Reforming regulation in the markets for home loans.

• Author: Block-Lieb, Susan

Introduction I. Current Events A. The Miller Bill 1. Appropriateness, Disclosure, and Assignee Liability 2. High-Cost Mortgages 3. Housing Counseling 4. Mortgage Servicing and Appraisal Activities B. The Financial Product Safety Commission C. The Frank Bill D. The Dodd Bill E. The Dodd-Frank Bill Emerges From the Conference Committee F. In Sum II. Location, Location, Location A. The Institutional Location of the Bureau and its Significance B. Rulemaking Authority: Interactions Between the Bureau and Other Regulatory Agencies C. A Balancing Act III. Substance: Provisions From the Mortgage Reform and the AntiPredatory Lending Act Conclusion INTRODUCTION

The recent financial crisis has been variously explained as a crisis of financial gatekeepers, a crisis of consumer borrowing, and a crisis of unregulated and non-transparent systemic risk. It was all of those things, and more. The 2008 financial crisis highlighted the interdependence of consumer protection, safety, and soundness, and the costs associated with unalloyed solicitude for liquidity. In earlier articles, we retell the story of how the securitization of residential mortgages pumped up the level of risk in the financial system and turned lenders into marketers. We focused primarily on how these innovations encouraged consumer overleverage in the market for home loans. (1) Market incentives were, on their own, insufficient to restrain either lenders' or borrowers' decisionmaking. (2) These catastrophic results of aggressive marketing of residential mortgages credit demonstrates the need for effective consumer protection and consumer education--not just to protect consumers, but also to protect the integrity of the capital markets.

In this Article, we explore the content and institutional context for recently revised regulation of the markets for residential mortgages. We propose a market-sensitive reading of the Wall Street Reform and Consumer Protection Act (the "Act" or the "Dodd-Frank Act"), (3) and suggest that the Bureau of Consumer Financial Protection (the "Bureau") created under the Act should be understood to balance consumer protection with concerns for the liquidity, safety, and soundness of the financial markets. In particular, we argue that the Act has the potential to create a regulatory architecture that protects both consumers and the capital markets by distinguishing between financial products that can safely be financed through the capital markets and those that pose greater risks and should, by design, be more illiquid. This coordinated architecture can be implemented, we believe, by the new Bureau of Consumer Financial Protection through its related powers to prohibit unfair lending practices, promulgate safe harbor notices, and implement certain minimum mortgage origination standards. However, the devil will be in the details--both substantive and institutional--and, in our view, the new Bureau will have to flex its rulemaking muscle a bit to fully implement that vision.

With regard to institutional context, our focus is the newly created Bureau of Consumer Financial Protection. This new agency presents an opportunity for an improvement over episodic consumer financial protection legislation. Congress historically has been unable to resolve issues of consumer protection without heavy involvement from industry actors who, more often than not, either squelch reform efforts or steer legislation toward non-prescriptive forms of regulation. The Bureau has the potential, particularly with its location in the Federal Reserve System, to use its regulatory authority in a balanced way that considers both the market exigencies of consumer finance and the realities of consumer decisionmaking.

As to substance, we primarily discuss the implications of prescriptive regulation of predatory mortgages found in the Dodd-Frank Act. More than simply granting a newly created Bureau of Consumer Financial Protection the authority to regulate the market for home loans, these provisions establish federal minimum guidelines for mortgage originators, creditors, and (most importantly) their assignees. While industry critics complained that earlier iterations of these provisions would have prevented resuscitation of the still sputtering secondary market in residential mortgages, we are critical of these reforms from a slightly different perspective. The reforms are calculated to increase the liquidity of non-predatory home loans (and, thus, the strengthening of the market for residential mortgage-backed securities from its current moribund levels), while limiting the marketability of non-standard and potentially predatory loans. In our view, unless the Bureau strengthens these provisions through its authority to create standardized forms, prescribe disclosure, and promulgate regulations to prevent unfair, deceptive, and abusive mortgage terms, they will fail to fulfill their potential as a sorting mechanism.

