“Modernizing” the Community Reinvestment Act

President Carter signs the Housing and Community Development Act of 1977, which contains the Community Reinvestment Act

The Trump Administration has been signaling its intent to do a makeover of the Community Reinvestment Act of 1977 (CRA) for quite a while, describing it as a much needed update.  Last June, Treasury stated in its Banks and Credit Unions report (one of a series of reports on A Financial System That Creates Economic Opportunities which I discuss here),

The CRA statute is in need of modernization, regulatory oversight must be harmonized, and greater clarity in remediating deficiencies is called for. It is very important to better align the benefits arising from banks’ CRA investments with the interest and needs of the communities that they serve and to improve the current supervisory and regulatory framework for CRA. . . . Aligning the regulatory oversight of CRA activities with a heightened focus on community investments is a high priority for the Secretary. (9)

Well, the modernization effort has now taken off with a Treasury Memorandum for The Office of The Comptroller of the Currency, The Board of Governors of The Federal Reserve System, The Federal Deposit Insurance Corporation. By way of background, the memorandum notes that

The Community Reinvestment Act (CRA) of 1977 was enacted to encourage banks to meet the credit and deposit needs of communities that they serve, including low- and moderate-income (LMI) communities, consistent with safe and sound operations. Banks are periodically assigned a CRA rating by one of the primary regulators – the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), and the Federal Deposit Insurance Corporation (FDIC), collectively the CRA regulators – based on the bank’s performance under the appropriate CRA tests or approved Strategic Plan. CRA was enacted in response to concerns about disinvestment and redlining as well as a desire to have financial institutions “play the leading role” in providing the “capital required for local housing and economic development needs.”

The U.S. banking industry has experienced substantial organizational and technological changes; however, the regulatory and performance expectations under CRA have not kept pace. Interstate banking, mortgage securitization, and internet and mobile banking are just a few of the major changes that have come about in the past four decades. In this evolving banking environment, changes should be made to the administration of CRA in order for it to achieve its intended purpose. (1, footnotes omitted)

The bank that Treasury Secretary Mnuchin used to head up, OneWest, had its own run-ins with CRA compliance. As a result, we should look carefully at how Treasury seeks to “modernize” the CRA. The Treasury memo has four recommendations:

  • Assessment Areas. The concept of assessment areas originated within the banking environment that existed in 1977, when there was no interstate banking and deposits almost always came from the community surrounding a branch. Treasury offers recommendations for updating the definitions of geographic assessment areas to reflect the changing nature of banking arising from changing technology, customer behavior, and other factors.
  • Examination Clarity and Flexibility. Both banks and communities would benefit from additional flexibility in the CRA performance evaluation process, including increasing clarity in the examination guidance. Treasury recommends improvements that could be made to CRA performance evaluation criteria that would increase the transparency and effectiveness of CRA rating determinations.
  • Examination Process. Certain aspects of the examination process need to be addressed in order to improve the timeliness of performance evaluations and to allow banks to be more accountable in planning their CRA activity. Treasury recommends improvements that could be made with respect to the timing of CRA examinations and issuance of performance evaluations, and to the consistent use of census data throughout an assessment period.
  • Performance. The purpose of CRA is to encourage banks to meet the credit and deposit needs of their entire community. The law does not have explicit penalties for nonperformance. However, performance is incentivized as regulators must consider CRA ratings as a part of various bank application processes and performance evaluation reports are made available to the public. Treasury offers recommendations as to how the current regulatory approach to downgrades for violations of consumer protection laws and various applications from banks with less than a Satisfactory rating could be improved to incentivize CRA performance. (2, footnotes omitted)

While there is lot to chew on here, I think a key issue will be the scope of the Assessment Areas. As banks move from straight ‘bricks and mortar’ to ‘bricks and clicks’ or even to pure clicks, it is harder to identify the community each bank serves.

