A duty to whom? Part 3, the response
Yesterday we saw that, in the lushly populated home-mortgage financial ecosystem, those closest to the borrower (individual agents and mortgage originators) were quite understandably marketing aggressively the new lower-payment-per-dollar-of-house loan variants that included not just interest-only loans but negative-amortization loans. Insurers were whimpering that lenders should be stopped, but unwilling to boycott the lenders themselves:
Stop me before I insure again!
So they turned, as markets often do, to government, in this case the Comptroller of the Currency:
The Comptroller’s office plans to seek new consumer disclosures that explain how the new loans work:
One defense to chicanery is better disclosure; ultimately, the consumer has to be her own last line of defense. Just as the Home Mortgage Disclosure Act (HMDA, pronounced humm-dah) had the effect of forcing into the market information that gradually alerted consumers to ancillary costs and charges, this type of disclosure [link in .pdf] will improve market comprehension:
For example, a borrower who takes out a $180,000 loan at 6.7% will pay $1,162 a month in payment and principal for the life of the 30-year loan.
That’s the basic level-payment self-amortizing loan.
But a borrower who gets an adjustable rate loan, interest-only, that adjusts after five years could see the payment jump from $990 a month to $1,832 if interest rates rose 5 percentage points.
As usual with journalistic examples, this mixes concepts and is imprecise. By my math, the interest-only loan would be $1,005 (not $990), so kicking up to self-amortizing (that is, with a new 30-year term) would raise the payment to $1,162. If the term were shrunk to 25 years, so that the loan would be fully repaid on the same original thirtieth anniversary of purchase, the payment would be $1,238. (That’s the price of deferring any repayment for five years and compressing it all into the next 25.)
Always show your work!
Meanwhile, a ‘5 percentage point’ rise in interest rates is 500 basis points. In other words, if the roof fell in.
Sorry, Mr. Bernanke, we thought the economy was stronger than that.
If the borrower had an “option” variant, his or her initial teaser $600-a-month payment could jump to $1,985.
Hence, if you were really aggressive, and the roof fell in … well,
Research shows that most people make the minimum payments, and will face mortgage balances that rise, not fall, leaving them deeper in debt than when they started.
“These products are designed so you can pay less now but pay more later, sometimes a lot more later,” Comptroller of the Currency John C. Dugan said in an interview. His agency is one of the five federal overseers that joined to issue the warning.
He called the loans “a response to rising house prices.”
Pump more nutrients into an ecosystem, and the plants grow. As they do, so grow the animals. In economic terms, adding capital pumps up demand, and that in turn pumps up prices. As we continue looking for reasons they ran up (like multi-housing families), demand stimulus is undoubtedly a contributor.
The vast majority of lenders had opposed the proposed guidance, which regulators have been discussing for more than a year, and they reacted with dismay yesterday.
“This guidance seems like regulatory overreach,” said Regina M. Lowrie, president and chief executive of RML Investments and president of the Mortgage Bankers Association, in a statement.
Much though I like the MBA and count its CEO, Jonathan Kempner, among my long-time professional friends, I cannot agree with Ms. Lowrie. Most people are not numerate, and you have to spell it out to them.
Many people have trouble seeing the numbers!
Indeed, that is a consultant’s job, to be expert to the client’s amateur, so that the client makes a wise and informed choice. Additionally, disclosure — like sharp boundaries — strengthens markets and increases overall volume and efficiency. Every time government has pushed markets toward transparency, they have prospered long-term.
Ms. Lowrie said that the “innovative, non-traditional mortgage products have allowed more people than ever to explore the possibility of homeownership.”
Doubtless true … but disclosure doesn’t stop borrowing, it just makes borrowers wiser, and therefore less likely to default. Further, since it is government applying the rules, the playing field will be level — won’t it?
Looks level to me.
One of the reasons many traditional banks opposed the new restrictions is that they argue that lenders not subject to federal oversight, such as mortgage brokers, will not be subject to the rules.
Only the good get Federally regulated?
That’s an entirely reasonable argument, but one the direct opposite of what Ms. Lowrie was suggesting. If regulation has no effect, it doesn’t matter to whom it applies. If it does have an effect — let’s say, to reduce volume short-term but increase stability long-term — then that effect needs to be applied to everybody.
