For many years I traveled every spring to Washington DC to participate in a grassroots lobby with the National Association of Mortgage Brokers. Before our lobby day came, during which we went up to the Capitol and petitioned our lawmakers about the issues near and dear to us, we sat through a two day conference planned by the leaders of our association, who scheduled training sessions, speeches by various politicians and agency directors, and normally a panel of consumer advocacy attorneys. The panels with the consumer advocates were always the liveliest and most contentious events of the sessions, since the attorneys representing the consumer groups made no attempt to conceal their contempt for us as vile and vulgar capitalist pigs who made our livings by loaning money. (One attorney from such a group drew the wrath of everyone in the room when she cooed condescendingly to us, "I suppose that all of you people here consider yourselves to be professionals.")
On one such occasion we were sitting in a crowded room with a panel of consumer advocates, when one of the female attorneys who was giving us her perspective of how the U.S. credit system should operate made the suggestion, "Wouldn't it be great if everyone could have a 7% rate?" The men in the room (the male attendees way outnumbered the female attendees at conference and they were so loud that a woman could hardly get a word in) immediately shouted from all parts of the room that her suggestion was both impossible and ridiculous. Nonplussed, the attorney stood her ground and just kept raising the interest rate until finally she got to 15%. Wouldn't it be great if everybody could have a 15% interest rate? By now we were all stunned. And then she made her point, "It doesn't matter what the rate is, just as long as it is the same for everyone."
I read a comment recently about the now disgraced ACORN, that said incorrectly that ACORN believed that every person was entitled to a home. That actually is not true. ACORN, and the attorney in my story above, and many of other consumer advocates I met in Washington, did not really want or expect to see everyone in a home. But they were deeply opposed to the credit system in the United States which they perceived was discriminatory.
Enter the new Bureau of Consumer Financial Protection and the Office of Fair Lending and Equal Opportunity. The stated purpose of the Bureau of Consumer Financial Protection is to "implement, and where applicable, enforce Federal consumer law consistently for the purpose of ensuring that markets for consumer financial products and services are fair, transparent and competitive."
While this sounds great on the surface, we have to remember that the credit system in the United States is by its very nature unfair and discriminatory, and that is the reason it works. Now of course, we have Fair Housing and Equal Opportunity Laws which prohibit discrimination against a person on the basis of race, religion, national origin, family status, and sexual orientation and these laws are rightly in place to allow every race, creed, religion, etc. a potential place at the table as homeowners. But beyond these protected classes, the system is a risk based one which discriminates heavily in favor of certain behaviors and lifestyles and against others. Without this discrimination--this risk based analysis of a person's situation--we could not have the credit and mortgage system we have today.
For example, take credit scores. Credit scores were developed in the late 1990's as a means for assigning a numerical value to person's credit history. The credit score enabled automated underwriting systems and opened up credit access at low rates for many Americans by allowing the development of a risk based program of lending which permitted the lender to use a high credit score to compensate for other factors lacking in the file--such as very little downpayment or very little savings. The credit scoring system in the U.S. is unique to us. I attended a workshop given by the FTC while at our legislative conference one year, and they explained to us that most other countries do not have a means of reporting both good and bad credit. For instance at the time that I attended this workshop(which was about 7 years ago) Australia did not have a system for reporting positive credit. The Australian system reported only negative credit, so if you had a credit report in Australia, and you charged off one item, but paid the rest of your credit perfectly, the credit report would show only the negative item and ignore all of the accounts you paid on time. Only the U.S. had a credit system which reflected all of the accounts which you had paid on time, the accounts which were not paid on time, how many open accounts you had, how much total debt was reporting, and used all of this information to formulate a score to determine your credit worthiness.
This system has allowed for a huge growth in access to credit at great terms and low rates, but it is completely discriminatory. A person with a low score is going to receive less favorable terms than a person with a high score. Ironically, since the federal government took Fannie Mae and Freddie Mac into conservatorship, Fannie and Freddie have changed their interest rate offerings to make them score based. A few years ago, if you got an approval through Fannie Mae, you got the same interest rate as any other person who also had the approval, regardless of your score. Today, a person with a 620 credit score will receive a much higher interest rate than a person with a 750 score on a thirty year fixed rate mortgage because of price adjustments for individuals with lower scores. To me, that seems unfair because I remember the system that was in place until very recently. I have talked to many deeply disappointed borrowers who cannot get a 4.875% interest rate on a thirty year mortgage because even though their credit profile is good, their score is too low. Only those with a 740 and above receive the best rates.
