The Importance of Avoiding Disputes

Remember when our parents used to drill into us that we should make every effort to live at peace with everyone and stay out of conflict whenever we could?  Some parents, like mine, followed that basic message with a second message: if somebody attacked us first we needed to defend ourselves. But that second admonition was only to be used if all of our efforts to avoid conflict had failed.  For most of us the basic message was clear--stay out of trouble if you possibly can.

Today, Fannie Mae has taken on the role once held by our parents of reminding us that disputes are bad.  No, I am not talking about the fight with the school yard bully at recess, or the on-going conflict with the neighbor who refuses to clean up the weeds and trash in his yard.  I am talking about disputed items on a credit report, which due to Fannie Mae's new guidelines have turned into a real problem for borrowers looking for conventional financing.

A few years ago, disputing items on credit reports was all the rage.  I have had borrowers with mobile phone accounts that they insist they never opened, utility bills they claim they never signed for, apartment leases that their ex-boyfriend/girlfriend was supposed to pay, etc.  Most people with collections on their credit report are fairly insistent that those accounts do not belong to them.  And in some cases, that is true.  We live in an age where identity theft is a huge business--from online hackers with spyware looking to steal account numbers and passwords to waitresses and waiters who are able to make copies of credit cards at restaurants, this society is filled with people who are benefiting financially from destroying another person's credit.  In some cases, the problem does not stem from something as sophisticated as formal identity theft but the account being billed does deserve to be disputed because it was double billed or previously paid, or the service or product being billed for was never supplied. 

Filing a dispute has been a fairly easy process since the three major credit bureaus became more accessible through their websites.  A consumer disputing a tradeline needs only to go to the website of the credit agency in question, order a copy of his own credit report, and then click the dispute tab to have the bureau investigate it.

While the dispute process has many legitimate uses, we also recognize that, as with many good things in this world, the process has been exploited and abused by credit repair companies who dispute all of the derogatory items on the credit report so that the creditors will have to respond to the credit reporting agencies' request for information.  The creditor is supposed to respond within 30 days, and if he fails to respond the agency is supposed to remove the item in question.  Of course, this is a very short-term fix because when the creditor does respond, the offending item goes right back on the credit report, but it has been used to artificially elevate credit scores very briefly so that borrowers who really do have very bad scores can temporarily raise their scores enough to get a loan.

Scams like these must have been what prompted Fannie Mae to make its new rule about disputed items.  A borrower with a disputed item on a Fannie Mae credit report must now have the dispute removed before the loan can close or else the credit score cannot be considered in underwriting. 

I had read about this a couple of months ago, but I was confronted with it this week as I was getting files ready to refinance.  One borrower in particular has basically good scores, extremely high income, low debt in relation to his amazingly high income, and a lot of assets.  He also has a few collection accounts which he refuses to pay.  I wanted to make sure that he would not be required to pay these accounts at closing (I have done quite a bit of work for his family and I know that he would rather not refinance than pay collection accounts, so I wanted to find this out first), so I started by running his file through the automated underwriting system to make sure that he could leave the collections unpaid.  And then, as I stared in amazement at my findings, I remembered what I had read about the disputed accounts a couple of months ago.  My borrower does not have to pay his collections because they total less than $5000.00, but in spite of his wealth, basically good scores, and low debt, he cannot get approved for this refinance because he disputed two of the accounts, which combined total less than $500.00 unless he removes the dispute from each credit reporting agency.  Removing a dispute could take months, and he is only refinancing to take advantage of the low interest rates right now.

The item he is disputing is a charge from an insurance company that he insists he does not owe.  The account is a couple of years old and is insignificant when compared to the rest of his credit history.  But here is the most amazing part--even if my borrower decided that the new refinance was more important to him than this measly collection and paid the collection account in full, Fannie Mae still would not give him the loan!  Even if the bill has been paid, if the account is on the credit report showing that it is in dispute, the credit scores cannot be utilized.  And since accounts stay on a person's credit report for seven years from the date of last activity, this account will be there a long time.

Yesterday I talked about how strict new underwriting guidelines are making it nearly impossible for even good borrowers to qualify for mortgage loans, and this new underwriting rule about disputes is another example.  I have no doubt that this rule was implemented to weed out weak borrowers who artificially inflate their credit scores by disputing items on their reports.  But, in an effort to sift out these borrowers, Fannie Mae is also punishing borrowers with long credit histories and scores that are reflective of how they have managed their credit over time but who have had a legitimate disagreement with a creditor.  The result is that borrowers like mine who are a good credit risk, have the income and assets to pay, and have a long, mostly clean credit history, get their loans denied.

In checking around, I learned that Freddie Mac does not have this same rule, so the file can be sent through their automated engine instead.  For my borrower, that means losing his interest rate lock since the lender I was going to use does not allow his specific loan product on Freddie Mac.  Fortunately, the rates are still low and we can salvage this deal.  But in a market with volatile rates, this would have cost him the opportunity to refinance and take his 15 year mortgage loan down to a 10 year while knocking nearly a point off his rate.

The morale of the story:  1.  Read the credit report carefully before you submit the file to see if there are any disputed accounts--even closed ones.  2. Remember Mom and Dad's words of wisdom and where ever possible, avoid disputes.

President of the Law Society visits GLC new offices

President of the Law Society of Scotland, Jamie Millar, received a warm welcome and tour of Govan Law Centre's new Orkney Street offices today. Mr Millar congratulated Govan Law Centre, its staff and board members, on securing the newly refurbished premises at the Orkney Street Enterprise Centre (OSEC). 

The facilities at OSEC provide the local community with access to free legal advice and representation, prevention of homelessness services, money and financial inclusion advice, help and support to get back to work or into further education, and access to social work services.

Mr Millar was in Govan to discuss access to justice issues in Scotland, with the Society's new Access to Justice Committee convener, GLC's Mike Dailly. The Society's new Access to Justice Committee is scheduled to have its first meeting later this week.

The True Case of Mr.and Mrs. X

With all of the bad news coming out of the housing sector last week, including slumping new and existing home sales, word that the Federal Reserve may have to start purchasing Treasury bonds again to keep the economy afloat and fears of a double-dip recession looming over us, I wanted to start this week by giving a good true life example of what I believe is killing the housing market:  unreasonable credit underwriting guidelines that don't make any sense.  The story that I am telling tonight is absolutely true--only the names have been changed to protect everyone involved.  And I think that it really illustrates why the housing sector is having so many problems.

My story begins this past June when I was asked to qualify Mr. and Mrs. X over the telephone because they were looking at purchasing a new home here in El Paso.  After speaking with Mrs. X, I was able to determine that Mr. X's new mid six figure salary in El Paso would be more than sufficient to qualify them for a home here in El Paso without them having to sell their existing home in Far Far Away.  Since their credit scores were sitting right at 800 and they had virtually no debt, I knew that this would be an easy transaction.

Mrs. X wanted to sell her home, but in July with summer coming to a close and school starting, she decided just to go ahead and purchase her home here while leaving the other one on the market.  But since she had not been able to sell the other home yet, she decided that she wanted to put only 10% down on the new home she was buying.  Since her first lien would be over $417,000 which was the conforming loan limit in El Paso, I checked lenders' guidelines carefully for a program which would allow her to borrow up to 90% of the sales price.  And finally, I found a loan program that would allow us to do two liens--a first lien of 80% and a second lien of 10% more.  I reviewed all of the product guidelines to make sure that we had a high enough credit score, low enough debt, etc.  I also talked to the lender's representative to make sure that everything was acceptable.  Then I sent off the second lien for approval with the second lien lender, and I got it approved within 24 hours.

Feeling good about the transaction, I uploaded the entire file to the first lien lender, ordered the appraisal, and waited.  I had been told that underwriting took 3 and a half days, but I sent the file in at the end of the month so I knew we could have some delays.  Three and a half days soon dragged into two weeks as we waited for underwriting and the appraisal.  And since I knew that appraisals on properties over half a million dollars in El Paso can sometimes be a challenge--of course the lender required us to use their appraisal management company--and I also knew that we could not get final underwriting approval without the appraisal, I waited.

Finally, two weeks after the file was submitted, I got the underwriting determination back.  But instead of an approval asking for little more than the appraisal,  I received a "suspense."  The investor to whom my lender was selling this loan had placed El Paso on a "declining markets" list for areas where the home values are dropping and for this reason they would not allow the second lien even though the second lien was already approved.

