Real estate industry ducks a mortgage bullet

Regulators postpone decision on 'ability to pay' standards

Call it what you want — a Hail Mary pass, a punt, kicking the can down the road, you name it.

But the fact remains: With the Consumer Financial Protection Bureau’s decision to put off action on its controversial "qualified mortgage" (QM) regulation, the real estate and mortgage finance industries have ducked a bullet, probably until the November elections are over. And possibly well beyond.

The delay, announced Thursday, also effectively postponed final action on another regulatory hot potato — the "QRM," or qualified residential mortgage plan, which is due to be issued by six federal agencies. The original version of that rule would have forced most lenders to demand minimum 20 percent down payments and require stringent debt-to-income ratios for borrowers receiving the lowest rates and best terms.

The proposal was seen as so harsh and damaging to housing that Realtors, builders, banks, unions and consumer groups protested to Congress and the White House, and got it sidetracked temporarily.

Since these alphabet-soup names of regulations can be a little confusing, here’s a quick overview. Both the QM and QRM are products of the Dodd-Frank financial reform legislation passed in 2010.

Think of QM as Congress’s mandate to the federal government to establish clear standards for borrowers’ "ability to pay" the mortgages they seek.

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Think of QRM as Congress’s effort to ensure that lenders who originate mortgages for the secondary market retain some risk on their own balance sheets in the event of a default.

During the boom years, brokers and wholesalers shipped poorly underwritten loans in massive quantities to Wall Street securitizers with no direct financial risk to themselves when the loans later defaulted.

But in the Dodd-Frank law, Congress said lenders will need to retain a 5 percent minimum ongoing stake in the loans they originate unless they meet certain baseline standards for safe underwriting: full documentation of income and assets, no potentially dangerous features such as negative amortization or balloon payments, among others.

In both cases, Congress left it up to federal agencies to draft the final rules to implement the statutory mandates. The Consumer Financial Protection Bureau, which took over the QM responsibility, was expected to issue its rule by the end of the month. Last week’s announcement of a new public comment period through July 9 is certain to delay the final rule for months — likely past the November elections.

So why should the real estate and mortgage finance industries cheer? Because it is proof that the Obama administration heard their concerns that a poorly drafted QM regulation could make getting a mortgage even tougher than it is today for large numbers of buyers and refinancers, and could starve the housing market of some of the capital it needs to rebound.

That message, sent directly to the West Wing of the White House by trade groups including the Mortgage Bankers Association and the National Association of Realtors, helped frame the issue in stark political terms: Does the Obama administration really want to stir up criticism of its housing policy during a re-election campaign in which the president’s record on the economy is his most vulnerable issue?

Last week we got the White House’s answer: No way!

Prior to the political punt, there were strong indications that the CFPB was leaning toward approving a QM rule favored by consumer groups but generally opposed by the housing industry. Rather than establishing a clear "safe harbor" set of standards for lenders to follow in order to be compliant with the law and minimize litigation — an option provided by Congress in the Dodd-Frank statute — the agency was expected to publish a rule that instead allowed defaulting consumers greater opportunities to take lenders to court charging technical compliance violations.

This option, which was also sanctioned by Congress, is known as the "rebuttable presumption." David Stevens, CEO and president of the Mortgage Bankers Association, told the White House and CFPB leadership that adopting this type of standard would force many lenders to tighten their underwriting standards to lessen the risk of legal challenges and reject even more applicants for financing than they do today.

Stevens estimated that the potential litigation costs of the CFPB’s intended approach could average between $70,000 and $110,000 per loan — new expenses that would cause some lenders to abandon the mortgage business altogether. Consumer groups scoffed at the industry’s estimates and the likelihood of increased litigation.

Ira Rheingold, executive director of the National Association of Consumer Advocates, called them "full of crap" in an interview with me, and argued that borrowers need to be able to challenge lenders in court to avoid the sort of abuses that arose during the bubble years.

Where’s this all headed? The CFPB says it needs time to examine data from Fannie Mae and Freddie Mac on key loan criteria associated with elevated defaults, such as debt-to-income ratios and borrower reserves. One threshold suggested by some consumer and banking groups is a maximum 43 percent back-end debt-to-income ratio, where total household debt payments including the mortgage do not exceed 43 percent of monthly household income.

Other mortgage groups say that’s too tight and inflexible, and that it would cut out 15 to 25 percent of current homebuyers, especially first-timers. Other real estate and mortgage groups are working on compromise plans for submission to the CFPB.

One would involve a blended approach: a set of baseline "safe harbor" thresholds such as 43 percent debt-to-income that would insulate lenders who comply from unreasonable litigation, but that would also open the door to potential "rebuttable presumption" legal challenges on loans that didn’t meet all the baseline requirements.

Whatever compromise alternatives the CFPB ultimately looks at between now and December, three things appear certain:

Any new set of mandatory underwriting restrictions, even with a six- to 12-month transition period, is likely to rattle the mortgage lending industry and put homebuyers with marginal credit and modest assets into a more difficult position on financing in 2013.

If Romney wins the election, all regulatory bets are off. Not only will CFPB Director Richard Cordray, appointed by Obama without Senate confirmation, be gone in January, the entire agency will be headed for a major shake-up at the very least, and legislative threats to its continued existence at the most.

If Obama returns for another four years, on the other hand, look for a tougher final QM rule out of CFPB, followed quickly by another regulatory headache for housing and the mortgage market, QRM.

Ken Harney writes an award-winning, nationally syndicated column, "The Nation’s Housing," and is the author of two books on real estate and mortgage finance.

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