The system discriminates in other ways. It favors the salaried over the self-employed. It favors those who save money over those who spend everything they get their hands on. It favors the frugal who work to keep their debt down over those who are maxed out on their credit cards. To the consumer advocates in Washington, this is unfair because everyone should have the same rate, no matter how high that rate has to be. The only way to accomplish this is to either charge everyone a 15% rate, or to use tax dollars to subsidize a 7% rate for those who do not qualify for it. In the first solution, all homeowners are paying to make everything equitable and in the second solution, all taxpayers are paying to make everything equitable. But the government has effectively removed any personal incentive to correct whatever situations exist that cause this individual to be a poor credit risk.
Trying to make the credit system in this country fair is like trying to make life fair--it is just not workable. Experience teaches that most of us do not really want our situation to be fair; we want it to be advantageous. For instance, we may believe that life has been unfair to us if we compare ourselves to our brother who was accepted into Harvard, became a successful neurosurgeon and now has a booming private practice and a summer home in Italy. But we will seldom complain that life is unfair when comparing our situation to that of our sister who dropped out of school at sixteen and now works nights at a convenience store. In the first example, we may spend our lives grumbling that "Fred always got all the breaks," but in the second example we will congratulate ourselves that we were more responsible than Sally. If someone told us that they would magically make our position equal to that of our sibling, we would be busy picking out the curtains for our new summer home if we could be made equal to Fred, but we would protest loudly if we were to suddenly be made equal to Sally.
Our credit system rewards good behaviors, responsible choices, and in some cases good fortune. The system will be kind to the twenty-eight year old woman with the 770 credit score who has never really worked a full day in her life, but holds a great position with her father's company who pays her an excellent salary which he direct deposits into her bank account. Nobody stands behind her as she closes on her $300,000 house with gift money from her parents as a downpayment and says, "Don't give her that loan. Yes she qualifies for it, but only because of her parents and the breaks she had in life."
Likewise, the credit system does not see the life story of the small business owner who never took a vacation or a sick day, paid all of his taxes and was kind to his neighbors, but lost his business during the recession and has seen his house go into foreclosure. The credit system will not differentiate between his plight and that of the compulsive gambler who was foreclosed on because he took the last three months of mortgage payments to place a bet on a "sure thing" at the race track. The system is impersonal, mercilous, and unfair.
However, our system also has built into it a reset button that allows our mistakes to fall off of our credit reports automatically after seven years. The person who has suffered through tragedy through no fault of his own and the chronically irresponsible person who has refused to honor any of his contracts are both afforded this same privilege. This small dispensation of grace means that for each of us, no matter who we are, what we have done, or what has been done to us, we have the ability to make a fresh start if we are willing to change. Come to think of it, that is not fair either, but it is certainly advantageous.
Showing posts with label SB 3217 financial reform. Show all posts
Showing posts with label SB 3217 financial reform. Show all posts
Don't Forget to Bring Home the Bacon
Where would modern government and Congress be without a little pork fat padding the end of every bill? That is the case with SB 3217, where the last nine pages of the 1566 bill create a whole new entitlement.
Now that the Senate bill has moved over back to committee to be reconciled with the House version, plenty of entities and industry insiders are weighing in on the provisions of the new soon to be law. But this final provision is buried so far at the back that it may go almost unnoticed even as we are paying for it.
Entitled Title XII, Improving Access to Mainstream Financial Institutions Act of 2010, the stated purpose of this Title is to, "encourage initiatives for financial products and services that are appropriate and accessible for millions of Americans who are not fully incorporated into the financial mainstream."
Put simply, the purpose of the title is to create incentives for the portion of our culture which does not maintain bank accounts and routinely uses pay day lenders as their money source.
