Tag Archives: Consumer Financial Protection Bureau

Paternalism or Consumer Protection?

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Adam Smith (not that one) and Todd Zywicki have posted Behavior, Paternalism, and Policy: Evaluating Consumer Financial Protection to SSRN. It opens,

The Consumer Financial Protection Bureau (CFPB) is one of the most powerful and least accountable regulatory agencies in American history. Immune from budgetary oversight by Congress and headed by a single director whom the president cannot remove except under special circumstances, the agency wields unconstrained, vaguely defined powers to regulate virtually every consumer and small business credit product in America In part, the CFPB has justified its ongoing intervention into financial credit markets based on a prior belief in the inability of consumers to competently weigh their decisions. This belief is founded on research conducted in the area of behavioral economics, which shows that people are prone to a variety of errors in their decision-making.

Beginning with the seminal work of Nobel Laureate Daniel Kahneman and his coauthor Amos Tversky, behavioral economics has identified numerous purported behavioral “anomalies” through extensive laboratory investigation. Anomalies (or behavioral biases) are defined as observed behavioral deviations from the predictions of neoclassical economic theory, where it is assumed that people rationally optimize according to a given set of information and constraints. Behavioral economists have sought to explain the sources of such anomalous choices by identifying and cataloging a variety of cognitive limitations and psychological biases.

Building on these findings, behavioral theorists have exported their research into the policy realm. This program, led by such luminaries as Richard Thaler and Cass Sunstein—and known as behavioral law and economics (BLE)—applies the insights gleaned from studies of human behavior to improve existing institutions by designing rules to compensate for (or take advantage of) behavioral biases. Starting from the premise that observed choices are inconsistent with neoclassical theory, behavioral economists argue that intervention is necessary to generate desirable outcomes for consumers who would otherwise make poor choices. (3-4, citation omitted)

As regular readers of this blog know, I am generally a fan of the CFPB. I recommend this paper to those who want the CFPB to be an effective tool of government. The paper critiques the CFPB in a variety of ways. I find a number of them convincing and one key one to be incredibly wrongheaded.

Convincing

  • The CFPB must avoid “confirmation bias” in its decision-making and its evidence-based analyses. (7)
  • The CFPB’s behavioral law and economics approach needs “a complementary behavioral political economy framework” to apply to the CFPB itself as a political actor. (39)
  • The CFPB should account for the ways that its actions might drive consumers to worse choices than they would face in the absence of heavy regulation of the credit markets. The paper gives illegal loan sharking as an example of a possible worse choice.
  • The CFPB would benefit from “‘adversarial review’ by a body of experts housed elsewhere in the Federal Reserve.” (40) This seems like a reasonable way to ensure that the CFPB both maintains its independence and avoids the echo chamber effect that an agency with one director (as opposed to an agency led by a bipartisan commission) might suffer from.

Wrongheaded

It amazes me that in 2014, commentators could say — “autonomous consumer choice should receive greater priority. Regulatory bodies inevitably will have an effect on the services firms choose to offer” — without addressing the negative impact of the unfettered consumer choices of the Subprime Boom that were a factor in the Subprime Bust. (39) We have not even finished with the foreclosure crisis that was the inevitable result of that boom and bust cycle. Yet law and economics scholars are already bemoaning the reduction of consumer choice caused by the regulatorily-favored Qualified Mortgage without also considering the Wild West atmosphere that characterized the mortgage market in the early 2000s. The regulatory state may not be able to craft a perfect credit market but the unfettered market failed to do so as well.

This paper does not take the full range of possible market structures (from heavy regulation to no regulation) seriously and so it is seriously flawed. It also cherry picks its facts and scholarly support at points. That being said, it does offer some trenchant comments and criticisms about the CFPB as currently structured and is therefore worth a read.

