January 13, 2011
30 Percent Down Or Interest Rates Up As Proposed By Wells Fargo
Wells Fargo & Co., the nation's largest mortgage lender, has asked U.S. regulators to set a down-payment standard of 30% on mortgages that wouldn't have to meet a new requirement that banks retain 5% of a loan if it is securitized. The so-called risk-retention requirement is aimed at preventing future housing meltdowns because lenders could face steeper losses if their loans go bad.
If regulators go along with the San Francisco bank's proposal, mortgage lenders still could make loans with down payments lower than 30%. But those loans would be more costly for the banks because of the risk-retention requirement. Lenders likely would pass those costs along to borrowers in the form of higher interest rates.
Of course that assumes securitization as we know it survives...
First Published: January 13, 2011 9:00 AM
Comments from "Plugged In" Readers
Whether this gets agreed to or not, it's a catastrophe, coming this April.
If they agree to it, 30% down will become the new standard for all but the best borrowers. Prices will fall drastically to the point that the worst borrowers will be able to bring 30% down.
"Tuesday's letter cited research from J.P. Morgan Securities that concluded mortgage rates could rise by as much as three percentage points for loans that are subject to risk-retention." 7.75 interest rates will mean prices have to fall by about 35% to allow the same person to be able to afford the same home.
If they don't agree to it, most banks will just stop making loans to all but the best borrowers, with a few making loans to the rest at very high rates, probably about 7.75%. Prices will fall drastically as every homeowner courts a set of buyers that is about 1/3 the number today.
"'A lot of originators just aren't going to do' loans that require risk retention, said Steven O'Connor, vice president for government relations at the Mortgage Bankers Association. The trade group's members include Wells Fargo."
This is a disaster, and anyone who buys before June is a fool.
Posted by: tipster at January 13, 2011 9:22 AM
Up in the sky!
It's a bird! It's a plane! No ... it's Ben Bernanke.
I'll believe it when I see it. Until then I'm going to assume that there will be another bailout loan program and this is just posturing by the banks to off-put risk onto the Fed.
Posted by: diemos at January 13, 2011 9:27 AM
buy the rumor, sell the news.
Posted by: anonee at January 13, 2011 9:51 AM
The WSJ sentence structure is a little confusing. It makes it sound like some mortgages are already exempt from the requirement and WF wants to raise the down payment requirements on them, shooting themselves in the foot. What the WSJ actually meant is, this, right?
Wells Fargo & Co., the nation's largest mortgage lender, has asked U.S. regulators to set a down-payment standard of 30% on mortgages [in lieu of having them] meet a new requirement that banks retain 5% of a loan if it is securitized.
Posted by: rr at January 13, 2011 10:00 AM
Yeah, this looks like some arm twisting by the banks to avoid more regulation led by our own W(t)F. What they're saying is basically "You can have us take the loans on our books but we'll shut down the pipes of credit and provoke another devastating RE meltdown as a consequence".
Now, every time the banks have claimed the end of the world was nigh, the govt has chickened out and heeded to the requests by their masters. I think the new rules are DOA.
Posted by: lol at January 13, 2011 10:42 AM
I was all set to comment about how this will be a catastrophe for housing, harsh medicine, etc. Then I remembered that all evidence from the last few years points to regulation moving in the opposite direction as this... therefore, I not only don't believe that 30% down will become the new standard, but they'll also figure out a way to relax that 5% retention req'd on sec'd loans. The banks and the FED are all in the same boat now (holding tr/billions in mortgage paper), so devaluing those holdings hardly makes sense.
Posted by: rabbits at January 13, 2011 11:04 AM
@rr -- WSJ may have corrected. I see this "Wells Fargo & Co., the nation's largest mortgage lender, has asked U.S. regulators to set a down-payment standard of 30% on mortgages that wouldn't have to meet a new requirement that banks retain 5% of a loan if it is securitized." (emphasis mine)
I think other banks were hoping that the exempted class of mortgages would be wider.
I'm not enough of a Kremlinologist to have much certainty as to how this will work out, but it does illustrate how much the market is dependent on government support. Look at how much the banks are complaining about having to keep 5% of a loan on their books.
Posted by: tc_sf at January 13, 2011 11:17 AM
So this is Wells' proposal for the less than 5% of loans that aren't FHA?
I'm with diemos here, except that most of the banks have already off-put most of their risk onto the Fed or Treasury.
Posted by: sfrenegade at January 13, 2011 11:20 AM
@sfrenegade -- My interpretation is that this is just for private (i.e. non-govermental) lenders so it would not apply to the FHA.
