Tag Archives: Willis

Running Circles around the CFPB

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Lauren Willis has posted The Consumer Financial Protection Bureau and the Quest for Consumer Comprehension to SSRN.  It addresses an important subject — the cat and mouse game of the regulator and the regulated. The abstract reads,

To ensure that consumers understand financial products’ “costs, benefits, and risks,” the Consumer Financial Protection Bureau has been redesigning mandated disclosures, primarily through iterative lab testing. But no matter how well these disclosures perform in experiments, firms will run circles around the disclosures when studies end and marketing begins. To meet the challenge of the dynamic twenty-first-century consumer financial marketplace, the bureau should require firms to demonstrate that a good proportion of their customers understand key pertinent facts about the financial products they buy. Comprehension rules would induce firms to inform consumers and simplify products, tasks that firms are better equipped than the bureau to perform. (74)

The Bureau has worked hard to tackle financial education in a meaningful way, but Willis is right that this is a Herculean task given the profit incentive that financial institutions have to run circles around consumers and the Bureau itself. Willis explains

the feebleness of mandated disclosures, the inherent flaws in the alternatives the CFPB has been pursuing, the advantages firms have over regulators in ensuring their customers’ comprehension, and the CFPB’s legal authority to require customer confusion audits and enforce comprehension rules. I then elaborate on a few examples of how this form of regulation might operate in practice, including these four key elements:

1. Measuring the quality of a valued outcome (comprehension) rather than of an input that is often pointless (mandated or preapproved disclosure);

2. Assessing actual customer comprehension in the field as conditions change over time, rather than imagining what the “reasonable consumer” would understand or testing consumers in the lab or in single-shot field experiments;

3. Requiring firms to affirmatively and routinely demonstrate customer understanding, rather than relying on the bureau’s limited resources to examine firm performance ad hoc when problems arise ; and

4. Giving firms the flexibility and responsibility to effectively inform their customers about key relevant costs, benefits and risks through whatever means the firms see fit, whether that be education or product simplification, rather than asking regulators to dictate how disclosures and products should be designed. (76) (footnotes omitted)

Hopefully the Bureau will take a serious look at Willis’ critique.  It is important, of course, to get consumer financial literacy right in order to benefit consumers directly. But it is also important for the Bureau to get it right in order to protect its reputation as an effective regulator that brings real value to the consumer finance sector.

Housing out of Thin Air

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NYU’s Furman Center has posted a policy brief, Creating Affordable Housing out of Thin Air: The Economics of Mandatory Inclusionary Zoning in New York City. It opens,

In May 2014, New York City’s new mayor released an ambitious housing agenda that set forth a multi-pronged, ten-year plan to build or preserve 200,000 units of affordable housing. One of the most talked-about initiatives in the plan was encapsulated in its statement, “In future re-zonings that unlock substantial new housing capacity, the city must require, not simply encourage, the production of affordable housing in order to ensure balanced growth, fair housing opportunity, and diverse neighborhoods.” In other words, the city intends to combine upzoning with mandatory inclusionary zoning in order to increase the supply of affordable housing and promote economic diversity. (1)
Inclusionary zoning, “using land use regulation to link development of market-rate housing units to the creation of affordable housing,” is seen by many as a low-cost policy to support a broader affordable housing approach. (2) There is a limit to the reach of such a program because developers will only build if the overall project pencils out, including any units of mandatory inclusionary zoning.
The policy brief’s conclusions are important:
In many neighborhoods, including some that the city has already targeted for the new program, market rents are too low to justify new mid- and high-rise construction, so additional density would offer no immediate value to developers that could be used to cross-subsidize affordable units. In these areas, inclusionary zoning will need to rely on direct city subsidy for the time being if it is to generate any new units at all regardless of the income level they serve.
Where high rents make additional density valuable, there is capacity to cross-subsidize new affordable units without direct subsidy, but the development of a workable inclusionary zoning policy will be complex. The amount of affordable housing the city could require without dampening the rate of new construction or relying on developers to accept lower financial returns or landowners to be willing to sell at lower prices will vary widely depending on a neighborhood’s market rent, the magnitude of the upzoning, and, to a lesser extent, on the level of affordability required in the rent-restricted units. Where developers must provide the required affordable housing, and whether they can instead pay a fee directly to the city, also bears heavily on the number of affordable units a mandatory inclusionary zoning policy has the potential to generate, but raises other difficult issues. (14-15)
The de Blasio Administration’s housing and land use team is very sophisticated (including the Furman Center’s former director, Vicki Been, now Commissioner at the Department of Housing Preservation and Development), so the City will be well aware of these constraints on a mandatory inclusionary housing program. Nonetheless, it will be of great importance to design a flexible program that can adapt to changing market conditions to ensure that such a program is actually a spur to new development and not merely a well-intentioned initiative.