CFPB Strategy on Mortgage Data

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The CFPB released its Strategic Plan, Budget, and Performance Plan and Report which provides a good summary of what the Bureau has done to date. I was particularly interested in this summary of its work to build a representative database of mortgages:

In FY 2013, the CFPB began a partnership with the Federal Housing Finance Agency (FHFA) to build the National Mortgage Database (NMDB). This work continues in FY 2014. For this database, the FHFA and the Bureau have procured (from a credit reporting agency) credit information with respect to a random and representative sample of 5% of mortgages held by consumers. The NMDB is the first dataset that will provide a truly representative sample of mortgages so as to allow analysis of mortgages over the life of the loans, including firsts, seconds, and home equity loans.

In all of the data used for its analyses, the Bureau will work to ensure that strong protections are in place around personally identifiable information. (66)

Such a database (assuming privacy concerns are adequately addressed) will be an invaluable tool for the Bureau (and researchers too, to the extent that they are allowed to access it). One question that the Strategic Plan does not answer is how fresh will the mortgage data be. The mortgage market can innovate at warp speed, as it did in the mid-2000s, so it will be important for the CFPB database to be as current as possible and accessible to researchers as quickly as possible. That being said, even if the data is a bit stale, it will still provide invaluable guidance regarding abusive behaviors in the market. It should also provide guidance regarding a lack of sustainable credit in the market generally as well as within those communities that have historically suffered from such a lack, low- and moderate-income communities as well as communities of color.

On a separate note, I would say that the Strategic Plan makes some assumptions about the efficacy of financial education that should probably be studied carefully. There is a lot of research that challenges the usefulness of financial education. The Bureau should grapple with that research before it invests heavily in financial education implementation.

Reiss on Frannie Reform

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Law360.com quoted me in Capital Rules To Spread Beyond Banks Under Housing Bill (behind a paywall). The story reads in part,

Mortgage servicers, aggregators and other actors in the U.S. housing finance market would for the first time be subject to the same capital requirements that apply to banks under a new bipartisan bill aimed at replacing Fannie Mae and Freddie Mac, potentially eliminating an advantage nonbank firms currently enjoy.

The elimination of Fannie Mae and Freddie Mac is the centerpiece of S. 1217, the Housing Finance Reform and Taxpayer Protection Act of 2014, introduced by Senate Banking Committee Chairman Tim Johnson, D-S.D., and the committee’s ranking Republican, Sen. Mike Crapo, R-Wyo. The government-sponsored entities would be replaced by a proposed Federal Mortgage Insurance Corp. that would backstop the housing finance market in a manner similar to the Federal Deposit Insurance Corp.’s backing of the banking system.

Among the details in the 442-page bill released Sunday are provisions that would allow the FMIC to impose capital standards and other “safety and soundness” rules to mortgage servicers, firms that package mortgages into securities and guarantors that provide the private capital backing to mortgage-backed securities. Compliance with these standards would be required for access to a government guarantee.

Previously those types of institutions have not been subject to safety and soundness rules, unless they were part of a bank. If the Johnson-Crapo bill moves forward as currently written, those firms could be in for a big change, said David Reiss, a professor at Brooklyn Law School.

“Historically, nonbanks have had a lot less regulation than banks. So, by giving them a safety and soundness regulator you are taking away a regulatory advantage – that is, less regulation – that they have had as financial institutions,” he said.

*     *      *

“What it effectively does is create safety and soundness standards for guarantors, aggregators and servicers, as if they were banks. There’s been this long debate about what you do about the nondepository institutions, and this would empower FMIC to supervise private-party participants like banks,” said Laurence Platt, a partner with K&L Gates LLP.

Specifically, the potential rules would apply to aggregators, which serve to collect mortgages and pack them into securities, and guarantors, or firms that provide the private capital to back those securities. Mortgage servicers that process payments and provide other services to mortgages inside those securities would also be included under the FMIC’s regulatory umbrella, according to the bill.

The FMIC would also have the power to force the largest guarantors and aggregators to maintain higher capital standards than their smaller competitors as a way to mitigate the risk of any such market player becoming too big to fail, and will be able to limit such firms’ market share if they get too big, according to the bill.