By now, Mr. X had flown back home and was preparing to drive a moving truck down to El Pas filled with all of the family's furniture and belongings.  I called Mrs. X to tell her what had happened and she immediately went to work selling stocks and liquidating her accounts to get the 20% down payment which the lender now required.  By the following afternoon, she had wired the down payment to the title company and sent me proof of the assets.  I sent everything back to the underwriter, and since we now had an appraisal which was actually significantly higher than the sales price of the house, I hoped that the lender would now sign off on our conditions.

I was about to be disappointed yet again.  This file had to have a supervisory underwriter's signature.  That meant another week before our file and our appraisal could be reviewed.  By now, Mr. and Mrs. X and their furniture and children were in El Paso with no place to stay.  And when the file came out of underwriting again, it had new conditions on it--conditions added by the supervisory underwriter who, as she expressed in an email to me, would have added even more conditions than these except that the primary underwriter talked her out of doing so.  In addition to wanting additional print outs of paperwork already supplied, the supervisory underwriter wanted to see more money in savings to prove that Mr. and Mrs. X could make the payments on their new home for at least six months.  We had to document every cent that we could find even though the entire down payment had been sourced and verified and was waiting at the title company.  And since we were not allowed to use the cash value of life insurance or retirement accounts as reserves, this proved to be quite a challenge.  Further, the underwriter gave us credit for only 60% of the value of their remaining stock accounts.  Using these restrictions we could barely squeak out proof of the required savings. 

Mr. and Mrs. X closed last Thursday, fifteen days past their closing date.  We had three underwriters involved.  The X family ended up having to rent the house they were purchasing in order to have a place for themselves and their furniture while we worked to meet all of the demands being placed on us.  I had to send them the underwriting worksheets to prove that what I was telling them about their conditions of approval was true.  They simply could not accept that they would be having these kinds of problems qualifying for a loan.  After all, when they purchased their home eight years ago, they did not have any problems at all.  And if they had been purchasing this home three years ago, they would not have had these problems--they would have been qualified, closed and moved in right on time. 

The next time that I hear someone say that the U.S is only in the mess it is in because "a bunch of people got homes who couldn't afford them," I will think of Mr. and Mrs. X.   The mortgage industry has evolved in just a couple of years from looking for ways to put everyone into a home to looking for reasons to deny every file.  Lenders and investors are so afraid of making a loan that goes bad that they do not want to take a risk on anyone--even people like the Xs who are not much of a risk at all.  That is the reason that one major investor in jumbo loans (loans over the conforming loan limit) has publicly stated that they are comfortable denying 70% of the mortgage applications they see. After being pilloried for years for making "bad" loans which destroyed the economy, we as an industry almost feel righteous when we turn a loan down.  We are holding the line against a potential default, but we are also holding up a transaction--a flesh and blood buyer and seller who need to move on with their lives.  And until this new mindset changes, we are not going to see the housing market improve no matter what kind of incentives the government provides.

And the Good News Just Keeps on Coming...

On the heels of a dismal existing home sales report on Tuesday, Wednesday saw a dismal new home sales report. The National Association of Realtors is reporting that sales of new homes have hit a historic low of 276,000 for the month of July. That is the lowest number of recorded sales since record-keeping began in 1963. At the same time, housing prices have fallen to the lowest levels in 7 years--the median price for a single family home is now $204,000 which is the lowest since 2003.

This is bad news not only for real estate but for the construction industry as well, and it is also bad news for the job market as real estate and construction have been steady employers for the last 10 years or so. As new home sales continue to drop, we are going to see more builders closing their doors, which is going to lead to more bankruptcies and layoffs and general economic problems.

It also bad news for my industry. According to the NAR report, mortgage purchase applications are currently at the lowest levels in 13 years while mortgage interest rates are the lowest levels in 20 years. Eighty-two percent of mortgage applications are for refinances.

Of course these are national averages. In my city, El Paso, Texas, the local news is reporting that our sales of existing homes have actually dropped 44% between June and July as opposed to 27% which is the national average. That really is shocking because we have never had huge appreciation in our market and as a result we never had to deal with huge depreciation either. Our values were stable, and we counted on the influx of buyers from Mexico and the influx of troops from Fort Bliss, Texas to keep us afloat no matter what was going on nationally. So a 44% drop is astounding.

In response to all of this bad news, CNBC posted a story that the Fed is looking at resuming its program to purchase treasury notes in order to further drive down mortgage interest rates to spark some activity. (The Federal Reserve was holding rates down through March of 2010 with a program to purchase mortgage backed securities. When the Fed's intervention ended in March, all of us expected interest rates to rise, so the interest rate drop this summer was an unexpected gift.) But with 10 and 15 year fixed rates currently at 3.875% and below, I do not see how further lowering interest rates is going to do anything but help the same set of borrowers with great credit and income who have been refinancing for the past two years free up a little more cash.

Don't misunderstand--I am thrilled that the rates are low. It is exciting to see borrowers actually save hundreds of dollars per month and lower their already low interest rates by 1% or more. Last year when I was refinancing borrowers, I thought I had seen the lowest rates I ever would. But I do believe that there is a point when just continuing to lower interest rates is a wasted exercise. If borrowers are not going to buy houses when the thirty year rate is under 4.5%, will they be more motivated if the thirty year rate is under 3.5%? I don't think so.

I believe that the real problem is the inability of borrowers to qualify under the strict underwriting guidelines. Put simply, nobody likes rejection. Many people will really avoid situations where they feel embarrassed, and for many potential homebuyers, being denied for a loan is a potentially embarrassing situation. Borrowers do not want to apply for a loan there is a good chance they are not going to get.

On top of that, the paperwork is so huge and the requirements are so exacting that many borrowers lose patience during the process. Many people do not like signing hundreds of pages of forms they do not understand both during the application process and at closing. I received a closing package today that was 147 pages! There were so many documents that the attorneys who prepared it finally just sent an additional loan package to make sure that title had everything they needed. Borrowers are discouraged by high costs, delays, and stacks of paperwork, and they don't want to go through all of the headaches to be told, "I am sorry, but at the end we just could not get you into this home."

If we want to get the economy moving in the right direction again, we have to loosen up access to credit. If mortgage guidelines were relaxed, more borrowers would qualify, which would induce more borrowers to apply. As they purchased homes, the builders would start selling homes, the sellers who are waiting to sell their own homes before they can purchase new homes would now be able to buy homes, etc. Before long, builders and the real estate community might be able to actually hire some help, which would put Americans back to work. Those new hires would then have some money to spend at their local retailer, and before long he or she could hire some help,too. And then, those new hires would have some money to spend. But the entire process begins with access to credit.

I realize that the justification for making credit guidelines so tight is that we do not want the kinds of problems we saw two years ago in the credit markets. Lending money is by its very nature risky--there is always a possibility that for one reason or another the person you loan to will not pay you back. The only loan that is 100% risk free is the one that never gets made in the first place. So rather than rushing to buy treasury notes to drive rates down, why not try loosening up lending guidelines and circulating some money in the form of mortgage loans with reasonable interest rates. Since Fannie Mae and Freddie Mac are both controlled by the government, this would be easy to do and it might pay off for the whole country!

Recovery Summer is Coming to a Close

The big story today in the world of mortgages and real estate lending is the National Association of Realtors' survey which shows that sales of existing homes have dropped 27.2% from June of 2010 to July of 2010 and have hit the lowest level for single family home sales in 15 years. According to the Washington Post, this is the biggest one month drop on record since 1968. The Post quotes economist Paul Dales, "The housing market is undermining the already faltering wider economic recovery. With the increasingly inevitable double-dip in prices yet to come, things could yet get a lot worse."

Of course, sales have been slow since the homebuyer tax credit ended on April 30, 2010. Up until that time, borrowers were putting in contracts to qualify for the tax credit. But the timing of the credit expiration seemed to be designed to carry the real estate market into summer, since the period between Memorial Day and Labor Day is the time when families with children traditionally purchase new homes and move. Now, with Labor Day less than 2 weeks away, the NAR report takes on special significance for sellers hoping to unload their homes before this prime window of opportunity closes.

The irony is that the White House dubbed the summer of 2010 "Recovery Summer" and sent members of the administration on a good will tour to explain to Americans how things really are getting better. But the slumping home sales are a clear sign that for many buyers, sellers and real estate and mortgage professionals, there is no recovery to celebrate.

I particularly appreciate Dales' comment, "The housing market is undermining the already faltering wider economic recovery," as if housing professionals are purposely sabotaging overall efforts at economic growth. Even though this summer has seen some of the lowest mortgage rates in the history of records, the facts are that many homebuyers cannot qualify because of strict lending standards. The regulations which were supposed to make the housing markets safer have shut out so many borrowers that the entire real estate market is suffering.

