Thursday, March 31, 2011

The Judge Weighs In

Yesterday afternoon, after two days of waiting, our inboxes began to fill up with announcements that the federal judge reviewing the requests for an injunction to prevent implementation of the Fed Rule on loan originator compensation  had denied the requests filed by NAMB and NAIHP.  To most of us, I am sure that the judge's ruling was not a surprise.  Personally, I would have been shocked to see a ruling issuing a preliminary injunction.  But I was very interested to see why the judge ruled as she did.  A friend in Dallas emailed Judge Beryl Howell's opinion on the case and reading it this morning was very enlightening.  So today, I want to share the key points with all of you.

First, a little background.  Judge Howell is an Obama appointee who is likely to be sympathetic to one of the Administration's key pieces of legislation--the Dodd Frank bill.  So her political sympathies likely impacted her decision.  But her key points spelled out in the 46 page memorandum show that she has actually thought about the issue and they give us a good idea of where we as an industry stand now--one day prior to implementation of the Federal Reserve Rule.

NAMB and NAIHP filed suits asking for a preliminary injunction to keep the Fed Rule from being enacted tomorrow.  Judge Howell writes in her opinion that, in order for an injunction to be granted, four criteria must be met. "To warrant injunctive relief, the plaintiff 'must establish that he is likely to succeed on the merits, that he is likely to suffer irreparable harm in the absence of preliminary relief, that the balance of equities tips in his favor, and that an injunction is in the public interest'....The purpose of a preliminary injunction 'is merely to preserve the relative positions of the parties until a trial on the merits can be held.'..."Without a 'substantial indication' of the plaintiff's likelihood of success on the merits, 'there would be no justification for the court's intrusion into the ordinary processes of adminstration and judicial review.'"  This is key, because in each of the areas that NAMB and NAIHP were requesting relief, the judge found that the plaintiffs had very little likelihood of "success on the merits" and there was, therefore, no reason to grant the injunction.

Regarding the issue of whether the Federal Reserve Board has the authority to issue the loan originator compensation rule, Judge Howard found that they do.  "Based on the current record, the Court believes that proposed regulations are (e) rational and directed toward preventing unfair practices, within the meaning of that term in Section 5 of the FTC Act.  The Congress delegated the Board broad authority under TILA and HOEPA. As the Supreme Court noted, a Court that disregards the Board's views with regard to TILA 'embarks on a voyage without a compass' because proper regulation of the lending industry 'is an empirical process that entails investigation into consumer psychology and that presupposes broad experience with credit practices. Administrative agencies are simply better suited than courts to engage in such a process.'"

Most interesting of all was the court's assessment of the inevitable destruction of the small mortgage broker as a result of this rule.  "Regarding the Rule's likely adverse effect on small mortgage brokers, the Board concluded that 'the benefits of the prohibition to consumers outweigh the associated compliance costs....In reaching this conclusion, the Board considered studies about the benefits of independent mortgage brokers to consumer choice and costs, but found them 'not dispositive.' It also indicated its belief that the Rule would not 'require small brokerage firms to go out of business,' since creditors rely on them, and its optimistic view that 'new business models' will allow them to compete."  A major part of the request for an injunction centered around NAIHP's and NAMB's claims that the Rule will do "irreparable harm" to the small mortgage broker community.  In her opinion, Judge Howell defined the legal standards of irreparable harm.  She wrote that the D.C. circuit court has set a standard for irreparable harm that "must be both certain and great; it must be actual and not theoretical."  Irreparable harm may not be merely economic harm; to meet the legal definition the plaintiff must be able to prove that the harm is so great that it will actually cause the affected businesses to cease to exist. Merely losing money does not meet the standard. "Under this Circuit's irreparable harm standard, 'harm is that is 'merely economic' in character is not sufficiently grave'...Economic harm may qualify as irreparable, however, 'where a plaintiff's alleged damages are unrecoverable.'

Both NAIHP and NAMB argued that the rule would do irreparable harm.  Judge Howell ruled that NAIHP did not sufficiently make their case for irreparable harm  or show that the harm they were attempting to prove was "actual and not theoretical."  However, she found that the NAMB attorneys did meet the standard for irreparable harm.  NAMB provided attestations from five small business owners who testified that the new loan originator compensation rules and the prohibitions on commission-based compensation will cause them to have to lay off their loan originators and originate as one-man shops, which in turn will not allow them to generate enough income to cover their overhead.  Thousands of small brokerages will be forced to close nationwide because of the new rules, and thousands of people working in support positions for these companies will find themselves unemployed.  In response to the testimony and the attestations presented, Judge Howard wrote the following:  "NAMB has sufficiently demonstrated that its members will likely be irreparably harmed by the implementation of the Board's Rule prohibiting dual compensation for loan originators who are paid directly by the consumer. Although NAMB members face purely economic injury, they sufficiently assert that this injury will 'result in the complete destruction of their businesses' which certainly constitutes irreparable harm." 

But even though NAMB attorneys presented enough evidence to show that irreparable harm is being done, Judge Howell denied the injunction.  Why?  Because the public good being done by the rule outweighs the harm done to the small business owners in the industry. Judge Howell agrees with the FRB that the current manner of compensation to loan originators is unfair to consumers. "Under the FTC Act, a practice is unfair if it 'causes or is likely to cause substantial injury to consumers which is not reasonably unavoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition.' An injury may be considered substantial even if it 'causes a small amount of harm to a large number of people.'"  Of course, this interpretation of fairness completely obscures the fact that consumers are likelier to get a better deal when they have many options to choose from.  Rather than permitting practices which might cause "a small amount of harm to a large number of people," the judge is siding with the FRB to support a ruling which will cause a large amount of harm to a small number of people (us). "The Board has admitted in the Rule's supplementary comments that small independent brokerages and loan originators across the country will be substantially affected by the Rule and its prohibitions on certain compensation practices....Plaintiff NAMB has demonstrated that its members face irreparable harm absent an injunction enjoining the Final Rule...Although NAMB's demonstration that its members face substantial irreparable harm is compelling, the Court must consider the plaintiff's harm against both the public interest furthered by the Rule and the fact that the plaintiffs have not demonstrated a likelihood of success on the merits.  That said, the Board has reasonably concluded that the Rule will further public policy interests, a position that is further supported by the Dodd Frank Act....Based upon the record, despite the harm plaintiffs' members may face, the Court must deny the plaintiffs' motions for injunctive relief."

And that is the crux of the matter.  Yes, the mortgage brokers are going out of business; yes all of the small business owners who invested our lives, our time and our money in building our businesses are going to lose everything we have worked for.  But in the end, our demise is in the public interest, because we don't deserve to be saved.  The world is better off without us. 

Maybe the question we need to be asking is what gives a government bureaucracy or a federal judge the right to determine whether our industry has the right to exist.  Why is their definition of "public interest" more important than our survival?

Unfortunately, this case could go to 1000 judges who would probably all say the same thing.  This is not a battle which can be won in court--it has to be won in the court of public opinion which can lead to changes to the legislation behind the Fed Rule. But at least now, we know where we stand with the judge.

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Wednesday, March 30, 2011

The FDIC Announces the New Qualified Residential Mortgages

Yesterday, as most of us in the residential loan origination community waited for the outcome of the request for an injunction for the Federal Reserve's loan originator compensation rule, the FDIC made some news of its own.  FDIC chairwoman Sheila C. Bair issued a press release that the FDIC is ready to issue a proposed rule on the new qualified residential mortgages (QRMs) which will be exempt from the 5% credit risk retention rules which are required as part of the Dodd Frank bill.  

The actual proposed rule itself has not yet been published in the Federal Register.  Look for that to happen in a few days, followed by the 60 day proposed comment period.  There is so much in this rule in terms of standards for a loan to meet the criteria of a qualified residential mortgage that comments from industry participants are going to be very critical.  We will report back on that when the proposed rule is published.

Today I just want to focus on the tone of Ms. Bair's statements, because I think that her remarks in the press release speak volumes about the future, or lack thereof, of the independent mortgage originator or mortgage broker, in the brave new world of mortgage lending.

You may recall that Dodd Frank requires that the originator of the residential mortgage retains 5% of the loan as risk retention for the life of the loan.  This "skin in the game" approach is supposed to guard against making risky loans that are likely to default.  But, as with just about everything else that is happening right now in residential loan origination, the new rules work heavily in favor of large banking entities like Wells Fargo and JP Morgan Chase who can afford to retain 5% securitization.  The rule works against the smaller community banks who cannot afford to keep 5% of the mortgages on their books, and they are death to the small mortgage broker who has made his or her living by originating and selling mortgages.  Small companies like mine cannot afford to keep any part of the loans that we originate, so we are out of the game.