I think the idea is to get the private loan market working again. Currently t government lending is dominating the market, but I'd hope that this isn't a "new normal" and that at some point we'll return to a mostly private mortgage market.
Also note that buyers of securitized loans are now fully aware that banks with no retention have less incentive to do quality underwriting. So buyers may demand a higher standard then the government minimum.
Posted by: tc_sf at January 13, 2011 11:34 AM
tc_sf, you may be right, but I read this to mean that these rules would apply to loans securitized through Fannie or Freddie (or privately, which is all but non-existent now) but not through Sallie Mae (i.e. FHA) which permits lower down payments generally. But the article is not really clear on this.
Posted by: A.T. at January 13, 2011 11:48 AM
Sorry, I should be more clear, the 5% of loans that aren't FHA/Fannie Mae/Freddie Mac. The banksters are going to get a free ride no matter what with the people we have running things. All they have to do is claim that we'll have another crisis...
Posted by: sfrenegade at January 13, 2011 11:52 AM
@A.T. -- Haven't read the bill directly, but going off this: "The Dodd-Frank Act provides regulatory authority to grant a total or partial exemption from the risk retention provisions for any securitization of assets issued or guaranteed by the U.S. government or U.S. government agencies, as well as any securitization of assets issued or guaranteed by a state or by any political subdivision of a state or territory, or by any public instrumentality of a state or territory that is exempt from the registration requirements of the Securities Act of 1933 by reason of section 3(a)(2) of that Act, or a security defined as a qualified scholarship funding bond in section 150(d)(2) of the Internal Revenue Code of 1986. Also exempt from the risk retention requirements are any assets made, insured, guaranteed, or purchased by any institution that is subject to the supervision of the Farm Credit Administration, including the Federal Agricultural Mortgage Corporation, and any residential, multifamily, or health care facility mortgage loan asset, or securitization based directly or indirectly on such an asset, which is insured or guaranteed by the U.S. government or a U.S. government agency. However, assets issued or guaranteed by Fannie Mae, Freddie Mac or the federal home loan banks are not exempt."
So technically regulators have the power to exempt government agencies, but Fannie & Freddie are not considered government agencies in this regard.
The paragraph below the one quoted above seems to grant regulators broad powers to exempt whatever entities if doing so would serve the "public good".
Posted by: tc_sf at January 13, 2011 12:08 PM
I agree that the rulemaking has been stacked in the banks favor. And I think that the banks and the NAR are very powerful lobbyists, and the NAR is going to be screaming bloody murder over something that chops housing prices.
However, if THIS rule was DOA, Wells Fargo wouldn't be arguing for an exemption as long as they get 30% down. So I get the sense that Wells understands that the 5% rule is not negotiable and it is not going to be retracted.
The only thing up for negotiation is WHICH mortgages the rule will cover, and so they are testing the boundaries of that determination. The rule only stays in effect for two years, so it's probably harder to argue to kill a temporary rule.
I haven't followed this rule, but I get the sense that it's going to be very hard to get congress to retract a rule that requires the banks to hold a mere 5%. I think that plays very badly on Main Street, and I think that the president and congress are paying more attention to that these days.
Posted by: tipster at January 13, 2011 1:35 PM
@tipster -- As I noted above I think there is a broad escape clause that could let regulators essentially nullify the rule. This doesn't seem too likely to me since as you point out it would play poorly to the public. Additionally as I mentioned above, buyers of these securities have a vested interest in seeing loan originators/homeowners having some skin in the game regardless of any regulatory minimum requirement. So there may be no practical effect of nullification.
On a technical note, I think the rule won't come into effect until one year after the regulations are finalized so any change would happen next April.
Also, I don't think the rule is temporary. Rather the length of time the originator/securitizer needs to retain the risk is time limited. I think the exact retention time is not specified by statute rather will be part of the regulatory rule making. The two years mentioned in the article is what people expect the retention time to be. ( i.e. As proposed, when a bank makes a loan with less then 30% down then bank will need to keep 5% of the loan, without hedging, for at least two years)
I do agree with you that the fact that banks would fight to avoid keeping 5% of loan values on their books for only two years speaks volumes about their opinion of price trends.
Posted by: tc_sf at January 13, 2011 2:24 PM
"the fact that banks would fight to avoid keeping 5% of loan values on their books for only two years speaks volumes about their opinion of price trends."
That is a good point. The "110% equity no-down" loans seemed to make sense when prices only went up! But my read is that the small banks would have trouble with this because they simply do not have enough capital to keep even 5% if they have any sizable loan portfolio, regardless of price trends. They think the big boys are pushing for this because the latter do have the capital, so the big boys will squeeze out the little ones.
