Sunday, December 26, 2010

In letter to SEC and Fed, Rep. Brad Miller Warns that Qualified Residential Mortgage Exception Could Swallow Dodd-Frank’s 5% Skin in the Game Mandate

A leading member of the House Financial Services Committee has asked the SEC to carefully craft rules for the qualified residential mortgage exception to the Dodd-Frank risk retention requirements for securitized mortgages lest the exception swallow the five percent skin in the game provision. In a letter to SEC Chair Mary Schapiro, Rep. Brad Miller (D-NC) also urged that any exception to the risk retention requirements of Section 941 of Dodd-Frank include rigorous requirements for servicing securitized residential mortgages.

Rep. Miller noted that Section 941 requires that securitizers retain five percent of the credit risk on mortgage-backed securities, which according to a recent study published by the Federal Reserve Bank of San Francisco by Christopher M. James dated December 13, 2010, and entitled “Mortgage-Backed Securities: How Important Is ‘Skin in the Game’?”, which finds that the requirement will have the intended effect of reducing “moral hazard” and significantly reducing the loss ratios on mortgage-backed securities.

The Dodd-Frank Act provides for an exception for qualified residential mortgages and for other exemptions and adjustments to the risk-retention requirement. Sponsored by Senators Mary Landrieu (D-LA) and Johnny Isakson (R-GA), the bi-partisan carve out for qualified residential mortgages is designed to ensure that originators of mortgages with a high FICO rating will not have to retain the five percent amount required of other securitized assets. (Cong. Record, May 12, 2010, S3576).

Rep. Miller strongly urged the SEC to use great care in allowing any exception to the risk retention requirement, and to be vigilant in assuring that any exception not defeat the purpose of the requirement. In his view, recent experience in financial regulation has been that seemingly modest, reasonable exceptions have swallowed the rules and allowed abusive practices to continue unabated. Thus, in considering any requested exception under Section 941, the SEC should remember that the advocates for rule-swallowing exceptions to other financial regulation have not been entirely candid with regulators or legislators on the likely effect of those exceptions.

While the rules adopted pursuant to section 941 must require rigorous underwriting standards for qualified residential mortgages or any other mortgages excepted from the risk retention requirement, he added that underwriting requirements are not enough. The rules must also address the servicing of securitized mortgages. In his view, much of the turmoil in the housing market is the result, not just of poorly underwritten mortgages, but of conduct by mortgage servicers. Rep. Miller emphasized that Dodd-Frank authorizes the SEC and other federal financial regulators to reform servicing practices

He urged that any rule for securitized mortgages require that servicers not be affiliated with the securitizer since there are potential conflicts of interest and no apparent countervailing justification. He said that at a recent hearing of the Financial Services Committee witnesses from major servicers were unable to offer any advantage in being affiliated with securitizers, other than to offer full service to customers, a justification he viewed as entirely unpersuasive. Homeowners may select the bank with which they have a credit card or a checking account, he noted, but they have no say in who services their mortgage.

In fact, community banks and credit unions have been reluctant to sell the mortgages that they originate to “private-label securitizers” for fear that the mortgages will be serviced by an affiliate of a bank, and the servicer will use that relationship to cross market other banking services to the homeowner. Requiring that servicers be independent of banks, therefore, would advance the goal of increasing the availability of credit on reasonable terms to consumers.

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