Despite claims that leverage rules have been “watered-down,” the new standards sure to come later this winter from U.S. regulators will be very tough. They are yet another capital constraint on mortgage finance once Fannie and Freddie are finally consigned to their fate. If it take as much as $500 billion to replace the GSEs and keep thirty-year FRMs as before, the post-GSE world will be one with lots fewer high-quality FRMs because banks simply can’t play and, at least for a while, there isn’t enough non-bank capital to make up the difference.

As a report sent Monday to FedFin clients explains ( ), the only way banks, especially big ones, can compete in residential-mortgage finance is to find the sweet spot where both the leverage and risk-based capital rules are too low. With big-bank leverage soon to be set at 6%, the only loans for which this works are high-risk ones. Credit enhancement like MI will suffer since leverage doesn’t count it as a capital buffer, but the big losers in the new regime will be banks. For all but the highest-risk mortgages, they will be out-gunned by hedge funds and other players outside the regulators’ ambit.