"Soon after the housing bust, federal regulators working on repairing the mortgage market thought it was sound policy to have borrowers make sizable down payments on their new homes.
On Tuesday, the regulators completed that overhaul, but they left out any requirement for borrowers to make a down payment. The new regulations aim to strengthen the vast market for bonds that are backed with mortgages and other loans. The market is not back on its feet, despite low interest rates. But the regulators said that the new rules could set the stage for more lending.
“Finalizing this rule represents a major step forward to providing greater certainty to the housing finance market and paves the way for increased participation by the private sector,” said Melvin L. Watt, director of the Federal Housing Finance Agency, one of the regulators that adopted the rule. “Lenders have wanted and needed to know what the new rules of the road are and this rule defines them.”
The regulators left out the down payment requirement after a firestorm of criticism from bankers and consumer advocates. They asserted that such a measure could restrain the flow of housing credit, particularly to borrowers who would have to save for many years to afford a down payment.
But some financial experts are disappointed with the new rules. They contend that, over time, the exclusion of a down payment requirement could once again allow banks to stoke dangerous risks in the financial system — and then evade the pain when the losses pile up.
“This is unfortunate,” said Sheila C. Bair, former chairwoman of the Federal Deposit Insurance Corporation, another of the regulators that approved the so-called risk retention rules on Tuesday. “If the loan goes bad, you have much bigger losses with zero percent down than 20 percent down.”
The Office of the Comptroller of the Currency also adopted the rules on Tuesday, and the Federal Reserve and the Securities and Exchange Commission are expected to sign off on them on Wednesday.
The overhaul has its roots in the years leading up to the financial crisis of 2008. Banks and Wall Street firms packaged billions of dollars of shoddy mortgages and sold them to bond investors, who later suffered huge losses when the loans went bad. To guard against that happening again, the Dodd-Frank Act of 2010 required banks to hold on to a slice of the loans they sold. As a starting point, the new rules require banks to hold onto 5 percent of the loans they sell. But there are exemptions in the so-called risk retention rule that may enable the banks to hold less or nothing.
The biggest loophole applies to residential mortgages.
Specifically, Dodd-Frank said banks did not have to hold on to home loans if they had a low risk of default. The theory was that such mortgages would probably not end up causing high losses for investors, so the retention regulation did not need to apply to them.
In the first draft of the rule, issued in 2011, regulators identified a solid down payment as something that significantly reduced the likelihood of default on a mortgage. Citing data to support their case, the regulators proposed that the exempt mortgages needed to have a down payment of at least 20 percent of the purchase price of the house.
In the following months, however, housing advocacy groups, mortgage bankers and even some bond investors called upon the regulators to get rid of the 20 percent down payment feature. Instead, they wanted the overhaul to simply apply another new set of home loan requirements — called “qualified mortgage” rules — that do not demand any down payments.
Importantly, the first version of the risk retention rules did not set out to prevent banks from making loans with low down payments; it merely required that banks hold a small portion of them.
Still, the fear was that making banks have some “skin in the game” in this way would stop them from lending in the first place. The regulators acknowledged that worry on Tuesday. “The agencies expressed concern about imposing further constraints on mortgage credit availability under the prevailing tight mortgage lending conditions,” the final version of the rule said.
Still, as crucial as the debate over down payments may be, it will probably remain an academic pursuit for a long time.
Right now, the only low down payment mortgages that banks are making have government backing. The risk retention overhaul approved on Tuesday is intended to revive the market for home loans that do not have a government guarantee.
And the mortgage market over all is probably going to be dominated by down payment loans for the foreseeable future. Fannie Mae and Freddie Mac, for instance, guarantee about half of all mortgages that lenders make — and those two government entities typically require down payments of around 20 percent. And, currently, the mortgages that do not have government backing are nearly all to wealthy individuals, who usually make big down payments.
The aim is for taxpayers to step back from providing so much support to the mortgage market in the future. For that to happen, private investors need to buy a lot more nongovernment mortgages than they do now. The big question, however, is whether private investors will tolerate loans with low down payments. “It will really be up to the investors,” Ms. Bair said, “If they want better lending standards, it is up to them.”