The caveat is the "qualified residential mortgage".  Loans that are classified as QRMs, which includes FHA, VA and, as long as they remain in conservatorship, Fannie Mae and Freddie Mac, are exempt from the 5% risk retention rule.  So these mortgages can be originated and sold as they are today.  That is the reason that the definition of the QRMs is so critical; these are the only loans that the smaller players in the real estate market will be allowed to originate.

That is what makes Sheila Bair's comments so telling. "The general rule set out in Dodd Frank is to require issuers of securitized loans to retain 5 percent interest in the risk of loss. The law provides an exception to that rule and directs the agencies to set a standard for underwriting and product features, that, as shown by historical data, result in lower risk of default such that risk retention is not necessary. The QRM is the exception, not the rule, and as such I believe it should be narrowly drawn....Because QRM loans are exempt from risk retention, the proposed QRM definition sets appropriately high standards regarding documentation of income, past borrower performance, a low debt-to-income ratio for monthly housing expenses and total debt obligations, elimination of payment shock features, a maximum loan-to-value or LTV ratio, a minimum down payment and other quality underwriting standards.  This does NOT mean that under the rule, all home buyers would have to meet these high standards to qualify for a mortgage. On the contrary, I anticipate that QRMs will be a small slice of the market, with greater flexibility provided for loans securitized with risk retention or held in portfolio."  (All emphasis in bold lettering added).

What we do know is that the new rule requires a 20% down payment, which has led the mortgage insurance company PMI to ask what role the mortgage insurance companies will play, if any, in the new mortgage world that is being written today.  What we also know is that loans sold to Fannie and Freddie will be QRMs as long as they remain in conservatorship; however, as the Obama Administration moves to shut down Fannie and Freddie and reduce the size of their portfolios as they announced in February, we will see fewer and fewer loans selling to the two agencies.

What is most amazing about this, however, is the blatant way that the federal government is redirecting the mortgage delivery system in the United States.  Five years ago, mortgage brokers originated between 65 and 70% of mortgages in the United States.  By last year that number had declined to between 10-12%.  Barring an injunction from a federal judge later today, April 1 will see a new rule implemented that will change the compensation of loan originators nationwide, most affecting the few independents left and the smaller community banks.  Now with the QRM standards, Bair is saying outright that these are to be a small slice of the market--the exception, not the rule.  That delivers the major slice of housing market pie to the banking giants.

The irony here is amazing.  Three years ago we were told that Wells Fargo and JP Morgan Chase were too big to fail.  Very little TARP money, if any, went to small regional banks or community banks.  None went to small businesses like mine.  Now three years later, the mega banks are just fine and we are too small to be of any importance.  The fact that small players are being beaten and pushed out of the residential housing market is heralded as a consumer safety issue!

Stay tuned as we examine the proposed rules in detail as more information becomes available.

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Monday, March 28, 2011

Elizabeth I

"My concern about a rule-based approach is straightforward. Putting down rules here and there can be like putting down fence posts on the prairie:  They can be too easy to run around. And when the lawyers show everyone how to jog around the fence posts, the regulator responds with more rules. Pretty soon, there are so many rules that it is hard to move. Newcomers are scared off before they start. Small competitors-- particularly in this context, community banks and credit unions--can't afford to hire an army of lawyers, which puts them at a competitive disadvantage. We can choose a better way."  (Elizabeth Warren special adviser to the Treasury Secretary for the Consumer Financial Protection Bureau as quoted in U.S. Treasury News, as part of her written testimony before the House Subcommittee on Financial Institution and Consumer Credit Committee on Financial Services.  March 16, 2011.)

On March 16, 2011 interim head of the CFPB and its de facto czar Elizabeth Warren testified before Congress as to the goals of the Consumer Financial Protection Bureau, one  most powerful organizations ever to be created within the government.  If you recall, the White House did not believe that Warren could pass confirmation so they appointed her as interim director instead.  Although Warren has testified that she is really just an adviser to the President and the Treasury Secretary, House Financial Services Chairman Spencer Bachus (R-Al) argues that she is in fact acting director and that the Obama Administration has skipped the confirmation process. Earlier this month, Bachus introduced a bill which would replace the single individual Director of the CFPB with a five member bi-partisan commission (as the legislation has been presented, no more than three members of the commission could represent a single political party, so the commission would always represent divergent views. Each member of the commission would be appointed by the President and confirmed by the Senate.)  "A balanced bipartisan commission will protect consumers without giving such incredible power to just one unelected person in Washington D.C, as the Dodd-Frank Act does," Bachus stated.  A few hours ago, Bachus's new bill picked up an endorsement from the Independent Community Bankers of America, which could help catapult the bill to passage.

Although the Bachus bill would change the structure of the leadership of the CFPB, it does not change the fact that Dodd Frank has created a massive new bureaucracy which will take power this July.  Starting July 21, the CFPB will regulate credit cards, mortgages and other financial instruments.  For those of us working in financial services who have been dealing with incredible regulatory uncertainty, statements like the one I quoted by Warren at the beginning of this post regarding rule-making just give us another reason to shudder.  We are already trying to bring our industry into compliance with complex new Federal Reserve Rules on loan originator compensation and appraiser independence with very little clarification about what those rules mean or how we are to obey them.  And this blatant lack of regard for our need for information has created fear, uncertainty and cynicism throughout our industry.  At a time when the new home sales are at their lowest levels since the government began keeping records, and housing is headed into a double dip, uncertainty about compliance is bringing the mortgage industry to a standstill. Take for example, this actual opening paragraph from a memo sent out today by a wholesaler that I use with regard to the Federal Reserve Rule, "We have made every effort to bring our valued customers the best training and most up to date, relevant information on the Fed rule changes to TILA/Reg Z. I acknowledge that these rules make little sense. The Fed has provided minimal guidance on how to comply with these rules. We have all struggled to find a single way that these changes benefit the borrower, will help the recovery of the housing market, or help avoid future problems to the housing market and the economy as a whole. But, as Voltaire famously quoted, 'It is dangerous to be right when the government is wrong.'"  Does that sound like confidence to you?

When I read Warren's statements scoffing at clear-cut rules, I cringe.  In order to comply with rules, the industry being regulated must first understand what the rules are, how to comply with the rules, and exactly what we are expected to do.  The mortgage industry is overwhelmed with compliance issues.  But Warren seems to want to move away from rules and compliance and toward the "make it up as we go along" strategy that we are now suffering through with the Federal Reserve.  And that is extremely dangerous.  While it is true that "small competitors can't afford to hire an army of lawyers," to interpret the rules, they also cannot afford massive fines and examinations if they are found in violation of some obscure regulation that they did not know existed.  "While there is certainly a place for rules aimed at specific abuses, we do not envision new rules as the main focus of how the CFPB can best protect consumers. Indeed, the ideas put forth by the Administration and the legislation adopted by Congress provided several different tools for protecting consumers precisely so that the CFPB could use the best one for the job and not be forced to rely solely on its authority to write new regulations."

Consider this:  The CFPB is responsible for supervising all non-bank financial institutions including mortgage brokers, mortgage lenders, mortgage servicers, payday lenders, and private student loan providers.  The CFPB also regulates and examines depository institutions and credit unions with more than $10 billion in assets.  Smaller banks and credit unions will continue to be regulated and supervised by the agencies who currently regulate them.  So the CFPB handles the larger players in the market and the really tiny ones--independent mortgage brokers like me. Where do you suppose that most of their regulatory emphasis will be?  According to a story by Think Big Work Small last week, Warren has stated that nearly half of her department's budget will go to regulate non depository institutions.  In her prepared testimony before the House Financial Services Committee, Warren says, "This will be the first time that many of these non-bank financial services companies will be subject to federal compliance examinations.  We intend our examinations to be conducted efficiently and in a fair and transparent manner. We will strive to enforce the federal consumer financial laws appropriately while remaining cognizant of increasing compliance costs and burdens for regulated entities."  Warren is apparently planning extensive investigations; the FY 2011 budget for the CFPB is approximately $404 million, FY 2012 budget is approximately $445 million and FY 2013 is approximately $485 million.   That's a lot of oversight to complete what Warren says are the CFPB key functions, "consumer financial education, consumer complaint intake; registration of non-banks, supervision, examination and enforcement efforts, analytical support, monitoring and research, and industry guidance and rulemaking." 