The Post also cites a disconnect between buyers and sellers over the price of homes. "One reason the market is hurting is that buyers and sellers are in a standoff over prices. Many sellers are reluctant to lower their prices. And buyers are hesitating because they think home prices haven't bottomed out." Certainly, a lot of buyers have been influenced by internet stories of great houses being sold for pennies. But the reality is that every time that sellers lower their prices in desperation, they actually reduce the sales price of their entire neighborhood--not just their own home. If you have your home listed for $250,000 and the neighbor with a house the same size as yours on the same street just sold his for $200,000 last week, yours is probably not going to appraise, which means that you also will probably have to sell yours for $200,000. And when that happens on large scale, the entire city is affected and goes on a "declining markets" list which affects the financing that every borrower in that city can get. So even if your specific house is worth $250,000, if your city is deemed a "declining market" the buyer may need more downpayment which could keep him from qualifying. Reducing the housing prices is a vicious cycle--the lower they go, the worse financing actually gets until eventually the market does bottom out.

On top of that, we are starting to see news media reports encouraging people to rent rather than buy. With credit qualifying standards so tight, and values uncertain, many potential buyers are being encouraged to just simply rent their homes, which leads to fewer sales.

After September 11, the real estate market helped to get the economy rolling again. Low interest rates allowed borrowers to refinance into cheaper payments and to purchase new homes. The money that they cashed out from equity loans went back into the economy as purchases. Today we have some of the lowest interest rates ever, but the borrowers who could qualify for them have already refinanced their homes over the past few years, and the borrowers who could really benefit from them do not qualify.

A lot of people who would be buying houses this summer are hampered by the fact that they need to sell their own home and cannot. Tight new rules from Fannie Mae and Freddie Mac require that these sellers either prove through an appraisal that they have 30% equity in their homes or qualify with both payments and in some cases enough savings to cover six months' worth of house payments on the home they cannot sell. Very few borrowers can do that, and so they sit and wait for a buyer to come along to buy their old house before they can get a new one.

If the Treasury Department and the White House really want to salvage the rest of the summer and spark a real recovery, maybe they need to ease up on credit restrictions which are choking the life out the real estate market. Since taxpayers will probably spend around one trillion dollars when the final tally for Fannie and Freddie bailouts is totaled, maybe some of that money could be spent rewriting guidelines to make sense. If credit started flowing again and houses began to buy and sell, we might see the beginning of a recovery after all.

GLC's Iain Nisbet to address Belfast conference on education law

GLC's Education Law Unit Director, Iain Nisbet, solicitor and partner, will address a legal conference on educational additional support needs in Belfast this week (Thursday 26 August 2010).

The conference is being organised by the Special Educational Needs Advice Centre (SENAC) in Northern Ireland, in conjunction with the Queen’s University Centre for Human Rights.

Iain's presentation will include an examination of the Scottish experience of the Education (Additional Support for Learning) (Scotland) Act 2004.  Other conference contributors include Brian Lamb OBE, Philippa Stobbs and Frances Ross-Watt.  Further details of the Belfast conference are available online here.

The Cost of Reform

CNN Money posted a story today entitled, "How financial reform will really work." While the story breaks down the reform bill into different parts dealing with new regulation, mortgages, credit cards, etc., its basic theme is found in paragraph 3, "Borrowers and investors are likely to benefit from a higher level of regulation, but at the end of the day we could all be paying more for credit," according to Suffolk University Professor Kathleen Engel.

In fact, according to a Fox News story this morning, we are already paying more for credit. The average credit card interest rate is higher this year than last year at this time--not because of defaults but because credit card companies are raising the rates to offset their losses due to new restrictions limiting over the limit fees and late fees on credit cards. Since the cards are not allowed to raise interest rates without warning, they compensate by raising everybody's rate upfront.

The CNN money story states that we can expect more cost increases for credit items such as mortgages. The article quotes Keith Gumblinger, who is a mortgage analyst, as saying that lenders are going to pass on the higher costs of doing business due to financial reform on to the consumers. "We are not seeing it yet, because interest rates are so low and the mortgage market is still so weak."

Actually, we are seeing it now; we are just going to see it more later as the rates rise. An article published August 17 in Housingwire cites Bankrate's newest fee survey. According to the survey, mortgage origination and third party fees (appraisals, credit reports, surveys, etc.) have increased an average of 36.6% since last year. Loan origination fees have increased an average of 22.8% in 2010 and fees paid for services have increased an average of 47.2%. A 36-47% increase in fees in one year is huge. The culprits for the increased costs, according to Housingwire--the new good faith estimate and the higher costs of doing business because of increased regulation.

Since January 2010, the good faith estimate is a binding contract on the part of the lender, and if your loan originator underquotes, he or she has to pay the difference out of pocket. As a result, originators have to quote high. But as soon as the consumer has received and approved the higher estimate, there is no reason to ever reduce those fees.

Although Bankrate does not say so, I believe that another related reason that fees are increasing dramatically is that the new good faith estimate makes it almost impossible for a borrower to understand what he is paying and to whom he is paying it. The three page form is so confusing that it is easy to hide charges since it is illegal to break out the charges separately for the borrower. All fees are just lumped together into one block of charges. The problem is so serious that the title companies have to call after the closing to ask "How much is your check supposed to be?" before they send over the commission for the closing. Before the new good faith estimate, borrowers could negotiate with their loan originator because they could see the fees as separate items on the estimate, but now they have no idea how much of the money is going to the originator or to the lender, or to the attorneys who prepare the documents they sign.

According to Housingwire, the other reason that fees are increasing is that tight underwriting guidelines are so labor intensive that lenders and originators are having to increase their costs in order to cover expenses. And that also is true. As soon as the new good faith estimate was introduced, the title companies immediately raised their fees per transaction because the closings were about to become a lot more labor intensive. More time spent on each file equals fewer files that I can close, which equals less income, unless, of course, I raise the fees I charge per file and then I have fewer files and more income.

Still another reason that costs are going up, in my opinion, is the death of competition. Four years ago, when the mortgage industry was thriving, borrowers had a lot of choices. They could easily move a loan to a new bank or new loan originator to save some money. The borrower could normally transfer his appraisal as long as he had paid for it, so if he chose to move his file, he did not have to start over with a new appraisal. Today, with long underwriting turn times--sometimes as long as 20 to 30 days, and very few originators to choose from, borrowers feel trapped. And they feel that way because they are. A borrower who is buying a house may not be able to get a contract extension if he decides to change lenders after a long tedious underwriting process. Once a borrower has paid for an appraisal, which he almost certainly cannot transfer to a new lender, he has spent money which he is not going to recoup. Further, in an era of appraisal management companies, many appraisals do not come in for value. So a borrower who is lucky enough to have a good appraisal that his lender will approve is jeopardizing his entire transaction if he leaves his lender and starts over with a new lender and a new appraisal.

All of this means that in the new world of reform, you've got little choice but to go home with the one that brung ya', even if half way through the evening you discover that he is an obnoxious, two-timing jerk.

The supreme irony of all of this is that all of the reform we have seen in the past 12 months was supposed to make everything cheaper for borrowers. Last year, HUD repeatedly projected that the new good faith estimate would save borrowers approximately $700 per transaction. The new forms were supposed to improve competition by encouraging borrowers to shop for their mortgage loans, and increased disclosure was supposed to help them better understand the entire process. Instead, just the opposite has happened; according to the Bankrate survey last year the average cost of origination and third party fees for a $200,000 mortgage was $2739.00. This year the average cost of origination and third party fees for a $200,000 mortgage is $3741.00. Regulations that were supposed to save borrowers $700.00 per transaction are instead costing them approximately $1000 per transaction.

And if CNN Money's experts are to be believed, we are just getting started. After all, the costs associated with the newly passed financial reform bill have not even come into play yet.

Race discrimination suspected in couple's delay to sell home

George Willborn, popular comedian and radio personality, claims he was denied the purchase of a ahouse by a white couple, Daniel and Adrienne Sabbia, selling their chicago home because of his race.
On August 10, 2010, the U.S. Department of Housing and Urban Development announced that the couple along with their real estate agent Jeffrey Lowe will be charged with violating fair housing law. The the Willborns state the couple demonstrated "strange behaviour" during the house tour, and are accused of postponing negotiations although the Wilborns made a $1.7 million offer, the highest the sellers had received during the two years the home was on the market. Further, the Sabbias allegedly took the property off the market to avoid selling to the Wilborns. The real estate agent Jeffrey Lowe told government officials that the Sabbias did not want to sell to African Americans.
Wilborn filed the complaint in January, it was amended in March and July. The cases will be heard before an administrative judge unless the parties decided otherwise. Once learning of the complaint, the Sabbias offred to sell the property and all of its furnishings for $1.8 million. Punitive damages or equitable relief can be awarded if the judge finds the Wilborns were discriminated against.