Underwriting standards for mortgages that would be backed by the FMIC would match, as much as possible, the Consumer Financial Protection Bureau’s qualified mortgage standards, which went into effect in January, according to the legislation.

Moreover, the FMIC would be able to write regulations for force-placed insurance that is applied to mortgages where borrowers do not purchase their own private mortgage insurance under the legislation. The CFPB and other regulators have tackled perceived problems in the force-placed insurance market in recent months.

Extending those capital and other safety and soundness requirements to nonbank firms would be akin to extending supervision authority of nonbank mortgage servicers and other firms to the CFPB, a power granted by the Dodd-Frank Act, Reiss said.

“It can be described as part of the effort since the passage of Dodd-Frank to regulate the breadth of the financial services industry instead of one part of it, the banking sector,” he said.

Reiss on Mortgage Availability

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The Consumer Eagle quoted me in Will Mortgages be Harder to Get in 2014? It reads in part,

David Reiss, Professor of Law at Brooklyn Law School, also sees some benefit in more conservative guidelines. “The QM rules and ability-to-repay rules legislate commonsense things like making sure people can repay loans that they take out, which was something that was given up not only in the last boom but in the boom that preceded it. So from the consumer perspective, you now know that when you get a mortgage you’re probably going to be able to pay it back,” Reiss says. “Some consumers and some people in the industry would say let people make their own decisions with minimal consumer protection regulation, but we had a phase of that and it ended poorly for all of us.”

Borrowers who are self-employed or have irregular income may have a harder time qualifying for a loan under the new rules. Reiss notes that those who are ineligible for a QM may still be able to get a non-qualified mortgage. “What we haven’t seen is what this non-QM market is going to look like in 2014 and beyond,” Reiss says. “It’s a new market.”

Members of the banking industry have expressed concerns about the changes. In recent testimony before the House Committee on Financial Services, William Emerson, CEO of Quicken Loans and vice chair of the Mortgage Bankers Association, said the rules “are likely to unduly tighten mortgage credit for a significant number of creditworthy families who seek to buy or refinance a home” and “may impair credit access for many of the very consumers they are designed to protect.”

Reiss notes that consumer protections are always a compromise. “Regulators want to be conservative to protect consumers, but they also don’t want to keep people who would pay back their loans from getting credit,” he says. “There’s always a dance.”

Gimme (Mortgage) Data

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The CFPB announced that it is seeking feedback on potential changes to mortgage information reported under the Home Mortgage Disclosure Act (HMDA). Data collection seems like a pretty obscure issue, but some Republicans and financial industry interests have been attacking the CFPB for collecting so much data. Given the rapid changes in the consumer financial services sector, it seems to me that collecting more data about the types of products being offered to different types of consumers is essential to regulating that sector. For those unfamiliar with HMDA, it

was enacted in 1975 to provide information that the public and financial regulators could use to monitor whether financial institutions were serving the housing needs of their communities and providing access to residential mortgage credit. The law requires lenders to disclose information about the home mortgage loans they sell to consumers. HMDA was later expanded to capture information useful for identifying possible discriminatory lending patterns.

In the wake of the recent mortgage market crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) transferred HMDA rulemaking authority to the CFPB. The law directs the Bureau to expand the HMDA dataset to include additional loan information that would be helpful in spotting troublesome trends. (1)

 The CFPB is considering requiring the following information pursuant to HMDA:

  • total points and fees, and rate spreads for all loans
  • riskier loan features including teaser rates, prepayment penalties, and non-amortizing features
  • lender information, including unique identifier for the loan officer and the loan
  • property value and improved property location information
  • age and credit score (1-2)

There are additional data points under consideration, but these five alone would go a long way to identifyingpredatory trends as they are developing in the mortgage market. Lay people are probably unaware of the rate of change in the industry, but during boom times the kinds of products that are popular can change dramatically in a few months. It is hard enough for regulators to keep on top of such rapid changes, but it is even harder when they only have access to some of the relevant information. The CFPB’s proposal is a step in the right direction as it seeks to get a handle on the market that it regulates.