Dugan said their fears may be justified, but that banking regulators can control only the institutions they oversee.
If all fib, must none be prevented from fibbing?
“The most abusive practices have been made outside the banking system,” Dugan said. Banking regulators have said that 60% of such loans now are being made by unregulated lenders.
Only 2 of 5 are regulated
The Conference of State Bank Supervisors, however, has said it will advise its state members to enact similar restrictions on the entities they regulate, which would include many mortgage brokers.
When the Feds lead, the pack follows!
Here is the Federal government taking the logical lead; imposing a national standard on the largest financial institutions, and inviting states to replicate its guidance over the entities they oversee.
Best-practice regulation can ripple outwards.
Banking regulators have often been criticized for treating the industry too leniently, said Howard Glaser, now counsel to the National Alliance of Independent Mortgage Brokers and a former
“The upshot is that the Federal regulators stuck to their guns, rejecting bank requests for accommodations in the proposed guidance on every substantial matter,” Glaser said. “If anything they have strengthened the guidance.”
So far we have discussed only the disclosure requirements — telling the borrowers what they need to know. There’s a second strand of fiduciary duty: advisory.
The new guidance requires lenders to ensure that consumers have enough income to make a full payment that will permit them to pay down the mortgage balance. It also reminds lenders that they should be able to document the borrower’s income and asks them to review the loans brought to them by mortgage brokers [Originators. — Ed.].
There’s the third duty — oversight. The guidance places lenders, who are further removed from the action, into the position of looking over the shoulders of their mortgage originators.
Vigee LeBrun, checking out her originator
Now, one might think lenders would be doing this anyhow … so for whose is this obligation imposed? For the mortgage insurers, who rely on the lenders.
I need your data to be reliable.
Thus I find myself on the side of those who style themselves consumer advocates:
Consumer advocates applauded the warning. They have been clamoring for action in the face of a rising tide of borrowers complaining of being trapped in loans they don’t understand.
“I think it’s a really important step forward,” said Alys Cohen, staff attorney at the National Consumer Law Center. “The biggest crisis in predatory lending [pdf] now is that people are getting loans they can’t afford — and this guidance emphasizes that concern must come first. It’s a strong statement.”
‘Predatory lending’ refers broadly to the practice of consciously seeking to impoverish borrowers; usually it’s applied to reverse mortgages or home improvement loans, either at usurious interest rates, but here the definition is being stretched to include placing into debt borrowers who are palpably unable to repay it.
We have flexible underwriting standards
But Christopher Cruise, who trains mortgage brokers and has become alarmed by the implications of these loans for consumers and lenders, criticized what he called the long delay in enacting the guidance. It has been “an almost criminal abdication of regulator responsibility,” he said. Lenders have continued to make these loans even though regulators had begun expressing concerns.
“This stuff could have been issued two years ago,” Cruise said. “My initial response is ‘Where were you when consumers really needed you?’ “
Because markets are supposed to be smart, and because regulators should move resolutely:
Dugan said the process took time because of rules about comment periods and because regulators had to balance the needs of consumers and lenders. “We don’t step in lightly,” he said, adding that he believed the agency “acted in a timely fashion.”
We started this exercise seeing the lending community as monolithic:
Yep, that spells Megabank in Cyrillic
But the closer we inspected it, the more lending dissolved into ever-smaller constituent parts, like Aristotle’s atom:
I wonder how small a brain cell is
When an industry is fragmented into its fully diversified interdependent specialists — that is, when the housing finance ecosystem is lushly grown if not overgrown —
We sure have a system that covers the housing, don’t we?
— the holistic objectives the species collectively have — namely, ecosystemic vibrancy — similarly dissolve into self-interested short-sightedness, making prudent government intervention wise. We found in the Federal guidance not one but three elements of fiduciary duty:
· Disclosure. Of the true cost and financial implications of the loan.
· Advice. To the borrowers that may head them off from bad choices.
· Supervision. Of those closer to the origination by those further removed.
Now, there’s three benefits to this new guidance …
Gracefully done.