Where Credit is Due

Part of the financial summit this week was devoted to new credit card disclosures. And since it is now Friday and we are heading off to the weekend, when we will probably be using our credit cards more, I thought that the subject of credit card reform would be an appropriate one for the final post of the week.

In his paper, Behaviorally Informed Financial Services Regulation, Michael Barr and his co-authors propose disclosures which will "encourage good credit card behavior." As with mortgages, Barr believes that with credit card usage borrowers cannot be trusted to make their own decisions because, "behavioral economics suggests that consumers underestimate how much they will borrow and overestimate their ability to pay their bills in a timely manner." According to Barr's paper, nearly 60% of credit card holders fail to pay the full balance due on their credit cards every month. "Credit card debt is a good predictor of bankruptcy." Further, Barr states that creditors actually work to keep consumers from paying off their debt by forcing them to pay high fees for as long as possible until they finally they declare bankruptcy.

What Barr proposes is a new system of disclosures with an opt-out plan for credit cards. In this disclosure, the consumer would be required to make the payment to pay off their credit card balance in a short amount of time. They would also be offered an alternative plan with longer payments if the minimum payment were too burdensome, but they would have to opt-out of the higher payment to get the lower one. The authors of this paper believe that most consumers would choose to pay the higher default payment which would lead to lower costs and fees. Barr says that this might have consequences because "some consumers may follow the opt-out payment plan when it is unaffordable for them, consequently reducing necessary current consumption, such as medical care or sufficient food, or incurring other costly forms of debt."

So let's get this straight--to protect consumers from making only their low minimum payments on their credit cards, the now Assistant Secretary of the Treasury over Financial Institutions wants the credit card companies to create default payments high enough to pay off the cards in a relatively short period of time even if it means that the consumer may end up making those payment rather than paying for medical care or food. Well at least this might help with the obesity problem.

Late fees should also be regulated under this proposal. While Barr and his co-authors admit that the credit card issuers do need to charge late fees to motivate consumers to pay on time, they maintain that the issuers should not be allowed to benefit from consumers' poor choices. Rather, the majority of these fees would be put into a fund for "financial education and assistance to troubled borrowers." The credit card issuers would be allowed only to keep enough to cover the actual cost of collecting the late payments.

Nobody likes paying their credit card bill; I am the first to admit it. But credit cards are voluntarily entered into agreements for unsecured debt. We are not forced into agreements with credit card companies, and higher fees and charges is the price that we pay (literally) for the use of a small plastic card with no intrinsic value which allows us to make purchases we don't have the money to cover. And I think Barr's premise denies the basic truth that while a lot of Americans do certainly default on their cards, many others use credit to balance cash flow and pay their bills in a timely manner.

All of this just simply comes back to choice. The more regulation that is in place, and the less profitable that the cards are for the creditor, and the less available credit is going to be for the consumer. And raising the payments artificially high is not going to produce better behavior among consumers; rather it will increase defaults, which will in turn increase creditor's costs, which will in turn reduce access to credit. In a credit society such as ours, this will further slow the economy, which will lead to fewer consumer purchases, which leads to more job losses. Lack of access to credit fuels a vicious cycle with unemployment at the end.

Just something to think about the next time we are on-line paying our credit card bill.

Justice Secretary refuses to consider access to justice problems

Scotland’s Cabinet Secretary for Justice has refused to review the problems thrown up in Scottish bank charge cases, and denied there is any problem in Scots being able to take their bank to court to try and recover unfair overdraft charges. Recently, Scots using the accessible and consumer friendly small claims system have had their claims remitted to the ordinary sheriff court, at the request of UK banks, where legal expenses are potentially unlimited.

Following access to justice problems identified in the case of Walls v. Santander UK plc  the Shadow Cabinet Secretary for Justice, Richard Baker MSP, raised concerns over access to justice in such cases with Kenny MacAskill MSP. In a written response, Mr MacAskill said ‘I do not accept the argument that ordinary citizens in Scotland are denied basic rights to access justice’ and refuted any suggestion that there was a problem for Scots trying to recover unfair bank charges through the small claims court.

Mr MacAskill endorsed the sheriff’s conclusion in Walls v. Santander, that Scotland’s current civil court structure and legal aid system provided ‘sufficient’ access to justice from a human rights perspective. Mrs Walls has since lodged an application with the European Court of Human Rights in Strasbourg. Mr MacAskill also stated that he was unable to review the small claims rules due to his ongoing consideration of Lord Gill’s Scottish Civil Court Review.

GLC's Mike Dailly said: “The Justice Secretary’s denial is a mantra which makes no sense. It displays an arrogance and failure to grasp some fundamental facts and principles. UK banks are successfully moving small claim bank charge cases to the ordinary sheriff court, and Scottish consumers are faced with dropping their claims for fear of expenses, or trying to get legal aid if they can – and even then, possibly having to pay a contribution to the legal aid board bigger than their claim”.

“What is particularly puzzling is that Mr. MacAskill refuses to accept any concern whatsoever about access to justice, but our client (Mrs Walls) would have had to drop her claim, had we not been able to get her case sisted pending an application to the European Court of Human Rights".

"The whole point of the small claims court is to provide access to justice for citizens without fear of cost: a remedy which is proportionate in cost to the level of the monetary dispute. But that fair principle of proportionality is being knocked out of the ball park by the current practice of UK banks in bank charge litigation. We don’t have class actions in Scotland, so individual consumers are finding it impractical or impossible to challenge bank charges in court”.

“Kenny MacAskill could easily fix this problem by changing the rules on expenses. We’ve suggested the cap on small claims expenses could travel with the case where it is remitted to the ordinary sheriff court. However, the Justice Secretary says he cannot even look at this issue because he is considering the Scottish Civil Courts Review. That is a non-excuse, which sends a very clear message to the 1 in 5 Scots hit with overdraft charges: the Justice Secretary isn’t interested”.

And the Winner Is...

Remember the EPA contest with a $2500.00 prize for the best You-Tube video extolling the virtues of more regulation in American life? That contest, which was supposed to end May 17, was the subject of the first post I ever wrote for this blog. I thought about it again today as I read a letter that Ohio Congressman John Boehner (R-OH) has written to the White House regarding federal regulations.

According to the letter, dated August 16, the current Adminstration's published to do list of regulations includes "191 planned rulemakings, each with an estimated cost to our economy of $100 million or more and...a number of these planned rulemakings may each have an annual economic cost in excess of $1 billion. During a recent job forum conducted through our America Speaking Out initiative, the uncertainty resulting from such rulemakings was cited by private sector job creators as one of the primary impediments to job creation currently facing small businesses."

With the new unemployment filings right at 500,000 this week, the connection between increased regulations and jobs is worth taking a look at again. Boehner's letter seems to be focused on job growth and job creation--businesses cannot hire new employees because they are faced with too much uncertainty about the future.

But what about the connection between regulations and job loss? For example, what will be the impact of the new Federal Reserve rule regarding originator compensation? I have been reading commentaries from lenders and other participants in the mortgage community who have a much more positive outlook on the outcome of the Federal Reserve rule than I do. Many of these industry participants maintain that there is nothing to worry about because the rule will really not change the way that we do business since the yield spread premium is given to the borrower as a credit. I completely disagree with this assessment of the new rule, but even if they were correct, none of them is addressing the requirements to offer the lowest interest rate and lowest costs. The burden of proof that the originator offered every borrower the best deal that was available for the day is too difficult a burden for the small originator to bear. That is one reason that I believe that the new rule will ultimately force independent companies to close.

Consider that in 2006 there were an estimated 50,000 independent mortgage broker companies in the United States employing an average of 7 persons. Consider also that at that time mortgage brokers originated roughly 65% of the mortgage loans in the United States. Even without the regulatory changes we are seeing today, through market changes that number was supposed to drop dramatically. Today, mortgage brokers do an estimated 12% of residential mortgages in the United States. There are many fewer shops, but each independent mortgage shop that is left open represents at least one person who is still earning a living. If my assessment of the impact of the new rule is correct, and this new regulation closes the rest of us down, how many people will that add to the unemployment rolls? In my office, there are four of us. Four more unemployed people equals four fewer people putting money into the local economy and contributing to the tax base.

