Tag Archives: financial sector

Return to the Great Recession?

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US News & World Report quoted me in What Happens if Trump Dismantles the Financial Regulations of the Great Recession? It opens,

On Feb. 3, 2017, President Donald Trump signed two executive orders that will affect the financial sector. That change will come to consumers is undeniable. But exactly what change is coming is, naturally, up for debate.

One of the orders requires the Treasury secretary to review the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010 and designed to address some of the shortcomings in the financial system that led to the Great Recession. The other executive action mandates that the Labor Department review its Department of Labor Fiduciary Rule and look at its probable economic impact. As it stands now, the fiduciary rule is supposed to be phased in from April 10, 2017 to Jan. 1, 2018. The rule requires financial professionals who work with retirement plans or provide retirement planning advice to act in a way that’s only based on the client’s best interests.

What do these executive orders portend for consumers? Nobody knows, but what follows are some educated guesses – with best-case and worst-case outcomes.

How the housing market might be affected. There’s potential good news and bad news here, according to Francesco D’Acunto, a finance assistant professor at the University of Maryland. In a study performed by D’Acunto and faculty colleague Alberto Rossi, in the wake of Dodd-Frank, banks decreased mortgage lending to middle class families by about 15 percent in 2014.

“Title XIV, which regulates the mortgage market, could be in for a full-scale renovation that might ultimately improve the fortunes of potential homebuyers from the middle class,” D’Acunto says.

So if you’ve been having trouble getting a mortgage for a house, you may have less trouble – provided you find a reputable lender. Because the downside, according to D’Acunto, is that “such a move risks bringing a return of predatory behavior in lending and mortgage cross-selling, especially by large banks and by non-bank mortgage originators.”

To avoid that, D’Acunto hopes that Congress intervenes “surgically on Title XIV” and only reduces the regulatory costs imposed by the new Qualified Mortgage classification. Created by the Consumer Financial Protection Bureau, the Qualified Mortgage category of loans includes features designed to make it more likely that a consumer will be able to pay it back.

But if they don’t intervene with the careful attention to detail D’Acunto advises, then expect “big changes, most of them negative,” says David Reiss, a Brooklyn Law School professor whose specialty is in real estate finance.

Potential best-case scenario: After being denied a mortgage for some time, you finally get your house.

Potential worst-case scenario: Because you were steered to a high-interest loan you can’t afford, you lose your house.

How credit cards, auto loans and student loans might be affected. There has been a lot of talk that the CFPB could be a casualty in the executive order that asks the Treasury secretary to review Dodd-Frank. But will it be ripped to shreds or have its power diminished?

The latter seems to already be happening. For instance, lawmakers, led by Sen. David Perdue (R-Ga.), are in the midst of trying to repeal a rule that is scheduled to go into effect this fall. The rule, among other things, would mandate prepaid-card companies to disclose detailed information about their fees, make it easier to access account information and would curb a consumer’s losses if the cards are lost or stolen.

A little weakening might not be so bad, Reiss says. He thinks the CFPB has tightened “the credit box too much, meaning that some people who could manage more credit are not getting access to it.”

But he also thinks if the CFPB were dismantled, the negatives would far outweigh the positives.

Potential best-case scenario: Easier access to loans and more choices. And for some consumers who can now get that car or credit card, their quality of life improves.

Potential worst-case scenario: Thanks to that easier access, some consumers end up stuck with high-interest loans with a lot of hidden fees and rue the day they applied for them.

The Fate of the CFPB

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photo by Lawrence Jackson

President Obama Nominating Richard Cordray to Lead Consumer Financial Protection Bureau, with Elizabeth Warren

The United States Court of Appeals for the District of Columbia issued a decision in PHH Corporation v. Consumer Financial Protection Bureau, No. 15-1177 (October 11, 2016), that found an important aspect of the structure of the CFPB to be unconstitutional:  the insulation of the Director from Presidential supervision. While this decision will almost certainly be appealed, even if it is upheld, it will allow the the CFPB to continue functioning much as it has.

I was interviewed about the decision on NPR’s All Things Considered in a segment titled, Appeals Court Orders Restructuring Of Consumer Financial Protection Bureau (audio available). The transcript reads,

AUDIE CORNISH, HOST:

A federal appeals court has mandated big changes to the Consumer Financial Protection Bureau. The three-judge panel says the consumer watchdog agency is set up in a way that’s unconstitutional. In its ruling, the court says the agency will have to restructure. NPR’s Yuki Noguchi reports.