While rulemaking is a "key function" and in fact the chief rulemaker is being hired from the Federal Reserve--the agency that gave us our current nightmares with the loan originator compensation rule--Warren has far-reaching goals for her new agency.  "Just as important, in my opinion, is the need for data and data analytics to be a defining focus of the agency....The consumer bureau should not blindly follow the conventional wisdom of the time, but must be a thinking, investigating, questioning agency--and it's my hope that if the agency  is truly committed to examining data and making its decisions based on data, it can avoid capture by ideology or intellectual fashion."  The CFPB of Warren's design appears to be an ever-evolving agency which will gather data in order to determine which behaviors are acceptable and which are forbidden as it goes along.  "We have the opportunity to build a consumer bureau that is responsive to the dynamics of our time, using changes in technology to propel us....The consumer bureau can empower a well-informed population to help expose, early on, consumer financial tricks.  If rules are being broken, we don't need to wait for an expert in Washington, or the next scheduled examination to recognize the problem. If we set it up right from the beginning, the CFPB can collect and analyze data faster and get on top of problems almost as they occur, not years later...Using state of the art technology, the consumer bureau can solicit information from the American people about the benefits and frustrations that they face with consumer financial products---and it can organize that information and put it to good use...As we investigate anecdotal evidence, we can learn about good practices, bad practices, and downright unlawful practices. Then we can report on the good, the bad, and the ugly--subject, of course, to confidentiality and privacy concerns--to increase transparency and to push markets in the right directions."

There you have it--our new regulator with a massive budget, much of which is turned on small non-depository lenders, will be relying on technology and consumer complaints to decide policy and create a "thinking, investigating, questioning agency" which does not "blindly follow the conventional wisdom of the time" and which is not excessively hampered with a set block of rules.   And the current monarch of this new agency is our very own Elizabeth I, a consumer advocate whose nomination would not have been confirmed through the Senate but who is making the decisions guiding this massive, enormously powerful, well-funded beast of agency.  It is dangerous to be right when the government is wrong.

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Friday, March 25, 2011

You Die Today; I'll Wait Until Tomorrow

During the Stalin years of the Soviet Union, the nation became so destitute that eye witnesses reported that the bare earth appeared to actually be moving because the mice, rats, and other vermin were frantically searching for anything to eat.  Two men who escaped from the Soviet Union in that period knew that they had crossed the border when they found a discarded paper bag with a few crumbs left from a meal and a couple of used paper items.  Surely no one in Mother Russia would ever toss away such wealth, so they must be have made it to a neighboring country.  Neighbors betrayed neighbors as traitors to the government in order to get their government-issued apartments, since that was often the only way a young couple could hope to get their own place.  And the Soviet people coined saying in Russia which became something of a national motto, "You die today; I'll wait until tomorrow."

The small business community in the United States might want to adopt a similar mantra, considering the overall attack on small businesses taking place right now.  In fact, one of the single biggest attacks ever launched on a single industry happened April 1, and much of the non-real estate world does not even understand the implications.

We have spent weeks talking about the NAMB and NAIHP lawsuits against the Federal Reserve and the negative consequences to the housing industry and to consumers and small business owners involved in real estate. Two weeks ago,  Mike Anderson, government affairs chair of the National Association of Mortgage Brokers, put out a video warning of the potential consequences to all businesses of the Federal Reserve Rule.  I am attaching a link to Mike's video here so that you can see it for yourself.   What Mike is saying here may appear alarmist, but the truth is that the Federal Reserve has set a precedent right now which will reverberate through our entire country. 

First of all, under the guise of protecting consumers from "unfair and deceptive practices" the Federal Reserve and its legislative partner, the Dodd Frank bill, regulate the amount of money that independent self-employed business owners can charge for their services.  Our compensation is not controlled by market conditions, or consumer willingness to pay; it is actually written into law.  Second, the way in which we can be compensated is also regulated.  Dodd Frank is setting specific guidelines determining who can pay us, how we can be compensated and who cannot pay us.  We are not government contractors; we do not receive tax payer funds; we are independent small business owners who took risks and started our own companies with our own overhead and our own expenses, but our ability to set our wages is now being dictated by the government.

Another troublesome point in the Federal Reserve Board's interpretation of Dodd Frank in its new ruling is the animosity towards profitability that is being openly displayed.  In its various "clarifications" of the new Fed Rule, the Federal Reserve board keeps telling us that "profits are problematic."  Branch managers cannot be paid based on the profitability of their branches because "profits are problematic."  Prior to implementation of the Fed Rule, the Federal Reserve Board hosted a webinar which I did not participate in. According to those who did, one of the issues raised during the webinar was the matter of a mortgage broker selling his or her business for a profit.  Apparently the Federal Reserve Board attorneys believe that making a profit from the sale of a small business involved in loan originations is also a deceptive practice.

What is interesting about the FRB's problem with profit is that it is in direct conflict with IRS guidelines for small businesses.  The IRS uses profit to differentiate a business from a hobby.  So while a new business starting out is expected to have tax deductible losses in the beginning, at some point that business is expected to become profitable and that profitability generates taxable revenue.  An enterprise which never shows a profit is classified as a "hobby" and the expenses connected with it are not tax deductible.

The IRS's position is a sensible one--in this matter anyway--because the tax code is written to allow business owners to start their businesses and grow them with the expectation that they will become money-making enterprises which will contribute jobs, and revenue.  In a capitalist society, profit is both good and necessary.

But now, suddenly, profit is problematic, and fees earned by the small business owners are "unfair and deceptive practices."  This is scary language which could, and may, spread to every industry. Someday business owners in every profession may have a government agency telling them how much they are allowed to earn, how much they are allowed to pay their employees and whether they can sell their companies and for how much.  In the meantime, the rest of the country is watching us die today, and waiting for their turn to come tomorrow.

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Thursday, March 24, 2011

Suitability and Duty of Care

Most of the mortgage world is fixated on the new loan originator compensation standards being mandated next Friday by the Federal Reserve Board.  Last night, Daily Finance featured an article by Charles Hugh Smith entitled "New Mortgage Regulations Could Bruise Housing Market."  This  article was the first non-industry article that I have seen on the subject of the new loan originator compensation rules and the damaging effect that they are likely to have on the housing market.  I was truly amazed at the tone of the article and the fairness and open mindedness that Smith showed toward our industry.  It was very refreshing.

Still, when we focus simply on the compensation portion of the new rule, we are missing some key points of the regulations going into effect April 1, 2011.  The rule's language contains prohibitions on "steering" and it also creates a suitability standard for loan originators, and ultimately these two provisions may prove more troublesome to originators than the compensation portions of the new rule.

First I want to say that we are not the only industry dealing with this problem.  As part of Dodd Frank, many different financial services providers are dealing with the consequences of having a "fiduciary duty" to their clients.  Right now the SEC is crafting rules applying fiduciary duty to investment advisers.

But suitability standards create special obstacles for mortgage loan originators because they not only interfere with an individual borrower's right to make his own financial decisions about the type of mortgage that he wants, but they also contradict Fair Housing laws which require that originators treat all borrowers the same by providing equal access and opportunity to housing for all borrowers.  If we are held accountable for making sure that a borrower's loan is "suitable" for his situation, how can we provide all borrowers equal access to housing?  Simply put, we can't.

The problem with suitability is that it is a very subjective determination.  If Sally has been on her job for six months and is earning $90,000 a year, she may qualify for a 15 year mortgage, which is cheaper for her than a 30 year mortgage.  Perhaps Sally moved back in with her parents after college to save this money to buy her house.  The problem is that Sally has never owned a home before, so even though her credit is good, it is limited.  So is the fifteen year mortgage that Sally wants really suitable for her since she is a first time home buyer who is actually unfamiliar with the expenses of home ownership?  Would a thirty year note actually be more suitable even though it is more expensive in the long run?  What if in a year Sally is laid off and can't get another job in the area so her house gets foreclosed on?  Maybe it would have been more suitable for her not to buy a house at all; maybe she should have just rented a house for a while until she had more time on her job. Maybe as a single woman Sally should not be buying a house at all; maybe she should wait until she is married or in a relationship so that she will have a second income to help make the payments on the house. (You see where I am going with this.)

