The Consumer Financial Protection Bureau (CFPB) has finalized the “ability to repay” regulations requiring lenders to verify that home buyers can afford the mortgages they receive.
There was a time when this would have sounded like common underwriting sense to lenders and borrowers. But in the wake of the financial implosion – caused in no small part by reckless and abusive mortgage lending ― it sounds almost revolutionary.
"I firmly believe that if the ability-to-repay rule we are announcing today had existed a decade ago, many people…could have been spared the anguish of losing their homes and having their credit destroyed,” Richard Cordray, director of the CFPB, said in announcing the new rules.
The Dodd-Frank Financial Reform legislation mandated the ability to repay requirement, directing regulators to define a category of “qualified mortgages” that would be deemed to comply. The CFPB has defined as plain vanilla"lower-priced loans that are typically made to borrowers who pose fewer risks." This definition excludes loans with points and fees exceeding 3 percent, no- and low-documentation loans (known less than affectionately as “liar loans”) as well as mortgages with risky characteristics balloon payments, interest-only payments, negative amortization and terms longer than 30 years.
The rules specifically require lenders to base underwriting decisions on the actual principal and interest payments over the life of the loan (not on “teaser” rates in effect during a limited introductory period) and to consider eight specific underwriting criteria:
- Debt-to-income ratio (which can’t exceed 43 percent)
- Current income or assets;
- Employment status
- Current and expected earnings;
- Credit history;
- Monthly payments on the mortgage
- Other mortgage-related obligations and loans associated with the property
- Other debt obligations and
- Borrower’s ability to assume more debt
On the key issue concerning lenders and consumer advocates – how much of a “safe harbor” to carve out for qualifying loans – the CFPB essentially ‘split the baby’ offering broad protection from liability for prime loans made to borrowers posing little risk, but less protection for higher cost (mainly subprime) loans made to less credit-worthy borrowers. Lenders originating qualified mortgages in both categories are assumed to have met the base line requirement that they verify the borrower’s ability to repay. But while that establishes a safe harbor for prime loans, it creates a “rebuttable presumption” for high-cost loans, allowing borrowers to sue if they can demonstrate that they, in fact, lacked the income to make the required payments.
And the safe harbor for prime loans isn’t absolute, according to a CFPB fact sheet, which notes, “Consumers can still legally challenge their lender under this rule if they believe that the loan does not meet the definition of a qualified mortgage. This does not affect the rights of a consumer to challenge a lender for violating any other federal consumer protection laws,” the agency emphasizes.
Lenders, who generally viewed the rules as less restrictive than they had feared, were particularly relieved by the safe harbor, which turned out to be broader than they had expected. Consumer advocates were disappointed with the bifurcated approach for that reason.
"Even those with prime qualified mortgages can inherit discrimination," Lisa Rice, vice president of the National Fair Housing Alliance, said during a CFPB field hearing discussing the new rules. "We have to be ever mindful and watchful …to make sure that a tiered system does not perpetuate a situation where we have … a dual market," she warned.
Although pleased by the liability protection, some lenders expressed concern that the rules will perpetuate a conservative lending framework that many think is already too restrictive, with particularly negative consequences for lower-income borrowers dependent on subprime loans.
"The rule is certainly going to make it tougher and more expensive" to sell subprime loans, said Doug Rossbach, vice president and head of the financial services network at the consulting firm Northfield Highland, told American Banker. "Could a secondary market evolve outside those guidelines? It could,” he agreed, “but it's going to be expensive to the borrower."
Responding to concerns about the potential impact on credit availability, the CFPB decided to phase-in the debt-to-income limit over 7 years or until Congress restructures Fannie Mae and Freddie Mac, accepting as “qualified” loans with higher ratios, as long as they meet the secondary market underwriting requirements established by Fannie Mae or Freddie Mac.
The CFPB also exempted from the QM requirements smaller banks and credit unions with assets of less than $2 billion from the QM requirements (as long as they retain loans in their portfolio) and loan originated by ‘community development financial institutions, which would include credit unions that qualify for the National Credit Union Administration’s CDFI designation. These exemptions could make smaller institutions more competitive in the mortgage market, some industry executives believe.