While the memo does not offer a new definition for Assessment Areas, one could imagine alternative definitions that are either loose or stringent as far as CRA compliance is concerned. Because the CRA was intended to ensure that low and moderate-income communities had access to mortgage credit after years of redlining, any new definition of Assessment Areas should be designed to support that goal. We’ll have to see how the Trump Administration proceeds in this regard, but given its attitudes toward fair housing enforcement, I am not hopeful that the Administration will take the CRA’s goals seriously.

The Fate of CFPB’s Civil Investigative Demands

 

Mick Mulvaney’s Consumer Financial Protection Bureau issued a Request for Information Regarding Bureau Civil Investigative Demands and Associated Processes:

The Bureau is using this request for information to seek public input regarding the exercise of its authority to issue CIDs, including from entities who have received one or more CIDs from the Bureau, or members of the bar who represent these entities.

The issuance of CIDs is an essential tool for fulfilling the Bureau’s statutory mission of enforcing Federal consumer financial law. The Bureau issues CIDs in accordance with the law and in furtherance of its investigatory objectives. The Bureau understands, however, that responding to a CID can impose burdens on the recipients. Entities who have received one or more CIDs, members of the bar who represent these entities, and members of the public are likely to have useful information and perspectives on the benefits and burdens of the Bureau’s existing processes related to CIDs. The Bureau is especially interested in better understanding how its processes related to CIDs may be updated, streamlined, or revised to better achieve the Bureau’s statutory and regulatory objectives, while minimizing burdens, consistent with applicable law, and how to align the Bureau’s CID processes with those of other agencies with similar authorities. Interested parties may also be well-positioned to identify those parts of the Bureau’s processes related to CIDs that are most in need of improvement, and, thus, assist the Bureau in prioritizing and properly tailoring its review process. In short, engaging CID recipients, potential CID recipients, and the public in an open, transparent process will help inform the Bureau’s review of its processes related to CIDs. (83 F.R. 3686 (Jan. 26, 2018))

There is a lot of subtext in this request, of course, because Mulvaney is set on hamstringing the Bureau which he has described as a “sick, sad” joke. A review of CIDs is likely to lead to a decrease in enforcement activity for the financial services companies regulated by the CFPB.

Be that as it may, the Bureau is seeking comments on “Specific suggestions regarding any potential updates or modifications to the Bureau’s practices regarding the formulation, issuance, or modification of CIDs consistent with the Bureau’s regulatory and statutory objectives, including, in as much detail as possible, the potential update or modification, supporting data or other information such as cost information or information concerning alignment with the processes of other agencies with similar authorities . . .” (Id.)

Comments are due by March 27, 2018.

Credit Risk Transfer and Financial Crises

photo by Dean Hochman

Susan Wachter posted Credit Risk Transfer, Informed Markets, and Securitization to SSRN. It opens,

Across countries and over time, credit expansions have led to episodes of real estate booms and busts. Ten years ago, the Global Financial Crisis (GFC), the most recent of these, began with the Panic of 2007. The pricing of MBS had given no indication of rising credit risk. Nor had market indicators such as early payment default or delinquency – higher house prices censored the growing underlying credit risk. Myopic lenders, who believed that house prices would continue to increase, underpriced credit risk.

In the aftermath of the crisis, under the Dodd Frank Act, Congress put into place a new financial regulatory architecture with increased capital requirements and stress tests to limit the banking sector’s role in the amplification of real estate price bubbles. There remains, however, a major piece of unfinished business: the reform of the US housing finance system whose failure was central to the GFC. Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs), put into conservatorship under the Housing and Economic Recovery Act (HERA) of 2008, await a mandate for a new securitization structure. The future state of the housing finance system in the US is still not resolved.

Currently, US taxpayers back almost all securitized mortgages through the GSEs and Ginnie Mae. While pre-crisis, private label securitization (PLS) had provided a significant share of funding for mortgages, since 2007, PLS has withdrawn from the market.