The Equal Credit laws were created so that loan originators cannot make arbitrary decisions about an individual's credit worthiness based on race, religion, sexual orientation, age or familial status.  Under the standards set by those laws, borrowers either qualify based on guidelines or they don't.  It is not the loan originator's job (or right) to make further determinations about their overall worthiness to purchase a home or to refinance a home.  We can give advice (as I often have based on experience when I see someone making a decision I think might be unwise).  But in the end the decision is the borrowers--not mine.  And that is exactly as it should be.  After all, the borrower is the one making the payment.

I wonder how many of us would like to live in a world where all professions had a "suitability" standard.  How many of us would like to go shopping for a new dress if the sales lady had a legal obligation to tell us that we look terrible in it, or that the color clashes with our hair color.  After all, if I get home in that dress and realize how awful it looks on, I am likely to never wear it again, and possibly not to pay the charge card I put it on, which could result in a financial loss for the credit card company.  The sales lady would have to ignore the rather obvious fact that whether or not I look terrible in my new dress is largely a matter of opinion--I might feel beautiful in it, and my new boyfriend might agree with me rather than the sales lady.  Or what if the waiter at the restaurant had a "suitability" standard as he served us our lunch.  Maybe I really want the ravioli, but he can tell by looking at me that I need to lose weight so he will agree to serve me only the salad with balsamic vinegar.  If he has a duty of care, he would not want to be responsible for ill health brought on by poor lifestyle choices and eating habits.

Ridiculous, you say.  A mortgage is arguably the largest financial purchase that most people make over a lifetime, and it is a complicated transaction, so borrowers need to be protected from possible bad choices.  It is just foolish to compare buying a dress or buying lunch to buying a home.  Really?  I pulled some statistics off of this week showing that the average American owes credit card balances of over $14,000.  How much of that outstanding balance was spent on foolish, or unnecessary purchases?  We hear constantly about heart disease, diabetes, and the cost of poor health to our society as a whole.  How many of those problems are brought on by poor dietary choices.  Fashion is a complicated industry; nutrition is complicated.  Does the level of complexity of the issues involved drive my ability to make choices about my own life.

Where does it stop?  If we can determine for another person what home loan is suitable, who is to say that someone will not determine for all of us what other choices we can make? And as give up the responsibility for our choices, we also give up the freedom to make decisions which can benefit us in the future.

When we first started the mortgage company, one of my first goals was to get us a license in the state of New Mexico.  To get that license, I had to get a bond, and to get the bond I had to have a financial statement prepared by a CPA.  My father, who was also my business partner, knew a CPA through a group he was involved with, and he asked him to prepare the financial statement.  Our finances at the time looked awfully sad--we had no money except for an IRA totalling a little under $11,000 that I had cashed in to open the business.  We had a six month lease on an office that we paid $245.00 a month for (to include utilities and a typewriter.)  We had no industry experience, no customer base, no reserves to draw on.  We could not even afford a computer for our first eighteen months in operation.  My dad's acquaintance prepared the financial statement--which he charged us for, of course-- and at the end of the statement he put his notes.  "This company probably will not be open in one year."  I was furious--we might be small and we might be broke, but I knew we were going to make it and I was not going to send out a financial statement that said otherwise.  I promptly hired a different CPA to prepare a financial statement without the editorial opinions, I sent it to the bonding company, got our bond, and got our New Mexico license.  We were on our way.

That was 13 years ago next Friday.  I am grateful every day that the first CPA was wrong.  I am even more grateful that my future was not determined by another person's opinions regarding what was suitable for us.

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Tuesday, March 22, 2011

Whose Driving?--Attempting to Navigate New Anti-Steering Rules

As we do the final countdown to April 1, 2011, when the Federal Reserve's new rules on loan originator compensation go into effect, we now find ourselves nine days away from implementing a rule that few, if any, of us really understand.  In my office we have received letters and new broker agreements from each of our lenders explaining that we need to choose our type (consumer or lender-paid) of compensation and the amount of compensation we will be receiving.  We have all undoubtedly attended numerous webinars about following the new rules regarding compensation.  But two parts of the new rule seem to remain amazingly cloudy no matter how many webinars or trainings we attend--the anti-steering provisions and the suitability provisions of the new rule.  Today I want to talk about anti-steering, and the next post will deal with "duty of care" and "suitability."

One of the changes to the Truth in Lending Act going into effect April 1, 2011 is that it prohibits the loan originator from steering a consumer into a transaction where the loan originator would be receive a higher amount of compensation as compared to another loan transaction unless the loan is in the consumer's interest.  A independent loan originator (formerly called a mortgage broker) must provide the consumer with "a significant number of" choices--at least three if he works with at least three different lenders--and he must allow the consumer to choose from among loans with the lowest interest rate,  the lowest interest rate without a balloon or demand feature or interest only payments or a prepayment penalty, and the lowest origination fees and discount points.  One of my lenders provided us this week with a certification form that we and the borrowers are to sign verifying that they have selected among their various options for the loan with the interest rate and fees which are best suited to their situation.  At the bottom of the form is the following certification: "I certify that the Broker provided me with options of available loans of all types in which I expressed an interest and that I selected a loan product that I believe to be in my interest. I acknowledge and understand that the Broker need not inform me about potential loan product examples if the Broker made a good faith determination that I would not qualify for it."

So we are to choose from among at least three lenders with whom we have broker agreements to give the borrower a quote as to the interest rates and fees.  There are a couple of obvious problems with implementing this in the real world.  When HUD introduced the 2010 Good Faith Estimate, they informed us that the good faith estimate is a binding contract and that we are not to be changing it.  So presumably, we have to use a fees worksheet to work up the fees and the interest rates from various lenders and then provide the consumer with the good faith estimate based on the costs/interest rate combination he chooses.  We are to show the consumer the loan with the lowest interest rate, and the lowest costs.  Presumably, the lowest interest rate is the lowest thirty year rate available among our lenders.  (Does lowest mean the lowest rate sheet rate or the lowest rate with the maximum discount points possible?  Nobody has clarified that point for me.)  The lowest fees and points would come from the lender with the lowest costs.  Before the new good faith estimates were introduced, I had a template programmed for each of my lenders, with their updated administrative costs.  After I met with the borrower, I selected the lender template for the lender I wanted to use and I generated an estimate based on those fees.  If something happened that I had to change lenders, I could simply select another template and reissue the good faith estimate, but since there was normally only a slight variation in lender fees this usually was not necessary.

Today, however, we cannot do that.  Remember that a changed lender is not a changed circumstance, so we cannot reissue the good faith estimate now just because we change lenders.  When GFE 2010 was introduced, we no longer had the option of raising any of the lender fees by even one dollar, since the origination fee block could not increase even slightly.  I did what I suspect many other originators did; I used the lender with the highest fees for my good faith estimate and then I raised my processing fee slightly so that my estimate was padded a little.  That way, if a lender fee had changed, I had enough money quoted in the origination fee to cover any slight variances and the borrower could still close.  And that system worked really well for me--in almost 15 months of using the new GFEs I have not had a problem because my fees were always quoted high enough that when we closed the actual borrower charges were equal or less than my quotation.  I was able to stay in compliance and the borrower left happy.

Two weeks from now, all of that is going to change again.  The borrower must be presented with different loan pricing options, and unless we are receiving our compensation from the consumer, we as brokers cannot "cure" any shortages.  I can no longer charge a processing fee, or any other fee, directly to the consumer, and I cannot use any part of the compensation that the lender pays me to credit the borrower.  So how do we comply?

It seems to me that we are going to have to go back to the old lender-template policy and update it frequently.  Lender fees have risen sharply in the last six weeks as the industry gets ready to make this change, so originators are going to have to watch very carefully to make sure that we have correct, updated fees for each lender since we do not have ability to fix any mistakes.  Once the borrower selects a loan, and we issue the good faith estimate, we are then locked into those terms.  So if our lender turns down the borrower's loan, and he selected the lender with the lowest closing costs, we will not be able to send him to a different lender with higher closing costs since we cannot reissue the good faith estimate. 

