WORD ON THE STREET: The calamities of the last decade – even the crisis caused by the calamity in mortgages – do not make us at the Consumer Financial Protection Bureau (CFPB) doubt the value of free and competitive markets. Quite the contrary, in fact. The failures of the mortgage market underscore just what functioning, efficient markets are supposed to be all about in the first place. They're supposed to be fair; they're supposed to be transparent; they're supposed to create incentives for hard work and smart decisions.
We shouldn't expect the mortgage market to really work unless, and until, it has those qualities – fairness, transparency and aligned incentives.
Let me start with basic fairness. One of the commonsense steps we can take to promote fairness in finance is to fight illegal discrimination. Now, make no mistake: I firmly believe that discrimination is considerably less prevalent in America today than it was when my parents arrived here (46 years ago), or when I was born (41 years ago), or even when I started my career in finance (which feels like a million years ago). We have made some progress.
And that's not by accident. That's because consumer groups, civil rights groups, regulators, law enforcement agencies and bankers themselves have all made fair access to credit a priority. But there is more work to do. After all, it's called a credit ‘cycle’ for a reason. And in a tight credit market like today's, the unfortunate reality is that we need to pay particular attention to credit-access issues to ensure that discriminatory practices cannot take root and flourish.
The CFPB wants to ensure that lenders are not creating conditions that make loans more expensive, or access more difficult, for certain populations. Earlier this week, our director, Richard Cordray, reaffirmed our support of what is called the ‘disparate impact’ doctrine. The bureau will monitor lenders' practices. And if those practices have an unintentional but unlawful discriminatory impact on a segment of the population, the bureau will intervene. It's as simple as that.
America's fair-lending laws are focused on fairness among consumers. But fairness among financial services firms matters, too. That's part of why the CFPB is such a dramatic step forward. It shouldn't matter what type of financial institution you are or what consumer product you sell. If you want to participate in consumer financial services, you should follow the same basic rules as everybody else. And you should expect those rules to be enforced. If you allow different players to play by different rules, you encourage a destructive race to the bottom.
Critically, the bureau is the first federal agency to have supervisory authority over non-depository financial firms – and we take that responsibility very seriously. So fairness is core to our agenda.
But so is transparency. Markets don't work well if both parties to a transaction don't understand what they're getting into. I hope that some of you already know about our efforts to bring better substantive transparency to the mortgage origination markets. We are working to streamline, integrate and simplify two needlessly complicated federal disclosure forms – one under the Truth in Lending Act, and the other under the Real Estate Settlement Procedures Act, so that borrowers have a better chance to actually understand the price and risk profile of their obligations.
But transparency isn't just about the front end of the mortgage business – it matters at the back end too, in mortgage servicing. The CFPB has previewed a series of commonsense rules that we're considering in mortgage servicing. They include practical ideas on improving transparency. For instance, maybe servicers should give borrowers better information about how much they owe every month; or an earlier heads-up that their adjustable rate mortgage payments are about to change; or warn them that they are going to be force-placed into a potentially expensive insurance policy.
So we're trying to take a commonsense approach to fairness – and to transparency. And, perhaps most fundamentally of all, to financial incentives.
Cover your assets
I've spent the vast majority of my career in consumer finance. I've been in and around finance companies, commercial banks, and investment banks. And through all of that, I learned one thing above all others: Although there are bad mistakes, there are some bad people, and there are occasional bad breaks, fundamentally, when all is said and done – people are generally good, but they generally do what they are paid to do.
So if we want businesses to do the right thing, they shouldn't be paid to do the wrong thing. Bankers shouldn't win when customers lose.
Let me give you an example from the mortgage bubble. Too often, it was the case that mortgage brokers were paid more to give borrowers a worse deal. If a borrower could qualify for a loan at, say, 6%, a broker might be paid a special bounty – called a ‘yield spread premium’ – to juice that rate from 6% up to 8%. As a result, the most important, most visible person in the mortgage process for many borrowers – the mortgage broker – had a financial stake that was confusingly and perversely in direct opposition to the interest of the consumer himself. If people are paid to treat customers poorly, it shouldn't be surprising when they do.
The Federal Reserve Board and then Congress took important steps in this area, and it's our job at the bureau to propose and finalize regulations that end these practices. We're working hard to do just that.
Financial incentives matter. Ideally, lenders' and borrowers' incentives should be aligned; both of them win when borrowers can afford their loans. At some tacit level, ordinary people know that. When they sit down at the closing table, there is a certain element of trust that your lender isn't setting you up to fail. And that is the underpinning of another substantial policy effort that we have under way at the bureau: The Dodd-Frank Act's ‘ability to repay’ requirement in mortgages.
Again, let me hearken back to my days as a banker. Here's what should be the least surprising lending advice you've ever heard: If you are going to lend money, you should probably care about getting paid back. And if you care about getting paid back, you should probably inquire about, and evaluate, a borrower's ability to pay you back.
That should not be controversial. And it isn't – not to the vast majority of big banks and community banks, credit unions and thrifts that actually held on to some of the risk of the mortgages that they were originating during the bubble. Nor is it surprising to any banker trying to build or sustain a customer franchise – after all, a customer franchise only endures and thrives if its customers win.
But unfortunately, because of misaligned incentives in the mortgage business, millions of borrowers were set up to fail. Borrowers were sold increasingly exotic, nontraditional mortgages that they didn't understand and couldn't afford. Lenders did that because the risk was separated from the reward. Lenders could make money by repackaging and selling off your loan.
Congress tackled this problem through a number of complementary provisions in the Dodd-Frank Act, including the so-called ‘ability to repay’ provision. Put in its simplest form, Congress has required that lenders reach a good-faith determination that a mortgage borrower has a reasonable ability to repay the loan. If lenders don't do that, the law lays out real consequences.
As part of the broader ‘ability to repay’ mandate, Congress also designated so-called qualified mortgages, which are structurally safer and pose lower risk for borrowers, and which are underwritten according to standards that make it reasonable to expect that borrowers have an ability to repay. The Federal Reserve Board proposed a regulation last year that would give definition and effect to the ‘ability to repay’ provisions, and we inherited that proposal when we opened for business last July. We have had the benefit of extensive public comment on the proposal, and we have ourselves undertaken a significant analytical effort – with a cross-functional team of economists, lawyers and market experts.
We are considering a wide range of issues. First and foremost, we want to ensure that consumers are not sold mortgages they do not understand and cannot afford. We want to minimize compliance burden where possible, in part through the careful definition of those lower-risk ‘qualified mortgages.’
We want to ensure that, as the market stabilizes over time, every segment of prudent loans has the benefit of sufficient investor appetite and a competitive market. We want to avoid any inappropriate disincentive that would prevent lenders from making prudent, profitable loans in seemingly higher-risk or nontraditional segments – like loans to self-employed borrowers.
We want to enable the mortgage market to do what other free and efficient markets do as a matter of course: take smart, prudent, profitable risks; treat customers fairly; and serve customers well. We want consumer finance markets to work.
Raj Date is deputy director of the CFPB. This article was adapted and edited from a speech delivered on April 20 before the Greenlining Institute Conference in Los Angeles. The full text is available online.