The Consumer Financial Protection Bureau recently announced sweeping new rules governing mortgage lending. These rules carry important implications for future business developments going forward.
Lending institutions are, very properly, working to adjust to the new rules and to make sure compliance programs are in place. At the same time, however, both the CFPB and the nation's mortgage lenders need to consider these regulations' limitations and to prepare for the next wave of issues that will confront the industry.
Let us start by acknowledging the regulations do target a number of seriously dangerous and, frankly, predatory practices. For example, the new rules functionally prevent making loans to borrowers where their payments will exceed 43% of the borrower's income. Similarly, the practice of loading loans with inflated upfront fees will be highly restricted. Lastly, certain balloon and interest only mortgages which could appear deceptively inexpensive will be a thing of the past.
Equally important, the new regulations provide certainty. Loans that meet the new regulations – so called "qualified mortgages" – will enjoy a safe harbor provision and not be subject to legal action. If they follow the rules and have the proper internal controls in place, banks should be able to lend without having to worry about class action lawsuits.
Reaction to the new rules has been mixed. Certainty and a safe harbor are significant virtues. Moreover, some of the shadier practices engaged in by some lenders harmed the reputation of everyone and provided an unfair playing field. Most of the industry should be happy to see that at an end.
The problem is that these regulations are, like the Maginot Line, fighting the last war. Many of the most abusive practices the new rules prohibit were already ended by the economic meltdown of the last decade. For instance, they will make it much harder for lenders to make infamous NINA loans – No Income, No Assets – and other loans that fail to adequately account for a borrower's actual ability to repay. However, few of those loans are still being made because of the credit crunch and lack of a secondary market in which to sell them.
This does not mean unscrupulous lenders have been eliminated, only that they have been forced to morph into new shells. And it is those new shells that regulators and the rest of the industry need to confront.
To some extent, this is the natural progression of things. As a senior prosecutor at the New York Attorney General's office in the last decade, I helped put in place regulations and industry practices within the financial services industry designed to target abuses of the late 1990s. These were the abuses we had been fighting and so were the natural subjects for new rules.
Similarly, the CFPB's regulations, rightly, target specific practices we know to be harmful. But new practices, just as harmful and exempt from the regulations, will emerge. Remember: The Maginot line was not breached; new technology made it possible to go around it.
This presents a challenge for the CFPB and for banks going forward: While the rules provide a safe harbor that protect from litigation, they fail to necessarily address the next wave of dubious practices. As such, responsible lenders are still forced to compete with a few bad actors and will potentially have to weather the fallout from their actions.