This whole business of providing quotations from different lenders creates another problem.  As we receive our lender-paid compensation agreements, we have the option of selecting various compensation percentages from each lender.  Therefore, it would be possible to have an agreement that lender A will pay us 1% on each transaction, lender B will pay us 1.5% on each transaction, and lender C will pay us 2%.  We are supposed to provide each borrower with a quote from each lender.  But what if we routinely send twice as much business to Lender C as we do to Lenders A and B?  In such a scenario, we can be accused of violating the anti-steering provisions of the rule because the rule is supposed to ensure that the loan originator will not steer the borrower into a loan which provides greater compensation for the originator.  I have been told that if we can justify the decision to use Lender C based on service or underwriting superiority or speed in closing, we will not have a problem, but it seems to me that this would be a tough sell.  Remember also that we may not just be defending our decisions to a compliance auditor from the Consumer Financial Protection Bureau--we could actually be defending our actions before a judge since our method of compensation and whether we have complied fully with the new rules can be the basis for the borrower claiming life of loan defense to foreclosure starting this July.  For that reason, it seems safer to me to have the same level of compensation with all lenders in a lender-paid compensation agreement so that no borrower can accuse the originator of steering the transaction.

What is most interesting to me is that when I have asked wholesaler reps about these issues, their responses have basically been that they don't know the answers yet.  The wholesalers are so quick to tell me that they cannot give me legal advice that they actually cannot address any of the greater issues with trying to comply with the new rule.  And each piece of information we get generates more questions than answers.

I am very interested to see how others in the origination community are preparing to deal with these issues.  Please post your comments below.  I would love to read them.

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Friday, March 18, 2011

What Now?

I sit in my office this Friday afternoon, listening to the traffic go by through the open windows, while I wait to drive over to the title company to close a purchase loan for two of the best borrowers I have ever worked with.  The purchasers, who were well qualified--were also extremely pleasant and agreeable through the loan process.  The appraisal came in higher than the sales price.  The lender asked for reasonable conditions and cleared them quickly. The documents came in time for both the first and second lien; and we are scheduled to close and fund today on the final day of our contract.  It was a dream transaction--the kind that rarely occurs any more but that helps me remember why I have chosen mortgage origination as a profession for the past thirteen years.

It seems strange then, today, to know that in less than 2 weeks, mortgage origination as we know it today will change radically.  Some lenders are actually implementing the new rules early, so loans that are being originated under the current standards will have to be locked by Friday, March 25.  How incredible to think that we are only 7 days away from the biggest shift that our industry has experienced during my career.

After days of hearing about filed law suits, requests for injunctions, letters from Senators, and letters from various Congressmen, we are now only days away from implementation of the FRB new rule on loan originator compensation and, as was the case with RESPA reform in January of 2010, it is starting to look as though the cavalry is not going to show up to save us. None of the efforts to delay the rule appear to have made any headway whatsoever, and now we are all left with the question, "What now?"

This week I had an interesting email exchange with a reader from California who is disillusioned with the efforts to influence our elected representatives and disheartened by the complete lack of support for our industry.  He raises some very good points in drawing analogies between our situation as loan originators and the mandates imposed on the appraisers by HVCC.  And he notes that the independent loan originator is being squeezed out of the industry--we handle roughly 10% of the mortgage originations today as opposed to about 65% five years ago.  "What I can't quite get, and maybe it's just me, is how the Fed has the authority to impose this draconian ruling on an entire industry."  Finally my email pen pal points out that if the government can impose these restrictions on our industry, what is to stop the micro management of any other industry?  What is to stop the government from regulating the compensation of people in all walks of life?

I thought that this email raised such good points that I have spent several days thinking about it.  The reader is looking for a way to stop the implementation of the Fed Rule in two weeks.  All of us would like to see that.  But if we are not successful in doing that, as it appears that we will not be, then what?

I believe that the only solution to this situation is to repeal Dodd Frank.  That may seem like an unattainable goal, but it isn't.  Remember that Michele Bachmann has already introduced a bill to repeal Dodd Frank.  That was largely a token gesture with no support, but it shows that a bill can be introduced.  The problem is that there is no support for repeal.  And that is largely our own fault.

Our combined industries of real estate services--appraisals, loan origination, title services, and real estate services--contributed in a large way to the huge economic boom that this country experienced in the last decade.  We made the American Dream of Homeownership possible for millions of people.  But the media and special interests turned us into villains and we allowed them to.  Rather than touting the good things that we had accomplished for the country, we focused on "the bad actors" who needed to get out of the industry.  And we wasted time lobbying politicians who despised us.  At the beginning of 2008, I had an opportunity to go meet with El Paso Congressman Sylvestre Reyes.  This meeting was made possible by the fact that I had recently assisted one of his aides in the purchase of his first home.  The aide set up the meeting so that I could discuss my concerns about the types of regulation being drafted, but the Congressman did not show up. Instead, he sent a second aide, who listened to my concerns and then smirked as he told me that "there are definitely going to be reforms."  I knew right then that I had wasted my time.  Sending emails and letters to people whose minds are closed is a waste of ink and the time that it takes to put our thoughts on paper.

But that is not to say that there is nothing we can do.  We can be our own advocates, since no one will advocate for us. Who is better qualified than us to tell our communities the truth about why their house values are dropping or to explain to the despondent home owner why he can't sell his house? I am amazed when I meet consumers who ask me how long I think it will be before financing returns to "normal".  So many people believe that the current tightening of lending standards is just an overreaction to the loose lending guidelines of the past and in a few years balance will return.  When I get to talk to these borrowers, I tell them that this is not just lenders being strict--the stringent new guidelines are codified into law and they will remain tough as long as the law does.

Nationally there has been a lot of support for amending or repealing the health care law.  The Dodd-Frank bill, which will easily have consequences as sweeping as Obama Care, has been barely mentioned at all.  Why?  Because many Americans believe that Obama Care will impact on their lives negatively, whereas most Americans don't appear to believe that Dodd Frank impacts their lives at all.  Most people seem to think that Dodd Frank affects only "greedy rich people".  They do not know or care that it is costing thousands of small business owners their businesses, that it will affect home values nationwide, that it will ultimately impact on every American who wants to buy or sell their home from now on.

But we can help to change that perception by telling the truth whenever and wherever we get the opportunity. The next time you are talking to your neighbor who is complaining that he is so underwater in his mortgage that he could go deep sea fishing, don't just sympathize.  Tell him that property values are going to keep dropping as long as housing financing is almost non existent and as long as appraisers are forced to work for appraisal management companies.  And when your family member or friend complains that he cannot get any service at the bank or that his loan application has been denied, let him know that this is why we need choices in financing.

My reader said that he does not want our industry be "Don Quixotic."  And I certainly don't want that either--Don Quixote never accomplished anything!  But a consistent, on point, honest message about the real reason that things are not improving in the housing industry can make a geniune impact. 

As bad as everything seems today, we will probably all still be alive in two years.  The only message politicians remember is the one they receive at the ballot box, so exercise your right to vote and find out where your representative stands (and has stood) on Dodd Frank and financial reform.  Today we are losing our jobs, but in 2012, it's their turn.

Tuesday, March 15, 2011

Spencer Bachus and the House Financial Services Committee vs. the Fed Rule

A few minutes ago I received an email from a good friend containing a link to a letter that the House Financial Services Committee and its chair, Spencer Bachus, signed and sent to the Federal Reserve and its chair, Ben Bernanke.  The letter, dated today, March 15, asks the Federal Reserve to delay its implementation of the Federal Reserve Rule on loan originator compensation past the April 1, 2011 scheduled date and to "provide proper written guidance to facilitate compliance by affected entities."  The letter states that regulation is "intentionally vague", that "the Board has refused to provide formal guidance and that different members of the Board staff have offered differing interpretations of its meaning.  Given the importance of the rule in protecting consumers as well as ensuring a fair application to small businesses or companies that may experience significant job loss due to its implementation, we recommend that the Board delay implementation of the final rule..."

While regular readers of this post know that I have been extremely pessimistic about efforts to delay the final rule, I must say that reading this letter and seeing the signatures on it from the House Financial Services Committee is heartening.  Some long time friends to the small independent mortgage entity are signers including Donald Manzullo R-IL  whom I have actually had the pleasure of hearing at a past NAMB legislative conference, our favorite Tea Partier Ron Paul (Texas), and Pete Sessions (R TX.).  Judy Biggert signed the letter as well (R IL).  Those of us who have been in the industry a long time remember that Judy Biggert was an advocate for our industry during the original fight to stop RESPA reform from 2002  to 2004.  Some well known national figures are signed on this as well--Peter King from New York and Michele Bachmann from Minnesota have penned their support as well.  There are many others, of course--the letter contains 31 signatures from Congress persons who were willing to sign their names on a letter taking a stand for the small business community.