Maybe rather than just looking a job creation, we need to be looking at the impact of regulation on job loss. Maybe that would be a good video contest for the government--a contest for the best video explaining how and why you lost your job. The maker of the winning video gets hired by the government agency hosting the contest.

So who won that EPA video contest anyway? Apparently, no one. I checked the EPA website and there is no mention of the contest or the winner. A search of also turned up nothing. A June 6, 2010, post on nextgov by Aliya Sternstein reports that the EPA came under serious fire from lawmakers for using tax dollars to pay contest prizes. Apparently Marsha Blackburn (R-Tenn.) and Pete Olson (R-Tx) reportedly entered the EPA contest jointly themselves with a video encouraging citizens to stop "silly regulations." (They promised that if they won, the cash prize would be donated to the Treasury after making the point that taxpayers may not want to see their tax dollars used to pay contest prizes.)

The Office of Management and Budget issued a memo in March stating that it is permissible for government agencies to hold contests with cash prizes, but the memo also stated that not all winners should receive an award--sometimes the best reward is just the joy and experience of participating. And the EPA itself had left room to refuse to award a prize if in their judgement none of the entries deserved to win.

So it appears that at the end, no winner was selected at all. And to me, this is the only fitting ending to such a contest. As in this contest, in life as government regulation dictates more and more of what we are allowed to do, where we are allowed to work, and what we are allowed to have, there are no winners.

This is Where it Gets Sticky

A large part of this week's discussion has been devoted to a paper entitled "Behaviorally Informed Financial Services Regulation," co-authored by Michael S. Barr. At the time that the paper was published in 2008, Barr was a law professor with the University of Michigan. Today he is the Assistant Secretary of the Treasury over Financial Institutions and a major proponent of financial reform. This week, as the Treasury Department holds its summit to find new ways to disclose mortgage products and credit card terms, I thought that looking at Barr's writings on the subjects could provide some genuine insight into what we may expect from the new forms.

We have already seen that Barr wants to change the game of lending by shifting from a rules-based disclosure model to a standards-based disclosure model. His premise is that it is not enough to give borrowers forms to sign which explain their loan product, because they often don't understand the forms, so he wants to move to a different standard where the courts and a powerful new consumer financial protection agency can determine after closing whether the forms adequately explained the terms of the loan.

However, remember that Barr's basic premise is that individuals left to themselves cannot be trusted to make good choices--either in the loan products they select or in the provider of those loan products (the mortgage broker). Therefore, the only way to achieve desirable results is to limit and control the choices that the consumer is presented with in the first place.

To achieve this, we need to dramatically change the way we present mortgage loan options to the borrowers. "While the causes of the mortgage crisis are myriad, a central problem was that many borrowers took out loans that they did not understand and could not afford. Brokers and lenders offered loans that looked much less expensive than they really were, because of low initial monthly payments and hidden costly features. Families commonly make mistakes in taking out home mortgages because they are misled by broker sales tactics, misunderstand the complicated terms and financial tradeoffs in mortgages, wrongly forecast their own behavior, and misperceive the risks of borrowing." Barr and his co-authors go on to discuss possible solutions to this problem. For instance, Barr says that improved disclosures might help, but good marketing can overcome product disclosure. Product regulation might help by "reducing emotional pressures related to potentially bad decision-making by reducing the number of choices and eliminating loan features that put pressure on borrowers to refinance on bad terms." But there is always a danger that product regulation will backfire because "the government may simply get it wrong."

Therefore, Barr writes, "we propose a new form of regulation. We propose that a default be established with increased liability exposure for deviations that harm consumers. For lack of a better term, we call this a 'sticky' opt out mortgage system." Barr devotes several pages to explaining the "sticky" opt out system and how it would work to induce lenders and borrowers to prefer good loans over bad loans.

Here's how it would work: The mortgage lender can offer a thirty year fixed rate mortgage full income documentation mortgage. The lender could charge whatever interest rate he wanted to on this package. The lender could also offer other mortgages if he wanted to, but the thirty year fixed rate mortgage would be the "default mortgage." In order to get a different type of loan, the borrower would have to opt-out of the standard loan and choose a different loan which would come with increased disclosures explaining the risks.

Now to the "sticky" part. Merely having to opt-out of a loan and read an additional package of disclosures does not provide enough motivation for the lender to strongly encourage the borrower to take the standard thirty year fixed rate loan. So as an extra incentive, if the borrower chooses any loan other than the thirty year fixed rate mortgage, the lender faces legal consequences if that loan defaults. "If default occurs when a borrower opts out, the borrower could raise the lack of reasonable disclosure as a defense to bankruptcy or foreclosure. Using an objective reasonableness standard akin to that used for warranty analysis under the Uniform Commercial Code, if the court determined that the disclosure would not effectively communicate the key terms and risks of the mortgage to the typical borrower, the court could modify or rescind the loan contract." Barr also anticipates that a consumer financial protection agency could take responsibility for supervising the disclosures by imposing fines on lenders if the disclosures for any mortgages other than the standard mortgages were found to be "unreasonable."

Barr's premise is that such a system would force virtually all borrowers into a 30 year fixed rate mortgage. And that is true--by creating a system where the only loan that is safe from excessive scrutiny is the thirty year fixed rate mortgage, regulators ensure that this is the only loan a borrower can expect to receive. But here is what Barr does not say--the thirty year fixed rate mortgage is not the cheapest, most cost effective mortgage on the market. It's not even close. The 15 and 10 year mortgages offer much greater cost savings to the consumers. Even though the payments are higher on these mortgages, the interest rates are markedly lower and the borrower saves a lot of money over the lifetime of the loan by paying a higher payment over a fewer number of years. While these mortgages are not appropriate for many borrowers, over the last two or three years as interest rates have dropped, we have seen many borrowers refinance from a thirty year to a twenty year, fifteen year or ten year mortgage while lowering their rate and keeping their payment almost the same. Such refinances can save the borrower hundreds of thousands of dollars if done during the early years of the loan. But the system that Barr proposes would cause such punitive consequences for lenders that they could not afford to sell these other loan products.

And even Barr and his co-authors admit that there would be casualties to his approach. "Implementation of the measure may be costly and the disclosure requirement and uncertainty regarding enforcement of the standard might reduce overall access to home mortgage lending...Low income, minority or first-time homeowners who have benefited from more flexible underwriting and more innovative mortgage developments might see their access reduced if the standard set of mortgages does not include products suitable to their needs."

And that is true too. A "one size fits all" approach to lending is going to leave a lot of borrowers behind. We are seeing that more and more in lending now as many people who would like to purchase or refinance cannot qualify to do so. But then, to address a problem that Barr himself has created, he changes the rules once again. "One might develop 'smart defaults' based on key borrower characteristics, such as income and age. With a handful of key facts, an optimal default might be offered to an individual borrower. The optimal default would consist of a mortgage or set of mortgages that the typical borrower with that income, age and education would prefer." Yet this approach creates still another problem which Barr also acknowledges, "it may difficult to design smart defaults consistent with fair lending laws."

No, Mr. Barr, try impossible. The Equal Credit and Opportunity Act and Fair Housing Laws make it illegal to look at a person and choose their loan product or access to credit for them based on age, race, sex, national origin, religion or familial status. Those laws dictate that all borrowers must be treated equally and given equal access to credit. And that would take us back to just one loan product.

The overall problem with this approach is that it assumes that adult human beings are not smart enough to make their own choices and so the government must dictate those choices for them. Whenever, the government begins dictating what we can have, everyone is going to have less. Of course, when people have a lot of options available to them, they are going to make mistakes. However, many people are going to make good, sound choices. When we deny someone the ability to make mistakes, we also deny them the ability to make choices that would benefit them. The flip side of freedom to succeed is freedom to fail, and when we are not free to fail, we are not free at all. In the past, we have chosen to believe that as a society all of us have a right to participate equally and to make our own decisions about our lives. With that understanding, we have also chosen to understand that sometimes we as individuals and we as a society are going to make bad choices which will then have bad consequences. But that is an acceptable risk in a free society. Legislating good sense is about as difficult as legislating morality--it just creates a sticky mess for everyone.

The Broker

I have not read John Grisham's novel, The Broker, which tells the story of a Washington power broker who, in fear of his life, has to flee the government and go to Italy. My mother has--she tells me that it is a good read. Of course, if Grisham had been writing about a mortgage broker his novel would have been the sad story of a tired, overworked individual who, in fear of his livelihood, has to flee excessive government regulation and find a new career path. That probably would not be such a good read, and for those of us in the lending industry it might hit too close to home to be enjoyable at all.