Reforming Fannie & Freddie’s Multifamily Business

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Mark Willis & Andrew Neidhardt’s article, Reforming the National Housing Finance System: What’s at Risk for the Multifamily Rental Market if Fannie Mae and Freddie Mac Go Away?, was recently published in a special issue of the NYU Journal of Law & Business. Most of the ink spilled about the reform of Fannie and Freddie addresses their single-family lines of business. The single-family business is much bigger, but the multifamily business is also an important part of what they do.

The author’s conclude that

Reform of the nation’s housing finance system needs to be careful not to disrupt unnecessarily the existing multifamily housing market. The near collapse of Fannie and Freddie’s single-family business over five years ago resulted in conservatorship and has spawned calls for their termination. While a general consensus has since emerged that Fannie and Freddie should be phased out over time, no consensus exists as to which, if any, of their functions need to be replaced in order to preserve the affordability and availability of housing in general, and multifamily rentals in particular.

On the multifamily side, Fannie and Freddie have built specialized units using financing models that involve private sector risk-sharing (i.e., DUS lender capital at risk or investors holding subordinate tranches of K-series securities) and that have resulted in low default rates and limited credit losses. These units have benefited from an implicit government guarantee of their corporate debt, which has expanded their access to capital and lowered its cost. As a result of the implicit guarantee, Fannie and Freddie have been able to: 1) offer longer term mortgages than generally available from banks, 2) provide countercyclical support to the rental market by funding new mortgages throughout the recent housing and economic downturn, and 3) ensure that the vast majority of the mortgages they fund offer rents affordable to households earning less than even 80% of area median income.

The potential for moral hazard can be reduced without disrupting the multifamily housing market simply by separating out and nationalizing the government guarantee It would then be possible to: 1) spin off the multifamily businesses of Fannie and Freddie into self-contained entities and 2) create an explicit government guarantee, offered by a government entity, and paid for through premiums on the insured MBS. The first step could happen now with FHFA authorization. These new subsidiaries could also begin to pay their respective holding companies for providing the guarantee on their MBS. The second step requires Congressional legislation. Once the public guarantor is up and running, the guarantee would be purchased from it and these subsidiaries could then be sold to private investors. As for other reforms that would explicitly restrict market access to the government guarantee, the best approach would be to first test the private sector’s appetite for risk on higher-end deals. (539-40)

This article has a lot to offer in terms of analyzing how Fannie and Freddie’s multifamily business is distinct from their single-family business. But I do not think that it fully makes the case that the multifamily sector suffers from some sort of market failure that requires so much government intervention as it advocates. I suspect that private capital could be put into a first loss position for much more of the lending in this sector. The government could continue to support the low- and moderate-income rental market without being on the hook for the rest of the multifamily market.

GSE Shareholder Litigation Issue

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The NYU Journal of Law & Business has posted a special issue devoted to the GSE shareholder litigation. Here are the links for the the individual articles:

The Government Takeover of Fannie Mae and Freddie Mac: Upending Capital Markets with Lax Business and Constitutional Standards
Richard A. Epstein
The Fannie and Freddie Bailouts Through the Corporate Lens
Adam B. Badawi & Anthony J. Casey
An Overview of the Fannie and Freddie Conservatorship Litigation
Davis Reiss
Back to the Future: Returning to Private-Sector Residential Mortgage Finance
Lawrence J. White
Reforming the National Housing Finance System: What’s at Risk for the Multifamily Rental Market if Fannie Mae and Freddie Mac Go Away?
Mark Willis & Andrew Neidhardt

I have blogged about drafts of some of the articles here (Epstein), here (Badawi and Casey) and here (my contribution) and I may very well blog about the rest of them over the next few weeks. Given the nature of legal scholarship, these articles were written well before many of this year’s developments in the GSE shareholder litigations (such as Judge Lamberth’s ruling in the District Court for the District of Columbia case).  Nonetheless, these articles have a lot to offer in terms of understanding the broader issues at stake in the ongoing litigation (the first three articles) and in terms of reform efforts going forward (the last two articles).

