c.2013 New York Times News Service

c.2013 New York Times News Service

There was no single cause of the financial crisis, but a chief one was surely the way mortgage loans were made by people who believed they had no reason to care if the loan was repaid.

That was why the Dodd-Frank financial overhaul law included risk retention — called “skin in the game” — as a major reform. For all but the safest loans, someone connected to the loan had to keep a stake in it. If such a loan went bad, then that lender would suffer along with those who bought securities containing it.

“To me,” said Barney Frank, the former chairman of the House Financial Services Committee and co-author of the law, “the single most important part of the bill was risk retention.”

But it now appears that section will be rendered moot as multiple regulators give in to pressure brought by an odd coalition to classify virtually every mortgage as exempt from the risk retention law. That coalition includes large parts of the banking industry, which seems to have no desire to stand behind its loans, as well as consumer advocates and the housing industry. The latter groups say they are worried that poorer people will be unable to obtain loans if all loans cannot be securitized.

On the other side, asking regulators not to gut the law is an equally unusual, if smaller, coalition. It includes Frank; Sheila C. Bair, the former chairwoman of the Federal Deposit Insurance Corp.; and the American Enterprise Institute, a conservative research group that has rarely, if ever, found itself in agreement with Frank on a regulatory issue.

The Dodd-Frank law told regulators to effectively set up three categories of mortgages. At the top were “qualified residential mortgages,” called QRM. Those were to be the only mortgages that did not require skin in the game if they were pooled and sliced up into securities.

Under that were “qualified mortgages,” called QM. The Consumer Financial Protection Bureau was to establish standards for those, which it has done. Those rules, to take effect Jan. 10, were supposed to protect consumers, not the financial system. The bottom category was to include mortgages that met neither of those standards. They would require risk retention, as did the QM mortgages.

The rules on qualified mortgages are meant to assure that consumers can afford them, and the requirements are rather low. Lenders must go to the trouble of verifying a borrower’s income, and the total monthly debt obligation must be no more than 43 percent of pretax income. There are no requirements for down payments or limits on how much is lent relative to the value of the property.

Before the lending excesses that led to the crash, Bair said in an interview this week, banks generally refused to make loans on which repayments would be more than 35 percent of income, and often had lower limits.

“There is,” she said, “a lot of room under QM to make mortgages that should not be made.”

That brings us to QRM — the qualified residential mortgage. The six regulators that are supposed to agree on rules for that put out a proposal in 2011 that gave in to the banks on many issues but not all. The banks reacted with anger, and the latest proposal is a virtual complete surrender. It essentially says that any mortgage that meets qualified mortgage standards will meet the higher ones as well.

“The result,” Frank wrote in a comment letter, “would be two categories, those that fall below standards and probably shouldn’t be made, and those that could be made and would not be subject to risk retention.”

“I am not surprised,” Frank added, that “the overwhelming majority of commenters who are interested in building, selling or promoting the sale of housing to lower-income people support effectively abolishing risk retention. I should note that if all of these people were correct in their collective judgment, we would not have had the crisis that we had.”

Three fellows of the American Enterprise Institute — Edward J. Pinto, Peter J. Wallison and Alex J. Pollock — agree.

“With the demise of an independent QRM,” they wrote in a comment letter, “the credit quality objective of the Dodd-Frank law has been lost.”

Essentially, many of those who want to effectively abolish the QRM category fear that if lenders are forced to retain some risk, such loans will either not be made or will be prohibitively costly. They seem to take for granted that no bank will be willing to retain risk.

Thus the Virginia Housing Coalition, which supports affordable housing, warned in a comment letter that a 20 percent down payment requirement “would drastically limit access to mortgages and would put homeownership out of reach for low and moderate-income families, first-time homebuyers, and disproportionally affect African-American and Latino families.”

That argument frustrates Frank. Speaking last week at a conference organized by the Clearing House, a group of large banks, he noted that until the 1980s risk retention was common for home mortgages. Banks made loans and kept them on their balance sheets, just as they did other types of loans. The securitization revolution changed that, and now the banks like the idea of collecting fees without risking their own capital.

To those who would defend the status quo, other reforms in the Dodd-Frank law mean there is no need for risk retention.

The requirement that banks evaluate a customer’s ability to repay, along with new appraisal rules, “will help to discourage inaccurate or fraudulent appraisal practices,” wrote the Center for American Progress, a liberal research group. “Together, these restrictions will prevent the securitization of the type of predatory and unsustainable loans that inflated the housing bubble and led to the subsequent foreclosure crisis.”

A main reason it is not clear how this will turn out is that the Dodd-Frank law said many rules had to be jointly issued by numerous regulators, without providing any way to resolve differences.

The QM definition was left up to one regulator, the consumer protection agency, whose director could decide. In the case of the QRM rule, however, unanimous approval of six regulators is required. They are the Office of the Comptroller of the Currency, the Securities and Exchange Commission, the Federal Reserve, the Federal Housing Finance Agency, the Department of Housing and Urban Development and the FDIC.

They appear to be somewhat divided. While the primary proposal out for comments calls for no rules above the QM standard, the regulators also asked for comment on requiring a down payment of as much as 30 percent to be able to avoid risk retention. The housing industry hates that idea. Bair thinks it is a good one.

Most of the regulators appear to have been convinced that there is too much risk that a nascent housing recovery would be threatened if banks had to be responsible for the lending decisions they made. The question is whether others will give in and agree.

The banks lost their fight to avoid “skin in the game” in Congress, but they may well win it in the regulatory agencies.