As Congress continues to debate legislation that would reshape our financial regulatory system, there is an issue that has garnered relatively little attention, yet it has the potential to shutter thousands of small businesses while fundamentally altering the way families in smaller communities get affordable mortgages. That issue is risk retention.
Contained in both the House and Senate bills, but overshadowed by more controversial provisions such as the Consumer Financial Protection Agency and bailout fund, risk retention would require mortgage originators who make loans to borrowers, as well as the securitizers who then sell those loans to investors in the secondary market, to hold a certain portion of that loan on their books.
The idea behind risk retention — that lenders will make better loans if they have "skin in the game" — is well-intended. As a member of the Small Business Committee, however, I know just how devastating of an effect a one-size-fits-all requirement would have on our nation's smaller, independent mortgage lenders. The fact is, it would quickly put them out of business, taking away important jobs and making affordable credit more difficult to obtain for millions of families.
Families in small communities throughout the nation, and specifically in Central Illinois, depend on nondepository lenders to borrow money to purchase or refinance a home. An across-the-board risk retention requirement will not only hurt these lenders but will unjustly penalize our small-town communities that depend on them as the best source for loans. These lenders are not the Goldman Sachs brokers who receive $10 million bonuses for shorting the market or AIG executives who jet around the country on the taxpayer's dime. They are the local sponsors of Little League teams and the backers of community events.
When a nondepository bank loans money to a borrower to purchase a home, it borrows these funds from another bank. After the mortgage closes, it is sold to an investor. The lender then repays the original loan that it used to make the mortgage and originates new loans.
The simple fact is that nondepository lenders, by the nature of their business model, do not hold loans on their books. This is not to say that these small lenders don't have a fair amount of "skin in the game" already. Should the borrower default on the mortgage, the investor who purchased the mortgage can go back and inspect the original underwriting done by the lender. If it is determined that the lender failed to exercise proper due diligence, these nondepository lenders must take the loss on the loan.
If that isn't "skin in the game," I don't know what is. Risk retention, if forced on smaller lenders, would quickly put them out of business.
The irony here is clear as day. Regulatory reform, we have been repeatedly told, is intended to end "too big to fail." But by putting smaller lenders out of business, risk retention will perversely consolidate lending in the largest banks. By driving so many of the small lenders out of the business of making loans, we're essentially making those companies that are fortunate enough to survive bigger and bigger — essentially codifying the concept of companies being "too big to fail."
As we continue to debate the financial regulatory reform legislation, there is a simple fix to negate the potentially catastrophic effects risk retention will have on small, independently owned nonbank lenders. By exempting loans that are of lower risk from these new onerous guidelines, we can avoid the layoffs and credit crunch that will occur when the hundreds of nondepository lenders are subjected to these requirements.
For instance, Congress should exempt lower-risk loans that are fully amortized and fully documented, and have a sufficient down payment. By doing so, we would be encouraging stable and safer loans that would lead to a rebuilding of the mortgage and real estate markets.
The bottom line is by putting smaller lenders out of business, we will be drastically limiting the choice of consumers and perpetuating "too big to fail." Instead of harming our smaller communities and the small businesses in them, let's enact sensible risk retention provisions that will lead to safer loans and a stronger real estate market.
Rep. Aaron Schock (R-Ill.) is a member of the Small Business Committee.