Housing Policy, Going Forward

Mark Calabria

The Hill published a column of mine, The Next Two Years of Federal Housing Policy Could Be Positive under Mark Calabria. it opens,

The Trump administration has been a nightmare for housing advocates. Housing and Urban Development Secretary Carson has stopped enforcing fair housing laws, with assists from Treasury Secretary Steven Mnuchin and Comptroller of the Currency Joseph Otting. Those two have been working to scale back fair lending enforcement and the Community Reinvestment Act.

Consumer Financial Protection Bureau Acting Director Mulvaney has gutted consumer protection in the mortgage market. I am more hopeful though when it comes to housing finance reform. The administration has nominated Mark Calabria to be the next director of the Federal Housing Finance Agency; the FHFA is Fannie Mae and Freddie Mac’s regulator.

There have been three types of leaders on Trump’s team that have been working on housing issues. First are those who seek to explicitly undermine the work of the agency they lead, like Mulvaney. Leaders like Mulvaney are generally proponents of a radical conservative ideology that has been way out of step with American political norms until the Tea Party movement swept through Congress. Second are those who pay some lip service to the agency’s mission, but work to undermine it, like Carson. And third are those who are clearly industry favorites, like Mnuchin and Otting. They primarily seek to address concerns of the industry they regulate at the expense of their agency’s broader public mission.

Calabria represents a fourth type of leader, one who is more likely to implement a more traditional Republican agenda for the housing sector. For the last couple of years, he has been serving as Vice President Pence’s chief economist.

Cutting Back on Community Reinvestment

Bloomberg Law quoted me in Banks Look to Narrow Exams Under Community Reinvestment Act. It opens,

Banks see an opening to limit the types of violations that could lead to a Community Reinvestment Act downgrade as federal regulators begin rewriting rules under the 1977 law.

Banks say regulators have improperly used consumer fair lending and other violations involving credit cards or other financial products to evaluate compliance with the law meant to increase lending and investment to lower-income communities.

“When a bank violates a consumer protection law, there is no shortage of enforcement agencies and legal regimes available to seek redress and punishment. Adding the CRA to that long list thus has little marginal benefit, and risks diluting and undermining the CRA’s core purpose of promoting community reinvestment,” the Bank Policy Institute, a leading bank lobbying group, said in a Nov. 19 comment letter to the Office of the Comptroller of the Currency.

The OCC set the stage for a CRA rewrite in August by releasing an advanced notice of proposed rulemaking. The Federal Reserve and Federal Deposit Insurance Corp. have signaled a desire to sign on to a joint proposal.

With that momentum building, banks are taking their shot to limit the types of enforcement actions included in CRA reviews. They want CRA reviews to focus on mortgages, small business and other community development investments.

The question of how non-CRA-related violations apply to banks’ community lending reviews is not merely a theoretical exercise.

Wells Fargo & Co. saw its CRA grade downgraded two levels to “needs to improve”in March 2017 following the revelation of the fake accounts it generated for consumers. Several states and municipalities cut off business with the bank in response.

CRA exam cycles run three years for large national banks and can run longer for smaller banks that perform well. Banks receive one of four grades—outstanding, satisfactory, needs to improve or substantial noncompliance—and a poor grade can restrict their merger and branch expansion plans.

OCC, Treasury Leading Push

The Trump administration, led by Treasury Secretary Steven Mnuchin and Comptroller of the Currency Joseph Otting, has been pushing for the latest CRA revision.

Both of those officials ran into CRA trouble when they tried to sell OneWest Bank to CIT Group Inc. Mnuchin was OneWest’s chairman and Otting its chief executive.

The Treasury Department released a report on “modernizing the CRA” in April. Included in that report is a call to not allow fair lending enforcement investigations from the Consumer Financial Protection Bureau and other regulators to slow down CRA reviews.

Otting went farther, issuing a bulletin on Aug. 15 highlighting that his agency’s examiners will no longer take into account non-CRA lending violations when assessing a bank’s CRA compliance.

The FDIC and the Fed have not yet followed suit. But banks want the three agencies to set a common policy on dealing with non-CRA related enforcement actions in their community lending reviews.