“A long-term consequence of this rule is it could shift at least a certain class of borrowers toward community banks and away from the big national players because community banks will have more flexibility,” s Camden Fine, president and chief executive of the Independent Community Bankers of America, told the Washington Post.
Housing industry executives and analysts have been cheering the housing market recovery, proclaiming it strong and sustainable. But not everyone is convinced. The main problem, Quinn Eddins, director of research a Radar Logic, believes, is that it is investors, not homebuyers, who are driving the positive numbers, and those investors aren’t buying from home builders or home owners; they are buying from financial institutions selling foreclosed properties and from other investors who are selling distressed properties they’ve acquired.
“Some commentators suggest that investor-driven home price appreciation could spur demand among housing consumers, which will in turn bring about a broad-based and sustainable recovery in the nation’s housing markets,” Eddins wrote in a recent market report. And that may be the case, he said, “but we are skeptical of this theory.”
Because “traditional” homebuyers are still pretty much sidelined by conservative underwriting guidelines, Eddins argues, “it is hard to see a direct connection between the current increase in institutional demand and future gains in household demand.” Equally problematic, he suggests, the strategy investors are using – buying foreclosed properties and renting them – will eventually kill that business model, because it will push prices up to the point at which “the economics of buy-to-rent strategies no longer work.”
Rather than the sustainable recovery other analysts see, Eddins anticipates another negative cycle, with falling demand from investors increasing the REO inventories of banks and pushing prices down again, until investor demand recovers, starting the current trend over again – invests will dominate the market, pushing sales and prices upward. This cycle will continue, Eddins predicts, “until consumer demand recovers and drives a real recovery in housing values.”
Biting the Hand...
American International Group has decided not to join in a $25 billion investor suit challenging the federal bail-out that, by all accounts, prevented AIG’s collapse when the financial markets melted down in 2008. Reports that the company was contemplating the legal action met with a combination of disbelief and outrage and no small amount of derision from government officials, media commentators and business executives.
Several members of the House signed a letter telling the AIG Chairman, “Don’t do it. Don’t ever think about it.”
“We should counter-sue for stupidity," Robert Reich, Secretary of Labor under former President Bill Clinton and now a Berkeley professor, suggested in a widely repeated tweet. Humorist Andrew Borowitz, meanwhile, wrote a satirical letter, purportedly from AIG to taxpayers, explaining that the company was simply “standing up for one of the most precious American rights of all: the right to sue someone who has just saved your life." The letter added that AIG was seeking additional bail-out money to finance the suit.
The suit triggering this storm and fury was filed by AIG’s long-time CEO, Hank Greenberg, who was forced to resign in 2005 because of an accounting scandal and has been something of a gadfly for the company ever since. Greenberg now owns a 12 percent stake in AIG through his company, Starr International, and has been pressuring the AIG board to join his suit on behalf of shareholders. The suit doesn’t suggest that the bail-out, which pumped $182 billion of federal money into the company, was unnecessary; but it does contend that the terms of the rescue — imposing an excessive interest rate (14 percent) and giving the government a 92 percent stake in the company – were onerous, amounting to, what the suit argues is an unconstitutional taking of private property without compensation.
A federal judge in Manhattan dismissed the suit, agreeing with the government’s key point – AIG was not forced to accept the loan from the Federal Reserve; it could have chosen bankruptcy instead – the only other alternative available at the time. “The company voluntarily accepted the hard terms offered by the one and only rescuer that stood between it and imminent bankruptcy,” the court concluded. The Court of Appeals for the Second Circuit has agreed to hear Greenberg’s appeal of that decision and has been waiting for the AIG board to decide whether to join the suit or not.
Critics roundly criticized AIG’s contemplation of the suit as tone deaf at best and insulting at worst. But some who shared that consensus view also acknowledged that, tone deaf or not, the board had a fiduciary obligation to consider the suit (or at least, appear to do so), and could be subject to a shareholder suit if it declined to do so.
The decision not to become involved “was about continuing to move this company forward, not backward," Robert Benmosche, A.I.G.'s chief executive and a director, explained in an internal memorandum to employees. "We as a company have kept our promise to return every dollar America invested in us, plus a substantial profit," he added.
Still, coming shortly after AIG had released a national television advertising campaign entitled, “Thank You America,” the timing of the board meeting to consider the suit couldn’t have been worse, highlighting the board’s uncomfortable position and making it difficult to counter the perception that the company was “biting the hand that rescued it.”