Posted by: A.T. at January 13, 2011 2:48 PM
I don't think it says anything about "price trends". Having to retain some portion of the loan on their books would prevent banks from just being mortgage transaction shops like many home lenders were during the easy money boom. They were able to just basically churn a set amount of capital endlessly by selling all the loans they originated. But as we saw when Wall Street stopped buying the loans a bunch of them instantly folded because their entire business model was getting X dollars of capital (or even just borrowing it), lending it out, selling the loans, then lending out the proceeds, rinse and repeat and continue to lower lending standards in order to find the next set of borrowers. Requiring them to keep a portion of the loan puts a limit to how many times they can turnover the portfolio.
Plus it will also hopefully prevent them for once again participating in a race to the bottom in search of borrowers since they will have a portion of the loan on their books.
Posted by: Rillion at January 13, 2011 3:21 PM
@A.T. -- Regarding the small banks it's possible they simply don't have enough capital, but the basic business of banks is taking deposits then turning around and lending it out. So they have to do something with the depository capital providing they get enough risk adjusted return.
My guess is that this rule is intended to prevent the practice of keeping only good loans on the books and selling off the trash.
Also, consider this from a MBS buyer's point of view. How attractive would it be to buy a MBS from some small bank that not only isn't keeping a chunk of the loans on its books, but doesn't even have the capital required to do so?
Posted by: tc_sf at January 13, 2011 3:28 PM
@Rilllion -- During the boom lending activity was probably constrained by access to capital. And some firms may have collapsed due to a lack of liquidity. But the underling reality of the collapse was due to homeowners actually not paying their mortgages and a decline in value of the collateral (the house).
If prices are trending upwards then your risk as a lender is limited since even if someone defaults you can repo the home and re-sell it. Plus homeowners are much less likely to default in a rising market since they have incentive and ability to sell for a profit. In a falling market people are much more likely to default and the cost of default to the lender is much higher.
I'm of the opinion that the current lack of private market lending is not due to a lack of capital but rather a lack of risk adjusted return. i.e. mortgages rates are low and lending risk is high.
Posted by: tc_sf at January 13, 2011 3:52 PM
"I'm of the opinion that the current lack of private market lending is not due to a lack of capital but rather a lack of risk adjusted return. i.e. mortgages rates are low and lending risk is high."
That is my take on it too. You could probably securitize an 8% loan quite easily, but what's the incentive to buy a bond for a 4% loan? When interest rates go up, you'll lose a ton of principal.
Risk-retention is one of those things bond buyers should be demanding in many types of sales. For example, when Goldman does an IPO of Facebook in the future, isn't it much more comfortable that Goldman has a stake in the company?
Posted by: sfrenegade at January 13, 2011 4:19 PM
"when Goldman does an IPO of Facebook in the future, isn't it much more comfortable that Goldman has a stake in the company?"
Well, maybe not, if Goldman's stake (paid for with taxpayer funds at 0.01%) is a fraction of the amount they'll make in fees handling the IPO, which will fetch a higher price (w/ higher fees) because of the Goldman-created "comfort" you note, and Goldman thus really could not care less if Facebook's share price nosedives right after the IPO!
But I agree with your point on mortgage lending. Just not this particular example . . .
Posted by: A.T. at January 13, 2011 4:31 PM
Goldman paid for a $450M stake, right? Presumably, an IPO could be worth $200M in fees, which would be syndicated, so Goldman would get maybe $100M. I think many people would be more comfortable if Goldman put $450M at stake to get a sure $100M.
$200M is a plausible number for the fees they'd get per this financial writer: http://finance.fortune.cnn.com/2011/01/04/five-reasons-why-im-not-buying-facebook/
Posted by: sfrenegade at January 13, 2011 4:41 PM
Regarding having skin in the game, I'd conjecture that what the banks really don't like about the Dodd-Frank rule is the requirement that they not hedge away the required "skin".
From a banks POV, the ideal situation would seem to involve retain a stake in the investment but then hedge away any financial exposure if you didn't actually believe in the investment. This would allow you to use the fact that you had some exposure essentially as a marketing tool to sway potential investors without actually taking any risk.
This would seem to be easy to do for mortgages, perhaps more difficult with a private company like Facebook. But I would be at least somewhat wary that the $450M state didn't reflect their net exposure to Facebook's prospects.