YUKI NOGUCHI, BYLINE: The suit was brought by a mortgage lender called PHH, which asked the court to invalidate a $109 million enforcement action against it and scrap the agency, too. The D.C. Court of Appeals sent the fine back to the bureau for review.

But it also ruled that the CFPB’s director has too much power to write and enforce rules without enough oversight from another branch of government. The remedy, the panel says, is that the CFPB should fall under the president’s control. And the president should be able to remove the director at will.

The CFPB’s opponents in the financial services industry declared victory. Bill Himpler is executive vice president for the American Financial Services Association.

BILL HIMPLER: Our issue is still with the authority given to a single director. That is, as the court pointed out, not subject to a lot of oversight.

NOGUCHI: Himpler instead supports a CFPB run by a bipartisan commission, similar to others like the Securities and Exchange Commission. David Reiss, a law professor at Brooklyn Law School, says the ruling is not an existential challenge to the CFPB or its past decisions.

DAVID REISS: The decision does not invalidate the CFPB’s actions. This is more about its structure going forward.

NOGUCHI: Reiss says an appeal to the Supreme Court is all but guaranteed. Indeed, the CFPB says it disagrees with the conclusion. In an emailed statement, a spokesperson says the ruling does not change its mission and that it is, quote, “considering options for seeking further review of the court’s decision.”

Dennis Kelleher is CEO of Better Markets, a group that advocates for stronger financial regulation. He says the bureau’s actions on banks have made the financial sector more determined to undercut the agency.

DENNIS KELLEHER: They do not want a consumer watchdog on the Wall Street beat. That’s what this fight is about.

NOGUCHI: The decision was not unanimous on all the issues. Judge Karen Henderson dissented in part, saying the panel overreached in calling the bureau’s structure unconstitutional. Yuki Noguchi, NPR News, Washington.

 

Urban Income Inequality

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photo by sonyblockbuster

The union-affiliated Economic Policy Institute has released a report, Income Inequality in the U.S. by State, Metropolitan Area, and County. The report finds that

The rise in inequality in the United States, which began in the late 1970s, continues in the post–Great Recession era. This rising inequality is not just a story of those in the financial sector in the greater New York City metropolitan area reaping outsized rewards from speculation in financial markets. It affects every state, and extends to the nation’s metro areas and counties, many of which are more unequal than the country as a whole. In fact, the unequal income growth since the late 1970s has pushed the top 1 percent’s share of all income above 24 percent (the 1928 national peak share) in five states, 22 metro areas, and 75 counties. It is a problem when CEOs and financial-sector executives at the commanding heights of the private economy appropriate more than their fair share of the nation’s expanding economic pie. We can fix the problem with policies that return the economy to full employment and return bargaining power to U.S. workers.

The specific findings are very interesting. They include,

  • Overall in the U.S. the top 1 percent took home 20.1 percent of all income in 2013. (4)
  • To be in the top 1 percent nationally, a family needs an income of $389,436. Twelve states, 109 metro areas, and 339 counties have thresholds above that level. (2)
  • Between 2009 and 2013, the top 1 percent captured 85.1 percent of total income growth in the United States. Over this period, the average income of the top 1 percent grew 17.4 percent, about 25 times as much as the average income of the bottom 99 percent, which grew 0.7 percent. (3)
  • Between 1979 and 2013, the top 1 percent’s share of income doubled nationally, increasing from 10 percent to 20.1 percent. (4)
  • The share of income held by the top 1 percent declined in every state but one between 1928 and 1979. (4)
  • From 1979 to 2007 the share of income held by the top 1 percent increased in every state and the District of Columbia. (4)
  • Nine states had gaps wider than the national gap. In the most unequal states—New York, Connecticut, and Wyoming—the top 1 percent earned average incomes more than 40 times those of the bottom 99 percent. (2)
  • For states the highest thresholds are in Connecticut ($659,979), the District of Columbia ($554,719), New Jersey ($547,737), Massachusetts ($539,055), and New York ($517,557). Thresholds above $1 million can be found in four metro areas (Jackson, Wyoming-Idaho; Bridgeport-Stamford-Norwalk, Connecticut; Summit Park, Utah; and Williston, North Dakota) and 12 counties. (3)

The income threshold of the top 1% for individual counties is also interesting.  For example, New York County (Manhattan) comes in second, at $1,424,582 (following Teton, WY at $2,216,883) and San Francisco County comes in 24th at $894,792. (18, Table 6)

Income inequality is a fact of life for big cities and affects so many aspects of American life — housing, healthcare, education, to name a few important ones. The Economic Policy Institute focuses on union-movement responses to income inequality, but urbanists could also consider how to respond systematically to income inequality in the design of urban systems like those for healthcare, transportation and education. If the federal government is not ready to do anything about income inequality itself, states and local governments can make some progress dealing with its consequences. That is a far better route than acting as if income inequality is just some kind unexpected aspect of modern urban life and then bemoaning its visible manifestations, such as homelessness.

