Watchdog: Without Regulation, Consumer Mortgages Could Dry Up

We’re seeing it pretty often these days: federal watchdogs, under fire from Congressional Republicans and banking industry leaders for over-regulating, walking onto the banks’ turf and staring them down. First came Elizabeth Warren, the fiery de facto leader of the Consumer Financial Protection Bureau, telling the virulently anti-regulation U.S. Chamber of Commerce that she wanted new rules to strengthen American companies, not weaken them.

Now the Securities and Exchange Commission is stepping into the fight. Last week, SEC Chairwoman Mary Shapiro gave a speech to the annual meeting of the American Securitization Forum, which represents people who bundle all kinds of real loans—mortgages, car loans, etc.—and chop them into chunks called securities for investors to buy.

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There’s just one problem, Shapiro pointed out: Nobody’s buying. The volume of mortgage-backed securities bought by private investors plummeted from $609 billion in 2006 to just $231 million last year, Shapiro said. And all but one of those deals required the explicit guarantee of the federal government before investors would come anywhere near.

To Shapiro, the message is clear. Despite the securities industry’s resistance, it needs better regulation, especially when it comes to telling investors what they’re actually buying. Or there won’t be much of an industry left.

“In the aftermath of the crisis, would-be investors are waiting for needed reforms in the securitization market before they are willing to wade back in,” Shapiro said in her prepared remarks. “But efforts to implement the reforms that would bring investors back to the markets are being met with strong and what I believe to be short-sighted resistance.”

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What does this mean for the average American? »

OK, What’s the Point?

What does this mean for the average American? Because right now, the only reason regular people are getting mortgages is because the federal government is buying or insuring basically all of them. If the government stops doing that, as all Congressional Republicans and some Democrats propose, there will be nobody left buying mortgages.

And that’s a problem, because the entire modern mortgage system is founded on liquidity. Without someone to sell your mortgage to, your bank has to hold it in its own vault until you eventually repay it. In the meantime, it can’t lend that money to anyone else. Some banks and credit unions, especially small ones, did hold onto some of the mortgages they wrote during the housing boom. But at most mid- to large-sized banks, the loans were already bundled and sold to waiting investors before any living, breathing homebuyers had even signed their John Hancocks to a mortgage application.

Multiply that by millions of mortgages, and you see the problem. Pretty soon, banks won’t have any money to lend, which means a return to the old, pre-Depression truism: “The only people who can get a loan are the people who don’t need one.”

Real-life mortgages may seem pretty far removed from the esoteric world of mortgage-backed securities. In fact, Shapiro pointed out Wednesday, they are joined at the hip.

“In conjunction with low interest rates and rising home prices, securitization helped fuel the real estate boom of the last decade,” she said.

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Industry Hits Back

It’s unlikely that the people listening to Shaprio’s speech were much moved by it. Leaders in the securitization industry believe that the proposed rules would prolong the current problem of investors fleeing the mortgage markets like rats from a sinking ship.

The “proposals will keep a significant amount of private capital on the sidelines,” according to a press release by the forum in March. “Drawing private capital out of the mortgage finance system, rather than encouraging its entry, will only serve to further depress home prices nationwide and keep first-time home buyers out of a housing market suffering from a severe oversupply of available homes.”

Which means that, despite Shapiro’s face-to-face confrontation on Wednesday, securitizers are unlikely to drop their opposition to the reforms anytime soon.

What do you think?

Who’s right here? Are the securities guys scaring investors away and further delaying the widely-predicted, oft-postponed recovery?

Or is it actually regulators like Shapiro and her Democratic supporters in Congress? Let us know what you think.

[Related: How to Order Your Free Annual Credit Report]

Image: Corey Leopold, via Flickr