Divided SEC Adopts Mortgage Rule, Decries Lax Lending

Senate Banking Committee Holds Hearing On SEC Nominees
Andrew Harrer/Bloomberg via Getty ImagesSEC Commissioner Daniel Gallagher, a Republican, voted against the new mortgage rule, an expected move.

By Sarah N. Lynch

WASHINGTON -- U.S. securities regulators adopted a rule Wednesday designed to avert another financial crisis, but two officials dissented, saying it didn't do enough to discourage banks from lending to borrowers with shaky credit and then passing the mortgage risk to investors.

The Securities and Exchange Commission approved the so-called "risk retention" rule by a 3-2 vote, while the U.S. Federal Reserve is expected to approve it later Wednesday.

The rule requires banks to keep at least 5 percent of the risk on their books when they securitize loans. This "skin in the game" is aimed at aligning the bank's interest with investors that buy the loans.

But two Republican commissioners said they couldn't support the rule in part because they believe its exemption for low-risk mortgages is too broad and doesn't sufficiently crack down on lax underwriting standards. They also said the rule perpetuates the dominant role of government-sponsored enterprises such as Fannie Mae in the housing market.

%VIRTUAL-WSSCourseInline-750%"Today could have been the day when the commission and its regulatory partners ... stood strong, resisted political and special interest group pressure, and courageously seized this golden opportunity to address the failed federal housing policy that was one of the central causes of the financial crisis," said Republican SEC Commissioner Daniel Gallagher.

Before the financial crisis, banks pumped up lending volumes, little concerned about the risks since they planned to unload the loans. The system imploded when subprime mortgage borrowers started defaulting.

The dissents by Gallagher and Michael Piwowar were widely expected, after they published a letter to the editor in The Wall Street Journal in June.

Other banking and housing regulators gave their nod Tuesday. The agencies are required by the 2010 Dodd-Frank Wall Street financial reform law to implement the rule.

Their concerns, however, reflect the broader public debate about the delicate balance between mortgage lending standards and the need to protect investors.

The most hotly contested issue centers on the scope of an exemption for ordinary "qualified" residential mortgages. In 2011, regulators originally proposed defining qualified mortgages as those requiring borrowers to make hefty down payments.

Regulators scrapped the plan after the industry pushed back, saying it would stifle the housing market for lower-income buyers.

In Wednesday's final rule, the definition of a qualified mortgage is much looser than first proposed in 2011, and aligns with a definition in a separate rule by the Consumer Financial Protection Bureau.

In a study, SEC economists said the exemption is now so broad that the "same economic incentives" for the banks that existed prior to the financial crisis "may persist."

SEC Commissioner Luis Aguilar, a Democrat who voted in favor of the rule, acknowledged some outstanding concerns with the scope of the exemption.

But, he said, the rule contains a safeguard that allows regulators to periodically review how it defines a qualified residential mortgage, and has asked SEC staff to provide annual updates.

Originally published