The CFPB Giveth and the CFPB Taketh Away

Last Thursday we got a glimpse of the new normal for creating new technologies in the mortgage space. The CFPB issued a policy statement about providing a “no action letter” to companies seeking to develop and implement new technologies. 

What is a “no action letter?”

It is not some kind of Zen-like, written mantra, that hypostatizes reality. It is not an attorney’s opinion letter, offering some prognostication about legal liability. It is not a declaratory statement that seems to offer solutions but is mostly devoid of meaning. In the case of the CFPB’s “no action letter,” it is just a letter that offers some grudging, limited inclination to let companies gauge how their new technologies may or may not conform with existing law and regulations, purportedly providing a semblance of approval possibly in advance of the technology’s implementation.

The idea here is the notion that submitting products to the bureau for a preëmptive, regulatory review will head off future prosecution of regulatory violations. I use the word “notion,” rather than the word “assurance,” since it is debatable whether the CFPB’s determination that the new product which meets existing regulatory standards would fully protect a company from an immediate enforcement action.

The fact is the CFPB’s “no action letter” policy will not really lift the threat of an enforcement action, because the agency retains the right to reverse its decision upon finding the product runs afoul of existing law. Therefore, the limits on the protection that a “no action letter” affords do little to abate the uncertainties that such a policy would nevertheless supply the space or incentive that companies need to come up with new ways to serve customers.

And incentive is the energy that drives creativity and willingness to take risks!

It is one thing to dangle a carrot, but when there are no specific guidelines to follow in order to avoid the stick, that seems a bit of a challenge to negotiate. Innovation comes through incentives and risks, not a placebo letter that giveth the appearance of compliance but may just as well taketh it away if the hope of some “certainty” evaporates.

This initiative has been around for a few years. Back in 2012, the Bureau started a program called “Project Catalyst,” which allowed firms to work with the CFPB on new products that had the potential to lead to new rules to accommodate financial technology innovations. Actually, the “no action letters” concept was proposed subsequently in late 2014 as part of the foregoing program. The current iteration of these letters is to provide an evaluation of how a new technology works within the existing regulatory structure. As such, excluded from this evaluation process will be products and technologies that did not exist when certain consumer financial protection laws, like TILA and RESPA, were created.

Put yourself in the place of a financial technology company. If you are a start-up with substantial pecuniary resources, you may seek a CFPB “no action letter,” but if you are a big company in the technology space, you would now have to put yourself through rather intense scrutiny from the Bureau. Consider this: if you build a product and implement it, yet seek the CFPB’s approval for it, and the CFPB says your product does not meet regulatory compliance, you would be admitting to a violation.

This is where risk plays its central role in our economy, for risk is measured in the marketplace in our economic system. How is it possible that the CFPB can second guess the results of market action with respect to risk? Once a product is used, risk is the feedback that improves a product as well as ensures standards of regulatory compliance. Does the Bureau have such a crystal ball?

The process of taking a technology product through a “no action letter” review would have to be exhaustive in terms of the sheer demands on time, professional involvement, and monetary considerations. Virtually every aspect of the product would need to be described and be able to withstand a battering of investigative regulatory oversight. Each request for more documentation and proof of regulatory compliance would be yet another turning of the screw.

Then there is the sharing of information that the Bureau plans to offer the public. In this regards, the Bureau plans to publish the letter, along with a product summary, to the CFPB’s website. Even rejected applications will be published. More concerning, however, is the potential leaking of proprietary information belonging to the product’s inventors.

But for all this, the Bureau offers its limited assurance that it will not file an enforcement action once the product hits the market – all the while retaining the right to revoke its opinion at any time!

Furthermore, the “no action letter” will not be binding on courts, civil litigants, or other regulatory agencies. So, just how valuable is this letter?

Jonathan Foxx

President & Managing Director

Lenders Compliance Group

Too Big to Fail: A Wayward Path

I take no great pride in stating that I have actually read the entire Dodd-Frank Act - 2,300 pages. It was a brutal read, but I plotted it, graphed it, bookmarked it, highlighted it, cross-referenced it, and set up an extensive spreadsheet that cross-tabulated all the sections, subsections, sub-sub-sections, and adduced each attendant citation.

In the midst of getting through this kaleidoscopic endeavor, I was particularly interested in finding out how the concept of “too big to fail” (or “TBTF” as it has come to be known) would be defined and transmogrified into procedural action.

Unfortunately, I came away from the experience with the view that TBTF was a myth, a fable created to mollify the masses into believing that the financial meltdown won’t happen again.

And here we are in 2016, years away from the DFA’s effective date of July 21, 2010, and finally my concerns are being recognized – by none other than Neel Kashkari, currently president of the Federal Reserve Bank of Minneapolis, but back then a chief architect of the government’s response to the financial crisis.

Recently, Kashkari said that the DFA did not go far enough and TBTF is “an ongoing, large risk to our economy.” He suggested that possible solutions include proposing the break-up of large money center banks.

He ought to know: Kashkari was the interim Assistant Secretary of the Treasury for Financial Stability from October 2008 to May 2009, and he oversaw the Troubled Asset Relief Program (TARP) that was a major component of the government's response to the financial crisis.

