Home -> Law Blog Directory -> Corporate & Securities Law Blogs -> Institutional Shareholder Services -- Corporate Governance Blog

Corporate & Securities Law

: Institutional Shareholder Services -- Corporate Governance Blog

New US Mortgage Bill Seeks to Correct IncentivesSubmitted by: Laura Nishikawa, Sustainability Research Analyst

A new mortgage bill was recently announced by the House Financial Services Committee that would require mortgage originators to retain a minimum of 5% of the credit risk of a mortgage. The provision is part of a much broader effort to curb risky lending practices, and seeks to encourage more responsiblelending by preventing lenders from off-loading the risk of the loans they originate.

Although the bill has garnered vigorous opposition from industry groups, and will not likely be passed in its existing state, the risk retention provision marks an important step in the right direction by addressing the misalignment of incentives that has been at the root of the current financial crisis.

Our research has identified four broad effects of the legislation:

* Consumers will benefit from greater accountability: No longer able to off-load credit risk, lenders will have an incentive to make more sustainable loans based on the borrower's reasonable ability to repay.

* Non-bank lenders will need to raise capital: Lacking a deposit base, many non-bank mortgage originators will have to raise capital and fundamentally rethink their business models if they are to keep a greater proportion of loans on-balance-sheet.

* Banks that originate-to-hold will benefit from increased market share: As smaller lenders are pushed out, banks that underwrite sustainable loans with the intention of keeping them on-balance-sheet will have a competitive advantage in the new regulatory environment.

* Effects on securitization are unclear: On one hand, forcing lenders to retain credit risk could increase investor confidence in securitized products. On the other hand, complementary measures in the bill allow the final investor to be sued by a borrower who is the victim of a fraudulent or predatory loan.

The pending bill also include measures that 1) empower borrowers to sue investors if the victim of a predatory or fraudulent loan, 2) set minimum standards for mortgages based on the borrower's documented ability to repay, and 3) require that refinancing yields a net tangible benefit for borrowers.

While the bill as a whole is largely based on a bill passed by the House in 2007, the risk retention provision is a new addition that could mark a larger shift toward addressing incentives in the wave of US bank regulation that is to come.

Full post as published by Institutional Shareholder Services -- Corporate Governance Blog on April 23, 2009 (boomark / email).