“Dave was a tireless and vocal advocate for the mortgage industry, and for homeownership — especially for underserved communities — and in recent years was equally devoted to the fight against prostate cancer,” noted Rick Sharga, founder and CEO of CJ Patrick. “Dave really was one of the good guys.” 

The passing of David Stevens at the very young age of 66 brings into sharp focus some of the challenges that the housing finance industry faces today. Many of these challenges are the result of partisan politics plain and simple, and come from the policy actions of individuals who may or may not have the best interests of consumers or the housing market at heart.  And they may not even know why.

Take the Basel III endgame proposal, for example. Dave had a lot of problems with the B3E proposal. He told American Banker last August: “We thought the current Basel rule made sense, but this one's going to have downstream effects that are going to be very broad in the housing system." 

We filed comments on the “B3E” proposal last week. The proposal ignores market risk that was made so evident in the failure of Silicon Valley Bank, and instead mistakenly demonizes whole loans and mortgage servicing rights. You can read all of the comments on the B3E proposal on the Fed’s website. 

To honor our departed comrade Dave Stevens, who started his career in the secondary market where dry mortgage notes are sold to investors, let’s delve down into the historical reasons why the B3E proposal is so badly constructed, both from a financial perspective and from an historical view. 

Gain-on-sale accounting for mortgage assets in the United States goes back half a century and is the result of legislation and rule making by the Securities and Exchange Commission and Financial Accounting Standards Board over the decades.  Since the creation of Fannie Mae in the 1930s and the first issuance of mortgage-backed securities by Ginnie Mae in 1970, encouraging the financing and sale of mortgages has been a matter of public policy in the United States. But not at the Fed. 

Reading the B3E proposal, it’s as though we all were living in Germany. U.S. bank regulators led by Fed Vice Chairman William Barr seem intent upon prohibiting bank investments in mortgage loans and MSRs. The entire B3E proposal reflects an alien, European view of housing finance that conflicts with established American law and regulation. 

The B3E proposal will discourage banks from originating mortgage loans of all types, not just the government insured loans that most banks have avoided since the 2012 National Mortgage Settlement and the first Basel III rule. How did this strange misalignment between housing policy and bank regulation occur? 

U.S. regulators operate from the false assumption that mortgage loans and MSRs represent a risk to banks, but this assumption is inaccurate and is not supported by the public record. Conventional and government-insured loans carry U.S. government guarantees against credit loss. Do the folks at the Fed understand this nuance? 

Private-label jumbo loans and non-qualified mortgage loans owned by banks have loss rates that have been negative for the past five years. Where is the problem? Current capital rules for 1-4 family mortgages put $4 worth of capital behind every mortgage note. This is twice the maximum net-loss rate experienced in 2008, when half of the mortgage market was private. 

Likewise, the B3E proposal imposes further punitive capital charges and effectively a lower ceiling on mortgage servicing assets, perhaps the most valuable investment a bank or nonbank may own. These valuable, naturally occurring negative-duration assets have periodic cash flows that strengthen banks and nonbanks alike. MSRs also contain valuable embedded options that are not recognized under generally accepted accounting principles.

The real issue that caused regulators in the U.S. and Europe to adopt a negative view of MSRs is the unsafe and unsound behavior of a few large lenders such as Countrywide, Washington Mutual Bank, Bear Stearns and Lehman Brothers. Defaults on private label loans, not losses from MSRs, caused the failures of these banks, yet the large equity investments in servicing assets are blamed for subsequent credit losses.

If regulators truly understood the positive role of negative duration MSRs in preserving and growing bank capital, Vice Chairman Barr would seek to lower the capital requirement levied upon servicing assets. Specifically, the Fed and other agencies should reverse course and instead encourage banks to originate and retain mortgage servicing as a countercyclical capital buffer and interest rate hedge. 

Rather than erecting artificial barriers to bank holdings of MSRs, Vice Chairman Barr should actually decrease the capital requirement and place a fixed limit on mortgage servicing asset holdings vs. capital subject to supervisory oversight. Banks which use MSRs as part of a comprehensive risk management strategy should be given lower capital treatment. 

If a bank (or nonbank) has competence in originating residential mortgage loans and managing loans and MSRs as part of a formal Asset Liability Committee strategy, and many do, then the activity should be encouraged with lower capital treatment. The Fed and other agencies need to develop a better understanding of the operations of individual banks rather than setting arbitrary limits that make little sense financially and in prudential terms. 

Half a century ago, banks that originated residential mortgages retained the loans on the balance sheet and never recognized a separate MSR. The servicing asset was simply part of the value of the loan — and a long-term capital asset for the bank. MSRs were an invisible and very tangible source of liquidity for the bank, especially during times of elevated credit losses. 

For many banks and nonbanks since the 1990s, retaining sufficient servicing to cover the bank’s operating expenses during times of economic stress was a key goal. The fees and float from an ample servicing book allowed the depository to focus all of net interest income on loss mitigation during a recession, preserving bank capital and adding stability to the industry.

In more recent times, regulators in the U.S. and Europe have waged a relentless campaign against MSRs and residential mortgage assets more generally. European regulatory agencies in particular reflect an obsessive political bias against single-family homes that is in conflict with American economic interests and values. If gain-on-sale accounting is the law of the United States, why is the Fed attacking investments in MSRs?  

The groundswell of opposition to the Basel III endgame proposal from all parts of the U.S. mortgage finance, homebuilding and real estate finance sectors evidence the broad public concern with Vice Chairman Barr’s proposal. The Board and other agencies face the prospect of a political rebuke by Congress should these changes in capital treatment for loans and MSR not be scrapped. The Fed and other agencies should remember that encouraging housing finance is public policy in the United States.