Regulators propose tighter rules for mortgage-backed securities

Lenders would have to originate mortgages with at least a 20% down payment if they want to repackage the loan to sell to other investors without keeping some of the risk on their books, according to a proposal that U.S. bank regulators endorsed Tuesday.

The Federal Deposit Insurance Corp. board and the Federal Reserve agreed to seek public comment on the proposal, which is intended to restore lending discipline and define the safest form of mortgages that can be completely resold to other investors.

However, the rule is expected to have little near-term effect because not many investors are yet eager to buy repackaged mortgages and because it would not include loans sold to mortgage finance giants Fannie Mae and Freddie Mac.

Last year’s Dodd-Frank financial reform law requires firms that package loans into securities — a practice known as securitization — to keep at least 5% of the credit risk on their books.

The provision is meant to force securitizers to share in the risk so they don’t churn out poorly underwritten loans and then pass along all the risk to investors, as happened during the 2007-09 financial crisis.

Mortgages that meet strict underwriting standards are exempt from the risk requirement.

Mortgages sold to Fannie and Freddie would also be able to escape the risk retention requirement, at least while the mortgage finance giants remain controlled by the government.

Some analysts argued that the proposal, as written, would not have much of a short-term effect on the housing and securitizations market.

“The zero risk retention requirement for loans sold to Fannie and Freddie really knocks the teeth out of this proposal,” said Jaret Seiberg, an analyst at MF Global Inc. “It means that 97% of the mortgage market will be outside the risk retention regime.”

The U.S. government stands behind nearly 90% of home mortgages. Fannie and Freddie already have tightened their requirements for loans they will purchase, mandating higher credit scores for borrowers and bigger down payments.

The rule includes more than 170 questions that regulators are seeking feedback on from stakeholders, indicating the proposal could change significantly before it is finalized.

Small banks, consumer groups and some mortgage lenders have complained that a 20% down payment is too high and would make it difficult for many people to purchase a home, causing a further drag on the struggling U.S. housing market.