“Regulators should develop consistent policies clarifying that CRA will not be used as a general enforcement tool,” the American Bankers Association said in a Nov. 15 comment letter.

There is some merit to the idea, according to David Reiss, a professor at Brooklyn Law School and the research director at the Center for Urban Business Entrepreneurship.

“It’s delinking fair lending concerns, which are regulated elsewhere, from CRA concerns. From an industry perspective that may make a lot of sense,” he said in a Nov. 30 phone interview.

The proposal, taken in a vacuum, may be reasonable. But in the context of broader attempts to weaken the CRA, it should be viewed more skeptically.

Hope for GSE Shareholders

Judge Lamberth issued an opinion in Fairholme Funds, Inc. v. FHFA (Civ. No.13-1439) (Sept. 28, 2018) that gives some hope to the private shareholders of Fannie Mae and Freddie Mac. These shareholders have been on the losing end of nearly every case brought against the government relating to its handling of the conservatorships of the two companies.  Readers of this blog know that I have long been a skeptic of the shareholders’ claims because of the broad powers granted the government by the Housing and Economic Recovery Act of 2008, passed during the height of the financial crisis, as well as the highly regulated environment in which the two companies operate. This highly regulated environment means that GSE profits are driven by regulatory decisions much more than those of other financial institutions. As such, Fannie and Freddie live and die by the sword of government intervention in the mortgage market.

Judge Lamberth had dismissed the plaintiffs’ claims in their entirety, but was reversed in part on appeal. In this case, he revisits the issues arising from the reversal of his earlier dismissal. Once again, Judge Lamberth dismisses a number of the plaintiffs’ claims, but he finds that that their claim that the government breached the duty of good faith survives.

The opinion gives a road map that shareholders can follow to success. The judge identifies allegations that, if true, would be a sufficient factual basis for a holding that the government breached the implied covenant of good faith and fair dealing. It is plausible that the preponderance of proof may support these allegations. Some evidence has already come to light that indicates that at least some government actors had good reason to believe that Fannie and Freddie were on the cusp of sustained profitability when the government implemented the net worth sweep. The net worth sweep had redirected the net profits of the two companies to the U.S. Treasury.

Judge Lamberth highlights some of aspects of the plaintiffs’ argument that he found compelling at the motion to dismiss phase of this litigation. First, he notes that absence of “any increased funding commitment” is atypical when senior shareholders receive “enhanced disbursement rights,” as was the case when the government implemented the net worth sweep. (21) He also states that the plaintiffs would not have expected that the GSEs would have extinguished “the possibility of dividends arbitrarily or unreasonably.” (22)

While this opinion is good news for the plaintiffs, it is still unclear what their endgame would be if they were to get a final judgment that the net worth sweep was invalid. Depending on the outcome of regulatory and legislative debates about the future of the two companies, the win may be a pyrrhic one. Time will tell. In the interim, expect more discovery battles, motions for summary judgment and even a trial in this case. So, while this opinion gives shareholders some hope of ultimate success, and perhaps some leverage in political and regulatory debates, I do not see it as a game changer in itself.

In terms of the bigger picture, there are a lot of changes on the horizon regarding the future of the housing finance system. The midterm elections; Hensarling and Corker’s departure from Congress; and the Trump Administration’s priorities are all bigger drivers of the housing finance reform train, at least for now.

GSE Shareholders Floored, Again

The United States Court of Appeals for the Eighth Circuit issued an opinion in Saxton v. FHFA (No. 17-1727, Aug. 23, 2018). The Eighth Circuit joins the Fifth, Sixth, Seventh and D.C. Circuits in rejecting the arguments of Fannie and Freddie shareholders that the Federal Housing Finance Agency exceeded its authority as conservator of Fannie Mae and Freddie Mac and acted arbitrarily and capriciously. The Court provides the following overview:

     The financial crisis of 2008 prompted Congress to take several actions to fend off economic disaster. One of those measures propped up Fannie Mae and Freddie Mac. Fannie and Freddie, which were founded by Congress back in 1938 and 1970, buy home mortgages from lenders, thereby freeing lenders to make more loans. See generally 12 U.S.C. § 4501. Although established by Congress, Fannie and Freddie operate like private companies: they have shareholders, boards of directors, and executives appointed by those boards. But Fannie and Freddie also have something most private businesses do not: the backing of the United States Treasury. 

