New Fed Rules May Hamper Mortgage Lending by Elaine360

housingmktNew liquidity rules for banks will put a drag on mortgage lending, one of the most important sectors of the economy, a finance expert predicts in an article for American Banker.

The Federal Reserve’s proposed Liquidity Coverage Ratio rule attempts to ensure that large banks have enough liquid assets to survive a severe liquidity crunch, says Clifford Rossi, a professor at the Robert H. Smith School of Business at the University of Maryland. Their high-quality liquid assets (HQLAs) would have to be at least 100 percent of net cash outflows during a 30-day stress period.

The idea is well intentioned, he says. The last financial crisis clearly showed that stronger liquidity provisions are needed. The problem is in the details, specifically defining HQLAs.

“The stakes are high for the mortgage industry as to where the final liquidity rules will fall as treatment of [mortgage-backed securities] as high-quality liquid assets has significant implications for ones issued in a post-GSE environment,” he says.

The proposal would discourage banks from holding safe, high-quality mortgages, he says. Mortgages backed by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, as well as high-quality non-GSE mortgage-backed securities and lines of credit from Federal Home Loan Banks will be less attractive to hold.

The liquidity rules give Ginnie Mae securities greater weight, classifying them in the top tier of liquid assets. GSE securities must be discounted by 15 percent, and they fall in the second tier of assets that cannot exceed 40 percent of HQLAs.

“As a result, GSE securities are placed at a disadvantage to Ginnie Mae securities in terms of banks’ regulatory liquidity preference,” he says.

The rule also says high-quality, private-label residential MBS cannot be counted as HQLA. The Fed estimates that banks will have to raise liquidity buffers by $200 billion to meet the rule. Values of GSE and private-label securities may fall.

The rule, he argues, creates additional headwinds for the private MBS market just as Congress is preparing to consider shrinking the government’s role in the mortgages.

The Fed’s argument for placing GSE bonds in the second-rated tier is “curious given they are still snapping up these bonds under their quantitative easing program,” Rossi states.

The Fed says GSE securities lack full government guarantee, so they should be treated differently than Ginnie Mae bonds.

“Tell that to taxpayers that footed the bill for both agencies after they entered conservatorship in 2008, ” he says.

The liquidity rule will surely increase borrowing costs, Stefan Walter, a former secretary general of the Basel Committee on Banking Supervision, told Bloomberg.

“Nothing is free,” he said. “Buying more resilience in normal and good times means that liquidity will be priced-in more than before, and that will have a certain degree of impact on the cost of credit. That’s the obvious trade-off.”

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