Recent Lessons for the QRM

On October 1st, the loan limits at which the FHA, Fannie Mae, and Freddie Mac can finance and refinance loans were lowered in 669 counties across the US.[1] The result was dramatic and provides a valuable insight into the impact of another potential change to the mortgage finance system: the qualified residential (QRM) mortgage rule.

The QRM rule is a set of requirements with which mortgages that are to be securitized and sold into the secondary market must comply.  If a loan within a securitization does not meet one of the rules, then the securitizer must retain 5% of the ownership in that securitization.  Any loss on loans in the non-QRM securitization would first be absorbed by the securitizer’s 5% ownership stake before impacting private investors who purchase the other 95% of the securitization.  In this way, the securitizer has “skin in the game”.  The group of regulators who wrote the proposed rule, including the Federal Reserve, the Treasury, and the FDIC, believe that the 5% retention will align incentives of securitizes with those of investors, a critical component of the mortgage finance system that was missing during the recent housing boom.  Over the last two decades, private securitizations have played an increasingly important role in directing funds from private investors to home buyers.  In the wake of the housing bust, the FHA and the GSEs gained much of the market share from private label securitizers.  However, if the government’s role in mortgage finance declines in the decade to come, as many policy makers hope, private securitizations will once again grow in importance.  Thus, providing the transparency, recourse, and aligned incentives that protect investors from undue and unseen risks is important.

An overly stringent set of rules could hurt the economy, though.  Excessive downpayment requirements or high mortgage rates will inhibit homebuyers from utilizing the flow of funds from the private sector.  Sluggish demand for housing in turn hurts the economy, which historically has averaged roughly 19% of the US’s annual GDP, but has recently fallen to just 15%.  Thus, the final QRM rule must balance the desire to improve safety to investors with the need for economic stability and growth.

Since an overly rigid QRM rule could weigh on the economy, it is important to understand how large of an impact it would have.  The recent change to the loan limits at which the FHA and the GSEs can finance mortgages provides a valuable insight.  Those borrowers impacted by the change now face at least some of the impacts that a non-QRM qualified borrower would face.  For instance, the downpayment requirement for a person who qualified for an FHA loan prior to the change in limits jumped from 3.5% to an average effective downpayment of 17.7% or more[2] with a private loan or GSE backed mortgage.  Likewise, the rates faced by borrowers in high cost areas have increased.  A survey conducted by NAR Research in the 669 counties affected by the change in the limits found that the average increase in mortgage rate for an affected borrower was 79 basis points. This trade off, larger downpayment or higher mortgage rates, will be the same choice faced by borrowers if the proposed QRM rule becomes law.

According to the same NAR survey results, 16% of borrowers in the affected areas who fell into the impacted price ranges chose to give up their home search as a result of the higher rates or increased downpayments.  To estimate the impact of QRM, this figure must be adjusted by the share of the market covered by the FHA, which is exempt from the rule, as well as the share of non-exempt loans that will qualify as a QRM.  Roughly 18% to 22% of loans financed by the GSEs between 1997 and 2003 would have qualified as a QRM according to the FHFA[3] and the FHA is exempt from the rule, which will drive more borrowers that direction.  If the FHA maintains a historically high 25% share of the mortgage market, these assumptions would imply that 9.6% of sales would fall out under the QRM.[4] NAR Research has estimated the impact on rates from the proposed QRM rule to be in a range of 85 to 180 additional basis points.  The 79 basis point impact and effective increase in downpayment from 3.5% to 20% from the loan limit change would roughly match the lower end of the estimated impact of the QRM rule.  On a national level, a reduction in home sales of 9.6% would translate to roughly 480,000 fewer home sales.  This assessment is in line with estimates from other groups like Moody’s Analytics[5] of 423,000 fewer home sales for a 100 basis point increase.  Such a decline would have a depressing impact on the housing market and economy, stifling demand which could place downward pressure on prices and possibly touch off another round of delinquencies and foreclosures.  What’s more, the 9.6% lower sales rate would not be a one-time event, but would drag on sales in every year that the QRM is in place.

The impact of the QRM rule could be far worse.  NAR’s estimate of an additional 85 to 180 basis points is at the middle range of current estimates for the QRM’s impact.  The American Securitization Forum, the trade association representing both securitizers of asset backed securities as well as the investors who purchase them, estimated in their comment letter to the regulators on the QRM rule that the impact could be as high as 200 additional basis points.[6] Subsequently, Moody’s Analytics estimated that more stringent language from the regulators on some of the nuances of future securization structures suggests that the impact might be even higher, in the range of 100 to 400 additional basis points, and would create a disincentive for banks to originate 30-year fixed rate mortgages.[7]

Finally, the FHFA’s historical estimates of the share of borrowers impacted by the QRM may understate the case.  According to statistics from NAR’s Profile of Home Buyers and Sellers, the share of repeat buyers who relied on savings for their downpayment rose from 40% to 59% between 2005 and 2011. Simultaneously, the share of repeat buyers who used proceeds from the sale of their primary residence fell from 66% to 41% over this same time period while the share of repeat buyers who used loans from their 401k/pension or gifts increased.  This shift toward dependence on savings swung beyond the pre-boom share of 51%, while proceeds from the sale of a prior home are also historically low.  The loss of equity from recent price declines has impacted repeat buyers’ ability to save and slow price growth over the next half decade will likely hamstring housing equity as a conduit for trade up buying.  Furthermore, the use of gifts and inheritance as well as the tapping of retirement savings like 401(k)s, IRA, and stocks has increased and in the latter case was much higher in 2011 than in 1997.  The heightened downpayment requirement under QRM could accelerate the diversion of funds from retirement to the downpayment.  The high downpayment requirement of the QRM would hurt repeat buyers and not just first-time buyers.

In the QRM rule, regulators must strike a balance between protecting investors, the banking system, and the flow of funds to homebuyer, while not stunting the economy’s ability to grow.  In the years to come, the QRM rule if enacted in its current form is likely to have a substantial negative impact on the housing market and the economy.  The recent change to the loan limits at which the FHA and GSE can finance mortgages provided a litmus test for the magnitude of the QRM’s impact, which suggests that it could undermine a housing recovery and create headwinds to economic growth.

[1] The limits were subsequently raised for the FHA, but not for the GSEs

[2]Based on the average county level decline in the FHA loan limits for the 669 affected areas and FHFA data.

[3] FHFA’s Mortgage Market Note of 3/31

[4] 100%-25% = 75% is the non-FHA share of the market; 75%*(1-20%) = 60% is the non-FHA, non-QRM qualified portion of the market, where the 20% is the average of the 18%-22% pre-boom/bust QRM share estimated by the FHFA; thus 60%*16% = 9.6% is the portion of the total market that will drop out under QRM

[5] http://www.economy.com/mark-zandi/documents/Reworking-Risk-Retention-062...

[6] http://www.americansecuritization.com/uploadedFiles/ASF_Risk_Retention_Comment_Letter.pdf page 49

[7] http://www.economy.com/mark-zandi/documents/2011-09-21-Zandi-A-Clarifica...