Sunday, November 19, 2017
Now that Richard Cordray is on his way out as director of the Consumer Financial Protection Bureau (CFPB), banking and financial services lobbyists are gearing up to attempt to unwind some of the bureau’s regulatory work and to put a halt to some of its more aggressive enforcement actions.
And it looks like they’ll likely get their way since President Trump appears to be ready to appoint (at least on an interim basis) the current director of the White House Office of Management and Budget, Mick Mulvaney.
For property professors (particularly the housing and real estate folks), there are some important things we should be on the look out for as things unfold. This is because the CFPB has played a major role in reshaping the way Americans have access to property—or more specifically, how they have access to mortgage credit that leads to homeownership.
One of the most important aspects of the Dodd-Frank Act when it comes to mortgage lending was the creation of a rule that requires firms that originate mortgage loans to make a good faith determination that the borrower has the ability to pay the loan. This may seem obvious, but in the lead-up to the 2008 crisis it was far from a universal practice. In fact, it was not at all uncommon for a mortgage lender to extend credit to a borrower using only the individual’s “stated income” on the loan application, without the lender ever conducting any independent verification or requiring documentation. This was often called “low-doc” or “no-doc” lending because hardly any documentation about the borrower was needed to advance credit. In certain instances the borrower could put down any number they wanted and the lender would nevertheless make the loan, relying solely on the ever-rising value of the real estate subject to the mortgage.
Mortgage lenders would also manufacture pay stubs, employment data, and income information in order to form the basis of mortgage underwriting. And some mortgage lenders—far from being concerned with a borrower’s credit worthiness—would actually encourage their employees to disregard a borrower’s actual ability to repay. One company called Long Beach Mortgage required little documentation, often accepting letters of credit from landlords, fake tax returns, or suspicious-looking pay stubs in lieu of verified statements of income. One former employee said that higher-ups at the company would frequently offer gifts to the loan reviewers in exchange for looking the other way on questionable loan applications. Antoinette Hendryx, a former loan reviewer for Long Beach Mortgage, said “’They’d offer kickbacks of money’” or said things like “’I’ll buy you a bottle of Dom Perignon.’ It was just crazy.”
So Dodd-Frank aimed to force mortgage lenders to study a borrower’s actual ability to repay a loan before extending credit. Dodd-Frank also empowered the CFPB to create a rule that would set forth a safe harbor for how lenders could meet the ability to repay requirement. This safe harbor rule (called the “Qualified Mortgage”) essentially states that if a lender makes a loan that is very “vanilla” (i.e., no predatory or out of the ordinary features, regular payment structure, fully amortized, etc.) then that lender will be deemed to have met the standard. As I’ve written here, lenders have fully embraced the Qualified Mortgage. Indeed, mortgage origination data indicate that something like 99 percent of all new mortgage loans are “Qualified Mortgages.”
But many lenders and industry advocates have argued that the Qualified Mortgage is hurting mortgage lending. And the Trump administration (via a report by the U.S. Treasury Department this past summer) indicated that it desired to loosen the ability to repay rule and change the qualified mortgage. Those goals might very well be met under a Director Mulvaney.
I wrote back in October of last year (here) on this blog that lending for low- to moderate-income borrowers and borrowers of color is indeed down. And total loan originations between 2014 and 2015 definitely took a dip (table with origination numbers for comparison here). But is the Qualified Mortgage and the Ability to Repay the reason for this?
A few months ago in September 2017, Federal Reserve researchers, using Home Mortgage Disclosure Act data, studied the decline in lending to low-income borrowers by major, traditional financial institutions. I thought their findings were interesting and useful in thinking about the causes of credit tightening. Quoting from their paper:
The Decline in FHA Lending
A second trend in the mortgage originations of the largest banks that might help explain their declining [low- and moderate-income (LMI)] share is a coincident decline in their origination of loans insured by the Federal Housing Administration (FHA). FHA insurance protects lenders against losses in the event of borrower default, and so allows borrowers with relatively small down payments or relatively low credit scores to access mortgage credit they might otherwise be denied. FHA loans are disproportionately used by LMI borrowers for these reasons.5
As shown in figure 3, the FHA share of loans originated by the three largest banks fell from 43 percent in 2010 to just 5 percent in 2016. Because FHA loans are much more likely to be originated to LMI borrowers, this decline is likely related to these banks' decrease in LMI lending. The share of FHA lending also declined for other banks and for nonbank lenders, though not as sharply as for the largest three banks.
The disproportionately large decline in both LMI and FHA lending by the largest three banks raises two questions. First, why did these largest three bank lenders reduce their FHA originations by more than other lenders during this period? Second, how much of the "excess" decline in lending to LMI borrowers by the three largest banks can be accounted for by the larger decline in FHA mortgages?
Reasons for the Decline in FHA Lending
One possible reason for the disproportionate decline in FHA lending by the largest banks could be related to recent litigation brought against them by the Department of Justice under the False Claims Act. The Department of Justice has argued that lenders who improperly certify mortgages as eligible for FHA insurance may be held liable for making false claims to the United States government, subjecting them to treble damages. Since 2011, the Department of Justice has sued a number of large mortgage lenders for violations of the False Claims Act, including each of the largest three bank lenders. The costs of these lawsuits have been large: for example, Wells Fargo reached a $1.2 billion settlement with the Department of Justice in 2016. While other lenders have also been targeted in these lawsuits, large banks have been particularly explicit about the effect of these lawsuits on their FHA lending. For example, in an April 2015 letter to shareholders, JP Morgan Chase CEO Jamie Dimon explained that the company had reduced its FHA lending in part because of the risk "from the penalties that the government charges if you make a mistake."
Several other factors have also contributed to the overall decrease in FHA lending since 2010. First, rising FHA insurance premiums over this period likely shifted demand away from the FHA. Second, lenders have faced significant uncertainty around the FHA's "indemnification" policy, which defines circumstances under which FHA insurance is voided because the loans are judged to be improperly underwritten. Third, the cost of servicing a delinquent FHA mortgage rose significantly during this period. While each of these factors likely raises the expected costs associated with FHA-guaranteed mortgages for all lenders, they could have induced larger reactions from the large bank lenders, whose overall profits are less dependent on their mortgage lending business.
So I think we need more data and analysis in order to better assess the effect of the Qualified Mortgage and the Ability to Repay on mortgage lending and the availability of credit. In another Fed study that was done in 2014 (which was the year that the new CFPB rules went into affect—although many lenders already started to comply the year before just to get ahead of the game), the data indicated that the rules caused no material difference in mortgage lending. Will the new CFPB director go through a probing process before making substantial changes to these important underwriting rules? And if they change, what will mortgage underwriting look like in the future? We’ll have to wait and see.
(Photo Credit Above: Athens Area Habitat for Humanity)