A provision of the Dodd-Frank financial reform law that is often overlooked is one requiring lenders to hold onto a portion of risky loans that they make. This addresses a key problem that contributed to the country’s economic meltdown, which was the ability for subprime lenders to securitize and sell off an entire loan, divorcing themselves from the risk of mortgage default.
As the Center for Public Integrity has pointed out, during the subprime bubble, “lenders were selling their loans to Wall Street, so they wouldn’t be left holding the deed in the event of a foreclosure.” Wall Street then sold the loans off to investors, moving the default risk even further down the road. This process fueled a dramatic decline in lending standards.
Dodd-Frank requires that lenders retain five percent of every loan on their books, so that they are not completely separated from default risk. McClatchy reports that the banks are trying to quietly nix that part of the law:
Financial lobbyists also are working to soften requirements that Wall Street firms put more “skin in the game” by retaining more mortgage bonds on their books to guard against shoddy lending…They’re trying to expand the definition of “plain vanilla” mortgages that would be exempted from the risk-retention requirements. [...]
The [American Securitization Forum] and its members want to exempt interest-only mortgages, which caused many unsophisticated borrowers to lose their homes. “Certain types of loans aren’t standard, but are appropriate for high creditworthy borrowers,” Deutsch said in an interview, pointing to wealthy borrowers who seek to maximize their mortgage-interest deductions at tax time.
During the debate over Dodd-Frank, the banks pushed Sen. Bob Corker (R-TN) to propose an amendment (which was ultimately defeated) striking the risk-retention provision from the bill. It’s no surprise that during the law’s rule-making phase, they are trying to weaken it as much as possible.
Exempting interest-only loans from the risk-retention requirement would be particularly detrimental, considering that they are risky loans that typically involve large resets, and the dramatic increase in monthly mortgage payments that such resets entail. “In a lot of ways, [an interest-only loan is] an illusion of homeownership with the reality of rental,” said Michael Calhoun, president of the Center for Responsible Lending.
With House Republicans hell-bent on rolling back provisions in Dodd-Frank, this is one more area that merits watching. After all, the banking industry is already counting on “better outcomes” with Republicans running the lower chamber.