The Financial Meltdown and Consumer Protection

photo by HTO

Larry Kirsch and Gregory D. Squires have published Meltdown: The Financial Crisis, Consumer Protection, and the Road Forward. According to the promotional material,

Meltdown reveals how the Consumer Financial Protection Bureau was able to curb important unsafe and unfair practices that led to the recent financial crisis. In interviews with key government, industry, and advocacy groups along with deep archival research, Kirsch and Squires show where the CFPB was able to overcome many abusive practices, where it was less able to do so, and why.

Open for business in 2011, the CFPB was Congress’s response to the financial catastrophe that shattered millions of middle-class and lower-income households and threatened the stability of the global economy. But only a few years later, with U.S. economic conditions on a path to recovery, there are already disturbing signs of the (re)emergence of the high-risk, high-reward credit practices that the CFPB was designed to curb. This book profiles how the Bureau has attempted to stop abusive and discriminatory lending practices in the mortgage and automobile lending sectors and documents the multilayered challenges faced by an untested new regulatory agency in its efforts to transform the broken—but lucrative—business practices of the financial services industry.

Authors Kirsch and Squires raise the question of whether the consumer protection approach to financial services reform will succeed over the long term in light of political and business efforts to scuttle it. Case studies of mortgage and automobile lending reforms highlight the key contextual and structural conditions that explain the CFPB’s ability to transform financial service industry business models and practices. Meltdown: The Financial Crisis, Consumer Protection, and the Road Forward is essential reading for a wide audience, including anyone involved in the provision of financial services, staff of financial services and consumer protection regulatory agencies, and fair lending and consumer protection advocates. Its accessible presentation of financial information will also serve students and general readers.

Features

  • Presents the first comprehensive examination of the CFPB that identifies its successes during its first five years of operation and addresses the challenges the bureau now faces
  • Exposes the alarming possibility that as the economy recovers, the Consumer Financial Protection Bureau’s efforts to protect consumers could be derailed by political and industry pressure
  • Offers provisional assessment of the effectiveness of the CFPB and consumer protection regulation
  • Gives readers unique access to insightful perspectives via on-the-record interviews with a cross-section of stakeholders, ranging from Richard Cordray (director of the CFPB) to public policy leaders, congressional staffers, advocates, scholars, and members of the press
  • Documents the historical and analytic narrative with more than 40 pages of end notes that will assist scholars, students, and practitioners

I would not describe the book as objective, given that Senator Elizabeth Warren wrote the forward and the President Obama’s point man on Dodd-Frank, Michael Barr, wrote the afterward. Indeed, it reads more like a panegyric. Nonetheless, the book has a lot to offer to scholars of the CFPB who are interested in hearing from the people who helped to stand up the Bureau.

Budding GSE Reform

The Mortgage Bankers Association has released a paper on GSE Reform: Creating a Sustainable, More Vibrant Secondary Mortgage Market (link to paper on this page). This paper builds on a shorter version that the MBA released a few months ago. Jim Parrott of the Urban Institute has provided a helpful comparison of the basic MBA proposal to two other leading proposals. This longer paper explains in detail

MBA’s recommended approach to GSE reform, the last piece of unfinished business from the 2008 financial crisis. It outlines the key principles and guardrails that should guide the reform effort and provides a detailed picture of a new secondary-market end state. It also attempts to shed light on two critical areas that have tested past reform efforts — the appropriate transition to the post-GSE system and the role of the secondary market in advancing an affordable-housing strategy. GSE reform holds the potential to help stabilize the housing market for decades to come. The time to take action is now. (1)

Basically, the MBA proposes that Fannie and Freddie be rechartered into two of a number of competitors that would guarantee mortgage-backed securities (MBS).  All of these guarantors would be specialized mortgage companies that are to be treated as regulated utilities owned by private shareholders. These guarantors would issue standardized MBS through the Common Securitization Platform that is currently being designed by Fannie and Freddie pursuant to the Federal Housing Finance Agency’s instructions.