The appropriate pricing of mortgage backed securities can discourage lending if risk rises, and, potentially, can limit housing bubbles that are enabled by excess credit. Securitization markets, including the over the counter market for residential mortgage backed securities (RMBS) and the ABX securitization index, failed to do this in the housing bubble years 2003-2007.

GSEs have recently developed Credit Risk Transfers (CRTs) to trade and price credit risk. The objective is to bring private market discipline to bear on risk taking in securitized lending. For the CRT market to accomplish this, it must avoid the failures of financial assets to price risk. Are prerequisites for this in place? (2, references omitted)

Wachter partially answers this question in her conclusion:

CRT markets, if appropriately structured, can signal a heightened likelihood of systemic risk. Capital markets failed to do this in the run-up to the financial crisis, due to misaligned incentives and shrouded information. With sufficiently informed and appropriately structured markets, CRTs can provide market based discovery of the pricing of risk, and, with appropriate regulatory and guarantor response, can advance the stability of mortgage finance markets. (10)

Credit risk transfer has not yet been tested by a serious financial crisis. Wachter is right to bring a spotlight on it now, before events in the mortgage market overtake us.

Safeguarding The CFPB’s Arbitration Rule

image by Nick Youngson http://nyphotographic.com/

 

I was one of the many signatories of this letter to Senators Crapo (R-ID) and Brown (D-OH) opposing H.R. Res. 111/S.J. Res. 47, “which would block the Consumer Financial Protection Bureau’s new forced arbitration rule.” the 423 signatories all agree “(1) it is important to protect financial consumers’ opportunity to participate in class proceedings; and (2) it is desirable for the CFPB to collect additional information regarding financial consumer arbitration.” The letter, reads, in part,

Class action lawsuits are an important means of protecting consumers harmed by violations of federal or state law. Class actions enable a court to see that a company’s violations are widespread and to order appropriate relief. The CFPB’s study shows that, over five years, 160 million class members were awarded $2.2 billion in relief – after deducting attorneys’ fees. Class actions are especially important for small dollar claims, because the time, expense and investigation needed for an individual claim typically make no sense either for the consumer or for an attorney. Additionally, class actions provide behavioral relief both for the plaintiffs and the public at large, incentivizing businesses to change their behavior or to refrain from similar practices.

Individual arbitrations are not a realistic substitute for class actions. Compared to the annual average of 32 million consumers receiving $440 million per year in class actions, the CFPB’s study found an average of only 16 consumers per year received relief from affirmative claims and another 23 received relief through counterclaims; in total, those consumers received an average of $180,770 per year. While the average per-person arbitration recovery may be higher than the average class action payment, the types of cases are completely different. The few arbitrations that people pursue tend to be individual disputes involving much larger dollar amounts than the smaller claims in class actions. Most consumers do not pursue individual claims in either court or arbitration for several reasons: they may not know their rights were violated; they may not know how to pursue a claim; the time and expense would outstrip any reward; or they cannot find an attorney willing to take an individual case. Thus, if a class action is not permitted, most consumers will have no chance at having their dispute vindicated at all. Class actions, on the other hand, are an efficient method of resolving claims impacting a large number of people.

The U.S. legal system depends on private enforcement of rights. Whereas some countries invest substantial resources in large government agencies to enforce their laws, the United States relies substantially on private enforcement. The CFPB’s study shows that, in those cases where there was overlap between private and public enforcement, private action preceded government enforcement 71% of the time. Moreover, consumer class actions provide monetary recoveries and reform of financial services and products to many consumers whose injuries are not the focus of public enforcers. American consumers can’t solely depend on government agencies to protect their rights.

Reporting on individual arbitrations will increase transparency, broaden understanding of arbitration, and improve the arbitration process. As scholars, we heartily endorse the information reporting requirements of the rule for individual arbitrations. This reporting will address many questions that have gone largely unanswered, due to the lack of transparency that currently exists in this area of law. For example, the public will now know the rate at which claimants prevail, whether it is important to be represented by an attorney, and whether repeat arbitrators tend to rule more favorably for one side than the other. The reporting will permit academic study, which will prompt a necessary debate on how to strengthen and improve the process.