     In 2008, with the mortgage meltdown at full tilt, Congress enacted the Housing and Economic Recovery Act (HERA or the Act). HERA created the Federal Housing Finance Agency (FHFA), and gave it the power to appoint itself either conservator or receiver of Fannie or Freddie should either company become critically undercapitalized. 12 U.S.C. § 4617(a)(2), (4). The Act includes a provision limiting judicial review: “Except as  provided in this section or at the request of the Director, no court may take any action to restrain or affect the exercise of powers or functions of the [FHFA] as a conservator or a receiver.” Id. § 4617(f). 

     Shortly after the Act’s passage, FHFA determined that both Fannie and Freddie were critically undercapitalized and appointed itself conservator. FHFA then entered an agreement with the U.S. Department of the Treasury whereby Treasury would acquire specially-created preferred stock and, in exchange, would make hundreds of billions of dollars in capital available to Fannie and Freddie. The idea was that Fannie and Freddie would exit conservatorship when they reimbursed the Treasury.

     But Fannie and Freddie remain under FHFA’s conservatorship today. Since the conservatorship began, FHFA and Treasury have amended their agreement several times. In the most recent amendment, FHFA agreed that, each quarter, Fannie and Freddie would pay to Treasury their entire net worth, minus a small buffer. This so-called “net worth sweep” is the basis of this litigation. 

     Three owners of Fannie and Freddie common stock sued FHFA and Treasury, claiming they had exceeded their powers under HERA and acted arbitrarily and capriciously by agreeing to the net worth sweep. The shareholders sought only an injunction setting aside the net worth sweep; they dismissed a claim seeking money damages. Relying on the D.C. Circuit’s opinion in Perry Capital LLC v. Mnuchin, 864 F.3d 591 (D.C. Cir. 2017), the district court dismissed the suit.

What amazes me as a longtime watcher of the GSE litigation is how supposedly dispassionate investors lose their heads when it comes to the GSE lawsuits. They cannot seem to fathom that judges will come to a different conclusion regarding HERA’s limitation on judicial review.

While I do not rule out that the Supreme Court could find otherwise, particularly if Judge Kavanaugh is confirmed, it seems like this unbroken string of losses should provide some sort of wake up call for GSE shareholders. But somehow, I doubt that it will.

Fight Over The Community Reinvestment Act

Bloomberg BNA quoted me in Community Investment Revamp for Banks Likely To Spark Fight (behind a paywall). It opens,

Community groups and banks agree that the Community Reinvestment Act needs an update, but with regulators beginning an ambitious overhaul of the 1977 law there is little agreement on how that update should look.

The Trump administration has been targeting the CRA — which measures how well banks lend to low- to middle-income areas — for a rewrite since last June. Comptroller of the Currency Joseph Otting said March 28 that the first draft would be coming in early April.

Otting set out some broad ideas that his agency, the Office of the Comptroller of the Currency, and the other regulators that oversee the CRA will present to the public. The Federal Reserve and the Federal Deposit Insurance Corporation also have responsibility for measuring banks’ compliance with the law, and the OCC says that it hopes the two agencies will sign on to the coming advanced notice of proposed rulemaking.

Banking industry experts and community groups all said that the broad strokes of the regulators’ plan sound promising, but few expect that comity to continue when the details come more into view.

“I think you can assume that everybody is not going to be happy,” Laurence Platt, a partner at Mayer Brown LLP, told Bloomberg Law.

The CRA’s Present

The Trump administration first put the CRA in its sights in a June 2017 Treasury Department report outlining its broader views on altering the rules banks operate under.

The law calls for the OCC, the Fed and the FDIC to periodically measure how much lending the banks they oversee do inside geographical assessment areas based on their branch and ATM locations. If banks are found not to do enough of such lending, regulators can stop some business activities or hold up branch expansions and mergers. But it hasn’t been updated for nearly two decades.

The Treasury Department followed up the June 2017 statement on the CRA with an April 3 report outlining its thinking on ways to modernize the law. The report largely aligns with the path laid out by Otting.