These MBS would be backed by the full faith and credit of the the federal government as well as by a federal mortgage insurance fund (MIF), which would be similar to the Federal Housing Administration’s MMI fund. This MIF would cover catastrophic losses. Like the FHA’s MMI fund, the MIF could be restored by means of higher premiums after the catastrophe had been dealt with.  This model would protect taxpayers from having to bail out the guarantors, as they did with Fannie and Freddie at the onset of the most recent financial crisis.

The MBA proposal is well thought out and should be taken very seriously by Congress and the Administration. That is not to say that it is the obvious best choice among the three that Parrott reviewed. But it clearly addresses the issues of concern to the broad middle of decision-makers and housing policy analysts.

Not everyone is in that broad middle of course. But there is a lot for the Warren wing of the Democratic party to like about this proposal as it includes affordable housing goals and subsidies. The Hensarling wing of the Republican party, on the other hand, is not likely to embrace this proposal because it still contemplates a significant role for the federal government in housing finance. We’ll see if a plan of this type can move forward without the support of the Chair of the House Financial Services Committee.

Is There a Bipartisan Fix for Fannie and Freddie?

photo by DonkeyHotey

The Hill published my latest column, Congress May Have Finally Found a Bipartisan Fix to Fannie and Freddie. It reads,

It is welcome news to hear that Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.) are looking to craft a bipartisan solution to the problem of Fannie Mae and Freddie Mac. The two massive mortgage companies have been in conservatorship since 2008 when they were on the verge of failing. At that time, nobody, just nobody, believed that they would still be in conservatorship nearly a decade later.

But here we are. Resolving this situation is of great importance to the financial well-being of the nation. These two companies guarantee trillions of dollars worth of mortgages and operate like black boxes, run by employees who don’t have a clear mission from their multiple masters in government.

This is the recipe for some kind of crisis.Maybe they will not underwrite their mortgage-backed securities properly. Maybe they will undertake a risky hedging strategy. We just don’t know, but there is reason to think that gargantuan organizations that have been in limbo for ten years may have developed all sorts of operational pathologies.

There have been a couple of serious attempts in the Senate to craft a long-term solution to this problem, but it was not a high priority for the Obama Administration and does not yet appear to be a high priority for the Trump Administration. Deep ideological divisions over the appropriate role of the government in the mortgage have also stymied progress on reform.

Rep. Jeb Hensarling (R-Texas), chairman of the House Financial Services Committee, leads a faction that wants to dramatically reduce the role of the government in the mortgage market. Sen. Elizabeth Warren (D-Mass.) leads a faction that wants to ensure that the government plays an active role in making homeownership, and housing more generally, more affordable to low- and moderate-income households. At this point, it is not clear whether a sufficiently broad coalition could be cobbled together to overcome the opposition to a compromise at the two ends of the spectrum.

2017 presents an opportunity to push reform forward, however. The terms of the conservatorship were changed in 2012 to require that the Fannie and Freddie reduce their capital cushion to zero by the end of this year. That means that if Fannie or Freddie has even one bad quarter and suffers losses, something that is bound to happen sooner or later, they would technically require a bailout from Treasury.

Now, such a bailout would not be such a terrible thing from a policy perspective as Fannie and Freddie have paid tens of billions of dollars more to the Treasury than they received in the bailout. But politically, a second bailout of Fannie or Freddie would be toxic for those who authorize it.

Some are arguing that we should kick the can down the housing finance reform road once again, by allowing Fannie and Freddie to retain some of their capital to protect them from such a scenario. But Corker and Warner seem to want to use the Dec. 31, 2017 end date to focus minds in Congress. They, along with some other colleagues, have warned Fannie and Freddie’s conservator, Federal Housing Finance Agency Director Mel Watt, not to increase the capital cushion for the two companies. They claim that it is Congress’ prerogative to make this call.

The conventional wisdom is that the stars have not aligned to make housing finance reform politically viable in the short term. The conventional wisdom is probably right because the housing finance system is working well enough for now. Mortgage rates are very low and while access to credit is a bit tight, it is not so tight that it is making headlines. So perhaps Senators Corker and Warner are right to use the fear factor of future bailouts as a goad to action.

