Tag Archives: FRB

Premature End to Foreclosure Review

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Congressman Cummings (D), the ranking minority member of the House Committee on Oversight and Government Reform, has sent a letter to Congressman Issa, the Chairman of the Committee, regarding the Independent Foreclosure Review. It opens,

I am writing to request that the Committee hold a hearing on widespread foreclosure abuses and illegal activities engaged in by mortgage servicing companies.  I request that the hearing also examine why the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency (OCC) appear to have prematurely ended the Independent Foreclosure Review (IFR) and entered into a major settlement agreement with most of the servicers just as the full extent of their harm was beginning to be revealed. (1)

It goes on to assert that “some mortgage servicing companies engaged in widespread and systemic foreclosure abuses, including charging improper and excessive fees, failing to process loan modifications in accordance with federal guidelines, and violating automatic stays after borrowers filed for bankruptcy.” (2) It concludes that it “remains unclear why the regulators terminated the IFR prematurely, how regulators determined the compensation amounts servicers were required to pay under the settlement, and how regulators could  claim that borrowers who were harmed by these servicers would benefit more from the settlement . . . than by allowing the IFR to be completed.” (2)

The letter raises a number of important concerns, but I will focus on just one — “how did the regulators arrive at the compensation amounts in the settlement?” (9) This particular settlement was for billions of dollars from BoA, PNC, JPMorgan and Citibank. This is an extraordinarily large sum, but the public is left with no sense of whether this sum is proportional to the harm done. I have raised this concern with other billion dollar settlements. As the federal government moves forward with these large settlements, it should carefully consider their expressive function — does the penalty fit the wrongdoing?  And if so, how was that calculated? People want to know.

Reiss on Rising Interest Rates

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ABC News quoted me in Small Interest Rate Changes Mean Big Money for Home Buyers.  The story reads in part,

As the economy continues to recover from the worst recession since the 1930s, mortgage interest rates remain at historically low levels.

The Primary Mortgage Market Survey, produced by Freddie Mac, reported in mid-March the average rate for 30-year fixed-rate mortgages was 4.32 percent; 15-year fixed-rate mortgages averaged 3.32 percent and interest rates 5-year Treasury-indexed hybrid adjustable rate mortgages averaged 3.02 percent. Nonetheless, Frank Nothaft, chief economist for Freddie Mac, speculated the Fed’s gradual tapering of its stimulus efforts may prompt a rise in mortgage interest rates.

If mortgage interest rates do rise significantly in the future, what, if any effect will there be on the home buying market? According to Steve Calk, chairman and Chief Executive Officer of The Federal Savings Bank, interest rates have never been the deciding factor for whether potential home buyers actually purchase a home.

“Whether interest rates are 5.5 percent or 7.5 percent, when people are ready to buy, they’ll buy a home,” Calk said.

Price, location, size, appreciation value – these are factors many would-be homeowners consider long before mortgage interest rates enter into the picture. However, once they begin actively searching for a home, interest rates often play a role in their ultimate buying decision.

This is especially the case when interest rates are high, according to David Reiss, Professor of Law at Brooklyn Law School.

“When people think about buying houses, they think about the price of the house. But what they really should be thinking of are the monthly costs. The average 25-year-old might not think about housing rates until they go to a mortgage broker.
“Then they discover that 8 percent interest may mean that instead of a $200,000 home they can only afford a $160,000 home,” Reiss said.

*     *      *

Tight credit and persistent high unemployment have almost certainly played a role in depressing home buying figures during the recovery, as has the large numbers of home owners who perhaps bought homes at the height of the bubble who now find themselves underwater on their mortgages. However, many underwater homeowners could be missing out on a unique opportunity presented by the present financial climate. In a housing market where prices are depressed and borrowing is cheap, home buyers with solid incomes and good credit can find lenders willing to extend credit on favorable terms, ultimately putting them ahead financially, even if they sell their present homes at a loss, according to Reiss.

“Many people feel stuck in place because they are underwater or the market is bad. But although it may be counterintuitive, it could actually be a smart move to sell in a bad market. It’s a bit more sophisticated strategy, but you could move out of a cheap home into a better home for not that much money,” Reiss said.

*     *     *

Education and due diligence in maintaining good credit are the most potent tools that potential home buyers can employ, whether they are seeking their first home, a larger home or are scaling down to smaller quarters as empty nesters. Obtaining prequalification can provide home seekers with a better idea of precisely how much house they can afford, Reiss said.

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.

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.

Qualified Mortgages and The Community Reinvestment Act

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Regulators issued an Interagency Statement on Supervisory Approach for Qualified and Non-Qualified Mortgage Loans relating to the interaction between the QM rules and Community Reinvestment Act enforcement. This statement complements a similar rule issued in October that addressed the interaction between the QM rules and fair lending enforcement.