The Road to Securitization

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Miguel Segoviano et al. of the IMF released a helpful Working Paper, Securitization:  Lessons Learned and the Road Ahead (also on SSRN). It opens,

Like most forms of financial innovation, there are cost and benefits associated with the securitization of cash flows. From a conceptual perspective, a sound and efficient market for securitization can be supportive of the financial system and broader economy in various ways such as lowering funding costs and improving the capital utilization of financial institutions—benefits which may be passed onto borrowers; helping issuers and investors diversify risk; and transforming pools of illiquid assets into tradable securities, thus stimulating the flow of credit—an issue of particular relevance for some European countries. However, these features need to be weighed against the potential costs, including the risk that securitization contributes to excessive credit growth in and outside of the formal banking system; principal-agent problems that amplify perverse incentives; the complexity and opaqueness of certain products which make efficient pricing problematic; and the heavy reliance of the industry on credit ratings. (3)

The authors identify lessons learned from the financial crisis as well as impediments to a renewed securitization market. They conclude with a set of policy recommendations.

I recommend this paper as a good overview. I particularly like that it looks beyond the United States market, although it does spend plenty of time looking at the history and structure of the U.S. market. The recommendations tend to be pretty reasonable, but not particularly innovative — implement Dodd-Frank-like requirements in non-U.S. jurisdictions; de-emphasize the role of NRSRO credit ratings; increase transparency and decrease needless complexity throughout the industry; modernize land record regimes, etc.

It is surely hard to get your hands around the global securitization industry, but it is important that we try to. Securitization is here to stay. We should manage its risks the best that we can.

CFPB Highlights: Leviathan Heeled

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The CFPB issued its Winter 2013 Supervisory Highlights.  Here are some mortgage highlights from the Highlights:

  • CFPB examiners found that two servicers had engaged in unfair practices in connection with servicing transfers. Specifically, these servicers failed to honor existing permanent or trial loan modifications after a servicing transfer. . . . These servicers also engaged in deception in connection with this practice by communicating to borrowers that they should have made the payments required by the original note, instead of acknowledging that the borrowers were to make reduced payments set by their trial modification agreements with the prior servicer. (5-6)
  • The Home Mortgage Disclosure Act (HMDA) is intended to provide the public with loan data that can be used: (i) to help determine whether financial institutions are serving the housing needs of their communities, (ii) to assist public officials in distributing public-sector investment to help attract private investment to areas where it is needed, and (iii) to assist in identifying possible discriminatory lending patterns and enforcing antidiscrimination statutes, such as the Equal Credit Opportunity Act (ECOA). The CFPB considers accurate HMDA data and effective HMDA compliance management systems to be of great importance.  . . . However, several HMDA reviews at financial institutions found error rates over the resubmission thresholds and Supervision directed the financial institutions to resubmit their HMDA data and improve their HMDA compliance systems.In October, the CFPB entered into Consent Orders with two lenders to address violations of HMDA. One entity, Mortgage Master, Inc., is a nonbank headquartered in Walpole, Massachusetts. The other entity, Washington Federal, is a bank headquartered in Seattle, Washington. (10-11, footnote omitted)

I’d have to say that the CFPB enforcement actions described in the Highlights are relatively small potatoes. One can read that in a couple of ways:

  • The industry is taking consumer financial protection far more seriously than it had before the CFPB was created; or
  • the CFPB is looking in the wrong place for regulatory noncompliance in the industry.

I think that the evidence bears out the former explanation. But I think that these highlights also demonstrate that the CFPB is not behaving like some out of control Leviathan, destroying all of the financial institutions in its grasp. Rather, it is taking very discrete actions based on documented misbehavior. Seems like a reasonable approach.