Performance-Based Consumer Law

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Lauren Willis has posted Performance-Based Consumer Law to SSRN. This article

makes the case for recognizing performance-based regulation as a distinct tool in the consumer-law regulatory toolbox and for employing this tool broadly. Performance-based consumer law has the potential to incentivize firms to educate rather than obfuscate, develop simple and intuitive product designs that align with rather than defy consumer expectations, and channel consumers to products that are suitable for the consumers’ circumstances. Moreover, the process of establishing performance standards would sharpen our understanding of our goals for consumer law, and the process of testing for compliance with those standards would produce data about how to meet those goals in a continually evolving marketplace. Even if performance-based regulation does not directly lead to dramatic gains in consumer comprehension or marked declines in unsuitable uses of consumer products, the process of establishing and implementing such regulation promises dividends for improving traditional forms of regulation. (1)
This seems like a pretty radical change from our current approaches to the regulation of consumer financial transactions. Willis argues that disclosure does not work (no argument there) and industry can easily circumvent bright line rules (no argument there). She claims that a suitability regime, like ones that exist in the brokerage industry, offer a superior alternatives.  She writes,
Suitability standards would be closer to traditional substantive regulation, but more flexible. Regulation might define suitable (or unsuitable) uses of types or features of products, or firms might define suitable uses of their products, provided that they did so publicly. Although suitability might be required of every transaction, testing every transaction for suitably would often be prohibitively expensive and ad hoc ex post enforcement would create only limited incentives for firm compliance. Better to set performance benchmarks for what proportion of the firm’s customers must use the products or features suitably (or not unsuitably) and use field-based testing of a sample of the firm’s customers to assess whether the benchmarks are met. Enforcement levers could include, e.g., fines, rewards, licensing consequences, regulator scrutiny, or unfair, deceptive, or abusive conduct liability. (4)
This is certainly intriguing. But just as certainly, one can see the consumer finance industry raising concerns about a lack of clear rules to guide their actions and the after-the-fact evaluations that this approach would subject them to. Willis is too quick to reject such concerns, but they are legitimate ones that would need to be addressed if performance-based consumer law was to be widely adopted. Nonetheless, this is an intriguing paper and its implications should be further explored.

Financial Literacy Literacy

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Personally, I was disappointed by the CFPB’s Financial Literacy Annual Report. It seems to me that the Bureau’s Division of Consumer Education and Engagement is thinking too small in setting forth its research agenda. For its financial education evaluation project,

The Bureau is conducting a quantitative evaluation of two existing financial coaching programs. Financial coaching generally involves one-on-one sessions with clients to increase clients’ awareness of their financial decisions and to provide support for clients to reach financial goals mutually set by the coach and client. (46)

Seems to me that there are some fundamental questions about financial literacy that need to be studied before small, resource-intensive projects like financial coaching are. I have blogged about these issues before, but the bottom line is that there is no solid empirical evidence that financial education achieves good results in general. So why study particular initiatives?

I would like to see the Bureau engage in a broad survey of financial literacy first and then develop a research agenda that reflects the big issues, including

  • do improved disclosures improve outcomes for consumers?
  • do consumers have the basic math skills to take advantage of disclosures?
  • what useful metrics exist for measuring the impact of financial literacy initiatives?

These are just a few big questions that I would want to answer before I looked at particular programs.

The Bureau should start from the premise that we have little reason to believe that financial education works.  Let’s build up a body of knowledge from there. If we assume that it works, as the Bureau’s current research agenda implies, then that assumption can lead us on a wild goose chase as we study program, after initiative, after project, looking for that golden-egg laying goose.