The statement acknowledges that lenders are still trying to figure out their way around the new mortgage rules (QM & ATR) that will go into effect in January. The agencies state that “the requirements of the Bureau’s Ability-to-Repay Rule and CRA are compatible. Accordingly, the agencies that conduct CRA evaluations do not anticipate that institutions’ decision to originate only QMs, absent other factors, would adversely affect their CRA evaluations.” (2)

This is important for lenders who intend to only originate plain vanilla QMs. There have been concerns that doing so may result in comparatively few mortgages being CRA-eligible. It seems eminently reasonable that lenders not find themselves between a CRA rock and a QM hard place if they decide to go the QM-only route. That being said, it will be important to continue to monitor whether low- and moderate-income neighborhoods are receiving sufficient amounts of mortgage credit. Given that major lenders are likely to originate non-QM products, this may not be a problem. But we will have to see how the non-QM sector develops next year before we can know for sure.

Qualified Residential Mortgage Comments

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The agencies responsible for the Qualified Residential Mortgage rules that address the issue of credit risk retention for mortgage-backed securities requested that comments on the proposed rulemaking be submitted by yesterday.  And comments there were.  Here is a sampling:

The Urban Institute argues that

In formulating their QRM recommendations, the Agencies have done an admirable job balancing these considerations: on one hand, they wanted QRM loans to have a low default rate; on the other hand, if QRM is too tight, it will impede efforts to bring private capital back into the market and will further restrict credit availability. The right balance would thus appear to be precisely where they have landed with their main proposal: that QRM equal QM. (2)

The Securities Industry and Financial Markets Association effectively agrees with this and argues that

QM should be adopted as the standard for QRM, rather than QM-plus. QM is a meaningful standard for high quality loans. The characteristics of QM-plus, particularly the 70 percent LTV ratio, would exclude most borrowers from these loans. We believe the adoption of QM-plus would reduce the competitiveness of private mortgage originators and delay the transition of the housing finance system away from the GSEs. (vi)

The American Enterprise Institute, on the other hand, argues that

The preferred response, in our opinion, is to implement the Dodd-Frank Act by creating a combination of the QM and a standard for a traditional prime mortgage that Congress intended for the QRM. For this reason, we have filed this comment with the agencies, detailing how it is possible to comply with the clear language and intent of the act and still provide a flexible set of standards for prime mortgages — which have low credit risk even under stress. (4)

My thoughts on the proposed QRM rule can be found here, here, here and here.

Qualified Mortgage Fair Lending Concerns Quashed

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Federal regulators (the FRB, CFPB, FDIC, NCUA and OCC) announced that “a creditor’s decision to offer only Qualified Mortgages would, absent other factors, elevate a supervised institution’s fair lending risk.” This announcement was intended to address lenders’ concerns that they could be stuck between a rock (QM regulations) and a hard place (fair lending requirements pursuant to the Equal Credit Opportunity Act and the Fair Housing Act). For instance, a lender might want to limit its risk of lawsuits relating to the mortgages it issues that could arise under a variety of state and federal consumer protection statutes by only issuing QMs only to find itself the defendant in a Fair Housing Act lawsuit that alleges that its lending practices had a disproportionate adverse impact on a protected class.

The five agencies issued an Interagency Statement on Fair Lending Compliance and the Ability-to-Repay and Qualified Mortgage Standards Rule that gives some context for this guidance:

the Agencies recognize that some creditors’ existing business models are such that all of the loans they originate will already satisfy the requirements for Qualified Mortgages. For instance, a creditor that has decided to restrict its mortgage lending only to loans that are purchasable on the secondary market might find that — in the current market — its loans are Qualified Mortgages under the transition provision that gives Qualified Mortgage status to most loans that are eligible for purchase, guarantee, or insurance by Fannie Mae, Freddie Mac, or certain federal agency programs.

With respect to any fair lending risk, the situation here is not substantially different from what creditors have historically faced in developing product offerings or responding to regulatory or market changes. The decisions creditors will make about their product offerings in response to the Ability-to-Repay Rule are similar to the decisions that creditors have made in the past with regard to other significant regulatory changes affecting particular types of loans. Some creditors, for example, decided not to offer “higher-priced mortgage loans” after July 2008, following the adoption of various rules regulating these loans or previously decided not to offer loans subject to the Home Ownership and Equity Protection Act after regulations to implement that statute were first adopted in 1995. We are unaware of any ECOA or Regulation B challenges to those decisions. Creditors should continue to evaluate fair lending risk as they would for other types of product selections, including by carefully monitoring their policies and practices and implementing effective compliance management systems. As with any other compliance matter, individual cases will be evaluated on their own merits. (2-3)

 Lenders and their representatives have raised this issue as a significant obstacle to a vibrant residential mortgage market. This interagency statement should put this concern to rest.