Federal Deposit Insurance Corporation Chair Sheila Bair recently took issue with the "Qualified Residential Mortgage" rule in a wide ranging interview conducted by New York Times editor Andrew Ross Sorkin at the Council on Foreign Relations seminar last Thursday. This was surprising feedback from Bair, a Bush appointee whose term of office ends on July 8, as she has been one of the stronger voices pushing back against anti-regulation forces. 

The Dodd-Frank financial reform act requires the originator of a residential mortgage to retain at least a 5 percent interest in that mortgage when selling it into the secondary market, a provision commonly referred to as "skin in the game."  Loans backed by FHA, VA, USDA, Fannie Mae and Freddie Mac will however be exempt from risk retention regs. For non-agency loans to meet the QRM definition and avoid being subject to risk retention regs, they must have down payments of 20% or more and a DTI of 28%/36% or less.  MORE DETAILS

Bair said that requiring securitizers to keep a 5 percent slice of loan packages "can do a lot to tame underwriting standards in a way that we regulators don't have to get into micromanaging what the standards are." However, the industry pushed the QRM exception into the bill so regulators now must define the new gold standard in mortgages "and these are just such great standards...we're just so sure against default that nobody would really need to retain any risk."  Now there is a huge push back, she said, because people think that this is going to become the new normal, "and I think people are right to the extent that it is going to create two-tiered pricing for securitized loans."

"So the risk retention loans will probably be some incrementally higher.  It's more like 10 or 15 basis points, not some of the other numbers that people are throwing around.  If we could just get rid of it it'd be fine with me, just making sure everybody keeps 5 percent, I would love that; that statute has this direction."

It is unclear whether Bair's comments reflect a growing opinion among regulators to forego QRM definitions and simply apply the 5 percent rule to all securitized loans including those backed by government agencies,  but we do know there has been a push-back from consumer advocates and politicians on the issue: FULL STORY

Bair commented on a number of other FDIC-related issues concerning  the economic downturn as well as the recovery.  Besides risk retention regulations, here are a few of the areas she touched upon in the discussion with Sorkin and the audience Q&A that followed.


"I think it's up to Congress to decide how much they want government involved in mortgage finance. I do think there's a difference between subsidizing mortgage finance and supporting home ownership.  And so I think they need to look at policies that actually promote home ownership; not a lot of leverage with people who own houses."

She suggested an FDIC model for supporting secondary mortgage finance; a government-run agency that charges premiums for this and prefunds a reserve to take losses if the loans go bad rather than a hybrid model of a private-sector entity with a government backstop.  "If I was going to continue a U.S. government presence, I would continue it (in housing for low and moderate income people) before I would continue it anyplace."

The foreclosure process, she said, is becoming dysfunctional.  There is an overhang of delinquencies and inventory and increasing litigation that will also be slowing things down.  Early on, she said, she had suggested a two part process; for retroactive problems there would be a bank-funded pool to provide a nominal settlement to waive claims and a process for those who were wrongfully foreclosed and going forward a streamlined modification that would write down loans below appraised value, give homeowners a year to perform before refinancing them with a bit of equity or they would agree to turn in their keys.  Something dramatic must be done rather than the current incremental fixes. Instead, she said, she sees modifications becoming more and more complicated.

She is quite angry with the servicers. "We saw this coming for years. We talked about ramping up their staff, putting assistance in place for workout, but it wasn't done. Now we have poor quality servicing plus litigation and issues around poor documentation.

Elizabeth Warren

While Bair didn't exactly throw Elizabeth Warren, the person designated to establish the new Consumer Financial Protection Bureau, under the bus, she didn't provide much support for her appointment as permanent CFPB Director.  It is critical there be a presidentially appointed and Senate-confirmed head, Bair said she hopes that the administration and the Senate "come together and for this and other jobs "find quality people to serve."

Sorkin quoted William Cohen's suggestion that it was Warren's duty as a citizen of this country to get out of the way; that there was no way to move the agency forward with her in the mix.   Bair responded, "Elizabeth is a very talented person who had a wonderful career prior to this and there's a lot of wonderful things she can do, and there are -- you know, there's a good reservoir of candidates out there, but I think it's important for the president to make a decision on this and to move forward and engage the Senate and hopefully in a way that can move these nominees to confirmation, because at this point it's looking like they're all going to get bogged down and I think that's a very difficult situation for the country right now."


Asked about the need for accountability for what happened in the financial industry prior to the collapse, Bair said, "We obviously can't put people in jail. We are certainly being very vigorous in suing directors and officers who we feel did not exercise the appropriate duty of care in running their banks; try to recoup some of the losses we suffered as part of the failed banks."  "Instead of just going after the (D&O) insurance proceeds; I think you need to have some pain be felt by people.  So I think you can -- you know, can have financial pain without sending somebody to jail, and maybe it's appropriate that some people should go to jail too."

I think at the origination level I think there was a lot of fraud going on, and I think the question is how much of it begs -- are there larger financial institutions funding this stuff, did they know about it and it was just a matter of looking the other way, not having appropriate controls or did they actually know about that."

Banking Regulation

Early in the discussion, Sorkin asked Bair about CitiBank CEO Jamie Dimon's recent remark that most of the bad actors and the exotic derivatives are gone; standards are higher, banks have more liquidity and capital, boards and regulators are tougher and more regulations are coming. The cumulative effects of regulation are the reason banks aren't lending and unemployment hasn't gotten better.

Bair responded that we need to be careful to ensure that regulations are efficient, understandable, and present the desired outcomes "But on basic things, obvious things like higher capital standards, I say full speed ahead and the higher the better."

A lot of research, she said, challenges that notion that higher capital requirements have much impact on lending.  "Lending is really just another way of funding your balance sheet, and it's more expensive than debt. But it can influence losses in a crisis. And then you have financial institutions, especially large ones, that are too highly leveraged. If you get into a crisis, they don't have that loss absorption capability, so they have to quickly reduce their balance sheet to maintain solvency, and that's what we saw during the crisis."

Now there is better regulation, higher capital standards, rules that prevent regulatory arbitrage.  There will always be cycles, she said, but we can help ensure these are normal cycles not economic cataclysm.

Too Big to Fail

Sorkin asked if regulations to prevent too big to fail will work or will create risk, and lead to political favor trading.

Bair said she did worry about the government's will to use the new tools, but not about favoritism.  FDIC has always had resolution authority for member banks and has tools to resolve banks and get the assets back into the private sector quickly; rules that don't allow favoritism.  Under Title II of Dodd-Frank that resolution authority now applies outside of insured banks

She said that large complex entities, especially those with multinational operations, will be difficult but not impossible to resolve. Banks are fundamentally too big if they cannot demonstrate that they can be resolved, than they are too big and need to be downsized now.  Unless those large banks think that FDIC and the Fed is serious about using that authority, we won't get credible resolution plans; we'll get "nice paper exercises to sit on the coffee table somewhere".

Bair said the FDIC could have easily resolved Lehman Brothers under the new rules.  There were ready buyers who had done due diligence, there was a lot of time for planning.  It might not, she said, have even gotten to resolution - the FDIC's authority provides strong incentives for bank management and bank boards to right their own ship.