October 24, 2014
It’s too bad that so many people in public life aren’t old enough to remember all the way back to 2008. That is the only explanation for the rush to remove down payment minimums for a risk retention requirement on mortgages placed in mortgage backed securities.
This is the topic of an excellent column by Floyd Norris on how the banking and housing industry, with the support of some consumer groups, managed to remove any down payment requirements. The idea was that banks would have to keep a portion of the risk on all but the safest loans, thereby increasing the likelihood that they would not issue bad loans.
However the rules in the Dodd-Frank bill have been watered down so that even loans with no down payment could be put into mortgage pools even though they have more than four times the default risk of loans with 20 percent down payments. It is also worth pointing out that the cost of requiring that banks retain risk on low down payment loans did not mean that people could not get loans without large down payments as often claimed.
In fact, the only issue was whether they would pay somewhat higher interest rates in the form of mortgage insurance. This would add roughly 0.6-0.7 percentage points to the cost of a typical loan, reflecting the higher default risk. This issue has been hugely misrepresented by the banking industry and its allies so that they can freely return to the practices of the bubble years.
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