Tag Archives: consumer protection

Wall Street’s New Toxic Transactions

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Toxic Real Estate

The National Consumer Law Center released a report, Toxic Transactions: How Land Installment Contracts Once Again Threaten Communities of Color. It describes land installment contracts as follows:

Land contracts are marketed as an alternative path to homeownership in credit-starved communities. The homebuyers entering into these transactions are disproportionately . . . people of color and living on limited income. Many are from immigrant communities.

These land contracts are built to fail, as sellers make more money by finding a way to cancel the contract so as to churn many successive would-be homeowners through the property. Since sellers have an incentive to churn the properties, their interests are exactly opposite to those of the buyers. This is a significant difference from the mainstream home purchase market, where generally the buyer and the seller both have the incentive to see the transaction succeed.

Reliable data about the prevalence of land contract sales is not readily available. According to the U.S. Census, 3.5 million people were buying a home through a land contract in 2009, the last year for which such data is available. But this number likely understates the prevalence of land contracts, as many contract buyers do not understand the nature of their transaction sufficiently to report it.

Evidence suggests that land contracts are making a resurgence in the wake of the foreclosure crisis. An investigative report by the Star Tribune found that land contract sales in the Twin Cities had increased 50% from 2007 to 2013. Recent reports from The New York Times and Bloomberg reveal growing interest from private equity-backed investors in using land contracts to turn a profit on the glut of foreclosed homes in blighted cities around the country.

Few states have laws addressing the problems with land installment contracts, and the state laws on the books are generally insufficient to protect consumers. The Consumer Financial Protection Bureau (CFPB) has the mandate to regulate and prevent unfair and deceptive practices in the consumer mortgage marketplace, but has not yet used this authority to address the problems with land installment contracts. (1-2, footnotes omitted)

This report shines light on this disturbing development in the housing market and describes the history of predatory land contracts in communities of color since the 1930s. It also shows how their use was abetted by credit discrimination: communities of color were redlined by mainstream lenders who were following policies set by the Federal Housing Administration and other government agencies.

The report describes how these contracts give the illusion of home ownership:

  • They are structured to fail so that the seller can resell the property to another unsuspecting buyer.
  • They shift the burden of major repairs to the buyer, without exposing the seller to claims that the homes breach the warranty of habitability that a landlord could face from a tenant.
  • They often have purchase prices that are far in excess of comparable properties on the regular home purchase market, a fact that is often masked by the way that land contract payments are structured.
  • The properties often have title problems, like unsatisfied mortgages, that would not have passed muster in a traditional sale of a house.
  • They often are structured to avoid consumer protection statutes that had been enacted in response to previous problems with land contracts.

The report identifies Wall Street firms, like Apollo Global Management, that are funding these businesses. It also proposes a variety of regulatory fixes, not least of which is to have the CFPB take an active role in this shadowy corner of the housing market.

This is all to the good, but I really have to wonder if we are stuck just treating the symptoms of income and wealth inequality. Just as it is hard to imagine how we could regulate ourselves out of the problems faced by tenants that were described in Matthew Desmond’s Evicted, it is hard to imagine that we can easily rid low-income communities of bottom feeders who prey on dreams of homeownership with one scheme or another. It is good, of course, that the National Consumer Law Center is working on this issue, but perhaps we all need to reach for bigger solutions at the same time that we try to stamp out this type of abusive behavior.

Caveat Rent-to-Own

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keys-1317391_1920WiseBread quoted me in 5 Things You Need to Know When Renting-to-Own a Home. It opens,

Your credit scores are too low. Or maybe you’ve run up too much credit card debt. Whatever the reason, you can’t qualify for the mortgage loan you need to buy a home. But there is hope: You can enter into a rent-to-own agreement and begin living in a home today — one that you might eventually be able to buy.

Just be careful: David Reiss, professor of law and research director for the Center for Urban Business at Brooklyn Law School, said that consumers need to be careful when entering rent-to-own arrangements. Often, these agreements end up with tenants losing money that they didn’t need to spend.

“Potential homebuyers should be very careful with rent-to-own opportunities,” Reiss said. “They have a long history of burning buyers. Does the law in your state provide any protection to a rent-to-own buyer who falls behind on payments? Could you end up losing everything that you had paid toward the purchase if you lose your job?”

These worries, and others, are why you need to do your research before signing a rent-to-own agreement. And it’s why you need to know these five key facts before agreeing to any rent-to-own contract.

1. How Do Monthly Rent and Final Selling Price Relate?

In a rent-to-own arrangement, you might pay a bit more in rent each month to the owner of a home. These extra dollars go toward reducing a final sales price for the home that you and the owner agree upon before you start renting.

