- US Treasury Department’s Community Development Financial Institutions Fund (CDFI Fund) released two reports discussing the difference in risk between conventional lenders and CDFIs.
- CFPB releases Arbitration Study required by the Dodd-Frank Act, which states that CFPB may prohibit or impose conditions or limitations on the use of” pre-dispute arbitration agreements concerning consumer financial products or services if it finds doing so “is in the public interest and for the protection of consumers.”
Tag Archives: Dodd-Frank Act
Shiller on Primitive Housing Finance
Robert Shiller has posted Why Is Housing Finance Still Stuck in Such a Primitive Stage? The abstract for this brief discussion paper reads:
The institutions for financing owner-occupied housing have not progressed as they should, and the financial innovation that has followed the financial crisis of 2007-9 has not been focused on improving the risk management of individual homeowners. This paper lists a number of barriers to housing finance innovation, and in light of these barriers, the problems of some major innovations of the past and future: self-amortizing mortgages, price-level adjusted mortgages (PLAMs), shared appreciation mortgages (SAMs), housing partnerships, and continuous workout mortgages (CWMs). (1)
The paper is more of an outline than a fleshed out argument, but it has some interesting points (and not just because the author recently won a Nobel Memorial Prize in Economics). They include
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Shared appreciation mortgages (SAMs), which offered some risk management of home price appreciation, were offered by the Bank of Scotland and Bear Stearns in the 1990s, but acquired a damaged reputation with the boom in home prices. U.K. homeowners who took such mortgages, and lost out on the speculative gains, were so angered that they filed a class-action lawsuit against the issuers. The suit was dropped, but the reputation loss was permanent. (5)
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There has been some questioning of the assumption that insuring homeowners against a decline in home value is a good thing. Sinai and Soulelis (2014) have written that the existing mortgage institutions may be close to optimal given that people want to live in their house forever, or move to a similar house whose price is correlated with the present house, and so are perfectly hedged. But their paper cannot be exactly right, given the sense of distress that homeowners are experiencing who are underwater. They are more certainly not right about all homeowners, many of whom actually plan to sell their home when they retire. (5-6)
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The difficulties in making improvements in mortgage institutions have to do with the complexity of the risk management problem, coupled with mistrust of institutional players. The Consumer Financial Protection Bureau, created by the Dodd-Frank Act and having authority over mortgages, among other things, seems oriented towards addressing complaints from the public, and has focused its attention so far on such things as unfair collection practices, bias against minorities, and excessive complexity of financial products being used to confuse customers. These are laudable concerns, but complaints that economists might register about the fundamental success of mortgage products to serve risk management well have not yet taken center stage. (6)
- New Development economics, Karlan and Appel (2011), Bannerjee and Duflo (2012) has shown how carefully controlled experiments can reveal solid steps to take regarding new financial institutions for poverty reduction. The same methods could be used to improve mortgage institutions, as well as rental, leasing, partnership and cooperative institutions, in advanced countries. (7)
These are just brief thoughts. It will be interesting to see how Shiller develops them further.
Non-QM Mortgages Risks and Best Practices
Moody’s issued a report, Non-QM US RMBS Face Higher Risk of Losses Than QM, but Impact on Transactions Will Vary, that discusses the risk that
US RMBS backed by non-qualified mortgages (those that do not meet a variety of underwriting criteria under new guidelines) will incur higher loss severities on defaulted loans than those backed by qualified mortgages. The key driver of the loss severities will be the higher legal costs and penalties for non-QM securitizations. In non-QM transactions, a defaulted borrower can more easily sue a securitization trust on the grounds that the loan violated the Ability-to-Repay (ATR) rule under the Dodd-Frank Act. . . . The extent of the risks for RMBS will vary, however, depending on the mortgage originators’ practices and documentation, the strength of the transactions’ representations and warranties, and whether the transactions include indemnifications that shield them from borrower lawsuits. (1)
The higher costs for non-QM investors may include longer foreclosure timelines and the resulting wear on the collateral.
If Moody’s analysis is right, however, the Dodd-Frank regime will be working as intended. It should incentivize mortgage originators to strengthen their compliance practices such as those relating to documentation, recordkeeping and third party due diligence. It should also incentivize securitizers to demand strong reps and warranties, put back and indemnification provisions. Sounds like a reasonable trade off to me.