“Our recommendations will improve the effectiveness of CRA by enhancing the assessment and examination process, enhancing the ability of banks to deliver services in the communities they serve while considering technological advances in the financial industry,” Treasury Secretary Steven Mnuchin said in a statement accompanying the report.

Changes to the Community Reinvestment Act have already begun, with the OCC under former acting Comptroller of the Currency Keith Noreika in October declaring that the OCC examiners would no longer include enforcement actions that are not linked to a bank’s CRA compliance in their rating.

That change was minor, and affected only one of the three regulators responsible for the CRA. Otting on March 28 laid out a host of other changes likely coming in a new proposal.

The CRA’s Future?

The broad outline Otting provided on March 28 largely highlights the areas in the CRA that community activists and banks have said need to be addressed.

Among the changes Otting said will be put out for comment include expanding the types of lending that would be included in calculations of banks’ CRA compliance to encompass small business, student lending and other money going into a community.

“I think there’s a sense that community-based activities, beyond individual lending, should be given more credit, such as small business loans and infrastructure loans,” Mayer Brown’s Platt said.

Other areas that are going to be addressed in the proposal will touch on the way CRA information is calculated and reported to the public. Currently, banks are examined for compliance every three to five years, and the banks’ reviews take an additional year.

Overall, Otting said the changes would be significant.

“This is monumental change for America,” Otting said in an appearance March 28 at the Operation Hope Global Forum in Atlanta.

The changes Otting discussed all sound promising, but they are vague. So fights are likely to emerge when the details come out.

“The comments that were made were vague enough to give you both concern and possible joy,” Taylor said.

One other aspect of the CRA that is ripe for reform is the geographic assessment areas regulators use to evaluate banks’ lending efforts. Otting and other regulators have yet to specifically outline their ideas for making changes to that, but both the comptroller and Fed Vice Chair for Supervision Randal Quarles have discussed including mobile banking, online lending, and other financial technology tools into their reviews.

How they elect to make that change is likely to be contentious as well.

“If the assessment area is poorly defined, then the CRA will lose its teeth and that’s going to drive CRA policy for a long time to come,” said David Reiss, a professor at Brooklyn Law School.

“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.

Treasury’s Take on Housing Finance Reform

Treasury Secretary Mnuchin Being Sworn In

The Department of the Treasury released its Strategic Plan for 2018-2022. One of its 17 Strategic Objectives is to promote housing finance reform:

Support housing finance reform to resolve Government-Sponsored Enterprise (GSE) conservatorships and prevent taxpayer bailouts of public and private mortgage finance entities, while promoting consumer choice within the mortgage market.

Desired Outcomes

Increased share of mortgage credit supported by private capital; Resolution of GSE conservatorships; Appropriate level of sustainable homeownership.

Why Does This Matter?

Fannie Mae and Freddie Mac have been in federal conservatorship for nine years. Taxpayers continue to stand behind their obligations through capital support agreements while there is no clear path for the resolution of their conservatorship. The GSEs, combined with federal housing programs such as those at the Federal Housing Administration and the Department of Veterans Affairs, support more than 70 percent of new mortgage originations. Changes should encourage the entry of greater private capital in the U.S. housing finance system. Resolution of the GSE conservatorships and right-sizing of federal housing programs is necessary to support a more sustainable U.S. housing finance system. (16)

The Plan states that Treasury’s strategies to achieve these objectives are to engage “stakeholders to develop housing finance reform recommendations.” (17) These stakeholders include Congress, the FHFA, Fed, SEC, CFPB, FDIC, HUD (including the FHA), VA, Fannie Mae, Freddie Mac, the Association of State Banking Regulators as well as “The Public.” Treasury further intends to disseminate “principles and recommendations for housing finance reform” and plan “for the resolution of current GSE conservatorships.” (Id.)

This is all to the good of course, but it is at such a high level of generality that it tells us next to nothing. In this regard, Trump’s Treasury is not all that different from Obama and George W. Bush’s. Treasury has not taken a lead on housing finance reform since the financial crisis began. While there is nothing wrong with letting Congress take the lead on this issue, it would move things forward if Treasury created an environment in which housing finance reform was clearly identified as a priority in Washington. Nothing good will come from letting Fannie and Freddie limp along in conservatorship for a decade or more.