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Regulators craft mortgage-lending rules

By Dina ElBoghdady
Washington Post Staff Writer
Thursday, March 3, 2011; 9:33 PM

Federal regulators are considering two options that would require lenders making certain types of mortgages to retain a stake in those loans, an effort designed to avert a repeat of the mortgage market meltdown and encourage prudent lending.

In the past, many lenders sold the loans they originated, which were later resold as securities. The original lenders were therefore off the hook if the loans went bad. Legislation enacted last year required lenders who sell certain loans to have "skin in the game" - specifically, by retaining at least a 5 percent stake in loans deemed to be risky.

But the legislation left it up to regulators to determine which types of loans should be exempt from this risk-retention rule. Several agencies have crafted a proposal that offers two options, sources familiar with the discussions said.

One option would exempt loans with at least a 10 percent down payment. The other option - supported by the Federal Reserve, the Office of the Comptroller of the Curency and the Federal Deposit Insurance Corporation - would exempt loans with a 20 percent down payment.

The original legislation said loans backed by the Federal Housing Administration would not be subject to the risk-retention rules. The new proposal will go beyond that to exempt any loans guaranteed by the federal government, including those backed by mortgage financiers Fannie Mae and Freddie Mac, sources said.

"Fannie and Freddie will not be mentioned specifically in the proposal, but having the government guarantee the loan can be constituted as satisfying risk retention," one source said.

The push to impose at least a 10 percent down payment is yet another regulatory move among many geared toward demanding higher down payments from borrowers. Requiring bigger down payments could limit the number of people who buy homes, especially among first-time buyers, some small banks and housing advocates have argued.

Last month, when the administration presented a proposal that would help scale back government involvement in the mortgage market, it supported gradually increasing the minimum down payment requirement to at least 10 percent for Fannie and Freddie loans.

At the time, people familiar with the plan said that the Federal Housing Administration was also looking into raising its minimum down payment to 5 percent from 3.5 percent.

Guy Cecala, publisher of Inside Mortgage Finance, said a risk-retention rule that does not affect government-backed loans would not have much of an immediate impact because Fannie, Freddie and the FHA guarantee about 90 percent of new home loans.

"But it will have an impact down the road if the private market ever comes back," Cecala said. "The writing is on the wall that you will see higher down payment requirements across the board."

Since the debate on risk retention began, some in the lending industry have said that many lenders might respond by making fewer loans, raising interest rates or both. That could have a chilling effect on lending and derail the housing market's chances of recovering, critics said.

But Rep. Barney Frank (D-Mass.) dismissed that reasoning at a hearing earlier this week.

"Are we really being told that there are so few institutions with confidence in their judgment that they won't make loans unless they could pass off the whole loan?" Frank said.

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