Since news of the Federal Reserve's final rule was announced yesterday, internet sites are buzzing with comments about how the final rule which ends yield spread premiums will affect the mortgage industry. I read the article posted today on Mortgage News Daily regarding the final rule. The article states that the Fed received 6000 comments about the proposed rule to end the practice of yield spread premiums--which allows mortgage originators to be paid on the spread of the interest rate--even though the rule was first announced in August of 2009. That is really amazing, because I am sure that there were more than 6000 comments posted in response to the Mortgage News Daily article today. Seriously, 6000 comments from an entire industry is pathetically few for an issue this important. I am not implying that more comments would have made a difference in the final rule, but I do believe that over the past two years, industry participants have largely given up on attempting to lend a voice to the regulation that is being passed. That is true partially because active originators have faced so many challenges with market crashes, wholesalers going bankrupt with no advance warnings, sudden guideline changes, and an overall decline in business that many people just do not have the energy for activism. But I believe that it is also true that many of us who used to work actively in grassroots lobby efforts, commenting on federal rules, and writing to our representatives have also given up and taken on a "What's the use anyway?" stance. In saying that, I am not assigning any blame whatsoever--it's really hard to keep going when the entire tide of public opinion is against you.

One area where I strongly disagree with the Mortgage News Daily Wire is in part of Adam Quinones' commentary. Starting April 1, when the new rule goes into effect, originators cannot be compensated on the spread on the interest rate. The new rule does mirror one aspect of the Dodd Frank Bill which says that the originator cannot receive compensation from the lender and the consumer on the same transaction. But then Quinones states, "To me that says a loan originator can earn rebate (yield spread) as long as they aren't being paid and {sic} origination fee. Plain and Simple: Am I missing something or is this pretty much the same way business is done right now."

Actually, that is not what the rule says. The rule, as I read the summary last night on the Federal Reserve website, says that the originator cannot be compensated on the terms of the loan, which includes the interest rate. Since January 1, mortgage brokers have been required to disclose all of the yield spread on any mortgage loan on the good faith estimate as a credit to the borrower to offset closing costs. Only mortgage brokers and loan officers are required to do this. No originator working for a depository bank is required to disclose this information. The new rule does at least apply to all individual originators whether they work for small independent companies or banks--no originator can be paid on the terms of the loan. However, the banks themselves can still receive the service release premium, which is the interest rate spread on the sale of the money. They just are not allowed to pay it to an employee. Talk about a quick way to improve the bottom line!

The new rule will have a huge impact on all mortgage originations. Remember that the Dodd Frank Bill contains a provision that total origination fees cannot exceed 3% of the loan amount and that an originator receiving compensation from a lender cannot also receive compensation from a consumer. Since this applies to all originators, let's look at how this would work in real life. Originator A works for Bank X which is a billion dollar corporation. The law says that he cannot receive compensation from the lender and also from the consumer. The law also says that he cannot be compensated on the terms of the loan except as a percentage, but he can be paid based on factors such as quality of loans produced, volume of work, etc. Bank X gives Originator A a base salary. Therefore, he cannot be compensated by the consumer. However, if he works hard and produces good quality loans, he could be eligible for a quarterly bonus.

The new rule specifices a "safe harbor" for loans with the lowest interest rate, "no risky features," and the lowest total dollar amount of points and fees. What does that mean exactly? After all, the lowest dollar amount of points and fees would be zero. To be in compliance and to be eligible for the safe harbor provisions, Bank X needs to publish one rate per day for each credit score tier. Persons with a 620-640 receive rate such and such, persons with a 640-660 receive rate such and such and so forth. Bank X also needs to publish one set of closing costs for each borrower--sort of back to the old idea of a one fee loan. That way, they can demonstrate that they have provided the consumer with the best available loan that day.

Now, Originator B works for himself. He has been an independent mortgage broker for 15 years. Each day he receives multiple rates from multiple lenders. He does not consolidate these into one sheet. He knows that Lender X will close certain borrowers more easily than Lender Y. Lender Y is offering him a pricing special of additional yield spread premium to earn his business, and even though he now has to credit that to the consumer, he can use that pricing incentive to offer a lower interest rate to consumers who qualify which helps him to woo business when he competes against Bank X.

Originator B does not get a salary from anyone. He has to pay for his office space, his computers, his phone lines, his Fed Ex bill. Unlike Originator A, he does not have potential borrowers coming in and out all day long, so he has to pay for whatever advertising he does to bring business in. He has to pay for memberships to organizations that might allow him to network and make contacts. He has to pay any employees who work for him. And unlike Originator A, he has to pay self-employment taxes.

Under the new rule, Originator B also cannot receive compensation from the lender if he receives it from the borrower also. But he cannot be paid on the terms of the loan, except just a percentage of the loan amount--the loan origination fee. The Dodd Frank amendment says that a borrower can be charged up to 3% in origination fees, but what borrower is going to pay 3% in loan fees? On a $200,000 loan that would be $6000.00. Most borrowers don't have that kind of money, and the ones who do can go over to Bank X and get a loan which will probably have no origination fee at all since Originator A is on a salary. Originator B used to be able to compete effectively because the lenders he sold to did not have to pay the cost of office space, or phone lines, or Fed Ex bills, for the areas where they had mortgage brokers, so they could offer him a better rate than Bank X and he could pass that rate on to his customers. And, he made a nice living off of the spread on the money, which the consumer did not have to write a check for at closing. The consumer got a low rate, and Originator B got a good payday. But now, with the new rules in place, Originator B will have to be able to prove that for every customer who walked in the door, he offered the best rate and the lowest cost loan based on all of the lenders he works with at any given time. That is virtually impossible to do, because it involves checking every lender for rates and costs without regard to other factors such as timeliness in underwriting or ability to underwrite a particular loan product.

But even if Originator B could pass this litmus test, which he cannot, he is going to realistically be getting paid 1% of the loan amount. And from that sum, he is going to have to pay the office rent bill, the phone bill, the utilities, the Fed Ex, the employee and the taxes. With whatever is left he might be able to buy some food and pay his own mortgage--maybe. Maybe some of his lenders could offer some type of a bonus system for quality and volume, but meeting the numbers to qualify for any such bonus would be nearly impossible for a broker who works for more than one investor. So Originator B is out of the game. No, Adam, it's not going to be at all the same as it is now.

As I read commentary on the Mortgage News Daily website and on numerous other websites on these issues, one point that bothers me is that there are always a lot of posted comments that these restrictions are the fault of the corrupt mortgage community--that we brought this on ourselves. I do not believe this either. No one would argue that the banking giants who are going to be taking over the origination industry are doing so because they are particulary virtuous, and I think it is equally false to say that our industry is ending because it is especially corrupt. Rather, our industry was remarkably successful. In 2006, more than 65% of residential mortgage loans were done by a mortgage broker. The last statistic that I heard this year stated that mortgage brokers now have only 12% of the market. We went from being an integral part of the mortgage delivery system to largely unnecessary--particulary as banks have consolidated and now have more branches in more locations. (Since they are paying for the brick and mortar anyway, why pay a broker too.)

I believe, rather, as I wrote last Friday, that what we are seeing now is part of a move to eliminate the independent business person completely and to force originators to work for other institutions. Michael S. Barr discusses the role of the mortgage broker in some depth in his paper, Behaviorally Informed Financial Services Regulation. In this paper, Barr writes, "An alternative approach to addressing the problem of market incentives to exploit behavioral biases would be to focus directly on restructuring brokers' duties to borrowers and reforming compensation schemes that provide incentives to brokers to mislead borrowers." Although he acknowledges that most states require that brokers disclose in writing that they are independent business people and not agents of the borrower, Barr says that this is not sufficient. "Brokers cannot be monitored sufficiently by the borrowers...and it is dubious that additional disclosures would help borrowers be better part because brokers' disclosures of potential conflicts of interest may paradoxically increase consumer trust...Thus, if the broker is required to tell the borrower that the broker works for himself, not in the interest of the borrower, the borrower's trust in the broker may increase: after all, the broker is being honest!" Barr mentions the national licensing laws (the SAFE Act had been signed into law months before he co-authored this paper) but he says that even this is not enough. His ultimate solution--"we need to shift from a lender-compensation system to a borrower compensation system, and we would need a regulatory system and resources to police the fiduciary duty. An interim step with much lower costs and potentially significant benefits would be to ban yield spread premiums." As you may recall from yesterday's post, Barr was a University of Michigan Law Professor when he wrote this paper; today he is Assistant Secretary of the Treasury for Financial Institutions and a huge proponent of financial reform.

