As Congress continues to debate Senator Dodd’s proposals to bring our financial regulatory system up to date, issues such as the perpetual bailout fund, a potential bank tax and the Consumer Financial Protection Agency have gotten most of the attention, but a little-known provision in the bill warrants closer examination.
The provision is known as risk retention, and can be aptly summarized as requiring lenders to put some “skin in the game.” This provision would require mortgage originators, who make loans to borrowers and then sell the loan to investors in the secondary market, to hold a certain portion of that loan on their books.
Yet this well-intentioned obligation will have an incredibly detrimental impact on those who can least afford it. Requiring our lenders to keep five percent of the original loan on their books would have a largely negative impact on our small, independent mortgage lenders, tying up already tight resources from being used to grow or offer future loans. As a member of the Small Business Committee, I know how this requirement would wreak havoc with both their business model and the borrower dependent on smaller lenders.
A one-size-fits-all requirement on risk retention will not only penalize small lenders, but will unjustly penalize our small-town communities which depend on these lenders as the best source for loans. These lenders are not the Goldman Sachs brokers who receive $10 million bonuses or AIG executives who jetset across the country on the taxpayer dime. They are the sponsors of Little League teams and the backers of local community events.
These small communities, including those right here in central Illinois, who depend on non-bank lenders to loan families money to purchase homes, could not only lose their lenders, they could also lose hundreds of jobs should this legislation pass. When a non-bank lender loans money to a borrower to purchase a home, they borrow these funds from another bank, and when the mortgage closes, it is sold to an investor. This allows the non-bank lender to use the money they made from selling the loan on the secondary mortgage market to pay back their loan from the bank and originate new loans.
It’s clear through this process that these small lenders have a fair amount of “skin in the game.” Should the borrower default on their mortgage, the investor who purchased the mortgage on the secondary market will go back and inspect the information the non-bank lender originally provided about the borrower. Should it be determined the lender did not do the proper due diligence, they must take the loss on the loan. If that isn’t “skin in the game,” I don’t know what is.
Furthermore, everyone wants to end the notion of certain companies being “too big to fail”; in fact, this is the impetus behind regulatory reform. Unfortunately, by driving so many of the small lenders out of the business of making loans, we’re essentially making those companies fortunate to stay in bigger and bigger, thereby ensuring the concept of companies being “too big to fail” as not one that will be going anywhere soon.
As we continue to debate financial regulatory reform legislation, there is a simple fix to negate the potentially catastrophic effects risk retention can have on small, independently owned non-bank lenders. By exempting loans of lower risk from these new onerous guidelines, we can avoid the layoffs and credit crunch that will occur when the hundreds of non-depository lenders are subjected to these requirements.
For instance, should Congress exempt a lower-risk loan that is fully amortized and fully documented with a specific down payment, we would be encouraging safer loans, which would stabilize and lead to a rebuilding of the mortgage and real estate markets.
The bottom line is that by putting smaller lenders out of business, we will be drastically limiting the choice of consumers and perpetuating “too big to fail.” Let’s continue our negotiations and write sensible provisions pertaining to risk retention that will lead to safer loans and a stronger real estate market. iBi
