Tag Archives: Dodd Frank

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.

 

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.

CFPB’s Regulatory Agenda — Collect More Data!

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The Consumer Financial Protection Bureau has published its Semiannual Regulatory Agenda in the Federal Register.  Of note are amendments to the Home Mortgage Disclosure Act’s Regulation C. These amendments are in the prerule stage.  The Agenda states that HMDA

requires certain financial institutions to collect and report information in connection with housing-related loans and applications they receive for such loans. The amendments made by the Dodd-Frank Act expand the scope of information relating to mortgage applications and loans that must be compiled, maintained, and reported under HMDA, including the ages of loan applicants and mortgagors, information relating to the points and fees payable at origination, the difference between the annual percentage rate associated with the loan and benchmark rates for all loans, the term of any prepayment penalty, the value of real property to be pledged as collateral, the term of the loan and of any introductory interest rate for the loan, the presence of contract terms allowing non-amortizing payments, the origination channel, and the credit scores of applicants and mortgagors. The Dodd-Frank Act also provides authority for the CFPB to require other information, including identifiers for loans, parcels, and loan originators. The CFPB expects to begin developing proposed regulations concerning the data to be collected and appropriate format, procedures, information safeguards, and privacy protections for information compiled and reported under HMDA. The CFPB may consider additional revisions to its regulations to accomplish the purposes of HMDA. (1243)

While esoteric for most, this is an important development. The lending industry collects lots of loan-level data. But that data is very expensive to access for academic and policy researchers. Improved loan-level data will better allow government agencies and researchers to study the mortgage market in a timely way. This will allow them (hopefull!) to identify unsustainable and predatory developments more quickly.

In another effort relevant to the mortgage market, the CFPB also noted that it “is continuing rulemaking activities that will further establish the Bureau’s nonbank supervisory authority by defining larger participants of certain markets for consumer financial products and services. Larger participants of such markets, as the Bureau defines by rule, are subject to the Bureau’s supervisory authority.” (1242)

Reiss on New Mortgage Regime

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Loans.org quoted me in a story, CFPB Rules Reiterate Current and Future Lending Practices. It reads in part,

David Reiss, professor of law at the Brooklyn Law School, said there could be other long-term effects due to this high DTI ratio since the lending rules will likely remain for several decades.

If the rules remain intact, the high DTI number can still be lowered at a later time. For instance, if few defaults occur when the bar is set at 43 percent, the limit might increase. Conversely, if a large number of defaults occur, the limit will decrease even further.

Reiss hopes that the agencies overseeing the rule will make these changes based on empirical evidence.

“I’m hopeful that regulation in this area will be numbers driven,” he said.

Despite the wording, Bill Parker, senior loan officer at Gencor Mortgage, said that lenders are technically “not required to ensure borrowers can repay their loans.” He said lenders are legally required to make a “good faith effort” for reviewing documents and facts about the borrower and indicating if he or she can repay the debt.

“If they do so, following the directives of the CFPB, then they are protected against suit by said borrower in the future,” Parker said. “If they can’t prove they investigated as required, then they lose the Safe Harbor and have to prove the borrower has not suffered harm because of this.”

The statute of limitations for the CFPB law is three years from the start of loan payments. After that time period, the lender is no longer required to provide evidence of loan compliance.

Even though the amendment could impact the current lending market, experts told loans.org that the CFPB’s standards will make a greater impact on the future of the housing industry.

Reiss believes that the stricter rules will create a sustainable lending market.

If QRM = QM, then FICO+CLTV > DTI ?@#?!?

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The long awaited Proposed Rule that addresses the definition of Qualified Residential Mortgages has finally been released, with comments due by October 30th. The Proposed Rule’s preferred definition of a QRM is the same as a Qualified Mortgage. There is going to be a lot of comments on this proposed rule because it indicates that a QRM will not require a down payment. This is a far cry from the 20 percent down payment required by the previous proposed rule (the 20011 Proposed Rule).

There is a lot to digest in the Proposed Rule. For today’s post, I will limit myself to a staff report from the SEC, Qualified Residential Mortgage: Background Data Analysis on Credit Risk Retention, that was issued a couple of days ago about the more restrictive definition of QRM contained in the 2011 Proposed Rule.  The report’s main findings included

  • Historical loans meeting the 2011 proposed QRM definition have significantly lower SDQ [serious delinquency] rates than historical loans meeting the QM definition, but applying this definition results in significantly lower loan volume than QM.
  • FICO and combined loan-to-value (CLTV) are strong determinants of historical loan performance, while the effect of debt-to-income (DTI) is much lower.
  • Adding FICO or CLTV restrictions to the QM definition reduces SDQ rates faster than the loss of loan volume: max ratios achieved at 760 FICO and 55% CLTV. (2)

Certainly, some readers’ eyes have glazed over by now, but this is important stuff and it embodies an important debate about underwriting.  Is it better to have an easy to understand heuristic like a down payment requirement? Or is it better to have a sophisticated approach to underwriting which looks at the layering of risks like credit score, loan to value ratio, debt to income ratio and other factors?

The first approach is hard to game by homeowners, lenders and politicians seeking to be “pro-homeowner.” But it can result in less than the optimal amount of credit being made available to potential homeowners because it may exclude those homeowners who do not present an unreasonable risk of default but who do not have the resources to put together a significant down payment.

The second approach is easier to game by lenders looking to increase market share and politicians who put pressure on regulated financial institutions to expand access to credit. But it can come closer to providing the optimal amount of credit, balancing the risk of default against the opportunity to become a homeowner.

It would be interesting if the final definition of QRM were able to encompass both of these approaches somehow, so that we can see how they perform against each other.

Financial Education on a Wing and Prayer?

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The CFPB released its report, Feedback from the Financial Education Field, which summarizes responses to an Request for Information on Effective Financial Education.  The CFPB is required by Dodd-Frank to establish an Office of Financial Education “to educate American consumers and help them make better-informed decisions.” (5)  The CFPB states that this “statutorily-mandated function serves as an important component of the CFPB’s consumer protection work.” (5)

But the feedback that the CFPB received is very disturbing.  Not surprising, just disturbing.  The report finds that “there is little systematic evidence about what approaches are most effective, for whom, and under what conditions.” (3) As of now, there “is a limited amount of rigorous evaluation on the effectiveness of financial education strategies and practices. A substantial amount of research in the field does not include control groups or use randomized control trials, and thus only limited compelling conclusions about financial education can be drawn, and often they cannot be reliably extrapolated to broader populations.” (11)  Very basic things about financial education are still unknown.  For instance, the CFPB acknowledges that there is uncertainty as to whether there is “a clear connection between financial knowledge and behavior.” (3)

For now, the CFPB should devote its efforts to evaluating “curricula, tools, and programs in order to identify programs and practices that are proven to improve financial outcomes.” (17)   It is depressing to think that the CFPB might use a significant portion of its resources to promote financial education initiatives without strong evidence that they will work. So the CFPB should hold off on making significant investments in this area until it can identify successful strategies through evidence based practices. Too much of housing policy is based on sketchy academic research. Such research is readily relied upon to support politically palatable or ideologically driven decisions.  But the CFPB should avoid taking the easy road as it will undercut its legitimacy and credibility in the long run.