Then, after a set number of years pass — usually anywhere from one to five — you’ll have the option to purchase the home, with the sales price lowered by however much extra money you paid along with your monthly rent checks. Not all companies that offer rent-to-own homes work this way. Some don’t ask for more money from tenants each month, and don’t apply any rental money toward lowering the eventual sales price of the home.

This latter option might be the better choice for you if you’re not certain that you’ll be able to qualify for a mortgage even after the rental period ends.

“A pitfall is if the tenant buyer signs into the program but will never be approved for financing, thus never purchases the house,” said John Matthews, president of operations of Chicago Lease to Own. “That is how the scammers out there have used rent-to-own to hurt people. They sell it to those who should never have been in the program and take their portion of the rent every month used ‘for the purchase of their home’ knowing that the tenant will never qualify to buy the home.”

Make sure you know — and are comfortable with — the home’s final sales price and monthly rent payments before you agree to a rent-to-own arrangement. And if you don’t want to pay extra in rent each month for a home that you might never end up buying? A rent-to-own agreement might not be for you.

Violations of Law and Consumer Harm

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The Federal Financial Institutions Examination Council (FFIEC) issued a notice and request for comment regarding the Uniform Interagency Consumer Compliance Rating System (CC Rating System). My comment letter reads as follows:

The Federal Financial Institutions Examination Council (FFIEC) issued a notice and request for comment regarding the Uniform Interagency Consumer Compliance Rating System (CC Rating System). The FFIEC is seeking to revise the CC Rating System “to reflect the regulatory, examination (supervisory), technological, and market changes that have occurred in the years since the current rating system was established.”  81 F.R. 26553.  It is a positive development that the federal government is seeking to implement a consistent approach to consumer protection across a broad swath of the financial services industry.  Nonetheless, the proposed CC Ratings System can be refined to further improve consumer protection in the financial services industry.

One of the CC Rating System’s categories is Violations of Law and Consumer Harm.  The request for comment notes that over the last few decades, the financial services industry has become more complex, and the broad array of risks in the market that can cause consumer harm has become increasingly clear.  Violations of various laws – including the Fair Housing Act and other fair lending laws, for example – may cause significant consumer harm that should raise supervisory concerns.  Recognizing this broad array of risks, the proposed revisions directs examiners to consider all violations of consumer laws based on the root cause, severity, duration, and pervasiveness.  This approach emphasizes the importance of various consumer protection laws, and is intended to reflect the broader array of risks and potential harm caused by consumer protection violations.  81 F.R. 26556.

This is all to the good.  Prior to the Subprime Crisis, a big part of the problem was that financial services companies used regulatory arbitrage to avoid scrutiny.  Lots of mortgage lending migrated to nonbanks that did not need to worry about unwanted attention from the regulators that scrutinized banks and other heavily regulated mortgage lenders.  (To be clear, Alan Greenspan and other federal regulators did not do a good job of scrutinizing the banks. But let’s leave that for another day.)  With the CFPB now regulating many nonbanks and with an updated CC Rating System in place, we should expect that regulatory arbitrage will decrease in the face of this coordinated regulatory action.

I would note, however, an ambiguity in the “Violations of Law and Consumer Harm” category, an ambiguity that should be cleared up in favor of additional consumer protections.  The category title, “Violations of Law and Consumer Harm,” implies that there are some types of consumer harm that are distinct from violations of law and that is obviously true. The discussion of the category emphasizes this by stating that it encompasses “the broad range of violations of consumer protection laws and evidence of consumer harm.” 81 F.R. 26556 (emphasis added).  And the text of the guidance itself states this as well, indicating that the category’s assessment factors “evaluate the dimensions of any identified violation or consumer harm.”  81 F.R. 26558 (emphasis added).

But the remainder of the discussion of this category only focuses on violations of law and pays little attention to “the broad array of risks in the market that can cause consumer harm” that are not also violations of law.  81 F.R. 26556.  Indeed, the four assessment factors for this category are all premises on causes of identified “violations of law.”  This is a significant failing for the CC Rating System because of the many types of consumer harm that are not clear violations of law.  As proposed, the “Violations of Law and Consumer Harm” category appears to be as much about protecting the bank from legal liability from lawsuits brought on behalf of consumers as it is about addressing the legitimate interests of the consumers of financial services.

As we sort out the after-effects of the Subprime Crisis, we have seen many situations where there was no clear violation of law but homeowners suffered from outrageous industry practices.  For instance, many borrowers are suffering needlessly at the hands of their mortgage servicers.  Some servicers are under-resourced, intentionally or not, and continue to treat their borrowers with a maddening disregard.  In some cases, this outrageous behavior does not amount to a clear violation of law, but is behavior that reflects most badly on the parties engaged in it.  The CC Rating System should both acknowledge this type of harm and address it to maximize the benefits that can flow from this forthcoming revision to it.