Some commentators suggested that the prospect of AIG suing the government was not all that different from the government suing JPMorgan for violations perpetrated by Bear Sterns, which the government had urged JPMorgan to acquire. “This is a story of a dog biting another dog,” one Bloomberg columnist noted. But, he acknowledged, “that doesn’t make the potential litigation any easier for taxpayers to swallow.”
Pulling the Plug
The $10 billion settlement agreement the Office of the Comptroller of the Currency (OCC) and the Federal Reserve announced earlier this month resolves allegations of widespread foreclosure abuses by 10 of the nation’s largest banks, ending the threat of ongoing litigation for those institutions and pulling the plug on the ill-fated and (most agree) ill-conceived government program designed to identify and compensate homeowners whose foreclosures were, or may have been, flawed.
Under the deal, the financial institutions will pay $3.3 billion directly to compensate borrowers plus an additional $5.2 billion in general mortgage-related assistance. The four remaining banks in the group targeted in this litigation are expected to accept the agreement as well.
The agreement came as criticism of the flawed foreclosure review program intensified. Press reports, including a detailed investigative report by American Banker, noted that the borrower-by borrower file reviews the regulators had mandated were taking longer than expected and producing relatively little compensation for borrowers, while netting the consultants conducting the reviews close to $1 billion in fees.
Fitch Ratings gave the agreement a thumbs up, saying it would enable the servicers to disentangle themselves from the review process and “refocus on completing other initiatives.” The agreement “also makes the final compensation structure clear and eliminates further cost for the independent reviews that will allow the servicers to better establish their future cost to service and potentially allow funds to be released for improvements in the quality of their services,” the Fitch analysts said.
While hardly anyone appeared to mourn the loss of the foreclosure review program, many consumer advocates and some legislators complained that the settlement agreement itself left much to be desired. For all its flaws, critics said, the foreclosure review was at least intended to identify the borrowers who had been harmed and assess the extent of their damages.
“It’s absurd that this money will be distributed with such little regard to who was actually harmed,” Bruce Marks, the chief executive of the nonprofit Neighborhood Assistance Corporation of America, told the New York Times.
Times columnist Joe Nocera outlined a laundry-list of problems with the settlement, among them: “It’s more about public relations than problem-solving; it failed to identify individuals responsible for the foreclosure abuses; and “it won’t actually help anybody.” The $3.3 billion in compensation will amount to an average of $1,150 for everyone who lost a home, which, Nocera noted, “doesn’t come close to making them whole.” . But the biggest problem, Nocera agreed, is the one cited by the NACA’s Marks: “The money is being distributed with no regard to whether a borrower suffered harm.”
Sheila Bair, former chairman of the Federal Deposit Insurance Corporation (FDIC), who had opposed the foreclosure review program when she headed the agency, was somewhat more sympathetic to the OCC. “This thing is a big mess which was dumped in the lap of the current OCC leadership,” she told the Times. “They are trying to make the best out of a very bad situation.”
Piling it On
In the wake of the economic downturn and the financial crisis that triggered it, American consumers have generally been paring credit card (and other) debt – “getting their financial house in order” is the typical, approving description of that trend. But while their parents and grandparents have been assiduously shedding debt, young adults, have been piling it one.
That’s the conclusion of a recent study, comparing the borrowing and repayment habits of consumers in different age groups with similar educations, incomes and family status. The study found that young adults born between 1980 and 1984, as a group, have $5,689 more credit card debt than their parents had at the same age and $8,156 more than their grandparents. And they tend to repay that debt more slowly – 24 percent more slowly than their parents and 77 percent more slowly than their grandparents.
The key concern, the study notes, is not just the current debt load for young adults, but what it suggests about their long-term financial future.
"Our projections are that the typical credit card holder[s] among younger Americans who keep a balance will die still owing money on their cards," Lucia Dunn, a professor of economics at Ohio State University and a co-author of the study, said in a press statement.
The ready availability of credit, lower interest rates and more relaxed attitudes toward acquiring debt are all contributing to the trend,” Dunn said. But “if our findings persist,” she warned, “we may be faced with a financial crisis among elderly people who can't pay off their credit cards."