20-percent rule for mortgage down payments unlikely in near future

September 23, 2011

Remember the proposed requirement from six federal agencies that home buyers make down payments of at least 20 percent if they want the lowest interest rates?

Remember the controversy that erupted over the plan last spring, when labor unions joined with bankers, civil rights groups, mortgage companies, real estate agents and consumer advocates to try to make sure it didn’t take effect? A bipartisan group of 39 senators and more than 250 Democrats and Republicans in the House even signed letters demanding that the agencies ditch the proposal on grounds that it would greatly harm a housing market in deep trouble.

Half a year has passed since then, so here’s an update: The 20-percent proposal is still alive, but it’s temporarily bogged down in agency reviews of the roughly 12,000 comments filed by interest groups and individuals. It almost certainly would not be ready for adoption until the first quarter of 2012. Even then, there would be a mandatory one-year lag before the requirement could take effect, pushing the issue into 2013 — well after the presidential and congressional elections.

But can it survive that long in its current form, given the rip currents of the political year that’s getting underway? The agencies themselves — the Federal Deposit Insurance Corp., the Treasury’s Office of the Comptroller of the Currency, the Department of Housing and Urban Development, the Federal Reserve, the Securities and Exchange Commission, and the Federal Housing Finance Agency — are officially remaining mum on the proposal during the comment review.

The group includes strong proponents of the 20-percent rule who argue that the “qualified residential mortgage” language Congress adopted in its 2010 Wall Street financial reform package requires them to devise a national standard for safe, low-risk home mortgages based on historical data on default and foreclosure risk. One of the statistical indicators of risk, based on studies of Fannie Mae and Freddie Mac mortgages, they say, is the amount of equity a borrower has in the property: The higher the initial equity, the lower the probability of foreclosure. Any standard that does not include down payments, proponents insist, will be deficient.

But the three co-sponsors of the provision say Congress expressly omitted any reference to down payments and never intended for the agencies to set an equity minimum that would prevent up to 40 percent of buyers from qualifying for a low-interest mortgage.

In testimony Sept. 8 before a House Financial Services subcommittee, Sen. Johnny Isakson (R-Ga.), one of the co-sponsors, said: “If this rule goes into effect as proposed, it will be the last nail in the coffin for the already crippled U.S. housing market. . . . Poor underwriting led us into the housing crisis, not down payments.”

Isakson, along with Sens. Mary Landrieu (D-La.) and Kay Hagan (D-N.C.), told the six agencies before they published the proposal that down payments were rejected in congressional discussions as an underwriting standard. The legislation intentionally left the door open for private mortgage insurance to cover the financial risks of down payments below 20 percent, just as the government-supervised mortgage investors Fannie Mae and Freddie Mac have permitted for decades.

A spokeswoman for Isakson declined to speculate whether, as rumored on Capitol Hill, he would introduce legislation to kill the 20-percent plan if it were adopted, but she did say in an e-mail that the senator has “faith that the regulators will make the right decision” and that “all his focus now is on stopping [the 20-percent plan] from happening.”

The controversy comes at a politically sensitive time for President Obama. Housing continues to be a lead weight holding back the economic recovery. His polling numbers are plunging, plus key segments of his political base — unions, community and economic development groups, and consumer activists — oppose any move to force working families to come up with more cash to buy a home. The six agencies’ rule — even in proposal form — is likely to be an attractive target for the president’s opponents next year.

The White House does not have the legal authority to dictate regulatory policy to independent bodies such as the Federal Reserve and the Federal Housing Finance Agency. But with Treasury and HUD playing important roles in formulating the final rule on mortgages, Obama has a direct pipeline to the policymaking process.

Bottom line: Don’t expect to see a 20-percent rule in the near future. Even independent regulators don’t operate in political vacuums. They’ve either gotten the message already or they will soon.

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