TRID Trials

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compliance definition

The Consumer Financial Protection Bureau issued the TILA-RESPA Integrated Disclosure (TRID) Rule which went into effect more than six months ago. The TRID Rule were designed to enhance consumer protections in the mortgage application process.  The mortgage industry has been very concerned about its ability to comply with the rule and has also highlighted the fact that borrowers now face longer waits to close as a result of the new regulatory regime. Many in the industry are calling for changes to TRID, but they are not yet in the offing. As far as I can tell, the main problems with TRID are just transition issues as the massive mortgage industry has to change in many ways, large and small, to comply with the new regime.

Kroll Bond Rating Agency has issued an RMBS Commentary which expects TRID to have only a limited impact on residential mortgage-backed securities enhancement levels. Kroll seems to be taking a reasonable position regarding the industry’s failure to consistently comply with the TRID Rule.

The commentary provides some useful information to those who follow TRID developments. Kroll believes that it “is possible many TRID-Eligible Loans originated in the near term will contain at least one technical error under TRID. Such violations, even if corrected in good faith, may carry assignee liability.” (1) At the same time, Kroll “believes the potential assignee liability stemming from TRID violations is both limited and quantifiable.” (1) It is worth contrasting this measured assessment with the histrionics that the credit rating industry displayed with the assignee liability provisions of many of the state anti-predatory lending laws that were enacted in the early 2000s.

Kroll does draw a distinction between the many TRID errors that are cropping up during this transition time and those that might occur over and over again without correction. The latter, of course, could be a magnet for class actions. That seems to me like a good outcome, particularly where the lender has been made aware of the violations by third parties.

While the mortgage industry has reasonably requested clarification of some aspects of the TRID Rule, the industry itself should be seeking to modernize and automate its processes to address not only TRID-induced changes but also the industry’s 20th century mindset. The modern mortgage closing is far from a paragon of technological efficiency.

 

Surveying Financial Well-Being

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photo by Sean MacEntee

The Consumer Financial Protection Bureau has issued a notice and request for comment on the Financial Well-Being National Survey. The CFPB is asking for comments on

(a) Whether the collection of information is necessary for the proper performance of the functions of the Bureau, including whether the information will have practical utility; (b) The accuracy of the Bureau’s estimate of the burden of the collection of information, including the validity of the methods and the assumptions used; (c) Ways to enhance the quality, utility, and clarity of the information to be collected; and (d) Ways to minimize the burden of the collection of information on respondents, including through the use of automated collection techniques or other forms of information technology. (81 F.R.13778)

The first question is of great importance and it is great that the CFPB is asking it. As I have frequently noted, financial education efforts have not been all that successful.  Moreover, efforts to improve financial literacy have often had perverse results.

My first instinct is that there is no harm in conducting the Financial Well-Being National Survey. It asks questions such as “How would you assess your overall financial knowledge?” and “How confident are you that the way you are managing money today is getting you to the results you want?” (5)

The key question that remains, however, is will the answers to such questions actually help shape consumer protection policy in a productive way? The CFPB should be sure that the answer to that question is yes before proceeding with the Survey.

Comments are due soon, on April 14th.  Get crackin’!

The Future of Securitization

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SEC Commissioner Piwowar

SEC Commissioner Piwowar

SEC Commissioner Michael Piwowar’s Remarks at ABS Vegas 2016 are worth a look for all of those interested in the future of the mortgage-backed securities market. I have interspersed selections of his remarks with my comments:

As our country’s capital markets regulator, the SEC’s tripartite mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.  Securitization can transform illiquid assets like mortgages, auto loans, credit card receivables, and future sales of David Bowie albums into marketable securities.  By serving as an efficient means of allocating scarce capital, securitization supports economic growth, business development, and job creation.  Securitization further fosters resiliency by diversifying the funding base of our economy.

There are many other benefits associated with securitization, including the potential for reduced costs of, and expanded access to, credit for borrowers, the ability to match risk profiles for specific investor demands, and increased secondary market liquidity.  Because banks and other originators can move loans off of their balance sheets into asset-backed securities (ABS), securitization can increase the availability of credit for both businesses and individuals.  In many instances, securitization can allow a person to obtain more favorable terms than can be obtained from a bank or other financial institution.

Thus, the ABS market serves as a critical source of capital, providing funding for home and automobile loans, credit cards, and many other purposes.  Yet, as shown during the recent financial crisis, investors may abandon the ABS market if they do not believe they possess sufficient information to evaluate the risks associated with a particular asset-backed security and to price it accordingly.

While I generally agree with Piwowar’s assessment of securitization’s value, it is worth noting that he does not acknowledge how important robust consumer protection is to maintaining a healthy securitization market over the long run.

