Tag Archives: Consumer Financial Protection Bureau

Who Knows The ABCs of Finance?

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Annamaria Lusardi recently posted a working paper, Financial Literacy: Do People Know the ABCs of FInance? to SSRN. The abstract reads,

Increasingly, individuals are in charge of their own financial security and are confronted with ever more complex financial instruments. However, there is evidence that many individuals are not well-equipped to make sound saving decisions. This paper looks at financial literacy, which is defined as the ability to process economic information and make informed decisions about financial planning, wealth accumulation, debt, and pensions. Failure to plan for retirement, lack of participation in the stock market, and poor borrowing behavior can all be linked to ignorance of basic financial concepts. Financial literacy impacts financial decision-making, with implications that apply to individuals, communities, countries, and society as a whole. Given the lack of financial literacy among the population, it may be important to remedy it by adding financial literacy to the school curriculum.

As I have stated previously, not only is financial literacy in bad shape, but efforts to improve it have not proven to be very effective. Lusardi’s paper has some sobering findings:

most individuals in the United States and in other countries cannot
perform simple calculations and do not understand basic financial concepts such as interest compounding, the difference between nominal and real values, and risk diversification. Knowledge of more complex concepts, such as the difference between bonds and stocks, the workings of mutual funds, and basic asset pricing, is even scarcer. Financial illiteracy is widespread among the general population and particularly acute among specific demographic groups, such as women, the young and the old, and those with low educational attainment. (3)

Because evidence does not demonstrate that additional financial education is all that effective, I take a different lesson from Lusardi’s review of survey results. The government should take an active role in regulating financial markets to protect consumers from abusive behavior and to encourage them to make good financial decisions. Financial education is no replacement for consumer protection.

Monday’s Adjudication Roundup

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  • Ocwen and Assurant settle with homeowners for $140 million in class action suit, in which the homeowners alleged that Ocwen received kickbacks by inflating premium costs for forced-placed insurance.
  • New York’s Appellate Division, First Department, affirmed dismissal of suit against UBS AG for $30 million, brought by Hanwha Life Insurance Co. (a Korean corporation) claiming that NY courts do not have an interest in adjudicating the suit. Hanwha purchased $30 million in credit-linked notes from UBS that turned out to be worthless. It was trying to recover its losses because it relied on UBS’s advice in purchasing the notes.
  • CFPB and the Maryland Attorney General filed suit and settlement consent orders against a title company and participants in an alleged illegal mortgage-kickback scheme.
  • After the National Credit Union Administration Board (NCUA) filed a complaint against HSBC for failing as trustee of $2 billion in residential mortgage-backed securities trusts, HSBC claims that the regulator lacks standing to represent the trusts and is barred by Delaware’s three-year statute of limitations.
  • Wells Fargo and Deutsche Bank moved to dismiss fives suits from BlackRock Inc., Pacific Investment Management Co. and NCUA for allegedly failing to watch over 850 RMBS trusts as the trustees.

Reiss on Anatomy of a Mortgage

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MainStreet quoted me in The Anatomy of a Mortgage – Determining Which Fees You Need to Pay. It reads in part,

All mortgages are not created equal, so reading the fine print before you agree to a long-term commitment is crucial.

Mortgage lenders now have become “very risk averse” since the financial crisis and are doing everything “pretty much by the book,” said Greg McBride, the chief financial analyst for Bankrate.com, a New York-based personal finance content company. “The rules on the ability of a homeowner to be able to repay are stricter than ten years ago,” he said. “Niche products have gone back to niche borrowers.”

While lenders are offering fewer risky products such as interest only mortgages to run-of-the-mill consumers, there are still hidden fees and other deceptive practices to be wary of, said Jason van den Brand, CEO of Lenda, the San Francisco-based online mortgage company.

In 2013, the Consumer Finance Protection Bureau issued guidelines to protect consumers from the types of mortgages that contributed to the financial crash. In the past, lenders were approving mortgages that allowed consumers to borrow large sums of money without any documentation such as pay stubs and offered extremely low interest rates to lure people into buying homes.

 “It also doesn’t mean that the potential to get bad mortgage advice has been eliminated,” van den Brand said. “There aren’t bad mortgage products, just bad advice and decisions.”

Here are the top seven things consumers should consider carefully.

