Senate Banking Committee Considers Small Bank Mortgage Lending

This post was written by Adam Rust and is a cross post from

The Senate Committee for Banking, Housing and Urban Affairs is taking testimony this morning on how pulling back the role of the GSEs would impact small banks. Senator Tim Johnson (D-SD) is hearing from small bankers, credit unions and two policy advocates:

“What you really find out is not the down payment, it is really other things: what is your debt-to-income, how are your credit cards, where the down payment is coming from…you want to look at the probability of repayment,” said Jack Hartings. “What I saw was a person buying a home for $100,000. But they would raise the price to $115,000 and give the buyer a down payment.” Harting is saying the truth about down-payment contributions. It was actually a fairly common practice. It was most often something offered by builders seeking to sell homes in a recently finished subdivision.

The interesting thing about the testimony was how it showed a disconnect between small bankers and the current political narrative. The small bankers and one of the policy advocates voiced concerns about high down payment requirements in the qualified residential mortgage rule and that small banks would be put at a competitive disadvantage in a market where most mortgage securitization is arranged by the same four big banks that are also originating the mortgages.

Upon hearing testimony from Hartings, Dunn, and Staatz that downpayments, either as required currently by the GSEs or through potential versions of a qualified residential mortgage, would impose challenges to their balance sheets, Jake Reed responded with this question:

“I hear that paper work is a large problem, and you don’t have to be diplomatic, you don’t have to hold back….I hear from a lot of small bankers and these are the people that are in the community, they are the ones that are buying the little league uniforms. Is that at risk here?….are you finding that people are saying ‘we should get out of mortgages…’we should sell to a big bank’?”

Reed presented a vision of small town bankers working to expand availability of soccer uniforms and doubting whether they should continue to run their businesses — all because of paperwork.

The bankers glossed over that idea.

“Possibly,” to paraphrase Hartings, “but we’re really worried about liquidity for our balance sheets. Succession is an issue, because people are getting older and often there aren’t the right people in the small towns.”

“We want to be in the mortgage business,” added Staatz.

The bankers insist that they can only make mortgages with a GSE, or something like it, to make their balance sheets viable. Several floated the idea of a co-operative model for MBS. They might be coming to that resolution by looking to existing successful co-operative models that flourish in many small towns. Rural electric co-operatives and local agricultural co-ops make small towns viable places to live and work.

Other solutions were put forth as well. Skillern proposed a model similar to state housing finance agencies: no public subsidy but a consistent mission to expand access to credit. Dunn suggested a gradual reduction of GSE involvement driven by more risk-based pricing.

The 30-year fixed rate mortgage, a staple of small bank lending, is at risk in a world without some kind of public purpose entity. Investment advisors tell me that they have little interest in buying mortgage-backed securities in this market. They say that the return does not justify the risk. I can’t doubt their position. An MBS that offers a 4 percent rate of return should be very safe. Yet an MBS is plagued by long-term interest rate risk in an inflationary environment, by the high possibility of unemployment, and by uncertainty of future legal changes.

The beauty of the GSEs has been to provide credit enhancements to elevate the quality of MBS. The GSEs, by virtue of their stated underwriting rules, give small banks a better chance. It is hard to imagine a market where the four big banks make all of the mortgages, buy all of the mortgages, and service all of the mortgages. The FHA balances risk by charging a uniform risk premium for all loans. FHA is a counter-cyclical model that preserves access during down times.


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