The Act authorizes the Secretary of the Treasury to establish "a multi year program of grants, cooperative agreements, financial agency agreements, and similar contracts or undertakings to promote initiatives designed to:"
1. Enable low to moderate income individuals to establish one or more accounts in federally insured depository institutions that are appropriate to meet the financial needs of such individuals.
2. To improve access to the provision of accounts, on reasonable terms, for low to moderate income individuals.
Further, the Secretary of the Treasury is authorized to establish multi-year programs through grants, contracts, or financial agency agreements, with banks and depository institutions to provide low cost, small loans up to $2500.00 which will be less expensive for consumers than payday loans.
As part of participation in this program, the lending institutions who take part shall offer financial education courses including counseling services, educational courses and wealth building programs to each consumer receiving this type of loan. The cost for this education will be covered through federal grants.
Since payday loans are notoriously high risk and a series of small balance loans which defaulted could wreak havoc on a bank's balance sheet, the Act also creates grants to establish a loan loss reserve fund to offset the costs of the small dollar loan program. This fund may not be used to make loans to consumers, but it may be used to recapture part or all of a defaulted loan under the small dollar loan program.
There will also be grants provided to be used for technology, staff support and other cots associated with this program.
The requirements for these loans is that they shall not exceed $2,500.00, must be repaid in installments, must have no pre-payment penalty, and must be reported as a tradeline by the institution to at least one of the consumer credit reporting agencies.
The Act does not fix a dollar amount on the cost of this program. Rather it says that "such sums as are necessary to administer and fund the programs and projects authorized by this title" are authorized to be appropriated to the Treasury Secretary beginning in fiscal year 2010.
I am not saying that payday loans are the ideal financial instrument, but is it really the responsibility of the Federal Government (aka the American Taxpayer) to provide low interest loans to consumers who have made lifestyle choices that preclude more traditional forms of credit and banking? The same bill that dictates that consumer choices need to be limited in mortgage loans and that creates a huge bureaucracy to supervise how responsible people obtain credit is going to spend as much as is deemed necessary to provide perhaps less responsible people with loans they would not qualify for in a free market.
If that's not pork, I don't know what is.
Now that the Senate bill has moved over back to committee to be reconciled with the House version, plenty of entities and industry insiders are weighing in on the provisions of the new soon to be law. But this final provision is buried so far at the back that it may go almost unnoticed even as we are paying for it.
Entitled Title XII, Improving Access to Mainstream Financial Institutions Act of 2010, the stated purpose of this Title is to, "encourage initiatives for financial products and services that are appropriate and accessible for millions of Americans who are not fully incorporated into the financial mainstream."
Put simply, the purpose of the title is to create incentives for the portion of our culture which does not maintain bank accounts and routinely uses pay day lenders as their money source.
The Act authorizes the Secretary of the Treasury to establish "a multi year program of grants, cooperative agreements, financial agency agreements, and similar contracts or undertakings to promote initiatives designed to:"
1. Enable low to moderate income individuals to establish one or more accounts in federally insured depository institutions that are appropriate to meet the financial needs of such individuals.
2. To improve access to the provision of accounts, on reasonable terms, for low to moderate income individuals.
Further, the Secretary of the Treasury is authorized to establish multi-year programs through grants, contracts, or financial agency agreements, with banks and depository institutions to provide low cost, small loans up to $2500.00 which will be less expensive for consumers than payday loans.
As part of participation in this program, the lending institutions who take part shall offer financial education courses including counseling services, educational courses and wealth building programs to each consumer receiving this type of loan. The cost for this education will be covered through federal grants.
Since payday loans are notoriously high risk and a series of small balance loans which defaulted could wreak havoc on a bank's balance sheet, the Act also creates grants to establish a loan loss reserve fund to offset the costs of the small dollar loan program. This fund may not be used to make loans to consumers, but it may be used to recapture part or all of a defaulted loan under the small dollar loan program.
There will also be grants provided to be used for technology, staff support and other cots associated with this program.
The requirements for these loans is that they shall not exceed $2,500.00, must be repaid in installments, must have no pre-payment penalty, and must be reported as a tradeline by the institution to at least one of the consumer credit reporting agencies.
The Act does not fix a dollar amount on the cost of this program. Rather it says that "such sums as are necessary to administer and fund the programs and projects authorized by this title" are authorized to be appropriated to the Treasury Secretary beginning in fiscal year 2010.
