Friday, March 4, 2011

The War on Real Estate Providers Wages On Part II

Today I conclude my two part discussion of the ongoing war on real estate providers currently being waged by the Federal Reserve.  The latest chapter in this war is the Federal Reserve Board's staff interpretation of payments by consumers to affiliated entities connected to mortgage companies as loan originator compensation under the definitions of the new Federal Reserve Rule on loan originator compensation.  Yesterday, I talked about a letter sent out on Monday, February 28, by various trade associations to Ben Bernanke, Chairman of the Federal Reserve and Sandra Braunstein, Director of Consumer and Community Affairs Division for the Federal Reserve, asking them to reverse the FRB staff's determination that payments to affiliated entities are part of loan originator compensation and therefore make it illegal for mortgage companies to receive any compensation paid by the lender.  A copy of this letter can be found at  in the library section.

What is most interesting to me about this situation is the tone of the letter that these organizations have sent to the Federal Reserve Board.  The basis of the letter is that the staff ruling will cause unintended or illogical consequences by punishing mortgage companies with affiliated businesses.  "For example, some real estate brokerage firms or title companies are part of corporate holding companies that may own other businesses such as utilities and insurance companies. If, at closing, it is discovered that a consumer has paid a fee to one of these insurance companies or utilities (which fall within the Dodd-Frank Wall Street Reform Act's broad 'common control' definition of 'affiliate') the Board's interpretation would prevent the mortgage company from receiving a fee from the lender to whom it brokers the loan since the consumer's fee to the insurance company or utility would also count as loan originator compensation....Under the staff's interpretation, bona fide and reasonable compensation paid by a seller/buyer for real estate brokerage services to that firm would be considered by the Board as direct compensation paid to the mortgage company which would mean that the real estate broker's affiliated mortgage company could not broker any loans and be paid for such brokerage activity by the lender without violating the lender compensation prohibition...This could not have been the intended result."

The letter goes on to point out--correctly--that the Dodd Frank bill specifically excludes real estate brokers from the definition of loan originator.  Section 1401 states that a mortgage originator "does not include a person or entity that only performs real estate brokerage activities and is licensed or registered under applicable State law, unless such a person is compensated by a lender or mortgage broker, or other mortgage originator, or by any agent of the lender, mortgage broker or mortgage originator."   And that is absolutely true, but the Dodd Frank bill leaves many areas open to further studies and rule making and that is what we are seeing here.  Even though the Dodd Frank bill excludes real estate agents, the FRB rule as currently interpreted does not exclude real estate brokerages or insurance companies, or any other entity that is affiliated with a mortgage originator.  And the problems for these affiliated entities may be much larger than the trade organizations even realize.  The Dodd Frank bill specifically caps loan origination fees at a total of 3%.  If the staff's interpretation of the FRB rule is allowed to stand and payments to affiliated entities are considered part of loan originator compensation, wouldn't the 3% cap apply to these entities as well?

The letter points out that title insurance rates are predominantly regulated by the states in which they operate. The FRB rule states that third parties fees are exempt from the provisions of the rule, but those exemptions do not apply to affiliated companies under the current interpretation.  So a mortgage originator could not be paid by the lender on a transaction where an affiliated company provided the title insurance.

What is most interesting to me about the letter is that we can deduce from the tone of the comments that the trade organizations represented have attempted to work out these issues with staff prior to writing to Bernanke and Braunstein.  Those efforts failed, since according to the letter the FRB staff is defending their position on the grounds that, "1. no comments were received on this point when the rule was proposed; and 2. the Dodd-Frank Wall Street Reform Act treats affiliates in a manner similar to what is articulated in the Board's final rule."  The trade associations have responded that no one could have possibly anticipated such a broad and sweeping interpretation of the rule to disallow affiliated business arrangements and that the rule goes way beyond the language of Dodd Frank.

The trade organizations have proposed sensible solutions and Bernanke and Braunstein may implement these instead.  But somehow, I don't think that will happen.  While I agree with the authors of the letter that the consequence are illogical, I do not agree that they are unintended.  When we look at the Federal Reserve final rule, the rule is written to favor banks and to drive independent originators out of business.  What better way to do that than to break up the "one-stop shop." 

Independent companies operating real estate brokerages, mortgage brokerages and title companies represent a juicy morsel of the real estate business.  That is business that the depository banks lose out on. By breaking up these affiliated business entities--which this rule will do if the current interpretation is allowed to stand--the Federal Reserve is once again handing business to the depository institutions by ending the competitive advantage of the ABA model.

As with the Dodd Frank bill, the FRB's rule punishes entrepreneurial companies who have worked to build a healthy business model.  We should be saddened by this but not surprised.  We have seen this same vindictive attitude towards business over and over for the past several years--in the passage of the SAFE Act, which put loan originators under a hugely burdensome national licensure system, and then in the creation of the Home Valuation Code of Conduct and its subsequent implementation into the Dodd Frank bill which robbed local appraisers of the opportunity to build local business relationships, and now finally in the Federal Reserve's final rule which is going to force independent originators out of business by taking away their income and destroying the relationships they have built.  Each of these changes has legislated away the competitive advantages of the hardest working, most aggressive participants in our industry.

The losers in this are not only the companies who will have to divest themselves of their affiliate relationships, but also the consumers who benefited from those relationships. At the end of the day, when we as a  society decide to punish initiative, everyone suffers.

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