20 Percent Down Payments on the Way...If We're Lucky

20 percent down paymentsFederal banking regulators are pushing for 20 percent down payments, according the Wall Street Journal. You see, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 -- the name which draws guffaws of cynical amazement among those who know what Chris "Friend of Angelo" Dodd, pictured left, and Barney "My Boyfriend is a Fannie Mae Executive" Frank were actually up to during the Bubble Years -- contains a provision authorizing federal regulators to define a "gold standard residential mortgage." Well, the busy beavers at the FDIC, OCC, and the Fed have done just that.

What they're pushing is for private mortgage loans that "qualify" to require 20 percent down payment for the mortgage, 25 percent equity for a refinance, and 30 percent equity for a cash-out refinance (where you take on a bigger mortgage, while liquidating the first one).

Predictably, various folks are squawking in response. Inman News, a real estate industry site, is reporting that an outfit named the Center for Responsible Lending thinks it's a horrible, horrible idea to require higher down payments. According to the CRL lobbyist cited in the story, Susanna Montezemolo, there really is no problem with low-down payment loans. The problem was with bad lending practices during the bubble years, with risky loan terms and weak underwriting standards.

Who to believe? What to think?

On the one hand, you've got a bunch of our feudal baronets -- sorry, public servants -- who know better than the banks who are risking their capital what sort of down payments they should require. Historical experience with government price controls -- whether a floor or a ceiling -- has not been a positive one overall, so I'm loath to credit that line of thinking.

But on the other hand, you have a "consumer advocacy organization" founded by two billionaires, Herb and Marion Sandler, who were named to Time magazine's list of "25 People to Blame for the Financial Crisis." It appears that the Sandlers made their billions by engaging in -- ready for this? -- subprime lending with risky loan terms and weak underwriting standards,
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namely the option-ARM.

How risky were their lending practices? Wachovia, the bank that bought their company, World Savings, imploded when these loans failed and was sold to Wells Fargo. To be fair, we must take into account the Sandlers' own version of what happened, but suddenly, I'm finding myself questioning the motivations of the CRL people. I know, it's because I'm evil and cynical.

In any event, what is even more interesting than the provenance of any particular policy position, is this "qualified residential mortgage." Qualified? Qualified for what?

It appears that when a mortgage is "qualified," there is a legal "safe harbor" presumption that would exempt said mortgage from a variety of unpleasantness (if you're a bank), such as the inability to charge points, the requirement to hold 5 percent of the loan amount as "risk retention" and such. That creates a pretty significant incentive for lenders to make sure their mortgages are qualifying as otherwise, they'd have to hold 5 percent of the amount in reserves even if they sell off the mortgage notes to the secondary market to be securitized.

Here's why we'd be lucky to end up with only 20 percent down payment requirement as one marker of a "qualifying residential mortgage": Big banks are pushing for even higher requirements. See, if consumers find it harder and harder to get a "qualifying mortgage" because it would require 25 percent down, or 30 percent down, then banks would likely want to step in and provide mortgages that require less money down. But those loans would be "non-qualifying", and be subject to the 5 percent risk retention rule. Big banks like Wells Fargo and Bank of America have the capital reserves to make those "non-qualifying" loans; little banks, thrifts, and S&Ls do not.

And should we take bets on whether those non-qualifying loans might carry a higher interest rate than a qualifying-loan? Any takers?

With strategic default no longer taboo in America, I would not be surprised if banks -- particularly big banks -- really push on as high a down-payment as possible. They cover themselves from risk on the one hand, while on the other, the big banks drive the little guys out of the market for the soon-to-be-ginormous non-qualifying mortgage market.

What of the Center for Responsible Lending? With enough lobbying and campaign contributions, I'm sure CRL can find some wiggle room over at FHA, but given this Administration's firm stance on housing as good rentals... I'd say good luck to them.

So, be prepared for 20 percent down payments in the not-so-distant future. But don't be surprised if that 20 percent turns out to be 30 percent...in the name of investor safety, of course.

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