I am not saying that payday loans are the ideal financial instrument, but is it really the responsibility of the Federal Government (aka the American Taxpayer) to provide low interest loans to consumers who have made lifestyle choices that preclude more traditional forms of credit and banking? The same bill that dictates that consumer choices need to be limited in mortgage loans and that creates a huge bureaucracy to supervise how responsible people obtain credit is going to spend as much as is deemed necessary to provide perhaps less responsible people with loans they would not qualify for in a free market.
If that's not pork, I don't know what is.
Killing Small Business Part II
Last week we discussed how the Merkley amendment kills small business by mandating caps on originator compensation. Today, I want to look at another aspect of the amendment to Senate bill 3217--the part that mandates that all loans must be underwritten to consider the borrower's ability to repay the loan.
Like so many other things that are codified into law, this sounds great on the surface. After all, we all know about the infamous "liar loans" that allowed waitresses with $10.00 an hour incomes to purchase $500,000 houses. So mandating that borrowers need to prove their incomes and be underwritten according to their incomes is actually necessary to prevent another housing meltdown. Right?
Not necessarily. To really understand what mandating that loans be underwritten based on income means, it is important to understand first that this is a moving target. Several years ago, underwriting to full income through Fannie Mae and Freddie Mac meant, for a salaried employee, one paystub and the most recent W2 from the previous year. For a self- employed person with great credit, it could mean the most recent year's tax returns. Many of the low documentation and no documentation programs were credit score driven and designed to help individuals who had the income but could not pass the underwriting litmus test. Today, underwriting standards have tilted dramatically against the small business owner and the self-employed or commissioned individual, making it harder for these people to qualify to purchase or refinance a home.
Let's look at a few examples:
Borrower # 1 has owned his own business for three years. He has exceptional credit (over 750), but when the recession started in 2007, he was one of the first to lose his job, so he took his savings and invested in setting up a business. Year # 1 he lost money. Year #2 (2008 filing period) he broke even but still got to carry forward some losses from the previous year on his income taxes. Year #3, 2009, he made a healthy profit and now six months into 2010, he is realizing a good income. His credit is strong, and he still has some savings. Now, he wants to take advantage of the lower interest rates and falling prices and purchase a new home. His neighbor Fred's sister in law is moving back to town and she needs a place to rent, so he has agreed to rent his existing home to her for 1250.00 a month. Since his escrowed house payment (principal, interest, taxes and insurance) is $1000.00 a month he will have the payment completely covered. Even though guidelines allow the underwriter to use only 75% of the rental income against the escrowed payment, he still has it covered.
Will borrower # 1 qualify? Probably not. Under current guidelines, the underwriter will have to average his income from 2009 and 2008 as reflected on his tax returns. Although he had a good year in 2009, in 2008 he broke even and he had a loss that carried forward from 2007. That will probably be enough to negate his profit in 2009. The income he is currently making won't make any difference--he will have to file his 2010 taxes in order to come up with a better average.
But let's suppose that our borrower made so much money in 2009 that even with averaging the two years together he still has enough income to qualify. Unless he has thirty percent equity in the house he is currently living in he will not be able to use the rent money from his new tenant to qualify--even if the new tenant is prepared to give him a check for the first month's rent before closing. (Some programs also require evidence of two year's experience as a landlord.) In this case, he has to qualify with the full payment on the existing house he owns now and the full payment on the new house he wants to purchase. The 30% equity rule was established about 18 months ago to prevent underwater borrowers who could not refinance from purchasing a new home at a lower interest rate and better terms and then letting the previous one go into foreclosure. But in practice, it can prevent qualified borrowers from being able to buy a home. Since the 30% equity must be established by an appraisal ordered through an appraisal management company by the lender, even if the borrower perceives that he has the equity in the house, that equity can be eaten up by something as arbitrary as a recent low-ball sale of a similar property on the same street. And the borrower, who has already paid for two appraisals, has no recourse unless he wants to start over with a different lender, pay for two more appraisals, and hope for a different outcome. So borrower # 1, who was willing to take a chance during a recession, work hard and build a new business, probably will not get his loan.
