by Mitria Wilson
It has been nearly four years since the Consumer Financial Protection Bureau (CFPB, Bureau, or Agency) first opened its doors. In that time, the independent federal agency has produced a slew of rules and regulations governing the financial services marketplace, engaged in a series of enforcement actions to reign in abusive practices, and embarked upon the course of providing much-needed consumer education and industry guidance. Yet, the Agency’s efforts in these respects have not been without criticism. Indeed, some in Washington and the financial services industry have questioned the very necessity of a federal consumer protection agency focused upon financial services—challenging everything from the Agency’s rulemakings and its objectivity, to its funding and autonomy.
Despite the vocal protests of these critics and their misgivings, the creation of the CFPB is likely the most positive and enduring accomplishment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). An honest reflection on its efforts so far suggests that this independent agency has embodied its mandate – protecting consumer finances, while benefiting both financial service providers and the financial marketplace as a whole. How? The answer is relatively straightforward. By serving as the principle catalyst of the federal effort to balance information asymmetry between sellers and consumers in the financial marketplace, the Bureau’s efforts promote stability for both groups. Both consumers and financial service providers that offer competitive, sustainable financial products benefit from the opportunity to exercise safer choices in a marketplace that rejects many of the real-life pitfalls associated with the principle of “caveat emptor.”
Caveat emptor, a Latin phrase meaning “let the buyer beware,” dominated early legal understanding of the rights and responsibilities of American consumers in the marketplace. The principle, which operated in practice long before, but was first legally adopted by the United States Supreme Court in Chief Justice John Marshall’s 1817 opinion in Laidlaw v. Organ, places the burden exclusively on consumers to perform all necessary due diligence when purchasing a product, service, or good. The result was that consumers, no matter how defective the product or service, had no meaningful legal recourse or redress. Yet, experience proved that, despite their best efforts, consumers often suffered from an information asymmetry that unfairly benefitted sellers by allowing the true nature of the quality (or lack thereof) of the sellers’ products or services to remain opaque. Therefore, even the most thorough of consumers were subjected to potentially meaningful harm.
The United States was first among modern nations to recognize this disparity. Throughout our history, this nation has led the charge in rejecting “caveat emptor” as an absolute doctrine in favor of establishing meaningful consumer protections designed to level the information playing field between sellers and consumers in the areas where it matters most. In 1906, the United States passed the Pure Food and Drugs Act, a law that firmly cemented the primary role of the Food and Drug Administration to act as a federal consumer protection agency. Likewise, the federal government established the National Highway Traffic Safety Administration in 1966 as a direct effort to ensure uniform safety standards for the cars we drive under the National Traffic and Motor Vehicle Safety Act. Finally, the Consumer Product Safety Commission ensures that buyers of physical products don’t have to worry about their televisions catching on fire or having their microwaves explode. Yet, in the area of financial products and services, similar singular federal oversight and uniform safety standards designed to protect consumers—especially consumers of mortgage products—remained largely unavailable.
Fast forward to 2007. That summer, a Harvard law professor specializing in bankruptcy law introduced the concept of consolidated federal oversight of consumer financial protections with a single, straightforward contention:
“If it’s good enough for microwaves, it’s good enough for mortgages.”
That thesis, made by Elizabeth Warren, is the genesis of the Consumer Financial Protection Bureau and indeed many of the mortgage reforms enacted under Dodd-Frank. As now Senator Warren explains, when it comes to mortgages and other financial products and services, “families need to know there is a strong and independent watchdog on their side in Washington.”
Recent history supports the Senator’s contention. In the aftermath of the housing crisis, Fannie Mae estimates show that 50 percent of subprime borrowers actually qualified for prime loans. Yield spread premiums were found in 85 to 90 percent of those mortgages. At a hearing before the Senate Banking Committee, Scott Stern−CEO of Lenders One−explained concern about the environment as follows:
“The truth is that many of us in the industry were deeply distressed by the growing practice of pushing high risk loans on borrowers who had no reasonable expectation of being able to repay the mortgage. Disclosures were often less than adequate, and faced with a bewildering array of loan terms, borrowers tended to trust their mortgage banker or broker. The broken trust that resulted has damaged borrower confidence in the mortgage industry.”
Too many lenders made consumers high risk, often deceptively packaged, home loans without either assessing whether borrowers could repay the loans or while knowing full well that borrowers would be incapable of repaying the loans. The underlying assumptions that support caveat emptor, the idea that sellers and consumers occupy equal bargaining positions and that they share access to the same information governing a loan product’s quality or suitability, were simply untrue at the height of mortgage lending during the housing bubble. We don’t permit unsafe products in the market generally, and this principle should also apply to financial products, especially given their potential to cause individual and widespread harm, as shown in the housing crisis and ensuing Great Recession. Modern notions of justice, fair dealing, and sound public policy necessitated the change to a new regulatory framework with a new regulatory body at its helm. Dodd-Frank accomplished that goal by the creation of the CFPB and the protections afforded by Title XIV.
A Measured and Balanced Approach
From its inception, the CFPB has suffered from attacks labeling it as an unnecessary, overreaching, and even lawless agency. Yet, reflection on the agency’s activities—free of political grandstanding and hyperbole—reveals that the Bureau has adopted fairly measured approaches. Examples of this restraint are perhaps best exemplified by the Bureau’s mortgage rules under the Ability-to-Repay (ATR) standard and Qualified Mortgage definition (QM).
Dodd–Frank creates a series of bright line rules to protect consumers from the abusive mortgage lending practices that led to the Great Recession. In implementing those mandates through regulations, the CFPB has sought to strike a balance between protecting consumers and maintaining access to credit.