 

 

Hypothetically Reforming Fannie and Freddie

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Ben Turner

S&P issued a report, Fannie, Freddie, and the FHLB System: Plus Ca Change . . . The report opens, “Despite reform talk in the years since the U.S. housing crisis, Standard & Poor’s Ratings Services believes the likelihood of extraordinary government support for key U.S. housing government­-related entities (GREs) Fannie Mae, Freddie Mac, and the Federal Home Loan Bank (FHLB) system remains “almost certain” in case of need.” (1) Notwithstanding the fact that S&P expects that this extraordinary support will last well into the next presidential administration, S&P “can envisage three “tail risk” scenarios in which such support could become less likely under certain conditions, but view each of these scenarios as improbable.” (1) The three scenarios, which S&P characterizes as plausible, albeit improbable, are

  • An electoral sweep, with favorable macroeconomic conditions and few competing legislative priorities;
  • Court judgments, pursuant to shareholder lawsuits, forcing the legislators’ hand; or
  • A renewed housing market crisis, with one or more of these GREs viewed as more cause than cure. (4)

In the first scenario, “an election gives one party control of all three legislative actors (the president, House of Representatives, and Senate), precluding the need for bipartisan compromise to enact major reforms to Fannie and Freddie via legislation.” (4)

In the second, Fannie and Freddie shareholders win lawsuits that stem from the “U.S. Treasury’s decision to modify, in 2012, the Preferred Stock Purchase Agreements (PSPAs) governing the terms of its financial support to Fannie and Freddie . . ..” (4)

The final scenario,

is a renewed housing market crisis, on a scale at least similar to that of 2008. Like the other two scenarios, we don’t view this as likely, at least in the coming few years . . . perhaps as a result of the unfortunate confluence of several negative surprises- ­­including, for example, overreaction to Federal Reserve monetary policy normalization, terms­-of­-trade shocks (geopolitical conflicts that cause a rapid and dramatic spike in energy costs, perhaps), fresh financial sector  problems that suddenly tighten the sector’s funding costs, and an abnormally long spell of bad weather. (5)

This seems like a pretty reasonable analysis of the likelihood of reform for Fannie and Freddie. But that should not stop us from bemoaning Congressional inaction on this topic. Obviously, Congress is too ideologically driven to bridge the gap between the left and right, but the likelihood that we are building toward some new kind of crisis increases with time. I can’t improve on S&P’s analysis in this report, but I’m sure unhappy about what it means for the long-term health of our housing finance system.

”

 

 

 

Loose Credit. Plummeting Prices.

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"Durdach Bros Miller Lite pic4" by MobiusDaXter

Christopher Palmer has posted Why Did So Many Subprime Borrowers Default During the Crisis: Loose Credit or Plummeting Prices? to SSRN. While this is a technical paper, it is clear from the title that it addresses an important question. If it can help us get to the root causes of the foreclosure crisis, it is worth considering. The abstract reads,

The surge in subprime mortgage defaults during the Great Recession triggered trillions of dollars of losses in the financial sector and accounted for more than 50% of foreclosures at the height of the crisis. In particular, subprime mortgages originated in 2006-2007 were three times more likely to default within three years than mortgages originated in 2003-2004.

In the ensuing years of debate, many have argued that this pattern across cohorts represents a deterioration in lending standards over time. I confirm this important channel empirically and quantify the relative importance of an alternative hypothesis: later cohorts defaulted at higher rates in large part because house price declines left them more likely to have negative equity.

Using comprehensive loan-level data that includes much of the recovery period, I find that changing borrower and loan characteristics can explain up to 40% of the difference in cohort default rates, with the remaining heterogeneity across cohorts caused by local house-price declines. To account for the endogeneity of prices — especially that price declines themselves could have been caused by subprime lending — I instrument for house price changes with long-run regional variation in house-price cyclicality.

Control-function results confirm that price declines unrelated to the credit expansion causally explain the majority of the disparity in cohort performance. Counterfactual simulations show that if 2006 borrowers had faced the price paths that the average 2003 borrower did, their annual default rate would have dropped from 12% to 5.6%.