Borrower # 2 is a salaried employee, but his wife is commissioned. Together they have decent credit and not a lot of debt. She has always worked for the same company but recently she moved to a different deparment where she has greater earning potential and she went from salaried plus commissioned to purely commissioned. She is currently earning about twice as much as she did last year. They also want to take advantage of the current low rates and buy a house. Will they qualify? Maybe but maybe not. Even though the wife has worked for the same company, she is now strictly commissioned. Her commissions would have to be averaged for two years, and even though she is making much more now than she was making with her salary, the underwriter would not take the previous salary into account--just the commissions. So unless the salaried spouse's income is strong enough to carry the deal, Borrower #2 may not qualify either.
Borrower # 3 is a career federal agent. He has 15 years on his job. His credit is excellent (over 750) and he has job stability and an annual income of just over six figures. Five years ago he got a divorce, and the court awarded his ex-wife child support, which he pays on time. Early last year, he re-married. His new wife has a bankruptcy and a foreclosure resulting from her previous divorce. She owns a deli, which with her child support from her ex was barely enough to keep her alive until she married our borrower. In 2009, they filed a joint tax return and since she is a sole proprietor with a struggling business, she filed a loss on the joint return.
To me, this is the most unfair example of all. Before the new underwriting guidelines went into effect, if you had one borrower with strong credit and stable income and a spouse with terrible credit and no income, you put the spouse with the good credit and the good income on the loan. Texas is a homestead state, so the spouse who did not qualify signed onto the deed of trust as a non-purchasing spouse and had ownership interest in the property, but neither their income nor their credit was considered for a conforming conventional loan.
The current guidelines change that. Even though borrower 3 receives all of his income from his salaried job with Uncle Sam, his new wife's losses from her business must be subtracted from his income even though she is not on the loan. And if he currently owns a home, he must be able to prove that he has 30% equity in the house, or he will have to qualify with that payment also and prove that he has 6 months of principal, interest, taxes and insurance put aside so that he can make the payment on the current home. Further, a 401K or other retirement account no longer qualifies for reserves, because in order to use that money we must have proof that he has actually withdrawn the funds. So even though all three of our borrowers might have put away some money in investments, we don't get to consider that money unless they have cashed out the investment and deposited it into the bank.
The Merkley amendment may sound as though it prevents another financial meltdown, but in reality, all of these new rules overlook the fact that people are individuals with individual challenges and problems. Rather than preventing problems, amendments like this one merely keep qualified, responsible borrowers from buying houses, and slow down the recovery.
Like so many other things that are codified into law, this sounds great on the surface. After all, we all know about the infamous "liar loans" that allowed waitresses with $10.00 an hour incomes to purchase $500,000 houses. So mandating that borrowers need to prove their incomes and be underwritten according to their incomes is actually necessary to prevent another housing meltdown. Right?
Not necessarily. To really understand what mandating that loans be underwritten based on income means, it is important to understand first that this is a moving target. Several years ago, underwriting to full income through Fannie Mae and Freddie Mac meant, for a salaried employee, one paystub and the most recent W2 from the previous year. For a self- employed person with great credit, it could mean the most recent year's tax returns. Many of the low documentation and no documentation programs were credit score driven and designed to help individuals who had the income but could not pass the underwriting litmus test. Today, underwriting standards have tilted dramatically against the small business owner and the self-employed or commissioned individual, making it harder for these people to qualify to purchase or refinance a home.
Let's look at a few examples:
Borrower # 1 has owned his own business for three years. He has exceptional credit (over 750), but when the recession started in 2007, he was one of the first to lose his job, so he took his savings and invested in setting up a business. Year # 1 he lost money. Year #2 (2008 filing period) he broke even but still got to carry forward some losses from the previous year on his income taxes. Year #3, 2009, he made a healthy profit and now six months into 2010, he is realizing a good income. His credit is strong, and he still has some savings. Now, he wants to take advantage of the lower interest rates and falling prices and purchase a new home. His neighbor Fred's sister in law is moving back to town and she needs a place to rent, so he has agreed to rent his existing home to her for 1250.00 a month. Since his escrowed house payment (principal, interest, taxes and insurance) is $1000.00 a month he will have the payment completely covered. Even though guidelines allow the underwriter to use only 75% of the rental income against the escrowed payment, he still has it covered.