As I look at the letter, I note that Barney Frank's name appears on the House Financial Services Committee.  Frank, who has given his name to the Dodd-Frank bill, did NOT sign the letter.  It must give him some heartburn to see his former committee send out a letter in the support of an industry he has worked so hard and openly to destroy.  It is a very Old Testament Mordecai versus Haman moment.  (See the Old Testament Book of Esther.)

Will it work?  I don't know, but a letter with so many prominent Congressional representatives might work.  In the past, such letters actually have made a huge impact.  And this letter, coupled with the letters from Senators David Vitter (R-LA) and Jon Tester (D MT) certainly bring pressure on the Federal Reserve and Bernanke that we as individuals could never hope to achieve.

Whether it works or not, I must congratulate everyone who is working behind the scenes to get this bill delayed.  And in 2012, we need to remember the names of the people on this list and the fact that they were willing to intercede for us.

Stay tuned.

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Monday, March 14, 2011


Last week I wrote a post about the letter that Senators Vitter and Tester wrote to Ben Bernanke, chairman of the Federal Reserve, asking him to delay implementation of the Fed Rule.  The reason they cited is that under Section 1413 of the Dodd Frank rule, the "defense to foreclosure" provisions, which become effective July 21, 2011, a violation of loan originator compensation can become a defense to foreclosure for the life of the loan.  "If a borrower prevails in such an action, the borrower is awarded 'enhanced penalties' under TILA and every loan originated under that compensation plan would become a liability.":

I was curious, so I decided to look up the provisions of section 1413.  Since the provisions of 1413 are actually an amendment to the existing Truth in Lending Act, the changes as written in the Dodd Frank Bill text are difficult to follow without actually having a copy TILA to go through as well.  For that reason, I am using a sixteen-page bill summary which appears on the MBAA website.

Here is how the summary defines Defense to Foreclosure:  Section 1413:  "Permits borrower to assert a defense to foreclosure against creditor or assignee or other holder of mortgage loan in judicial or non judicial foreclosure or any other action to collect debt in connection with mortgage loan when there is a violation of anti-steering and ability to repay provisions.  Claim can lead to actual damages, statutory damages and enhanced damages including return of finance charges."

Notice, that the claim can be against "creditor or assignee," which means that a current servicer of a closed, sold loan can be forced to pay "enhanced damages" if either the ability to repay or loan officer compensation statutes are violated.  Of course, the "qualified residential mortgages" which are now being developed create a "safe harbor" for lenders, but that safe harbor can be rebutted in a legal argument.

What many in our industry are ignoring today is that the major part of the Fed Rule's loan originator compensation rule is straight out of Dodd Frank.  The safe harbor provisions of Dodd Frank require a 3% limit on points and fees for qualified mortgages.  The borrower may pay up to 2% in bona fide discount points, providing that the interest rate being discounted is not more than 1% higher than the prime rate.  Government and private mortgage insurance premiums are also excluded from the 3% cap if a refund of such premiums can be prorated and monthly MI premiums paid after closing are excluded. 

Dodd Frank establishes prohibitions on "steering" by prohibiting payments to loan originators based on the terms of the loan and it prohibits the loan originator from receiving compensation from both the consumer and the lender. (Sound familiar?)  While the Federal Reserve Board has added some enhancements of their own, such as their ruling on affiliated business arrangements, for the most part, their rule comes straight out of the Dodd Frank bill which is the law of the land.

The Dodd Frank bill puts the penalty for violations of the compensation rules and "duty of care" on the shoulders of the loan originators as well as the servicers.  Not only can violations be used as "defense to foreclosure" for the life of the loan, but the individual loan originator can be held liable for penalties of the greater of actual damages or an amount equal to 3 times the total amount of compensation or "gain" received by the loan originator plus costs and reasonable attorney fees.

In other words, if a consumer stops paying his mortgage, for whatever reason, and the lender starts the foreclosure process, if the attorney can argue successfully that the loan originator compensation rules were violated in any way or that loan originator did not meet the "duty of care" requirements, the loan originator is required to pay back the greater of whatever damages the court awards to the consumer or 3 times his compensation plus attorney fees and closing costs.  

So let's see how this might look:  John originates a loan for Sally for a $300,000 home.  He knows that the new compensation rules do not allow him to collect money from both Sally and the lender, so he chooses consumer paid compensation of 1% or $3000.00.  Sally is receives a base salary from the office machines company where she works plus bonus.  Since she has been receiving the bonus for the last two years, John uses the bonus as part of her income.  Sally gets the loan.  One year later, the office equipment company files bankruptcy and Sally loses her job.  Since she is not able to find a job right away, she cannot make her payments on the house, and soon her current servicer begins foreclosure proceedings.

Sally gets an attorney who argues that she was not qualified properly with regard to her income because her bonus was used to qualify her and everyone knows that bonuses are discretionary.  Without the bonus, she would not have qualified.  Under the "defense to foreclosure" rules, Sally's home is now safe and she does not have to worry about making the payments.  In the course of the attorney's investigation, he finds out that John's company is structured as a corporation rather than a sole proprietorship.  Although he was self employed, the judge rules that he does not meet the "salaried" requirements of the Federal Reserve interpretation of the loan originator compensation rule.  So the judge rules that two violations have occurred.

Because of these violations, Sally's lender cannot foreclose on her even though she is not making the payments and in fact cannot afford to. And since the "defense of foreclosre" applies to the life of the loan, even when she gets a job and is able to make the payment, she can still live in her home without making hte payment and without fear of foreclosure.  John, on the other hand, is now liable for $9000.00 plus attorney fees and court costs for originating a loan that he worked hard on and believed was perfectly fine.  If he is like most loan originators today, John won't have the money, so the judgment will actually cost him his business.

Sound far fetched?  It isn't.  We are rapidly creating a world where consumers have no responsibility for their choices or actions.  Even though no one coerced Sally to purchase a $300,000 home and in fact when she bought the house she would have been insulted at the implication that she could not afford the house, as soon as she starts having financial difficulties, the purchase of the home and the loan that made it possible is everyone's fault but her own.  Meanwhile, John who has worked hard and survived three years of real estate drought, is out of business because of regulations he did not even understand he was disregarding.

Remember, this is part of Dodd Frank, not just the Fed Rule.  If we want to create a climate where originators will be able to do their jobs, we have to return to standards of personal responsibility and free enterprise.  A basic fact of lending is that the only incentive that lenders have to make large personal loans in the form of residential mortgages is the collateral of the home and the lender's right to foreclose on it.  As we make foreclosure impossible, we also make mortgage lending impossible.  And by punishing the delivery system for mortgages, which is the loan originator, we create a system where no housing loans exist at all.

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Friday, March 11, 2011

NAMB vs. The Federal Reserve

As I wrote yesterday, both the National Association of Mortgage Broker and the National Association of Independent Housing Professionals filed lawsuits this week to delay implementation of the Fed Rule on loan officer compensation, which is scheduled to take effect April 1, 2011.  The NAMB lawsuit was announced on Wednesday, and as far as I can tell, actually filed yesterday.  Today the Federal Reserve filed a motion asking the federal judge to combine both cases into one suit--to save money.

This is an interesting turn of events, since in NAMB's announcement video, Mike Anderson, NAMB's  legislative chair said clearly that he did not want the NAMB suit to be combined with the NAIHP suit.  He said that he had nothing against NAIHP, but 1. NAMB was arguing the suit from a completely different angle, and 2. the industry has only one shot at getting this rule delayed.  Two separate attacks, one of which might have a chance at success, is better for the industry than one combined attack, which, if defeated, will leave the industry with nowhere to go.

Obviously, the Federal Reserve agrees or they would not be petitioning to have the cases combined.  Apparently, they believe they have a better chance of winning this case if it is heard only once.

In the meantime, in an extraordinarily interesting development late this afternoon, NAMB sent out a letter signed by Senator David Vitter (R, LA) and Senator Jon Tester (D MT). A copy of the letter can be accessed by clicking HERE.   The bipartisan nature of the letter is a tribute to the effort that NAMB is putting into getting the Fed Rule delayed.  The letter, addressed to Ben Bernanke, asks for a delay in implementation of the FRB rule on the grounds that "We are concerned that this rule, which becomes effective on April 1, 2011, may have the unintended consequence of further increasing concentration in home mortgage market [sic]. ..Even before the beginning of the housing crisis in 2007, the home mortgage market has been dominated by three of the largest U.S. banks, which account for more than 51% of residential mortgage originations, with the top two alone accounting for a stunning 43% of the market. Yet to date, the Federal Reserve has declined to provide any written guidance to small mortgage lenders and brokers which would provide clarity and assist them with compliance."

