consumer protection regulation, QM, doing the work of an investor protection regulation QRM. That doesn't seem quite right. Lower probabilities of default under QM help investors, but once there's a default, Reg X raises the losses-given-default, and that's why a downpayment requirement really matters.  Unless those mortgages aren't getting made in the first place.  I understand the desire to ensure that housing prices (or at least nominal housing prices) do not fall any further and the need to ensure that everyone can obtain good housing. But I think we need to see the denuded QRM rulemaking for what it is:  an attempted regulatory stimulus of the housing market.


A collapse in  housing prices would not help financial stability.  But I don't think a downpayment requirement would cause such a collapse, just a slower growth.  What I worry about is that we're mortgaging future financial stability in order to get an immediate stimulus of housing prices.  That's a bad deal, imho. 

QRM doesn't really matter for the time being given that the private-label market is moribund.  And we're also doing all sorts of other housing stimulus, but the big one is continued low interest rates. The difference, however, is that interest rates can be turned on a dime. Good luck changing a 6-agency joint rulemaking any time soon.  I don't think we want this sort of sticky regulatory stimulus.  I don't think we want to be further boxing ourselves into unlimited support of house prices, in part because there's a natural upper bound to that support, and once we hit it, we're out of options. 

I still think we should have some sort of a general downpayment requirement for home mortgages, with affordable lending exceptions via FHA/VA, etc., where lower downpayments are off-set by insurance.  That said, I'm not sure that QRM was really the place to do it. Instead, we really should think about having a dynamic downpayment requirement that can be changed much like Fed interest rate targets. That sort of dynamic leverage regulation would enable much more nimble regulation of the housing market.  

Missed Servicing Reform Opportunity

At the same time, I think we also have to see QRM as a missed opportunity to fix mortgage servicing. The risk retention rule has some mortgage servicing requirements--for commercial mortgages. It's got nothing for residential mortgages.  QRM was an opportunity for a more rational, multi-regulator agreement on substantive reforms for residential mortgage servicing.  The regulators didn't step up to the plate on this. That's a shame because the servicing market continues to remain adrift:  it's being shaped by a lot of uncoordinated regulatory reforms:  Basel III, Reg X, litigation settlements, none of which really address any of the important investor protection issues or mandate substantive outcomes for consumers.  QRM was missed chance to fix servicing for both investors and consumers. 


Reg X provides a significant substantive change benefiting consumers vis-a-vis the 120 day rule for a primary residence. The rule essentially prohibits any foreclosure for reasons other than non-payment of the obligation (other than a due on sale clause or joining a the foreclosure action of a subordinate lender), making many default provisions in new and current contracts moot.

As for down payments, there really should be a requirement, and it should even be self imposed by investors. At 100% LTV, the lender is essentially purchasing real estate and leasing it back to the borrower (rent to own?). An OREO with no upside.

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