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Avoid choosing an adjustable rate mortgage or ARM when it makes more sense to select a fixed rate mortgage. Those low initial rates offered by ARMs are enticing, but they only make sense for homeowners who know that in less than ten years, they plan to upgrade to a large home, move to another neighborhood or relocate for work. Many ARMs are called a 5/1 or 7/1, which means that they are fixed at the introductory interest rate for five or seven years and then readjust every year after that, which increases your monthly mortgage payment said David Reiss, a law professor at Brooklyn Law School.

While many homeowners gravitate toward a 30-year mortgage, younger owners “should seriously consider getting an ARM if they think that they might move sooner rather than later,” he said. If you are single and buying a one-bedroom condo, it is likely you could sell that condo and buy a house in the future. “That person might not want to pay for the long-term safety of a 30-year fixed rate mortgage and instead save money with a 7/1 ARM,” Reiss said.

The Future of Fannie and Freddie: The Definitive Panel!

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The  NYU Journal of Law & Business has published The Future of Fannie and Freddie (also on SSRN):

This is a transcript of a panel discussion titled, “The Future of Fannie and Freddie.” The panelists were Dr. Mark Calabria from the Cato Institute; Professor David Reiss from Brooklyn Law School; Professor Lawrence White from NYU Stern School of Business; Dr. Mark Willis from NYU’s Furman Center for Real Estate and Urban Policy. The panel was moderated by Professor Michael Levine from NYU School of Law. Panelists looked at economic policy and future prospects for Fannie and Freddie. My remarks focused on the goals of housing finance policy.

The actual panel occurred some time ago, but it remains current given the limbo in which housing finance reform finds itself.

Friday’s Government Reports Roundup

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Home Loan Toolkit

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The Consumer Financial Protection Bureau has issued Your Home Loan Toolkit: A Step-by-Step Guide. The toolkit is designed to help potential homeowners navigate the process of buying a home. As the press release notes,

The toolkit provides a step-by-step guide to help consumers understand the nature and costs of real estate settlement services, define what affordable means to them, and find their best mortgage. The toolkit features interactive worksheets and checklists, conversation starters for discussions between consumers and lenders, and research tips to help consumers seek out and find important information.

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Creditors must provide the toolkit to mortgage applicants as a part of the application process, and other industry participants, including real estate professionals, are encouraged to provide it to potential homebuyers.

The toolkit asks many of the important questions that homebuyers have:

  • What does affordability mean for you?
  • What kind of credit profile do you have?
  • What kind of mortgage is right for you?
  • How do points work?
  • How do you comparison shop with lenders?
  • How does a closing work?
  • How do you read your Closing Disclosure?
  • How do keep your mortgage in good standing?

That being said, it remains to be seen whether this toolkit will actually help potential homeowners. It is important for the CFPB to design an effectiveness study to see how the toolkit performs in practice.

Mortgaging the Future

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The Federal Reserve Bank of San Francisco’s most recent Economic Letter is titled Mortgaging the Future? In it, Òscar Jordà, Moritz Schularick, and Alan M. Taylor evaluate the “Great Mortgaging” of the American economy:

In the six decades following World War II, bank lending measured as a ratio to GDP has quadrupled in advanced economies. To a great extent, this unprecedented expansion of credit was driven by a dramatic growth in mortgage loans. Lending backed by real estate has allowed households to leverage up and has changed the traditional business of banking in fundamental ways. This “Great Mortgaging” has had a profound influence on the dynamics of business cycles. (1)

I was particularly interested by the Letter’s Figure 2, which charted the ratio of mortgage debt to value of the U.S. housing stock over the last hundred years or so. The authors write,

The rise of mortgage lending exceeds what would be expected considering the increase in real estate values over the same time. Rather, it appears to also reflect an increase in household leverage. Although we cannot measure historical loan-to-value ratios directly, household mortgage debt appears to have risen faster than total real estate asset values in many countries including the United States. The resulting record-high leverage ratios can damage household balance sheets and therefore endanger the overall financial system. Figure 2 displays the ratio of household mortgage lending to the value of the total U.S. housing stock over the past 100 years. As the figure shows, that ratio has nearly quadrupled from about 0.15 in 1910 to about 0.5 today. (2)

An increase in leverage for households is not necessarily a bad thing. it allows households to make investments and to smooth their consumption over longer periods. But it can, of course, get to be too high. High leverage makes households less able to handle shocks such as unemployment, divorce and death. it would be helpful for economists to better model a socially optimal level of household leverage in order to guide regulators. The CFPB has taken a stab at this with its relatively new Ability-to-Repay regulation but we do not yet know if they got it right.