I found his discussion of the Dodd-Frank credit risk retention rules particularly interesting:

For the record, I voted against the credit risk retention rules.  These rules require a securitizer to retain a minimum 5% credit risk of any securitization transaction and generally prohibit the sponsor from hedging its retained interest.  I was particularly dismayed by the “one-size-fits-all” approach taken by the regulators to create a flat 5% risk retention requirement for all asset classes, except for securitizations involving so-called “qualified residential mortgages” (QRMs) for which the risk retention level is zero.  These were arbitrary choices.

Residential mortgages, commercial mortgages, credit card receivables, and automobile loans each have distinct and different attributes associated with their underlying borrowers.  Rather than carefully examining these attributes to determine an optimal credit risk retention rate for each asset class, prudential regulators in Washington, D.C., took the easy way out – they simply set it at the maximum statutory rate and ignored the authorization from Congress to create lower risk retention requirements or use alternative methods to align interests.

Perhaps the prudential bureaucrats had their own conflict of interests in setting these requirements.  After all, a prudential bureaucrat has a strong interest in self-preservation.  Will a prudential bureaucrat get credit if optimally tailored risk retention rates increase economic growth and provide additional opportunities to families and businesses across America?  No.  Will a prudential bureaucrat take the blame if the next financial crisis – and there will be one eventually – relates at all to securitizations?  Probably.  Hence, what better way to side step responsibility than to refrain from using reasoned judgment and rely solely on the most risk-averse interpretation of statute instead?

Bureaucratic self-preservation might also explain the decision to adopt as broad of an exemption for QRMs as possible, so as to minimize any political fallout from the real estate and housing industries.  Few will disagree that residential mortgage-backed securities played an important role in the 2008 financial crisis.  For those in the audience involved in RMBS offerings, you must be quite happy with the broad exemption from the risk retention rules.  For those of you in the audience who are involved in other types of securitizations that had little, if any, part in causing the financial crisis, you are probably wondering why you were unfairly targeted.  Unfortunately, unlike Las Vegas, what happens in Washington does not stay in Washington. (footnotes omitted)

Piwowar gives short shrift to the benefits of clear and simple rules, but it is still worth paying attention to his critique of the “one size fits all” risk retention rules. If researchers can demonstrate that these rules are not optimally tailored, perhaps that would provide a reason to reconsider them. This is, of course, a long shot, given that the rules have been finalized, but Piwowar is right to shine light on the issue nonetheless.

Candid and thoughtful remarks from regulators are always refreshing. These make the grade.

P2P, Mortgage Market Messiah?

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Monty Python's Life of Brian

As this is my last post of 2015, let me make a prediction about the 2016 mortgage market. Money’s Edge quoted me in Can P2P Lending Revive the Home Mortgage Market? It opens,

You just got turned down for a home mortgage – join the club. At one point the Mortgage Bankers Association estimated that about half of all applications were given the thumbs down. That was in the darkest housing days of 2008 but many still whisper that rejections remain plentiful as tougher qualifying rules – requiring more proof of income – stymie a lot of would be buyers.

And then there are the many millions who may not apply at all, out of fear of rejection.

Here’s the money question: is new-style P2P lending the solution for these would-be homeowners?

The question is easy, the answers are harder.

CPA Ravi Ramnarain pinpoints what’s going on: “Although it is well documented that banks and traditional mortgage lenders are extremely risk-averse in offering the average consumer an opportunity for a home loan, one must also consider that the recent Great Recession is still very fresh in the minds of a lot of people. Thus the fact that banks and traditional lenders are requiring regular customers to provide impeccable credit scores, low debt-to-income (DTI) ratios, and, in many cases, 20 percent down payments is not surprising. Person-to-person lending does indeed provide these potential customers with an alternate avenue to realize the ultimate dream of owning a home.”

Read that again: the CPA is saying that for some on whom traditional mortgage doors slammed shut there may be hope in the P2P, non-traditional route.

Meantime, David Reiss, a professor at Brooklyn Law, sounded a downer note: “I am pretty skeptical of the ability of P2P lending to bring lots of new capital to residential real estate market in the short term. As opposed to sharing economy leaders Uber and Airbnb which ignore and fight local and state regulation of their businesses, residential lending is heavily regulated by the federal government. It is hard to imagine that an innovative and large stream of capital can just flow into this market without complying with the many, many federal regulations that govern residential mortgage lending. These regulations will increase costs and slow the rate of growth of such a new stream of capital. That being said, as the P2P industry matures, it may figure out a cost-effective way down the line to compete with traditional lenders.”

From the Consumer Financial Protection Bureau (CFPB) to Fannie and Freddie, even the U.S. Treasury and the FDIC, a lot of federal fingers wrap around traditional mortgages. Much of it is well intended – the aims are heightened consumer protections while also controlling losses from defaults and foreclosures – but an upshot is a marketplace that is slow to embrace change.