Much attention has been paid recently to creating a new regulatory structure to help address the problems in the subprime mortgage market. However, regulation of the entire mortgage origination process itself — particularly third-party relationships, where most of the industry's recent troubles originated — deserves just as much attention or more.
The Financial Crimes Enforcement Network's most recent Suspicious Activity Report Activity Review illustrates the problem at the front end of the process; it said 58% of mortgage-related SARs filed last year were tied to broker-originated loans. On the back end, although the ratings agencies — including Moody's, Standard and Poor's, and Fitch — are making good-faith efforts to improve their analytic methodologies, there is still progress to be made.
Lenders and regulators need to carefully monitor relationships with, and the activities of, mortgage brokers and secondary-market players, including investment bankers, securities rating agencies, and investors.
Wall Street in particular needs to be able and willing to recognize risk and manage that risk in a prudent and responsible manner.
There have been some positive steps in this direction. The Department of Housing and Urban Development's recent proposal to revise the Real Estate Settlement Procedures Act is one example.
The proposal to overhaul home mortgage disclosure rules and help borrowers compare mortgage offers would likely require lenders and brokers to give borrowers a standard four-page "good-faith estimate" that would summarize the terms and settlement costs for the mortgages they offer.
The Federal Reserve Board's proposed revisions to Regulation Z — or the Truth-in-Lending Act — and the Home Ownership Equal Protection Act are some other good steps. And so is the creation of the National Mortgage Licensing System by the American Association of Residential Mortgage Regulators and the Conference of State Bank Supervisors. All of these moves mean that lenders will need to monitor, analyze, and manage critical borrower data — preventing loan infractions before they happen.
But more needs to happen and additional positive steps can be implemented practically and effectively. For example, lenders need to pay closer attention to sources of funding for potential predatory-lending activities — loans or investments that violate federal or state consumer protection laws, including fair-lending regulations. They should have evidence documenting the extent to which a due diligence review was performed by the investor on underlying high-cost home loans.
Lenders also need to make sure that their loans and investments are in complete compliance with Community Reinvestment Act and Home Mortgage Disclosure Act requirements in order to protect their consumers and avoid predatory and fair-lending violations. This includes verifying that a satisfactory due diligence review was performed on such loans.
Many of the additional steps that need to be taken in order to avoid another mortgage crisis are nothing new. Seven years ago the New York State Banking Department called upon supervised lenders to make sure their loans and investments strictly conformed to all state and federal regulatory requirements. In a letter to its lenders, which I wrote in my previous role as a deputy superintendent of banks with the Banking Department, the department requested these institutions collect the appropriate documentation and perform the due diligence necessary for effective compliance and operational risk management tied to their portfolios.
The letter went on to say that prior to purchasing or investing in high-cost home loans, the purchasing lender or investor performing due diligence should consider choosing statistically relevant samples of loans to evaluate.
It made several other recommendations that are applicable today as well.
It noted, for instance, that lenders were further encouraged to meet their CRA responsibilities by lending directly to qualified prime applicants and by offering affordable, "nonconventional" loans with risk-based prices to those who do not qualify for prime credit, as well as by making indirect investments.
Though made nearly a decade ago, these recommendations would help the mortgage industry deal with many of the problems it faces today. Following them could help lenders solve the lion's share of the issues related to compliance with fair-lending and anti-predatory-lending requirements. More importantly, it would help lenders underwrite and purchase loans that are profitable and provide a net tangible benefit to themselves and their borrowers.