As in Grisham's novel, where the government has put the broker in a position to be eliminated, so here the government is eliminating the last few independent brokers who have survived--survived market meltdowns, loss of income, testing requirements, tough underwriting standards, increased costs of doing business. The only way to finally get rid of us is to make it financially impossible to stay open.

But the ultimate extinction of the broker does not come without a cost. The reason that 65% of mortgage loans were done by brokers in 2006 was not that we were such clever crafty people who hypnotized our borrowers. It was that we offered personal service and flexibility which are largely missing in an on line or institutional experience. The fact that the broker was a self-employed commissioned person who had bills to pay and got paid only if the loan closed gave him or her an incentive to really go the extra mile for the borrower. A salaried employee of a huge bank is not going to have that same incentive. Nor are they going to offer the option of moving a problem loan to a different lender while keeping it in house--something which can save a borrower hours of time and legwork.

People may not think so today, but they're going to miss us when we're gone.

Consumer bank charges in China and the UK

China Radio International (CRI) reports from Beijing that commercial banks in some parts of China have recently raised the fees charged to customers for withdrawing cash from other banks ATM's. 

An online survey conducted by Chinese website showed that almost 90 percent of respondents think the increased charge is exploitative, and will have a negative impact on what is known as the cross-bank withdrawal business.

Now China's Banking Regulatory Commission says that to improve customer service it's considering revising the banks service pricing regulations.  The issue has also raised concerns about the way banks make their profits and how they charge customers for their services.

CRI's current affairs show, People in the Know, speaks to Professor Zhao Xijun of the School of Finance at Renmin University for the Chinese experience of bank charges, and Govan Law Centre's Mike Dailly for the UK perspective of bank charges.

Today's show is available online here.  It can also be heard on smart phones here.

The Game Changers

One day ahead of the Treasury Department's scheduled summit to work with members of the lending community and consumer advocacy groups to develop new disclosures for mortgages and credit cards, the Federal Reserve today published several new rules, including a new rule changing the truth in lending form to better disclose ARM adjustments, and a new rule banning originator compensation through interest rates (yield spread premiums). The ban on yield spread premiums, which will go into effect April 1, 2011, is ironic given that the Dodd-Frank bill included an amendment requiring that origination fees be capped at 3% and that the originator be paid either through lender-paid compensation or borrower-paid compensation but not both. The ruling today is merely a final nail in the coffin of the wholesale origination industry as a whole, which is staggering under the weight of testing and licensure requirements for each originator, mounds of new disclosures, and ever-tightening underwriting requirements.

The first announcement, though, which was that there will be additional changes to the truth in lending form which will better disclose ARMs (adjustable rate mortgages)and the transfer of mortgages from one servicer to another, seems to be a moot point since the Treasury and the new Consumer Financial Protection Bureau are charged with the job of creating a new form to replace both the good faith estimate and the truth in lending form.

I think everyone who works in lending and real estate would agree that the number of forms that we are now using in our industry borders on the ridiculous. Last week, I had to have one borrower sign three separate forms explaining that he would receive a copy of his appraisal at closing. It turned out that the form I had him sign at application had been discontinued by his lender and was no longer in use, although it contained essentially the same information as the other two forms. And there is no doubt that borrowers today have "form overload." They get so many disclosures saying essentially the same thing with ever so slightly different wording that they have no idea what they are seeing and after a short time they stop reading everything.

Supposedly, the new forms from the Treasury Department are going to simplify this process. But I am not at all certain that simplification is the true goal of this exercise. For instance, a paper entitled "Behaviorally Informed Financial Services Regulation" authored by a University of Michigan Law Professor named Michael S. Barr, along with two co-authors, which was published in October of 2008 and is available on line through the New America Foundation, suggests that we don't need better disclosure in terms of content--rather we need disclosure that changes both lenders' and borrowers' fundamental behaviors. Such a set of disclosures would do more than inform the borrower about the cost of a specific loan or the consequences of a specific loan product. Such a disclosure would actually change the game of lending for both the borrower and the lender alike, making the potential consequences so ugly for the lender that they would hestitate to take the risk of making loans outside of a very narrow box.

Why does this paper matter? Because in 2009, Michael S. Barr was appointed Assistant Secretary for Financial Institutions in the Treasury Department. These days, Barr is not just an academic teaching and writing theory; he is actually implementing it in real world settings as a proponent of financial reform and now a voice in the new disclosures that the Treasury Department is hoping to craft.

The theme of the paper is that current regulation focuses on two models. The first is disclosure of fees and costs to the consumer. The second model is anti-usury laws which prohibit loans which are considered exploitive and predatory. Barr and his co-authors believe that both approaches are severely lacking. "The [disclosure} model relies on fully rational agents who make intelligent choices...But these neoclassical assumptions are misplaced and in many contexts consequential...Individuals consistently make choices that they themselves agree, diminish their own well-being in significant ways...By contrast...usury laws and product restrictions start from the idea that certain prices or products are inherently unreasonable and that consumers need to be protected from making bad choices...but product regulation may in some contexts diminish access to credit or reduce innovation of financial products...Moreover for certain types of individuals, some limitations may themselves increase consumer confusion regarding what rules may apply to which products, and which products may be beneficial or harmful." And that is crux of the argument of this paper--traditionally mortgage disclosures have been aimed at presenting information to the borrower with the idea in mind that he can make his own informed decisions if given correct information. But Barr's point is that consumers do not make good decisions when allowed to make choices, so behaviorally informed regulation must change the choices they are allowed to make.

For instance, having required forms that the borrower must sign within a certain number of days, as we do now with the good faith estimate and the truth in lending form, allows the lender to say that he is following the law if he has presented these forms to the borrowers and had them sign them. But the borrower may not understand the form, even if he or she did sign it. Therefore, Barr recommends a completely different approach. Rather than a "rules based" disclosures such as we have in the Truth in Lending Act and the Good Faith Estimate where the lender is required to give certain forms containing specific information to a borrower within a given time frame, Barr wants to change the system to a "standards based" system of disclosure which will be largely determined after the loan has closed. "Rather than a rule, we would deploy a standard, and rather than a [pre closing] decision about content we would permit the standard to be enforced after loans are made. In essence, courts or expert agencies would determine whether the disclosure would have, under common understanding, effectively communicated the key terms of the mortgage to the typical borrower."

Therefore, if the borrower is not satisfied with his loan, the fact that he has signed three hundred forms explaining it is not going to protect the lender. In the new standards-based world of disclosure, no lender or originator will be able to merely comply with a set of rules. The standard will become whether the borrower really understood what was explained to him. And that, Barr says, actually becomes more clear after the closing as the borrower learns to live with the payments. "In essence, courts or expert agencies would determine whether the disclosure would have, under common understanding, effectively communicated key terms of the mortgage to the typical borrower." Of course, he acknowledges that this will be a very expensive process in the beginning as litigation costs skyrocket. However, he assures us that over time, "through agency action, guidance, model disclosures, 'no action' letters and court decisions, the parameters of the reasonableness standard would become known and predictable." That's comforting, I suppose. But then again, he told he was going to change the rules of the game.

Brave New World

It has been more than twenty years since I first read Aldous Huxley's dark anti-utopia about a society comprised of genetically engineered workers and elites. In Huxley's book, society has "bred" certain classes individuals to be less intelligent so that they can do all of the menial work while a higher class of elites runs the society. All of society is controlled through the universal use of Soma--a narcotic which induces placid behavior--and since the workers lack the intelligence of the elites, they never question their station in life, until one day a slightly more intelligent worker is born who challenges the system.

I have not thought about the book for years, but this week as our entire office took our national tests to comply with the Secure and Fair Mortgage Enforcement Act, I was reminded of Huxley's vision of a society of workers and elites.

I estimate that the cost to comply with the provisions of the Safe Act averaged approximately $500 for each person in my office. That cost would have been greater if the other three people here had needed continuing education hours for their licensure. Texas allowed them to certify the hours they had already accumulated from the prior licensing period. I, however, have always previously met my license requirement through an insurance license, which was legal under Texas licensure but not permissible under the Safe Act. So, when we were notified by the state in mid July that we would have to transition our licenses by mid August, I found myself taking 20 hours of continuing education, purchasing study guides and test prep for the office, and registering us to take both state and federal exams, all while working and closing loans during the busiest season of the year.

Today we finished the testing process. Because we have been in business for twelve years, Texas had grandfathered us in when they introduced testing as a license component in 2003. But there is no grandfathering with the SAFE Act, so each of us had to take a national test and each of us had to take a state test.