For example, because of Dodd-Frank and the CFPB’s reforms, all lenders must now assess a mortgage borrower’s ability to repay a loan. In many ways, this requirement reasonably evaluates a borrower’s ability to repay a mortgage loan is the centerpiece of Title XIV and Dodd-Frank’s mortgage provisions. The standard was written into law to place homeowners and the sustainability of their loans at the core of how mortgage loans are made in the United States. As a result, it discourages market forces that previously caused responsible originators to “race to the bottom” in order to preserve market share and remain competitive.
The CFPB’s Qualified Mortgage definition, which provides a presumption of compliance with the ability-to-repay standard for lenders that issue qualifying mortgages, prioritizes features that generally result in more sustainable lending for borrowers. Generally, a mortgage loan satisfies QM criteria if: 1) it is fully amortizing (i.e., no interest-only or negatively amortizing loans; 2) the points and fees do not exceed 3 percent of total loan amount, with larger percentages for small loans; 3) the terms do not exceed 30 years; and, 4) the rate is fixed or, for adjustable-rate loans, has been underwritten to the maximum rate permitted during the first five years. The decision to grant QM loans the strongest legal presumption available, a legal safe harbor, rather than a rebuttable presumption, was widely opposed by consumer advocates. Nevertheless, the CFPB felt that it was important to give originators greater certainty that they would face no legal liability if they chose to issue loans satisfying the definition.
In adopting the Qualified Mortgage rule, the CFPB also explicitly rejected the idea of one-size-fits-all regulation. Instead, the agency consciously carved out exemptions meant to address geographic and business-scale differences in the mortgage market. For example, mortgages originated by eligible small creditors can obtain QM status if the loan meets the adjusted points and fees thresholds, is fully amortizing, does not include interest-only payments, and has a term of no more than 30 years. In addition, the lender is also “required to consider the consumer’s DTI ratio or residual income and to verify the underlying information.” However, these lenders do not need to meet the 43 percent DTI ratio threshold or use the DTI ratio standards. These rules are designed to provide greater flexibility to smaller creditors and are crafted in a way that is designed to reflect their business model. Small creditor loans, for example, must be held in portfolio for three years to attain permanent QM status recognizing these lenders’ tendency to rely upon a portfolio lending model naturally.
The CFPB has also developed a successful track record in adapting regulations to ensure that the market remains competitive for smaller lenders. For example, the CFPB recently requested comment on whether to increase the 500 first-lien mortgage cap under QM’s small-creditor definition. The Center for Responsible Lending expressed support for a reasonable increase of the 500-loan cap, limiting any potential increase to rural banks or for loans held in portfolio. The CFPB’s proposal quadruples the limit, expanding the loan origination cap for small lenders from 500 first-lien mortgages to 2,000. This 2,000 limit is exclusive of loans held in portfolio by both the creditor and its affiliates.
In addition, the CFPB has proposed to only include first-lien mortgage originations of a small lender and its affiliate’s assets toward the current $2 billion asset cap. And, to accommodate concerns that the definition of a “rural and underserved” area is too narrow, the CFPB has proposed expanding the definition of rural areas by including any non-urban census blocks as defined by the U.S. Census Bureau. Finally, the CFPB is also proposing to allow grace and qualifying periods for small creditors to adjust to current and proposed standards.
While reasonable minds may not always agree on all specifications of the CFPB’s proposals, its seems rational to acknowledge and support the bureau’s ongoing efforts to reasonably explore how mortgage rules can further accommodate lenders, services, and other industry participants to facilitate access, while balancing the interests of consumers.
Preserving Independence
Given the mandates imposed by Dodd-Frank on the CFPB, a need to maintain the Agency’s independence remains a paramount concern. Lawmakers initially sought to ensure the Agency’s strength and autonomy through three core actions: (1) establishing automatic funding through the Board of Governors of the Federal Reserve separate from the annual appropriations process, (2) granting the agency a broad scope of legal authority, and (3) consolidating the agency’s leadership structure into a single, independent director who— after appointment and confirmation—is only removable for cause during a five-year term. President Bush and a broad bipartisan Congress enacted these same measures in the Housing and Economic Recovery Act of 2008 when creating the Federal Housing Finance Agency. The goal for both entities was the same: to ensure it they have the means, independence, and authority to do the job well.
Multiple pieces of legislation introduced by the 114th Congress seek to chip away at the CFPB’s independence in each one of these areas. These efforts are inconsistent with the funding practices of other federal financial regulators, the need for regulatory certainty and consistency in the mortgage and broader financial markets, and undermine the benefit of uniformity that is achieved by having a single regulator possess consumer protection oversight over market players of various sizes. Thus, rather than helping, they actually hurt the very markets and market players some policymakers are aiming to protect. That result is not only bad for consumers, but also ominous for a mortgage market still attempting to fully recover from the financial crisis.
In the four years since the CFPB has opened its doors, the mortgage market has experienced more certainty, home loans and their terms have become safer for and more transparent to consumers, and−contrary to some of the most dire predictions−even the market for non-qualified mortgage lending continues to grow. The sky is not falling. To the contrary, because of the CFPB and its rulemakings, it may actually be opening up in a way that allows mortgage lenders to fairly compete for consumers’ business based on product quality and price. Considering where we’ve been, that sounds like a giant step forward in the right direction.
Mitria Wilson is Vice President of Government Affairs and Senior Counsel at the Center for Responsible Lending. She has spent the last 15 years working on housing finance, economic development, wealth inequality, short-term lending, consumer protection and affordable housing issues. Mitria can be reached at: Mitria.Wilson@responsiblelending.org.
The post Balancing Caveat Emptor: Why the Consumer Financial Protection Bureau is Good for America, its Consumers, and the Providers of Financial Services appeared first on Mortgage Compliance Magazine.