Defenseless

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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