We are told that the Secure and Fair Enforcement Act, which was signed in 2008, is necessary to prevent another financial crisis. What I did not know until I had to do this test preparation is that the National Mortgage Licensing System, which directs the licensing procedures is actually just a few months older than the SAFE Act itself. The system was designed as a means for tracking loan officers nationwide so that each loan originator is assigned one federal number which follows him or her for life. Ultimately, the performance of the originator's loans will be tied to his or her license number so that defaults will follow the originator for life.

The tracking system makes it impossible for an originator whose license is suspended in one state to go to another state and begin originating. And the testing component is said to be necessary to measure knowledge and competency. But can knowledge and competency really be measured in a 100 question multiple choice test? Some of the questions were so vague that I had to really think--not about what the correct answer was but which answer I thought they wanted. Others were so basic that a person who cannot perform the simple functions necessary to answer them would not be able to work as an originator.

The irony is that while many educators decry multiple choice tests because they are basically a better indicator of how well you study than of how much you really know, the federal government is hinging people's careers on passing this test. And an overwhelming number of the people who take this test fail it the first time. The first person from my office to take the exam took hers on Monday. She came back and told me that the personnel at the testing center were congratulating her because of all of the people who had been scheduled to take the test that day, she was the first one who had passed it. One individual had just failed it for the seventh time.

But unlike many tests of its type, the SAFE Act National Mortgage Licensure Test does not allow an immediate do over. If you fail it, you have to wait thirty days before you can take it again. If you fail that it is another thirty days, and then another thirty days after that. After the fourth failed test, the applicant must wait 180 days (6 months) before testing. (By then this poor person will have had to go get a job because, of course, it is a criminal act to originate mortgage loans without a license.)

Fortunately for the unhappy originator, that other job can be right down the street originating loans for a depository bank because employees of depository banks do not have to undergo testing. (A requirement to test employees of depository banks would be onerous and difficult and expensive.) We are reminded of Barney Frank's promise to have death panels for non depository lending institutions.

So here is how it works out. If you have been a self-employed mortgage broker for 20 years, and you fail the test because you don't take tests well or you did not study hard enough or you have poor study skills, you cannot get your license until you pass the test. But with no experience at all you can work for the local branch of your bank supercenter.

When I was explaining this process to a friend of mine who works in a different but also heavily regulated industry, she replied that at least all of this regulation gets the people out of the industry who have no business being in it. I used to hear that sentiment constantly in the mortgage industry. Originators in our trade association were forever saying that we should have more regulation to get rid of the "bad actors."

But this attitude, and the assumption that the SAFE Act will accomplish this, is based on what I believe to be two false premises. Premise # 1 is that the financial meltdown was caused by poorly trained and undereducated originators and that by giving these people more training they will behave differently in the future. To that comment I would respond that, first of all, if a person really does not know how to calculate income or payments or debt ratios, he is going to get a rude awakening from his underwriter just minutes before his loan file is denied. And studying to the test does not mean that you really know anything about how to properly originate and process a loan.

The second premise is that people break laws because they don't know what the laws say. Certainly, since laws are constantly changing and being updated, an industry such as ours should have continuing education requirements. But to presume that most fraud is the result of lack of knowledge is silly. Imagine the number of hours of testing and continuing education that Bernie Madoff must have taken to maintain his licenses. That information just made him a more informed and effective crook. Education does not make a dishonest person honest.

Finally, do we really accept the premise that the financial meltdown occurred primarily because of under-educated, unsupervised greedy mortgage brokers putting people into houses they could not afford? When I got back from my test yesterday, I saw an article in the Washington Post about the chairman and chief executive of OneUnited Bank, Kevin L. Cohee, who is now at the center of the Maxine Waters' controversy. According to the Washington Post article, Cohee "promoted the a uniquely responsible investor in impoverished minority communities and urged prospective clients to live modestly. Customers ought to focus on 'real connections, real relationships,' Cohee urges in a recording on the bank's Web site. Avoid 'people who want to be with you based on the things that you have.'"

However, Cohee lived himself by a slightly different set of rules. The bank provided him with a Porsche and an $880,000 condo on Miami Beach and leased him a $26,500 a month mansion owned by Bruce Springsteen's drummer in California. When he and the drummer had a dispute over surveillance cameras, Cohee purchased a $6.4 million home in 2006 and OneUnited paid him a housing allowance. (At the height of the real estate boom none of my friends or acquaintances could pay $26,500 for a lease on a house or $6.4 million for a mansion.)

In 2008, Cohee's extravagant lifestyle caught up with him when the federal government issued a cease and desist order and accused the bank of lax spending. (You think?) Fortunately for Cohee, he had friends in high places, and he was able to plead his case directly to Barney Frank and Maxine Waters who came to the rescue with $12 million in TARP money,

All of this takes me back to Aldous Huxley and his Brave New World society of elites and workers. In the Huxley society, everyone is bred for and born into their class with no hope of upward mobility. But in real life, genetically engineering people for certain roles just is not practical, so to create a society of elites and workers, you have to eliminate the options that the workers would have to better themselves. So the self employed middle class business owner has to comply with expensive and difficult rules to keep his business. If he cannot comply, he can go work for a protected class who does not have to comply with these rules, but then he is relegated to the role of a worker with much less hope of improving his life. For an elite, however, such as Kevin Cohee, he does not have to be held to any standard because his political connections will absolve him from any wrongdoings or misdeeds. And so his status never changes. In Huxley's story, an elite could never be expected to do menial work because it would be too distasteful to him or her. And in real life, the scores of Kevin Cohees at the top of our system are allowed to live by a different set of rules.

Aldous Huxley would be proud.

Sheriff reduces property factors bill by 55%

In the case of Walker Sandford Property Management Ltd v. Mushtaq, Sheriff Ross ruled today that a property factor was not entitled to charge a Glasgow consumer monthly interest at 2.5% (equating to 30% APR) as the consumer had never agreed to the factor's contractual terms and conditions.  

Terms and conditions needed to be expressly or impliedly agreed at the outset of the arrangement or adopted by the parties' clear, specific, unequivocal actions. Simply adding the terms and conditions to an invoice was never a way of having conditions adopted. Accordingly, the factor was only entitled to payment in terms of the title deeds, and no interest was chargeable at all in terms of the title deeds.  Such charges therefore fell to be deleted.

Sheriff Ross also reduced the sum charged for second and subsequent monthly reminder/demand letters by one-third from £12 to £8.  Overall the sum sued of £2,678.55, was reduced to £1,213.13, resulting in a 55% reduction in the customer's bill. The action was dismissed with no expenses due to or by either party. The defender was represented by GLC's Iain Nisbet, solicitor and partner, and the pursuer's by Messrs Peacock Johnson Solicitors.

In cases highlighted by BBC Scotland last year, Sheriff Rae expressed concern at the amount of penalties levied by Walker Sandford Property Management Ltd, and in the end the company agreed to drop all penalty charges and interest.  In the past, Walker Sandford had previously issued remider/demand letters on a weekly basis, but now do so on a monthly basis for customers in arrears.

Dodgy figures and poor service: Govanhill evidence to Property Factors bill

Govanhill Law Centre (GhLC) has submitted evidence to the Scottish Parliament's Local Government Committee on the Property Factors (Scotland) Bill. 

The evidence compiled by GhLC's Lindsay Paterson is available here, and includes an example of alleged overcharging, mismanagement and misapplication of VAT by a large Glasgow property factor, as well as a survey of local property factors, carried out jointly with the local Govanhill Residents Group. 

85% of those surveyed supported the statutory regulation of property factors in Scotland, while over two-thirds of respondents said that they did not believe their factoring service was good value for money.

GLC tackles bank charges on Chinese state radio

GLC has participated in a radio discussion on overdraft charges on 'People in the Know', a current affairs programme on China Radio International in Beijing. 

GLC's Mike Dailly was invited to talk to the show's host, Nigel Ballard, about campaign work in the UK, and developments around the world, on challenging bank charges. Bank fees is an issue of growing interest in China. China Radio International, (CRI) is the only overseas broadcaster in the People's Republic of China. 

CRI is one of the "three central media organizations in China" owned by the state along with China National Radio (CNR) and China Central Television (CCTV).  People In the Know is China's only English-language current affairs program. PIK covers events that shape not only China, but the world as well. 

Originally known as 'Ask The Minister,' People In the Know is designed to give CRI listeners the views of experts and 'people in the know.' Foreign guests, including world leaders, have taken part in People In the Know to tackle tough issues, such as economics, diplomacy and national and international politics. CRI broadcasts across China, and the station is relayed around the world as an international service.

The show goes out next Monday, and can also be heard online.