Kashkari has stated, “now is the right time for Congress to consider going further than Dodd-Frank with bold, transformational solutions to solve this problem once and for all.”

But, why “now”?

What does he know about the exposure to systemic risk that we don’t know?

Mr. Kashkari spoke at the Brookings Institution, where he suggested solutions such as:

• Breaking up large banks into smaller, less-connected, less-important entities;
• Turning immense financial institutions into public utilities, subject to public utility regulations - for instance, forcing them to hold so much capital that they virtually cannot fail; and
• Using taxes throughout the financial system to reduce systemic risks wherever possible. 

The Minneapolis Fed has set forth an initiative to develop a plan to end TBTF, as noted by Kashkari in his presentation. It expects to deliver the plan by the end of the year, preceded by a series of policy symposiums to explore various options to combat TBTF.

But where are the legislators to be found to push forward with ways and means to reduce further the risk of systemic risk? Maybe another existential threat to the economy or another large-scale, financial crisis will bring the need to prevent systemic risk back into focus. Let’s hope not!

One thing’s for sure: policy makers have not taken the above-mentioned suggestions under advisement. The TBTF wildebeests continue to grow and grow, becoming ever more behemothic, labyrinthine, and super-colossal.

So, who has the most to gain maintaining the status quo? Of course, Wall Street, many of whose denizens – such as Goldman Sachs – had to become banks in the last go-round. And, of course, all the money center banks, those habituant Brobdingnags gorging off the federal reserve system.

Can’t seek resolution from those entities, especially given Kashkari’s epic recommendations!

In this election year, perhaps there are candidates listening, stumping for some or all of Mr. Kashkari’s recommendations, whether or not they are even aware of his position on this subject. Maybe they know the same something about systemic risk that Kashkari knows.

What do they know about the exposure to systemic risk that we don’t know?

Flint - Crisis in Mortgage Banking

Yesterday, February 8^th, FHA sent out the following announcement:

Property Eligibility Requirements Reminder for Properties Affected by Water Contamination

The Federal Housing Administration (FHA) recognizes the concerns over the quality of water that has had a negative impact not only on the residents and families in Genesee County, Michigan, especially Flint, Michigan, but also on home sales and mortgage lending in this area.

As a result of this emergency, FHA has become aware that there are single family housing properties that may be affected by contaminated water in Genesee County, Michigan. Mortgagees and other stakeholders involved with FHA transactions are reminded that to be eligible for FHA insurance, a property must meet FHA’s Property Acceptability Criteria as stated in the Single Family Housing Policy Handbook (SF Handbook) 4000.1, Section II.A.3.a.ii (F) and (J). 

(My emphases.)

In the citation, section (F) states, in part:

(F) Requirements for Living Unit

The Mortgagee must confirm that each living unit contains:

• a continuing and sufficient supply of safe and potable water under adequate pressure and of appropriate quality for all household uses. (My emphasis.) 

Section (J) states, in part:

(J) Environmental

The Mortgagee must confirm that the Property is free of all known environmental and safety hazards and adverse conditions that may affect the health and safety of the occupants … (My emphasis).

Erin Brockovich, the environmental activist, recently went on Stephen Colbert’s “The Late Show,” where she observed that “Flint is the tip of the iceberg.” A year ago, she had sent a team to Flint to investigate. Colbert asked her, “Is this the tip of the 'leadberg'” (sic).

Her response:

“I can tell you that Flint, Michigan is the tip of the iceberg. … I can tell you for certain that this is a national crisis that we are not getting ready to face. The crisis is already here. Even since Flint has hit the national stage, we’ve found out that Sebring, Ohio has the same problem … The same thing is happening in Louisiana, and we’re just now hearing rumors – I haven’t verified it before I came out – we’re having the same situation in Wisconsin.”

The deterioration of the infrastructure through the United States is a significant problem – indeed, a national emergency. In 2013 the American Society of Civil Engineers gave America’s dire situation a grade of D+, with a repair cost of $3.6 trillion. By the news since then, the deterioration has gotten worse!

When I use the word ‘infrastructure,’ it seems too much is tucked into that euphemistic nomenclature. Let’s be clear. A deteriorating infrastructure means the following necessities are rapidly declining: energy, transit, aviation, levees, dams, schools, roads, inland waterways, ports, waste water, rails, bridges, public parks, hazardous waste, and most certainly drinking water.

If this is not a national emergency, I don’t know what is!

We know there simply has not been much done to muster all-hands-on-deck to get our infrastructure on the mend. How do we know this? The crisis keeps getting larger each year, and a tidal wave of infrastructure obsolescence is gradually engulfing more and more of the economy.

Mortgage banking is a significant sector of the economy. It is dependent on real estate values to support property eligibility and long lasting loan performance. Given the crumbling of the country’s infrastructure, the tidal wave is heading straight for the mortgage banking industry.

Indeed, more than ever, the deteriorating infrastructure is amassing an increasing toll on the stability of the mortgage banking sector. It is one thing for investors, GSEs, and FHA to shy away from loans in disaster areas, induced by natural causes. But disaster areas caused by human error, such as in Flint, or by the lack of a national effort to repair the infrastructure? 

That is a disaster of a different sort, for it is entirely avoidable.

Jonathan Foxx
President & Managing Director
Lenders Compliance Group