Tag Archives: Board of Governors

“Modernizing” the Community Reinvestment Act

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President Carter signs the Housing and Community Development Act of 1977, which contains the Community Reinvestment Act

The Trump Administration has been signaling its intent to do a makeover of the Community Reinvestment Act of 1977 (CRA) for quite a while, describing it as a much needed update.  Last June, Treasury stated in its Banks and Credit Unions report (one of a series of reports on A Financial System That Creates Economic Opportunities which I discuss here),

The CRA statute is in need of modernization, regulatory oversight must be harmonized, and greater clarity in remediating deficiencies is called for. It is very important to better align the benefits arising from banks’ CRA investments with the interest and needs of the communities that they serve and to improve the current supervisory and regulatory framework for CRA. . . . Aligning the regulatory oversight of CRA activities with a heightened focus on community investments is a high priority for the Secretary. (9)

Well, the modernization effort has now taken off with a Treasury Memorandum for The Office of The Comptroller of the Currency, The Board of Governors of The Federal Reserve System, The Federal Deposit Insurance Corporation. By way of background, the memorandum notes that

The Community Reinvestment Act (CRA) of 1977 was enacted to encourage banks to meet the credit and deposit needs of communities that they serve, including low- and moderate-income (LMI) communities, consistent with safe and sound operations. Banks are periodically assigned a CRA rating by one of the primary regulators – the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), and the Federal Deposit Insurance Corporation (FDIC), collectively the CRA regulators – based on the bank’s performance under the appropriate CRA tests or approved Strategic Plan. CRA was enacted in response to concerns about disinvestment and redlining as well as a desire to have financial institutions “play the leading role” in providing the “capital required for local housing and economic development needs.”

The U.S. banking industry has experienced substantial organizational and technological changes; however, the regulatory and performance expectations under CRA have not kept pace. Interstate banking, mortgage securitization, and internet and mobile banking are just a few of the major changes that have come about in the past four decades. In this evolving banking environment, changes should be made to the administration of CRA in order for it to achieve its intended purpose. (1, footnotes omitted)

The bank that Treasury Secretary Mnuchin used to head up, OneWest, had its own run-ins with CRA compliance. As a result, we should look carefully at how Treasury seeks to “modernize” the CRA. The Treasury memo has four recommendations:

  • Assessment Areas. The concept of assessment areas originated within the banking environment that existed in 1977, when there was no interstate banking and deposits almost always came from the community surrounding a branch. Treasury offers recommendations for updating the definitions of geographic assessment areas to reflect the changing nature of banking arising from changing technology, customer behavior, and other factors.
  • Examination Clarity and Flexibility. Both banks and communities would benefit from additional flexibility in the CRA performance evaluation process, including increasing clarity in the examination guidance. Treasury recommends improvements that could be made to CRA performance evaluation criteria that would increase the transparency and effectiveness of CRA rating determinations.
  • Examination Process. Certain aspects of the examination process need to be addressed in order to improve the timeliness of performance evaluations and to allow banks to be more accountable in planning their CRA activity. Treasury recommends improvements that could be made with respect to the timing of CRA examinations and issuance of performance evaluations, and to the consistent use of census data throughout an assessment period.
  • Performance. The purpose of CRA is to encourage banks to meet the credit and deposit needs of their entire community. The law does not have explicit penalties for nonperformance. However, performance is incentivized as regulators must consider CRA ratings as a part of various bank application processes and performance evaluation reports are made available to the public. Treasury offers recommendations as to how the current regulatory approach to downgrades for violations of consumer protection laws and various applications from banks with less than a Satisfactory rating could be improved to incentivize CRA performance. (2, footnotes omitted)

While there is lot to chew on here, I think a key issue will be the scope of the Assessment Areas. As banks move from straight ‘bricks and mortar’ to ‘bricks and clicks’ or even to pure clicks, it is harder to identify the community each bank serves.

