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What to Do With the QM Patch?

LenderThe American Enterprise Institute’s Edward Pinto, Co-Director of the AEI Center on Housing Markets and Finance, recently addressed the topic of the expiring QM patch, and specifically criticized possible solutions put forward by the Urban Institute, calling their analysis a “classic case of bad economics.”

According to Pinto, Urban Institute’s recommended loan pricing standard cannot work, and the recommended Annual Percentage Offer Rate (APOR) would promote higher risk, rather than constrain it. Pinto notes that in order for a loan’s pricing to reflect risk, the loan must be priced for risk.

“As I noted back in 2013, FHA, the riskiest lender in the marketplace, does not price for risk,” Pinto said. “Thus its loans, no matter how risky, will easily and conveniently meet the APOR plus 150 basis point test.”

As for Fannie Mae and Freddie Mac, the APOR is based on the current offer rate for conventional, conforming mortgages with 20% down. According to Pinto, these are precisely the mortgages that the GSEs purchase in huge quantities. But government policy effectively requires the GSEs subsidize higher risk loans by charging higher rates on lower risk ones. This amounts to about $5 billion per year. In the process the APOR is raised and most, if not all, subsidized higher risk loans are under the APOR plus 150 basis point test.

“The result? Nearly all, if not all, of government insured loans (about 85% of the home loan market), will pass the APOR test regardless of risk. This is the test touted by UI as “reflect[ing] credit risk more holistically,” said Pinto.

Pinto concludes that the Urban Institute’s APOR recommendation to the CFPB are dangerous, especially to low- and moderate- income borrowers. He suggests that the best option would be to just let the patch expire in 2021, which, according to FHFA director Mark Calabria, is key to bringing the GSEs out of conservatorship. Patch usage has grown in the last few years, and according to Calabria, changing the patch would be a key tool to shrink Fannie and Freddie without a full overhaul, though he states that he does not intend to do away with it entirely.

In a recent interview with the Wall Street Journal, Calabria stated that he wants to put the now-profitable GSEs back into private hands, something that has been tried and failed by lawmakers in the past.

“I see my goal as setting a path to end the conservatorship” for the companies, he said, adding that “they have to be stronger, healthier companies” compared to before the 2008 housing crisis.

“My objective is to get us to a spot where we don’t have to worry about the system blowing itself up,” he continued.

About Author: Seth Welborn

Seth Welborn is a Harding University graduate with a degree in English and a minor in writing. He is a contributing writer for MReport. An East Texas Native, he has studied abroad in Athens, Greece and works part-time as a photographer.
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