Housing finance reform requires statesmanship because there are no short-term gains that will accrue to the politicians that lead it. And the long-term gains will be very diffuse – nobody will praise them for the crises that were averted by their actions to create a housing finance system fit for the 21st century. But this work is of great importance and far-thinking leaders on both sides of the aisle should support a solution that takes Fannie and Freddie out of the limbo of conservatorship.

It will require compromise and an acceptance of the fact that the perfect is the enemy of the good. But if compromise is reached, it may help to avoid another catastrophe that will be measured in the hundreds of billions of dollars. And it will ensure that we have a mortgage market that meets the needs of America’s families.

Consumer Protection, Going Forward

photo by Lawrence Jackson

Warren, Obama and Cordray

The New York Times quoted me in Consumer Protection Bureau Chief Braces for a Reckoning. It opens,

Mild-mannered, lawyerly and with a genius for trivia, Richard Cordray is not the sort of guy you picture at the center of Washington’s bitter partisan wars over regulation and consumer safeguards.

But there he is, a 57-year-old Buckeye who friends say prefers his hometown diner to a fancy political reception, testifying in hearing after hearing on Capitol Hill about the agency he leads, the Consumer Financial Protection Bureau. Republicans would like to do away with it — and with him, arguing that the agency should be led by a commission rather than one person.

And with a Republican sweep of Congress and the White House, they may get some or all of what they wish.

Mr. Cordray, a reluctant Washingtonian who has commuted here for six years from Grove City, Ohio, where his wife and twin children live, is the first director of the consumer watchdog agency, which was created in 2010 after Wall Street’s meltdown. By aggressively deploying his small army of workers — he has 1,600 of them — Mr. Cordray has turned the fledgling agency into one of Washington’s most powerful and pugnacious regulators.

The bureau has overhauled mortgage lending rules, reined in abusive debt collectors, prosecuted hundreds of companies and extracted nearly $12 billion from businesses in the form of canceled debts and consumer refunds. In September, it exposed the extent of Wells Fargo’s creation of two million fraudulent customer accounts, igniting a scandal that provoked widespread outrage and toppled the company’s chief executive.

And, according to Mr. Cordray, he and his team have barely scratched the surface of combating consumer abuse.

“We overcame momentous challenges — just building an agency from scratch, let alone one that deals with such a large sector of the economy,” Mr. Cordray said in an interview at his agency’s office here. “I’m satisfied with the progress we have made, but I’m not satisfied in the sense that there’s a lot more progress to be made. There’s still a lot to be done.”

But his future and the agency’s are uncertain. Democrats in Ohio are encouraging Mr. Cordray to run for governor in 2018, which would require him to quit his job in Washington fairly soon, rather than when his term ends in mid-2018. Champions of the agency are imploring him to stay, arguing that if he leaves, the agency is likely to be defanged, its powers to help consumers sapped.

Opponents of the bureau just won a big legal victory: The United States Court of Appeals for the District of Columbia Circuit said last month that the structure of the Consumer Financial Protection Bureau was unconstitutional, and that the president should have the power to fire its director at will.

The agency is challenging the decision — which was made in a lawsuit brought by the mortgage lender PHH Corporation that contests the consumer bureau’s authority to fine it — and that has temporarily stopped the decision from taking effect. But the ruling has kept alive questions about whether too much power is concentrated in Mr. Cordray’s job, and whether the agency should be dismantled or restructured.

Mr. Cordray, who also battled on behalf of consumers in his previous jobs as Ohio’s attorney general and, before that, its treasurer, is praised in some circles as enormously effective, wielding the bureau’s power to restructure some industries and terrify others.

The bureau has “helped save countless people across the country from abusive financial practices,” said Hilary O. Shelton, the N.A.A.C.P.’s senior vice president for advocacy and policy.

Even the regulator’s frequent foes — including Alan S. Kaplinsky, a partner at Ballard Spahr in Philadelphia, who says the agency often overreaches — acknowledge its impact.

“I’ve been practicing law in this area for well over 40 years, and there’s nothing that compares to it,” Mr. Kaplinsky said. “Every company in the consumer financial services market has felt the effects.”