Will borrower # 1 qualify? Probably not. Under current guidelines, the underwriter will have to average his income from 2009 and 2008 as reflected on his tax returns. Although he had a good year in 2009, in 2008 he broke even and he had a loss that carried forward from 2007. That will probably be enough to negate his profit in 2009. The income he is currently making won't make any difference--he will have to file his 2010 taxes in order to come up with a better average.
But let's suppose that our borrower made so much money in 2009 that even with averaging the two years together he still has enough income to qualify. Unless he has thirty percent equity in the house he is currently living in he will not be able to use the rent money from his new tenant to qualify--even if the new tenant is prepared to give him a check for the first month's rent before closing. (Some programs also require evidence of two year's experience as a landlord.) In this case, he has to qualify with the full payment on the existing house he owns now and the full payment on the new house he wants to purchase. The 30% equity rule was established about 18 months ago to prevent underwater borrowers who could not refinance from purchasing a new home at a lower interest rate and better terms and then letting the previous one go into foreclosure. But in practice, it can prevent qualified borrowers from being able to buy a home. Since the 30% equity must be established by an appraisal ordered through an appraisal management company by the lender, even if the borrower perceives that he has the equity in the house, that equity can be eaten up by something as arbitrary as a recent low-ball sale of a similar property on the same street. And the borrower, who has already paid for two appraisals, has no recourse unless he wants to start over with a different lender, pay for two more appraisals, and hope for a different outcome. So borrower # 1, who was willing to take a chance during a recession, work hard and build a new business, probably will not get his loan.
Borrower # 2 is a salaried employee, but his wife is commissioned. Together they have decent credit and not a lot of debt. She has always worked for the same company but recently she moved to a different deparment where she has greater earning potential and she went from salaried plus commissioned to purely commissioned. She is currently earning about twice as much as she did last year. They also want to take advantage of the current low rates and buy a house. Will they qualify? Maybe but maybe not. Even though the wife has worked for the same company, she is now strictly commissioned. Her commissions would have to be averaged for two years, and even though she is making much more now than she was making with her salary, the underwriter would not take the previous salary into account--just the commissions. So unless the salaried spouse's income is strong enough to carry the deal, Borrower #2 may not qualify either.
Borrower # 3 is a career federal agent. He has 15 years on his job. His credit is excellent (over 750) and he has job stability and an annual income of just over six figures. Five years ago he got a divorce, and the court awarded his ex-wife child support, which he pays on time. Early last year, he re-married. His new wife has a bankruptcy and a foreclosure resulting from her previous divorce. She owns a deli, which with her child support from her ex was barely enough to keep her alive until she married our borrower. In 2009, they filed a joint tax return and since she is a sole proprietor with a struggling business, she filed a loss on the joint return.
To me, this is the most unfair example of all. Before the new underwriting guidelines went into effect, if you had one borrower with strong credit and stable income and a spouse with terrible credit and no income, you put the spouse with the good credit and the good income on the loan. Texas is a homestead state, so the spouse who did not qualify signed onto the deed of trust as a non-purchasing spouse and had ownership interest in the property, but neither their income nor their credit was considered for a conforming conventional loan.
The current guidelines change that. Even though borrower 3 receives all of his income from his salaried job with Uncle Sam, his new wife's losses from her business must be subtracted from his income even though she is not on the loan. And if he currently owns a home, he must be able to prove that he has 30% equity in the house, or he will have to qualify with that payment also and prove that he has 6 months of principal, interest, taxes and insurance put aside so that he can make the payment on the current home. Further, a 401K or other retirement account no longer qualifies for reserves, because in order to use that money we must have proof that he has actually withdrawn the funds. So even though all three of our borrowers might have put away some money in investments, we don't get to consider that money unless they have cashed out the investment and deposited it into the bank.
The Merkley amendment may sound as though it prevents another financial meltdown, but in reality, all of these new rules overlook the fact that people are individuals with individual challenges and problems. Rather than preventing problems, amendments like this one merely keep qualified, responsible borrowers from buying houses, and slow down the recovery.
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