While the memo does not offer a new definition for Assessment Areas, one could imagine alternative definitions that are either loose or stringent as far as CRA compliance is concerned. Because the CRA was intended to ensure that low and moderate-income communities had access to mortgage credit after years of redlining, any new definition of Assessment Areas should be designed to support that goal. We’ll have to see how the Trump Administration proceeds in this regard, but given its attitudes toward fair housing enforcement, I am not hopeful that the Administration will take the CRA’s goals seriously.

Bringing Housing Finance Reform over the Finish Line

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photo by LarryWeisenberg

Mike Milkin at Milkin Institute Global Conference

The Milkin Institute have released Bringing Housing Finance Reform over the Finish Line. It opens,

The housing finance reform debate has once again gained momentum with the goal of those involved to move forward with bipartisan legislation in 2018 that results in a safe, sound, and enduring housing finance system.

While there is no shortage of content on the topic, two different conceptual approaches to reforming the secondary mortgage market structure are motivating legislative discussions. The first is a model in which multiple guarantor firms purchase mortgages from originators and aggregators and then bundle them into mortgage-backed securities (MBS) backed by a secondary federal guarantee that pays out only after private capital arranged by each guarantor takes considerable losses (the multiple-guarantor model). This approach incorporates several elements from the 2014 Johnson-Crapo Bill and a subsequent plan developed by the Mortgage Bankers Association. Fannie Mae and Freddie Mac—the government-sponsored enterprises (GSEs)—would continue as guarantors, but would face new competition and would no longer enjoy a government guarantee of their corporate debt or other government privileges and protections.

The second housing finance reform plan is based on a multiple-issuer, insurance-based model originally proposed by Ed DeMarco and Michael Bright at the Milken Institute, and builds on the existing Ginnie Mae system (the DeMarco/Bright model). In this model, Ginnie Mae would provide a full faith and credit wrap on MBS issued by approved issuers and backed by loan pools that are credit-enhanced either by (i) a government program such as the Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA), or (ii) Federal Housing Finance Agency (FHFA)- approved private credit enhancers that arrange for the required amounts of private capital to take on housing credit risk ahead of the government guarantee. Fannie Mae and Freddie Mac would be passed through receivership and reconstituted as credit enhancement entities mutually owned by their seller/servicers.

While the multiple guarantor and DeMarco/Bright models differ in many ways, they share important common features; both address key elements of housing finance reform that any effective legislation must embrace. In the remainder of this paper, we first identify these key reform elements. We then assess some common features of the two models that satisfy or advance these elements. The final section delves more deeply into the operational challenges of translating into legislative language specific reform elements that are shared by or unique to one of the two models. Getting housing finance reform right requires staying true to high-level critical reform elements while ensuring that technical legislative requirements make economic and operational sense.  (2-3, footnotes omitted)

The report does a good job of outlining areas of broad (not universal, just broad) agreement on housing finance reform, including

  • The private sector must be the primary source of mortgage credit and bear the primary burden for credit losses.
  • There must be an explicit federal backstop after private capital.
  • Credit must remain available in times of market stress.
  • Private firms benefiting from access to a government backstop must be subject to strong oversight. (4-5)

We are still far from having a legislative fix to the housing finance system, but it is helpful to have reports like this to focus us on where there is broad agreement so that legislators can tackle the areas where the differences remain.

Blockchain and Securitization

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image by David Stankiewicz

Deloitte prepared a report on behalf of the Structured Finance Industry Group and the Chamber of Digital Commerce, Applying Blockchain in Securitization: Opportunities for Reinvention. It opens,

The global financial system is betting on blockchain to revolutionize many aspects of its business, and we (the Structured Finance Industry Group and the Chamber of Digital Commerce) believe that securitization is one of the areas in the capital markets that could most benefit from this transformation. Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, recently called blockchain “a very important new technology” that “could make a big difference to the way in which transactions are cleared and settled in the global economy.” Financial services institutions have already invested over a billion dollars in the technology, with most big banks likely to have initiated blockchain projects by the end of 2017. There are already hundreds of use cases, ranging from international payments to securities processing, while technology firms including Amazon, Google, and IBM are offering a host of blockchain services aimed at the financial industry.