The Senators make a very interesting argument for delay of the Fed Rule.  "In addition, we remain concerned the Federal Reserve has not fully evaluated the impact of this rule on the housing market once the "defense to foreclosure" provisions contained in section 1413 of the Dodd-Frank Act come into effect on July 21, 2011.  Under this section, a violation of rules related to loan originator compensation will allow a borrower to assert that violation as a defense to foreclosure for the life of the loan.  If a borrower prevails in such an action, the borrower is awarded "enhanced penalties" under TILA and every loan originated under that compensation plan would become a liability. The interaction of the Fed's compensation plan with the provisions of the Dodd-Frank Act could have a devastating impact on the mortgage market as large lenders may be unwilling to take the risk of acquiring loans from community banks, mortgage bankers and brokers. Until this uncertainty is resolved it will impair the ability of community-based lenders and small mortgage brokers to compete in the market."

The letter also states that the Federal Reserve has postponed its three final rulemakings until rulemaking authority is transferred to the Consumer Financial Protection Bureau.  This postponement is in the "public interest" because "adopting those portions of the Board's proposals in a piecemeal fashion would be of limited benefit and the issuance of multiple rules with different implementation standards would create compliance difficulties." The Senators urge the Federal Reserve Board to apply this same standard to the Federal Reserve Rule on loan officer compensation.

The letter really makes a fascinating point.  If violations of this sweeping loan originator compensation mandate can be grounds for defense of foreclosure for the life of a loan, the major lenders cannot afford to purchase loans from mortgage brokers or from small banks or credit unions, because they cannot insure that the compensation  agreements are fully compliant.  And with the convoluted rules we see today, chances that violations will occur are better than not.  So not only will the Fed Rule kill the mortgage broker or independent originator (I realize that "mortgage brokers" do not really exist any more since the implementation of the SAFE ACT), but actually the rule will kill the entire secondary market as it exists today. 

It is going to be really interesting to see whether this letter or the two law suits makes any impact. Stay tuned!

Thursday, March 10, 2011

NAIHP vs. The Fed Rule

We end this week on the big industry news item of the week, which is the lawsuit that Mark Savitt and the National Association of Independent Housing Professionals have filed against the Federal Reserve to prevent the Fed Rule on Loan Originator Compensation from being enacted.  There have been rumors this week that the lawsuit was really a hoax, but "Housing Wire" has a link to the court documents on its website.  "Housing Wire" is also reporting that the National Association of Mortgage Brokers has filed a similar suit, and a press release issued by NAMB today confirms it.

First, let me say that I was a member of the National Association of Mortgage Brokers from 1998 to the end of 2007, when market conditions became too bad for me to justify the expense of involvement.  I helped to found the El Paso Association of Mortgage Brokers chapter in 1999, and I served as the President of the chapter from October 2001 to October 2002.  I participated in six national legislative conferences and attended state conventions up until 2005 when I began attending the Western Regional Conference in Las Vegas.  So I am very familiar with the organization.

While I do not know Mark Savitt personally, I have met and had conversations with him.  I have always believed him to be a good representative for our industry.

Having said all of that, if you are counting on these lawsuits to actually stop or even delay implementation of this bill, you need a new plan--immediately. The NAIHP lawsuit alleges that the new rule is "arbitrary and capricious" and "in excess of statutory jurisdiction and authority."  NAIHP wants the Federal Reserve to withdraw the rule and wait for the Consumer Financial Protection Bureau to implement its own regulations. (I have not seen a copy of the complaint filed by NAMB, although I did watch a video from the legislative chair who says that they are using an entirely different argument.  Since they did not clarify what that argument was, I will comment only on the NAIHP argument.)

One problem--the Consumer Financial Protection Bureau, when it is finally up and running, will be housed within the Federal Reserve.  So although the CFPB is autonomous, we can expect its thinking and its actions to pretty much mirror the thinking and actions of the Federal Reserve Board.

My second problem with this is the statement that the FRB rule is "in excess of statutory jurisdiction and authority."  Actually, its not.  The Dodd Frank bill opens the door for agencies like the FRB to exercise rule-making authority on many levels.  Really, Dodd Frank is just an enormous framework against which to write new legislation and to enact new rules.  While the bill itself does clearly set into law some new regulations--for example the Merkley amendment which caps loan originator compensation at 3% from all sources--much of the bill opens the door for the completion of a lot of studies, the creation of a number of powerful new governing entities, and the development and implementation of new statutory rules by those entities.  It is really just a huge backdrop for writing legislation without having to go back through Congress.

Anyone who reads the Dodd Frank bill is going to be struck by the amount of power that the bill gives to the various agencies--including power for the Federal Reserve to annihilate the independent loan originator.  And I believe that a judge is going to see this the same way--as long as Dodd Frank is the law of the land, the FRB and the other agencies now existing and soon to be created pretty much have the power to do whatever they want.

The final problem with the lawsuit is the last minute nature of the filing.  The Final Rule was released last August.  The industry has had over six months to react to it.  Filing a lawsuit now in March, three weeks before implementation, is a little bit like locking the barn door after the horse has not only gotten out but has run into the street and been hit by a car.  It's just simply too little too late.

Having worked on grass roots letter-writing campaigns and grass roots lobbies when NAMB worked against the RESPA reform rule, successfully from 2002 to 2004 and unsuccessfully in 2008 and 2009, I know that no amount of effort on the part of a trade group can guarantee results.  But if NAMB and NAIHP want to make a meaningful contribution to the financial services industry, they need to focus their next efforts on a public awareness campaign to get Dodd Frank repealed and to stop massive government takeovers of small business.  They would have better luck with that than they will arguing to a federal judge about why the Federal Reserve needs to be reigned in.  And, in the end, if successful, they would actually have made a huge contribution to the small business community and the future of housing finance in the U.S.

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Wednesday, March 9, 2011

The Road to Hell...

Karl Marx is credited with famously saying that "the road to hell is paved with good intentions."  As with just about everything else Marx ever said, I disagree with this statement.  Usually the road to hell is paved with very bad, often deliberate, intentions which result in very bad actions and ultimately very bad consequences.  Such is the case with financial reform and the plethora of rule-making happening right now as a result of the Dodd Frank bill.  But at the end of the day, whether the intentions behind the rule-making are good or bad, the destination is the same.

On April 1, not only will the new Fed Rules regarding loan originator compensation go through, but the Fed Rules governing appraiser independence will also become mandatory.  Of course, we have been living with variations of these rules since 2009 when the Home Valuation Code of Conduct was implemented, but Dodd-Frank and the Federal Reserve's rule-making have expanded these rules to all residential mortgage loans without regard to the problems that such rules create.

The title of this post is inspired by an article that posted in December of 2010 titled, "Have down payment, but stuck in appraisal hell."  The article follows Aaron and Beth Stiner, who have been forced to rent a home rather than purchase one because even though they had sufficient downpayment and could qualify for financing, they could not work out the appraisal issues on their home.  The article states that the couple, who lives in Phoenix, had decided to sell their home, had buyers for their home, and had found a new home that they wished to move up to.  They applied through a mortgage broker for a loan with GMAC.  The appraisal on the home came in at $295,000, and both the buyers and the sellers were in agreement on the value.  GMAC was not so sure however, and required a second appraisal.  This appraisal came for $25,000 less which did not allow the deal to go through.

The Stiners then switched lenders and started over.  The new appraisal on their prospective home came in at $290,000, but again the lender did not feel comfortable about the transaction, so they ordered a second appraisal, which came in much lower.

Meanwhile, the house that the Stiners were selling had three separate appraisals completed on it and each one came in lower than the previous one.  Four months later, the Stiners and their buyer gave up after having paid for seven appraisals collectively.  At the time of the article, they were renting out their previous home and renting the home they had wanted to buy.

Linda Stern, who wrote the article, interviewed Wells Fargo spokeswoman Vickee Adams, who said that Wells Fargo regularly requests three appraisals. (Wells Fargo was the lender for the prospective buyers of the Stiner's home.)  According to Vickee, "Wells Fargo must ensure that the value of the collateral supports the loan amount."