Ok, ok — this is hyper-technical! The implications, however, are important: “These results imply that a) tighter subprime lending standards would have muted the increase in defaults, but b) even the relatively “responsible” subprime mortgages of 2003–2004 were sensitive to significant property value declines.” (40) It concludes that, “In reality, cohort outcomes are driven by both vintage effects (i.e. characteristics bottled into the contracts at origination) and path dependency in that exposure to economic conditions affect cohorts differently depending on their history.” (40)

So, the bottom line is that loose credit and plummeting prices were both causes of the defaults during the crisis. Mortgage underwriters and policymakers are on notice that they need to account for both of them in order to be prepared for the next crisis. This paper’s contribution is that it has quantified the relative impact of each of those causes.

 

 

Reiss on SCOTUS Junior Lien Decision

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Bloomberg BNA quoted me in Nagging Economic and Credit Questions Dampen Bankruptcy Victory for Bankers (behind paywall). It reads, in part:

The U.S. Supreme Court delivered an important bankruptcy ruling for bankers that doesn’t, however, do anything about still-struggling homeowners (Bank of Am. N.A. v. Caulkett, 2015 BL 171240, U.S., No. 13-cv-01421, 6/1/15); (Bank of Am. N.A. v. Toledo-Cardona, 2015 BL 171240, U.S., No. 14-cv-00163, 6/1/15).

In a June 1 decision, the court said Chapter 7 debtors cannot void junior liens on their homes when first-lien debt exceeds the value of the property, as long as the senior debt is secured and allowed under the Bankruptcy Code.

The decision is a victory for Bank of America, which held both junior liens in the two related cases, and for banking groups that said a different result could have destabilized more than $40 billion in commercial loans secured by similar liens.

But Brooklyn Law School Professor David Reiss June 2 said the case highlights the need for a broad remedy for homeowners who have continued to struggle to make payments since the financial crisis.

“The bank’s position as a legal matter is a very reasonable one, but from a policy perspective we needed and still need a bigger and more systemic solution to the problems that households face,” Reiss told Bloomberg BNA.

*     *     *

[S]ome said the ruling highlights economic questions on several levels.

Reiss, who coedits a financial blog, June 2 said the case shows the federal government’s inability to deal head-on with the impact of financial turmoil in 2008 and 2009.

“Not enough is being done to move households beyond the crisis, and it’s bad for households and it’s bad for the financial sector,” Reiss said. “Here we are seven or eight years later and we’re sitting here with these valueless second mortgages. We’re just slogging through the muck and we’re not coming up with any good solutions to get past it.”

Reiss on Payday Lending Regs

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CRM Buyer quoted me in CFPB May Rein In Payday Lending. The story opens,

The Consumer Financial Protection Bureau is considering various approaches to reforming the payday loan industry, The Wall Street Journal reported on Sunday.

The bureau is concerned about the short-term, high-rate debt consumers take on, sources said.

States typically have been responsible for regulating payday loan company practices. If the CFPB should take action, it would be the first time federal regulations were applied to this niche in the financial sector.

Consumer advocates have long been calling for some restraints to be imposed on providers of these loans. Interest rates tend to be astronomical, and borrowers frequently are unable to repay the loans within the prescribed time period. What happens more often than not is that they roll their loans into the next pay period, committing to a never-ending series of high-interest, short-term contracts.

The CFPB reportedly is considering approval of a “vanilla” type of short-term loan with underwriting criteria that would establish whether the borrower actually would be able to repay it — an approach similar to the mortgage qualification requirements put in place after the financial crash.

That is not the only model reportedly under consideration, however, and the CFPB might waive such underwriting requirements for borrowers who don’t tap payday advance loans very often, the Journal reported.

Pushback can be expected from the industry, which has been under fire for years. The payday lenders’ argument is straightforward: With so many Americans living from paycheck to paycheck, their services are necessary to meet emergencies.

Defanging the Predator

“There is clearly a demand for payday lending by unbanked consumers who have needs for short-term credit but do not have access to credit cards, home equity loans or other loan products,” said David Reiss, professor of law at Brooklyn Law School.

“At the same time, payday lending repayment terms are often seen as onerous and predatory, with annual interest rates that run in the hundreds of percent and with many customers stuck in a cycle where they roll over their high cost debt from one month to the next, accruing more interest and fees along the way,” he told CRM Buyer.

Given the mission of the Consumer Financial Protection Bureau, Reiss said, it is natural for it to attempt to develop a regulatory structure for the industry that would allow it to function — but not extract predatory profits from its customers.