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NHC Beyond 4 Walls Podcast

Worse than anticipated – the proposed rule on bank capital is a partisan mistake.

This week, the three federal banking regulators, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation, proposed a new capital rule that would dramatically increase the capital treatment of most mortgage loans. Earlier this week, a diverse group of housing groups including NHC, the Mortgage Bankers Association, the National Association of REALTORS®, the NAACP and the National Urban League wrote to banking regulators warning of the damage that could be done to first-time and especially first-generation homebuyers by a proposed bank capital rule. That proposed rule that was advanced on Thursday was worse than we feared. Unless the bank regulators make major changes based on the comments they receive, this rule will be swept away with the next inevitable swing of the political pendulum, serving no one.

The proposed rule would increase the risk weighting of bank-originated mortgages with down payments below 20%, discouraging banks from making loans to low- and moderate-income homebuyers. In our letter, we noted that down payment cost is often the biggest barrier to buying a home for these groups, and warned that the proposed rule would make it harder for them to get a mortgage. Further, the increase would undercut the Community Reinvestment Act (CRA) and Special Purpose Credit Programs (SPCPs) that seek to redress barriers to homeownership. The FDIC itself noted in its own report on Down Payment and Closing Cost Assistance, that “for many low- and moderate-income people, the most significant barrier to homeownership is the down payment and closing costs associated with getting a mortgage loan.” Not only did the proposed rule ignore the concerns that it acknowledged, it explicitly dismissed the role of mortgage insurance paid by millions of homebuyers, so lenders and investors are protected from default.

“Without significant revisions, this proposal will increase borrowing costs and reduce credit availability for the very consumers and borrowers this administration ostensibly seeks to assist,” said Bob Broeksmit, President and CEO of the Mortgage Bankers Association, in a press release. “Given ongoing affordable housing challenges, regulators should be taking steps that encourage banks to better support real estate finance markets. These proposed changes do precisely the opposite during a time of near record-low single-family delinquencies and pristine underwriting. This proposal also undermines several current policy objectives, from closing the racial homeownership gap to promoting competition over consolidation.”

The proposed rule, which would implement the final components of the Basel III agreement and are known as the Basel III endgame, are intended to strengthen the banking system. In his opening remarks, Fed Vice Chair for Supervision Michael Barr acknowledged that “we are aware of concerns that the overall increase in capital requirements would be significant, and I look forward to comments in that regard.” Barr went on to say that he “…will pay close attention to and encourage thoughtful comments. Any rule will only benefit from a diversity of well-reasoned and good faith arguments. I look forward to the comments we will receive.” No such reassurance was offered by FDIC Chair Martin Gruenberg, who seemed fixated on the 2008 mortgage crisis, ignoring the transformational impact of the Dodd Frank Act that he and Vice Chair Barr helped write.

The deep problems with the proposed rule were not missed by the Federal Reserve Board’s Chair, Jerome Powell, in his opening statement. Powell noted the proposal “exceeds what is required by the Basel agreement and exceeds as well what we know of plans for implementation by other large jurisdictions.” Regarding the use of the so-called standardized approach, Powell said: “We will need to ensure that the consistency and anti-arbitrage benefits of the new standardized approaches outweigh the costs of treating the risks of some quite different business activities as identical, which could reduce risk capture and discourage less risky activities.”

Powell went on to acknowledge that “recent events have demonstrated the need to strengthen supervision and regulation for firms with assets between $100 billion and $250 billion,” however he warned that “raising capital requirements also increases the cost of, and reduces access to, credit. And the proposed very large increase in risk-weighted assets for market risk overall requires us to assess the risk that large U.S. banks could reduce their activities in this area, threatening a decline in liquidity in critical markets and a movement of some of these activities into the shadow banking sector.”

Fed Governor Michelle Bowman echoed the Chair’s and our concerns, saying “increased capital requirements for certain types of loans may also lead to a reduction in credit availability or increased prices, which could disproportionately harm underserved markets, businesses, and communities.”

FDIC Board member Jonathan McKernan raised a key concern that undercuts the entire foundation of the proposal, stating that it “offers no loss history or other evidence to support the sizing of the surcharge.” He also noted that “the proposal also does not acknowledge that we have rejected a recommendation made by the Financial Stability Oversight Council (“FSOC”) that the U.S. bank regulators coordinate with [the Federal Housing Finance Agency] …to harmonize capital requirements across the banks and the Government Sponsored Enterprises, Fannie Mae and Freddie Mac] …to mitigate risks to financial stability driven by capital arbitrage.”

