In the latest AEI Financial Services Outlook, AEI scholar Peter Wallison, who served as a member of the Financial Crisis Inquiry Commission, explains that we are beginning to see the outlines of the housing finance system envisaged by the new Dodd-Frank Act (DFA).
In particular, Wallison warns that should the risk-retention requirements of DFA be adopted substantially as written -- and if there are no changes in the other provisions the act has added to the laws governing mortgage lending -- the housing finance system of the future will place immense financial risks and regulatory costs on mortgage originators (lenders) and on the securitizers.
These flawed requirements will fail to prevent the growth of subprime and other low-quality lending, virtually ensure the continued existence of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, impair the development of a robust private-sector housing finance system in the United States, and provide insurmountable advantages for the largest banks in the limited private securitization system that might exist.
Among the key points:
- The key flaw in the Dodd-Frank Act (DFA) is its effort to control the quality of mortgages by imposing regulation and regulatory costs on lenders and securitizers.
- Because it focuses on only a narrow part of the mortgage market, and exempts the government-backed sectors, the act will do nothing to prevent the deterioration in mortgage underwriting standards.
- The fundamental flaws in the housing finance provisions of the DFA cannot be repaired by regulation; they should be repealed.
- A plan developed at AEI would define a "prime mortgage" by statute, making it possible to eliminate the qualified mortgage, the qualified residential mortgage, and the 5 percent risk retention.
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