The dynamic at work here is that banks like Wells Fargo do not just react to current market conditions--they try to get ahead of the curve on proposed regulations.  Currently there is speculation that appraisal reviews could become requirements for selling loans on the secondary market, which is good motivation for Wells Fargo to start the process now.  Couple that with the fact that Wells Fargo primarily sells its mortgage to Freddie Mac--or at least they did when I used their wholesale lending division--and that Freddie Mac's loan approvals contain on the approval a supposed value for the property submitted.  If the appraisal performed by the human appraiser is higher than that figure, the underwriter is just naturally going to assume that the appraiser is wrong and that Freddie Mac's value is correct.   Most borrowers who can get approved with Freddie Mac could also get approved with Fannie Mae, which has a much more lenient approach to property valuations, but Wells Fargo has traditionally had a rule that once a loan is submitted to Freddie Mac, it cannot be resubmitted to Fannie Mae. 

This is one reason that competition in the mortgage markets is so necessary.  For all of the Wells Fargos and GMAC's that are excessively conservative, there are other smaller regional companies that could offer other options.  But unless there are independent originators offering loan options from a variety of wholesale lenders, borrowers like the Stiners end up giving up and renting because they cannot work through the problems of getting a loan.

Many years ago, before the market crashed and the new legislation was enacted, I did a loan for a doctor who was moving from Long Island, New York to Southern, New Mexico.  He had already taken a position with a practice in his new city, and he had begun getting paychecks so we could verify his new income.  I was brokering the loan to Wells Fargo, and I had satisfied all of my conditions except one--Wells Fargo required a copy of the employment contract between the doctor and the new practice.  The problem with that was that the doctor and the new practice had mutually agreed that he was not going to sign a contract, and without that item Wells Fargo would not do the loan.

Believing this decision to be unjust, I petitioned all the way up to the wholesale lending manager in Dallas, but my request was adamantly refused.  I, then, moved the loan to a different lender who immediately approved it.  The new lender gave my borrower the same rate and terms as Wells Fargo, but they did not require the employment contract.  We closed right on time.

About a year later, the doctor called me to apply for a home equity line of credit on his house.  When I pulled the credit report, I saw that after we closed the loan, my lender had sold the closed loan to Wells Fargo, and they were servicing the mortgage!  Although they would not close the loan themselves, they were perfectly happy to buy it after someone else had closed it.

Today the options for straightening out problems such as the ones that the Stiners experienced are shrinking daily.  The opinions of experienced appraisers are outweighed by a computerized automated valuation model which assigns a value to a home without really knowing anything about the property.   Loan originators are being forced into working directly for lenders rather than working for themselves and representing a variety of lenders who could take a different view of problem loans.  And the whole country is paying the price.  Wallet Pop ran an online article on Friday, March 4, 2011 reporting that Standard & Poors Case-Shiller home price index is reporting a 4.1% decline in home prices during the last quarter of 2010, and that Robert Shiller has told that we can expect to see further home price declines of up to 25% as the real estate market experiences a "double dip."  The experts in the article blamed the lack of a tax credit similar to the one offered through April of 2010 for the decline in purchase activity.  But that is really a cop-out.  Tax credits did not exist through any of the real estate booms.  The problem is not the lack of government stimulus; rather it is regulatory strangulation of all aspects of the mortgage loan process that is driving experienced professionals out of the industry and qualified homebuyers away from the closing table.

When we realize that we are on the wrong road in life, we are supposed to turn around and come back.  But so far that is not happening.  Instead, our regulators just keep steering us further and further into housing hell.

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Monday, March 7, 2011

In Praise of Competition

This morning I had a good email exchange with a friend of mine who reads this post.  He disagreed with my position about Affiliated Business Arrangements, which are now in danger thanks to the Fed Rule on the Loan Originator Compensation.  The most recent staff interpretation threatens to make it impossible to get paid on these transactions because if the loan originator also owns another entity and the consumer pays the other entity, the loan originator cannot receive compensation from the lender without violating the "dual compensation" clause.  And, since Dodd Frank caps loan originator compensation at 3%, if the Federal Reserve Board's definition of payments to affiliated companies as part of the loan originator compensation stands, then the total of all payments to all entities would necessarily be capped at 3%, which would effectively force the companies to sell off their affiliates.

My friend's position is that we need to have a "good riddance" attitude toward affiliated business arrangements, and I suspect that many independent mortgage originators who do not have such relationships would share this attitude.  How many times have we been denied the opportunity to even quote business because we were shut out by a builder who owned his own mortgage company and would pay the consumer's closing costs if the consumer used the affiliated mortgage company?  Worse yet, how many of us have actually met borrowers who tell us that the builder will not accept a contract to purchase one of his houses without approval from his in-house mortgage company.  I understand the frustration, but today I want to play devil's advocate and write in defense of competition in all of its forms--including one-stop shops for mortgage products.

Competition keeps the world moving forward.  In El Paso, Texas, where I have spent my entire professional life--we have only one utility company that provides electricity.  El Paso Electric meets all of our electric needs.  We have very high electric rates, and we always have.  During the first week of February of 2011, El Paso was hit with an ice storm that dropped our temperatures to record lows.  For the first time in my life, I saw negative temperatures for overnight lows.   El Paso Electric's generators froze over and could not operate.  As a result, EP Electric had to purchase power from other areas, including Mexico.  However, EP Electric could not purchase enough for all of us, so the company instituted rolling blackouts for the city.  During various times of the day and evening, the power went out for at least an hour. Rumors persisted that some parts of town did not experience blackouts at all, but I verified that we lost power at our house on at least three separate occasions.  We lost also power at my office.

The rolling blackouts caused El Paso Water Utilities to lose power and, consequently, pipes froze and burst all over El Paso.  Many residents were without water for days.  After a few days, El Paso Water Utilities and El Paso Electric apparently had a conversation about not including EP Water in the EP Electric blackouts, but by then the damage had already been done.  El Paso's reservoirs of water dropped so low that high-water consumption businesses (laundry mats and car washes, for example) were ordered to close by the mayor.  Residents were ordered not to cook, shower, or wash their clothes until the water restrictions ended.  (Fortunately, this lasted for only about two days.)

El Paso Electric has told us that they will reassess their generators and the overall condition of their equipment, but they also have informed us that it would be prohibitively expensive for them to have generators which can perform in the high summer temperatures which we always experience and also in the extremely cold temperatures which we almost never experience.  They have further notified their customers  that this summer we can expect to see higher electric costs since they are passing on to the community the cost of having to buy electricity during the storm.

Now I contrast our situation with a monopoly utility company to that of my sister who just moved to Dallas.  In Dallas, there are many companies that provide electricity.  My sister tells me that she did not have to pay a deposit to set up her account although she and her husband are new residents of the city.  In El Paso, that would be unheard of.  Rates  in Dallas are comparatively  low and electricity providers are very competitive.  My sister's new home is entirely electric--it does not use natural gas at all.  In El Paso, such a home would be prohibitively expensive, but she tells me that in Dallas there are many such homes, because the utility rates are affordable.

Apparently, in Dallas the utility companies can afford to keep equipment that can survive both the ice storms and freezing temperatures that are part of East Texas winters, and also the sweltering heat and humidity that make up the summers.  (I visited Dallas in 2000 in September for a mortgage brokers' convention when the temperature was 113 degrees, so I know that they can match us for heat!)  And they manage to maintain that equipment and keep the lights turned on while charging less!

The difference here is competition.  Competition brings quality up and prices down.  And that is true in the housing and mortgage industries just as it is true in public utilities.  Are one stop shops anti-competitive?  In my opinion, they are not.  I am a very small mortgage company, and I have never been affiliated with anyone.  As a result, I never got business from the volume home builders.  But I developed niches that worked for me and that have sustained my company through three years of recession. If a builder wants to go through the headaches of owning a mortgage company and a title insurance company then he has the right to enjoy the profits of his dual enterprise.  Likewise, if a real estate company wants to own a mortgage company or a title company, those enterprises should be able to offer those services.   Meanwhile, those of us who have no affiliated companies but do have lower overhead distinguish ourselves by offering cheaper mortgages and lower interest rates. 

The most important fact I learned over nearly 13 years in the mortgage business is that when free enterprise is allowed to work, there is enough business for everyone.  A rising tide actually does lift all boats.  It is only when excessive regulation decides the winners and the losers in an industry that we all begin to suffer.  In a regulatory environment where we are all allowed to compete at whatever level we choose to, we as business people are able to grow our businesses and the consumer is presented with plenty of options and choices to get the home/loan combination that meets his needs.  Everyone wins. 

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