In conclusion, we strongly support the CFPB rule as an important step in protecting consumers. We believe it is vital that Congress not deprive injured consumers of the right to group together to have their day in court or block important research into the arbitration process.

Blockchain and Securitization

image by  David Stankiewicz

Deloitte prepared a report on behalf of the Structured Finance Industry Group and the Chamber of Digital Commerce, Applying Blockchain in Securitization: Opportunities for Reinvention. It opens,

The global financial system is betting on blockchain to revolutionize many aspects of its business, and we (the Structured Finance Industry Group and the Chamber of Digital Commerce) believe that securitization is one of the areas in the capital markets that could most benefit from this transformation. Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, recently called blockchain “a very important new technology” that “could make a big difference to the way in which transactions are cleared and settled in the global economy.” Financial services institutions have already invested over a billion dollars in the technology, with most big banks likely to have initiated blockchain projects by the end of 2017. There are already hundreds of use cases, ranging from international payments to securities processing, while technology firms including Amazon, Google, and IBM are offering a host of blockchain services aimed at the financial industry.

Why are all of these companies investing in blockchain? This new technology has the potential to dramatically disrupt the role of intermediaries—including that of banks—in financial transactions. Traditional activities performed by intermediaries might be changed or even replaced. Blockchain can also bring significant advances in efficiency, security, and transparency to many of the financial sector’s activities.

*     *     *

The Structured Finance Industry Group and the Chamber of Digital Commerce commissioned Deloitte & Touche LLP (Deloitte) to explore how blockchain might reinvent securitization—and how the securitization industry should consider preparing for this rapidly approaching future. This industry is exploring this nascent technology’s potential benefits and costs. Firm answers on blockchain’s likely use cases are not yet available, but discussions with securitization and blockchain experts have led to some key observations and insights about implications and possible paths forward. (1, footnotes omitted)

The report’s bottom line is that “[b]lockchain and smart contracts could catapult the securitization industry into a new digital age.” (2) It finds that

The technology’s potential to streamline processes, lower costs, increase the speed of transactions, enhance transparency, and fortify security could impact all participants in the securitization lifecycle—from originators, sponsors/issuers, and servicers to rating agencies, trustees, investors, and even regulators. (2)

The report provides a nice overview of blockchain basics for those who find distributed ledger technology to be mysterious. The real value of the report, however, is that it provides concrete guidance on how blockchain can be integrated in the securitization process. There is a chart on page 24 and an explanation of it on the following page that shows this in detail. This level of detail makes it much easier to visualize how blockchain can and most likely will change the nature of the business in years to come.

Assessing The Ability-to-Repay and Qualified Mortgage Rule

photo by Alan Levine

The Consumer Financial Protection Bureau has issued a Request for Information Regarding Ability-to-Repay/Qualified Mortgage Rule Assessment. Dodd-Frank

requires the Bureau to conduct an assessment of each significant rule or order adopted by the Bureau under Federal consumer financial law. The Bureau must publish a report of the assessment not later than five years after the effective date of such rule or order. The assessment must address, among other relevant factors, the rule’s effectiveness in meeting the purposes and objectives of title X of the Dodd Frank Act and the specific goals stated by the Bureau. The assessment also must reflect available evidence and any data that the Bureau reasonably may collect. Before publishing a report of its assessment, the Bureau must invite public comment on recommendations for modifying, expanding, or eliminating the significant rule or order. (82 F.R. 25247)

The Bureau invites the public to submit the following:

  1. Comments on the feasibility and effectiveness of the assessment plan, the objectives of the ATR/QM Rule that the Bureau intends to emphasize in the assessment, and the outcomes, metrics, baselines, and analytical methods for assessing the effectiveness of the rule as described in part IV above;
  2. Data and other factual information that may be useful for executing the Bureau’s assessment plan, as described in part IV above;
  3. Recommendations to improve the assessment plan, as well as data, other factual information, and sources of data that would be useful and available to execute any recommended improvements to the assessment plan;
  4. Data and other factual information about the benefits and costs of the ATR/ QM Rule for consumers, creditors, and other stakeholders in the mortgage industry; and about the impacts of the rule on transparency, efficiency, access, and innovation in the mortgage market;
  5. Data and other factual information about the rule’s effectiveness in meeting the purposes and objectives of Title X of the Dodd-Frank Act (section 1021), which are listed in part IV above;
  6. Recommendations for modifying, expanding, or eliminating the ATR/QM Rule. (82 F.R. 25250)

As with the RESPA Assessment, this ATR/QM Assessment provides “consumers and their advocates, housing counselors, mortgage creditors and other industry representatives, industry analysts, and other interested persons” with the opportunity to help shape how the ATR/QM Rule should work going forward. (Id.)

Comments must be received on or before July 31, 2017.

Fannie and Freddie’s Credit Risk Transfers

The Urban Institute’s Housing Finance Policy Center has released its February 2017 Housing Finance at a Glance Chartbook, always a great resource for housing geeks. Each Chartbook highlights one topic. This one focuses on GSE credit risk transfers, an important but technical subject:

The GSE’s credit risk transfer (CRT) program is growing and tapping into a more diverse investor base, reducing the costs of CRTs and improving liquidity in this market. At the same time, the continued reliance on back-end transactions is cause for concern
.
Freddie Mac‘s first two capital markets CRT transactions of 2017 have been different from previous Structured Agency Credit Risk (STACR) transactions in one important way. Unlike the pre-2017 deals, in which the first loss piece (Tranche B) was 100 basis points thick, the first loss piece (Tranche B2) in the latest transactions is only 50 basis points thick while second loss piece (B1) is also 50 basis points thick. Splitting the old B tranche more granularly in this manner is a noteworthy development for a few reasons.
Although this is hardly the first improvement the GSEs have made to their back-end CRT execution, it is an important one. Splitting the offering into more granular risk buckets will force investors to price the tranches more accurately, thus facilitating more precise price discovery of credit risk. More granular tranching will also help increase the demand for STACR securities. Investors who were previously willing, but unable to invest in the B tranche because investment guidelines prohibited them from taking first loss credit risk will now instead be able to invest in the second loss B1 tranche, which offers a higher expected returns than the previous second loss tranche (M2). Growing and diversifying the investor base is important because it makes the bidding process more efficient and minimizes the cost of risk transfer for Freddie Mac and the taxpayer. A larger, more diverse investor base also bodes well for the liquidity of the CRT market, which is still in its infancy.
Clearly, these innovations are important steps towards improving the efficiency of back-end CRT. But at the same time, they must be viewed in the context of the broader objectives of credit risk transfer and housing finance reform which have near unanimous support: reducing taxpayer risk, passing the benefits of CRT on to borrowers, facilitating broad availability of credit through the economic cycle, ensuring adequate access for lenders of all sizes, and promoting a variety of CRT executions, including at the front end to facilitate an understanding of which programs are most favorable under which circumstances.
Although the GSEs have experimented with front end mechanisms like lender recourse and deeper MI, these transactions have been few and far between, and with very little transparency about pricing and other terms. But more importantly, the GSEs’ continued and significant reliance on back-end capital markets transactions doesn’t put us on a path towards achieving some of the program objectives outlined above. This matters because it signals that the GSEs’ current strategy for credit risk transfer, which revolves largely around the success of back-end transactions, may ultimately keep the program from realizing its full potential. (5)
 So, all in all Fannie and Freddie are taking a step in the right direction, but it is just a small step on the road to housing finance reform.