Why are all of these companies investing in blockchain? This new technology has the potential to dramatically disrupt the role of intermediaries—including that of banks—in financial transactions. Traditional activities performed by intermediaries might be changed or even replaced. Blockchain can also bring significant advances in efficiency, security, and transparency to many of the financial sector’s activities.

*     *     *

The Structured Finance Industry Group and the Chamber of Digital Commerce commissioned Deloitte & Touche LLP (Deloitte) to explore how blockchain might reinvent securitization—and how the securitization industry should consider preparing for this rapidly approaching future. This industry is exploring this nascent technology’s potential benefits and costs. Firm answers on blockchain’s likely use cases are not yet available, but discussions with securitization and blockchain experts have led to some key observations and insights about implications and possible paths forward. (1, footnotes omitted)

The report’s bottom line is that “[b]lockchain and smart contracts could catapult the securitization industry into a new digital age.” (2) It finds that

The technology’s potential to streamline processes, lower costs, increase the speed of transactions, enhance transparency, and fortify security could impact all participants in the securitization lifecycle—from originators, sponsors/issuers, and servicers to rating agencies, trustees, investors, and even regulators. (2)

The report provides a nice overview of blockchain basics for those who find distributed ledger technology to be mysterious. The real value of the report, however, is that it provides concrete guidance on how blockchain can be integrated in the securitization process. There is a chart on page 24 and an explanation of it on the following page that shows this in detail. This level of detail makes it much easier to visualize how blockchain can and most likely will change the nature of the business in years to come.

Reforming the Fed

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Peter Conti-Brown and Simon Johnson posted their policy brief, Governing the Federal Reserve System after the Dodd-Frank Act, on SSRN (also on the Peterson Institute for International Economics website). I have said before that the Fed is a “riddle, wrapped in a mystery inside an enigma” and I stand by that characterization. This policy brief is very helpful, however, in identifying the legal structure of the Federal Reserve System as well as the practical constraints and political forces that affect the workings of that legal structure.

The authors write that by statute, the chair of the Fed

decides almost nothing herself: The Federal Reserve System is supervised by a Board of seven presidentially appointed, Senate-confirmed governors, of whom the chair is but one. In practice, the chair has frequently had a disproportionate influence on the monetary policy agenda and also the potential to predominate on regulatory matters—working closely with the Fed Board’s senior staff. Even so, for the most significant decisions, the Board must vote, and the chair must rely on the votes of the other six governors (for Board matters) and in addition, on a rotating basis, the votes of five of the twelve Reserve Bank presidents (for monetary policy). On regulation and supervision issues, the chair can do little of consequence without the support of at least three other governors. (1)

The brief goes on to document other aspects of the Fed’s organizational structure and the practical politics of Fed decisionmaking. For those of us who have a hard time parsing how the Fed acts, this is a useful document.

The brief also argues for a new approach to Fed governance:

The Fed chair is arguably the most important economic appointment any president makes. After the crises, new statute, and bold decisions of recent years, this job has become even more important.

During its first 100 years of existence, the position of Fed chair has risen to exercise great potential power. By statute, an appointee can remain in office 20 years or more. A perceived “maestro” effect in which insiders and outsiders are discouraged from challenging the chair is no longer a model with broad appeal, if it ever was.

The Board of Governors could provide an effective counterweight to the chair. Indeed, such a counterweight is what Congress intended by requiring presidential appointment and Senate confirmation of the entire Board. In order to break the tradition of a chair-dominated board, governors need sufficient expertise and experience to engage with and in some instances counteract the chair and Fed staff.

A president’s choice for Fed chair matters enormously, but the choice for members of the Board also matters a great deal. Monetary policy remains a crucial criterion but not at the exclusion of regulatory policy. The Board is second to none—in the nation and indeed arguably in the world—in its responsibility for regulatory oversight over the financial system. The president, members of the Senate, and the general public ignore these considerations at significant peril to the financial system and the economy. (9)

The brief presents a powerful alternative to business as usual at the Fed.  Hopefully, it will gain some traction.