Part I of this Article compares and contrasts House and Senate bills proposed (and/or passed), in the wake of the current financial crisis, both to reconfigure the market for home loans and re-regulate much of the financial services markets. This Part concludes by summarizing the reconciliation of the two bills achieved by the Dodd-Frank Act that combined and modified these earlier proposals. The Act combined the specific statutory protections of earlier legislative proposals with a broad grant of regulatory authority to a new Bureau of Consumer Financial Protection. We believe that the Dodd-Frank Act holds out the possibility (realizable through use of the Bureau's rulemaking authority) of a coordinated and systematized integration of the approaches discussed in those statutes. In Part II, we read Title X of the statute carefully, with one eye on what the statute says about its scope and the other on the Bureau's structural placement within the Federal Reserve. Moving from the creation of the Bureau and its scope of authority, Part III turns to Title XIV of the Act, which contains provisions from the Miller and Frank Bills (precursors to the Dodd-Frank Act) intended to regulate predatory mortgages. Although these provisions are not as strongly protective of consumers in the Dodd-Frank Act as they had been in the Miller and Frank Bills, or as we would like them to be, their inclusion in the Act clarifies the Bureau's scope of jurisdiction over residential mortgage loans and solidifies the importance of consumer protection in the market for home loans. We conclude by justifying our conclusion that the Act provides a coordinated regulatory architecture and shows how the grant of regulatory authority contained in the Dodd-Frank Act could be used to implement this balanced approach.

1. CURRENT EVENTS

   The Dodd-Frank Act took two years for Congress to enact because consumer advocates and industry interests debated how best to respond to the sub-prime mortgage crisis. Initially, proponents of regulatory reform proposed legislation to regulate or proscribe certain consumer financial products. (4) Opponents to regulatory reform argued that attempts to weed out bad actors and products would snuff out credit opportunities for the deserving, and thus that consumer protection legislation would both limit the liquidity of consumer debt and stifle product innovation. (5) In our view, the Wall Street Reform and Consumer Protection Act, signed by President Obama on July 21, 2010, comes close to satisfying both sets of substantive concerns, but much of its success rests on how it is implemented through administrative rulemaking.

   Securitization of home mortgages offered considerable benefits for certain borrowers. Access to capital markets financing reduced the cost of certain loans, and hence provided an interest rate advantage. This advantage, however, came with attendant risks. Capital markets borrowers relied heavily on gatekeepers to ensure that the borrowers would have the ability to repay the loans, that the value of the property was as represented, and that the borrower would not have defenses to enforcement. This reliance on gatekeepers created opportunities for abuse by mortgage originators. That abuse took the shape of poor loan origination practices, loan terms that were unsuitable for the particular borrower, and loans that the borrower had no meaningful ability to repay. These risks were greatest with nonstandard mortgages, and would have been significantly reduced where a lender was making the loan as an investment for its own account. The goal of the architecture articulated in the bills that preceded Dodd-Frank was to limit the types of mortgages that would have access to securitization to those that were safest. As enacted, these protections were significantly watered down. Nevertheless, because enforcement was entrusted to the Bureau, and the Bureau was also granted rulemaking power, we are hopeful that an effective sorting architecture is still possible.

   This Part discusses the various legislative proposals relating to home mortgages that formed the DNA for much of what became the Dodd-Frank Act. The subprime mortgage crisis had prompted members of Congress to introduce a wide range of regulatory proposals in both the 110th and 111th Congresses, and while several of these bills passed the House, none of them were adopted by the Senate until well after administrations changed in 2008. Although many bills had been introduced in the House and Senate, we focus primarily on the Miller and Frank Bills in the House and the Dodd Bill in the Senate.

   First, H.R. 1728, a bill introduced in the 111th Congress by North Carolina Representative Brad Miller (the "Miller Bill"), looked to regulate the marketers of mortgages through an approach aimed at mortgage brokers and other mortgage originators--requiring their licensing, mandating disclosure, and holding them accountable should they help originate a mortgage that was unsuitable for the borrower at the...