Instead, McKernan concludes that “in reverse engineering a significant increase in capital, we have backed ourselves into this surcharge without evidence or real rationale.”

The average downpayment for a first-time homebuyer is 6%, or $26,208 for a median-priced home, up from $19,740 in 2020. Since the first quarter of 2020, the median home sales price has skyrocketed 32% from $329,000 to $436,800. A 20% downpayment on a median-priced home would require nearly $105,000 cash at closing ($87,360 for the down payment and $17,432 in estimated closing costs).  It defies logic that regulators would encourage banks to triple the required downpayment for loans affordable to first-time homebuyers, locking out the very people they say they want to help.

The new proposal would dramatically increase the capital treatment of higher LTV loans. For those unable to afford a downpayment over 10%, the risk weighting would increase by 40%.

The current risk weights assigned to many of the loans are 50%. Under the new proposal, these would be raised to as much as 90% for large banks, tied to LTV ratios. In response to the our letter, Federal Reserve Vice Chair for Supervision Michael Barr acknowledged opposition to the proposed approach in his statement, noting the Federal Reserve is particularly interested in feedback “to ensure that the proposal does not unduly affect mortgage lending, including mortgages to under-served borrowers.”

Yet no such concern was expressed by the FDIC Chair or the Comptroller of the Currency. In fact, most of Vice Chair Barr’s statement defended “gold-plating” the Basel III standards as necessary to avoid future crises, like the one recently experienced as a result of the failures of Silicon Valley Bank and Signature Bank. The primary cause of these failures had nothing to do with credit risk. Ironically, the collapse of SVB was due to   incompetent interest rate risk management, which is unrelated to credit risk management, as well as and inadequate supervision, leading to a large depositor bank run. No amount of stress testing or additional capital would have prevented SVB’s failure. Signature Bank’s failure was due to the collapse of the cryptocurrency markets. How could regulators not understand these basic differences?

In our letter, we were concerned that the proposed rule would ignore the important role that mortgage insurance (MI) plays in mitigating the potential losses of low-down payment loans. It didn’t ignore MI. It directly dismissed it. In its own words, the proposed rule “does not recognize an insurance company engaged predominately in the business of providing credit protection (such as a monoline bond insurer or re-insurer) and also reflects the performance of private mortgage insurance during times of stress in the housing market.” In fact,  The mortgage insurance industry is healthy and better regulated than ever, and credit standards for all borrowers still far exceed those that predated the financial crisis of 2008.

The proposal doubles down on the approach of Basel III, without considering any of the complexities of modern mortgage underwriting, and ignoring the elimination of toxic product risk in the Dodd Frank Act. This change from the current risk weight harms low- and moderate-income homebuyers who rely on their relationship with their local bank branches – a relationship encouraged by the Community Reinvestment Act that all three of the banking agencies also supervise.

What neither Basel III or the proposed rule considers are the wide range of compensating factors that are also addressed in modern mortgage underwriting and mortgage risk management. These include a borrower’s debt-to-income ratio, credit history and most recently, rent payment history. It also explicitly negates the important role of mortgage insurance.

A recent study of mortgage risk in Oxford’s Journal of Financial Econometrics (Vol. 19, No. 2, 313–368) found that “the role of standard loan and borrower characteristics, such as FICO score, interest rates, and LTV ratios… are less influential predictors of mortgage delinquency than previously thought.” So why are the banking regulators taking such an archaic and destructive approach? Frankly, I have no idea.

We can do a lot better. “As an economic policymaker,” Governor Christopher Waller said, “I always ask, ‘What problem is solved from this proposal? What are the benefits of the proposal?’ If the answer is improved resiliency, then I want to know why the current capital framework does not provide an adequate level of resiliency. What empirical evidence shows that the current level of resilience is insufficient…”

These are the right questions, and if we can’t answer them in a way that is broadly accepted, we should throw out this rushed and ill-informed rule and start over. The political pendulum continues and the positive aspects of the rule will be swept away with its gaping flaws.

 

#BankCapitalRule  #MortgageLoans  #HousingPolicy  #AffordableHousing  #Homeownership  #FinancialRegulation  #BaselIII  #CommunityReinvestmentAct  #MortgageInsurance  #BlackHomeownership @FDIC @FederalReserveBoard @OCC

 

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