The Consumer Financial Protection Bureau has nearly replaced the Better Business Bureau as the first stop for dissatisfied customers seeking redress. It has handled more than a million complaints, many of which it has helped resolve.

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The housing crisis dominated the bureau’s early days. When Congress created the new overseer, it also dictated its first priority: making mortgages safer. The deadline was tight. If the bureau did not introduce new rules within 18 months, a congressionally mandated set of lending guidelines would automatically take effect.

The bureau made it with one day to spare.

It banned some practices that had fueled the crisis, like home loans with low teaser rates or no documentation of the borrower’s income, and steered lenders toward “qualified” loans with a stricter set of safeguards, including checks to ensure that customers could afford to repay what they borrowed.

After much grumbling — and many dire forecasts that the new rules would limit credit and harm consumers — mortgage lenders adjusted. They made nearly 3.7 million loans last year for home purchases, the highest number since 2007, according to government data.

“It seems like the financial services industry has figured out how to adapt to this new regulatory regime,” said David Reiss, a professor at Brooklyn Law School who studied the effects of the bureau’s rule-making. “We’ve moved from the fox-in-the-henhouse market in the early 2000s, where you could get away with nearly anything, to this new model, where someone is looking over your shoulder.”

Rigged Justice

photo by Toby Hudson

The Office of Senator Elizabeth Warren has released Rigged Justice: 2016 How Weak Enforcement Lets Corporate Offenders Off Easy. The Executive Summary states,

When government regulators and prosecutors fail to pursue big corporations or their executives who violate the law, or when the government lets them off with a slap on the wrist, corporate criminals have free rein to operate outside the law. They can game the system, cheat families, rip off taxpayers, and even take actions that result in the death of innocent victims—all with no serious consequences.

The failure to punish big corporations or their executives when they break the law undermines the foundations of this great country: If justice means a prison sentence for a teenager who steals a car, but it means nothing more than a sideways glance at a CEO who quietly engineers the theft of billions of dollars, then the promise of equal justice under the law has turned into a lie. The failure to prosecute big, visible crimes has a corrosive effect on the fabric of democracy and our shared belief that we are all equal in the eyes of the law.

Under the current approach to enforcement, corporate criminals routinely escape meaningful prosecution for their misconduct. This is so despite the fact that the law is unambiguous: if a corporation has violated the law, individuals within the corporation must also have violated the law. If the corporation is subject to charges of wrongdoing, so are those in the corporation who planned, authorized or took the actions. But even in cases of flagrant corporate law breaking, federal law enforcement agencies – and particularly the Department of Justice (DOJ) – rarely seek prosecution of individuals. In fact, federal agencies rarely pursue convictions of either large corporations or their executives in a court of law. Instead, they agree to criminal and civil settlements with corporations that rarely require any admission of wrongdoing and they let the executives go free without any individual accountability. (1)

I think the report’s central point is that the “contrast between the treatment of highly paid executives and everyone else couldn’t be sharper.” (1)

The report does not address some of the key issues that stand in the way of achieving substantive justice for financial wrongdoing. First, many of those accused of wrongdoing were well-represented by counsel who ensured that they did not violate any criminal laws, even if they engaged in rampant bad behavior. Second, contemporary jurisprudence of corporate criminal liability presents serious roadblocks to prosecutors who seek to pursue such wrongdoing. Third, many of these cases are incredibly resource heavy, even for federal prosecutors. This can incentivize them to go after other types of financial wrongdoing instead, such as insider trading.

It seems like it is too late to address much of the wrongdoing that arose from our most recent financial crisis. But if this report achieves one thing, I would hope that it gets Congress to focus on how corporations and their high-level executives could be held criminally accountable the next time around.

Housing Goals and Housing Finance Reform

The Federal Housing Finance Agency issued a proposed rule that would establish housing goals for Fannie and Freddie for the next three years. The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required that Fannie and Freddie’s regulator set annual housing goals to ensure that a certain proportion of the companies’ mortgage purchases serve low-income households and underserved areas. Among other things, the proposed rule would “establish a new housing subgoal for small multifamily properties affordable to low-income families,” a subject that happens to be near and dear to my heart.(54482)

This “duty to serve” is very controversial, at the heart of the debate over housing finance reform. Many Democrats oppose housing finance reform without it and many Republicans oppose reform with it. Indeed, it was one of the issues that stopped the Johnson-Crapo reform bill dead in its tracks.