Posted by: tc_sf at January 13, 2011 4:54 PM
You can bet Goldman will make a lot more than that in fees from Facebook. See:
Posted by: A.T. at January 13, 2011 5:03 PM
tc_sf, the reason I am cynical about this is that it seems like it's crying out to be gamed by the banksters.
Let's just assume that the rules happen as described in the article and the banks must retain 5% of a loan if it is securitized. As you say, the bank would want to hedge away their risk after they've convinced the sheep to be shorn (MBS buyers) that the bank has its own chips on the line. The banksters want to hide the fact that they actually are hedging their risk, so they just go ahead and create some nice, neat, off balance sheet vehicles to contain their hedges, and the auditors think that each bank has the required risk-retention, but in fact it's not there.
So all of this wrangling about the upcoming rules is just kabuki theater, IMHO. Even if it happens, which I strongly doubt it will, there's no reason to think that the banks will actually end up retaining more actual risk to their own capital.
Posted by: Brahma (incensed renter) at January 13, 2011 5:33 PM
Not sure if this is the form that passed, but found this on THOMAS
"(c) Standards for Regulations-
`(1) STANDARDS- The regulations prescribed under subsection (b) shall--
`(A) prohibit a securitizer from directly or indirectly hedging or otherwise transferring the credit risk that the securitizer is required to retain with respect to an asset;
I do agree that banks have strong incentive to get around this. It's beyond me to comment on whether an off balance sheet vehicle would work in this respect.
From a simple reading of the text above it does seem that you are only prohibited from hedging away the credit risk for the specific assets you are securitizing. A bank could potentially hedge against general housing market risk by shorting an index of other MBS's. Thereby only being exposed if the bank's loans did worse then market average.
Posted by: tc_sf at January 13, 2011 10:53 PM
Goldman stands to make hundreds of millions off the facebook IPO plus a large percentage of the profits of the $1.5 billion in private investment in facebook plus additional management fees from the new customers they will get from this. Goldman's business model is to inflate a bubble, reap windfall profits, let the bubble collapse, use it's government contacts to legitimize it or sweep it under the rug, rinse and repeat. It is a great deal for Goldman and Facebook insiders and a bad deal for anybody that buys the shares at the IPO.
Posted by: lyqwyd at January 13, 2011 11:11 PM
"You can bet Goldman will make a lot more than that in fees from Facebook."
Overall? Sure. But it's another $60M in fees from private placements from what you sent plus that profit percentage.
They will certainly get a ton, but I think even with the scale of the numbers, $450M might be material enough to risk for a number of years. Facebook could always go belly up as its former competitors have.
Posted by: sfrenegade at January 14, 2011 12:36 PM
Let's see whether Goldman hangs on to that $450mm stake after the IPO or whether they cash out at the market price that is established, in part, by the comfort level people have by pointing to Goldman's stake . . .
Posted by: A.T. at January 14, 2011 1:15 PM
This is bad news of you're an existing home owner and good news of you're not and looking to buy in the future. Lower prices with high interest, you'll be able to deduct more for the same level of payment since more if it is interest.
Posted by: welbilt bread machine at January 14, 2011 1:32 PM
Sure, but that could be 3 years from now or later. Putting $450M at stake with a bunch of 25 year olds who need adult supervision running things sounds like a risk to me.
I don't disagree that Goldman is looking at serious upside if Facebook retains its market status in the next several years, but people should be cautious for reasons in the link I posted above and for some other reasons. lyqwyd makes a good point on Goldman's typical behavior.
This is a obviously great deal for Goldman and Facebook insiders, but my original point still stands: many people who invest in Facebook will feel some degree of comfort from Goldman Sachs buying a piece of Facebook. Whether they should feel more comfort is always an open question, just like it would be if the banksters retained 5%, but for some reason decided it was an acceptable risk (e.g. by hedging in ways that they are allowed to hedge, for example).
Posted by: sfrenegade at January 14, 2011 2:00 PM
It appears that the FDIC is advocating for 20% down to avoid the retention requirement.
Posted by: tc_sf at March 29, 2011 7:52 PM
Looks like the proposed rules have an unlimited holding period and bar using credit insurance to escape retention requirements
Posted by: tc_sf at March 30, 2011 11:41 AM
I was looking for this exact thread yesterday to post about the FDIC's decision, but couldn't find the thread quickly. It'll be interest to see what the details are here. If what they're saying is that traditional prime loans with 20% down are going to be exempted from the rule, it's probably not so bad because those loans had a predictable default rate when the three Cs were met. The NAHB guy quoted in the article tc_sf is just whining for Bubble II.
Posted by: sfrenegade at March 30, 2011 12:27 PM