While this proposed rule is not momentous by any stretch of the imagination, it is worth noting that the FHFA, for all intents and purposes, seems to be the only party in the Capital that is moving housing finance reform forward in any way.

Once again, we should note that doing nothing is not the same as leaving everything the same. As Congress fails to strike an agreement on reform and Fannie and Freddie continue to limp along in their conservatorships, regulators and market participants will, by default, be designing the housing finance system of the 21st century. That is not how it should be done.

Comments are due by October 28, 2014.

Reiss on FHFA Leadership of Housing Finance Reform

Law360.com quoted me in FHFA Set To Take The Lead In Housing Finance Reform (behind a paywall). It reads in part,

With hopes for a legislative fix for the U.S. housing finance market fading after six key Democrats reportedly refused to support a reform bill pending in the Senate Banking Committee, the Federal Housing Finance Agency will become the central player in reshaping the market and set the terms for any future changes.

The Banking Committee’s leaders — Chairman Tim Johnson, D-S.D., and ranking member Mike Crapo, R-Idaho — were unable to scare up the overwhelming support their housing finance reform bill needed in a last-gasp effort at getting a vote from the full Senate. That leaves the bill’s prospects of getting to President Barack Obama prior to the midterm elections at near zero and the FHFA, the conservator for Fannie Mae and Freddie Mac since 2008, as the biggest player in reshaping the U.S. housing market.

“It was always my operating assumption that it was going to be exceedingly difficult to get congressional consensus. Most of the action was going to take place by way of the actions at the FHFA,” said former Republican Rep. Rick Lazio, now a partner at Jones Walker LLP.

The lack of legislation also throws a wild card into the equation, since FHFA head Mel Watt has essentially been silent about his intentions for the FHFA since he won Senate confirmation in December.

“Hopefully, Watt will have a positive vision of the future of the two companies,” said Brooklyn Law School professor David Reiss.

More than five years after Fannie Mae and Freddie Mac were placed under FHFA conservatorship after receiving a more-than-$187 billion taxpayer bailout in the fall of 2008, Congress has yet to act on creating a new system for home purchases and eliminating the two companies.

And then, beginning last spring, Congress kicked into gear.

First, Sen. Bob Corker, R-Tenn., and Sen. Mark Warner, D-Va., introduced a bill that Johnson and Crapo would use as the basis for their own legislation, leaving a limited role for government in guaranteeing the mortgage market.

Soon after, the House Financial Services Committee passed its own housing finance reform bill looking to eliminate the government’s role in the housing market entirely.

Johnson and Crapo released their bill, which would eliminate Fannie and Freddie within five years and replace it with a mortgage insurance agency modeled on the Federal Deposit Insurance Corp., in March. They scheduled a markup and vote on the bill for late April.

But the two senators delayed the vote at the last minute when it became clear that while they had the 12 votes needed to pass the bill out of the 22-member committee, they lacked the 16 to 18 votes needed to force Senate Majority Leader Harry Reid to bring it up for a vote.

Johnson and Crapo said they would continue negotiations with six undecided Democrats, but according to media reports, those negotiations foundered on worries about access to affordable housing in the bill.

Undeterred, Johnson vowed to bring the bill up for a vote next week.

“Those involved in the negotiations have indicated they are interested in continuing to work together to try and find common ground, so the Banking Committee will keep working after favorably reporting out the bill next week,” Sean Oblack, a Democratic spokesman for the committee, said in a Thursday statement.

Still, the failure to get overwhelming support for the Johnson-Crapo bill essentially dooms the prospects for housing finance legislation this year, Lazio said.

“The administration will probably wait until early next Congress to make a decision about whether they think reform is possible,” he said.

But reform efforts will not stop, since the FHFA has a large amount of discretion over the futures of Fannie Mae and Freddie Mac.

“The regulator here is very powerful,” Reiss said.

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