The Federal Reserve's Newest Proposed Rule--Underwriting Guidelines

On April 19, 2011, the Federal Reserve published a proposed rule to establish minimum underwriting guidelines for mortgages, as required by the Dodd Frank bill.

Last week I wrote about the Qualified Residential Mortgage proposal introduced by the FDIC.  The Federal Reserve's proposed rule is not nearly as detailed as the FDIC QRMs, but the underlying philosophy is pretty similar:

The Federal Reserve's proposal will apply "the ability to repay requirement to all consumer purpose mortgages, (except home equity lines of credit, timeshare plans, reverse mortgages or temporary loans)." To achieve this, the Federal Reserve proposes 4 compliance options 1. General Ability to Repay Standard, 2. Qualified Mortgages,  3. Balloon Payment Qualified Mortgages, 4. Refinancing of a Non Standard Mortgage.   Within each of these 4 compliance option categories are various sublevels of compliance.

For example, to meet the general ability to repay standard, an underwriter needs to consider the following 8 underwriting categories:

1. Income or assets of the borrower
2. Current employment status
3. The monthly payment on the mortgage
4. The monthly payment on any simultaneous mortgage
5. The monthly payment for mortgage related obligations
6. Current debt obligations
7. The monthly debt-to-income ratio or residual income
8. Credit history.

The creditor must also make sure that when he is underwriting an adjustable rate product, he is qualifying the borrower on the fully indexed rate.

The Federal Reserve is also trying to solidify their own definition of a "qualified mortgage" which is interesting since the FDIC is currently seeking comments on its own, massive qualified residential mortgage proposal.  The Federal Reserve's proposal to satisfy this requirement is actually more reasonable than the FDIC's.  The Fed Rule proposal merely says that the QRM should not contain negative amortization, interest-only payments or a balloon payment or exceed 30 years in term.  A QRM also would not have points and fees exceeding 3% of the total loan amount.  Income and assets must be verified to determine ability to repay and the loan must be underwritten using a fully amortized payment schedule over the loan term.

The 3% cap on points and fees is part of the Dodd Frank bill, but it will be interesting to see how that aligns with recently adopted industry practices as part of the loan originator compensation rule.  For instance, under the new rule, originators have a ceiling and a floor for loan origination fees.  If we are originating a loan of $60,000.00 we can set a floor at $1000.00.  However, with lender fees consistently rising (some wholesale lenders are now charging about $800.00 for their administration fees), and with states such as Texas requiring attorney fees as part of the origination fees, that is going to leave very little money for the originator.  If I have to pay the lender $800 and the law firm that prepares the documents an additional $300.00., on a $60,000 loan I am left with only making $700.00.  These fee caps are going to keep a lot of the smaller loans from getting done at all in a situation where the loan originator is commissioned.

Additionally, the Federal Reserve is proposing that the QRMs meet the following additional underwriting standards in which the underwriter considers:

• The consumer's employment status
• The monthly payment for any simultaneous mortgage
• The consumer's current debt obligations
• The monthly debt to income ratio or residual income and
• The consumer's credit history.

Recognizing that rural properties create special challenges for the lending community, the Fed's Rule allows for balloon payment qualified mortgages. "This option is meant to preserve access to credit for consumers located in rural or underserved areas where creditors may originate balloon loans to hedge against interest rate risk for loans held in portfolio."  Under the proposal, balloon payment mortgages with a term of five years or more qualify as long as the loan complies with the other requirements for a qualified mortgage.

Finally, the Federal Reserve's proposal allows a creditor to refinance a non-standard mortgage into a "standard mortgage" using streamline mortgages.  Under this part of the proposal, a creditor would be able to refinance a consumer into a mortgage with caps on points and fees without verifying the consumer's income or assets as long as the other requirements of the ability to repay section have been met.

The Federal Reserve's proposal with lengthen the amount of time that creditor are required to keep files and will prohibit structuring an closed end line of credit as an open ended line to evade the statutes.

While the individual points of this proposal are not bad, I do have a huge issue with codifying underwriting guidelines into federal law.  By setting up federal underwriting guidelines for mortgage lending, the government does not leave any room for the creation of new products or for individual analysis of the borrower's situation.  We see that in a major way with the FDIC's Qualified Residential Mortgages and on a much smaller scale with the Federal Reserve's proposed rule but the basic problem is the same.  The federal government should not be in the business of establishing lending criteria.

Comments are open until July 22, 2011. However, since the Consumer Financial Protection Bureau is scheduled to take over TILA rulemaking on July 21, 2011, the Federal Reserve will not be issuing a final rule. 

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SB 712: The Financial Takeover Repeal Act

On April 1, while most of us originators were celebrating the (very) temporary stay granted to us by the U.S. Appellate Court to prevent implementation of the Fed Rule on loan originator compensation, a bill was being unveiled in the Senate which, if passed, could actually help us.  Senator Jim DeMint (R SC) chairman of the Senate Steering Committee, introduced S. 712, The Financial Takeover Repeal Act of 2011, to completely repeal the Dodd Frank Act.  Currently the bill has 24 co-sponsors, including Sen. Richard Shelby (R AL), Sen. Mitch McConnell (R KY), Senator Rand Paul (R -KY)  and both Senators from Texas.  To see the full list of sponsors go to http://demint.senate.gov/. 

In his press announcement, Senator DeMint made the following argument for repeal of the bill, "We must repeal the Democrats' takeover of the financial markets that favors Wall Street corporations, over-regulates small businesses with massive new bureaucracy and hurts consumers. This financial takeover will strangle our economy and move jobs overseas unless it is repealed...The Dodd Frank financial takeover is producing hundreds of new regulations, forcing banks to charge consumers higher fees, and institutionalizing 'too big to fail' policies that favor Wall Street companies over small businesses."

Going to the Senator's website to read the press announcement is really worthwhile, because he provides links to the studies he cites to support his assertion that Dodd Frank needs to go. One of these is an article published by former Federal Reserve chair Alan Greenspan which was published in "Financial Times" on March 29, 2011.  Greenspan's comments are most interesting, "The financial system on which Dodd Frank is being imposed is far more complex than the lawmakers, and even most regulators, apparently contemplate. We will almost certainly end up with a number of regulatory inconsistencies whose consequences cannot be readily anticipated....In pressing forward, the regulators are being entrusted with forecasting and presumably preventing, all undesirable repercussions that might happen to a market when its regulatory conditions are importantly altered. No one has such skills."  I agree completely.  Dodd-Frank should have been subtitled, "The Law of Unintended Consequences," since it is basically a giant framework on which to hang numerous new laws and rules without having to go back to Congress.

DeMint quotes former Senator Chris Dodd, (D CT) whose name the bill bears, as saying about the Dodd Frank legislation, "No one will know until this is actually in place how it works."  That is very reminiscent of former Speaker of the House Nancy Pelosi's famous statement regarding health care, "We have to pass it to find out what is in it."  This is just one of many problems in Washington--legislators sponsor and write massive pieces of legislation they don't understand with far-reaching consequences they cannot appreciate and then force all of us to live with the results.

DeMint also cites a U.S. Chamber of Commerce study demonstrating that Dodd Frank regulations "could cut capital spending by over $5 billion and cost the U.S. over 100,000 jobs."

Jamie Dimon, CEO of JPMorgan Chase, is quoted as saying that Dodd Frank may "put the nails in the coffin" of the U.S. economy.  Recent studies indicate that excessive regulations on debit card fees may cause banks to stop issuing debit cards. Dimon likens the debit card fees restrictions to "basic price-fixing at its worst."

In what well may be the most interesting expert cited by DeMint, the outgoing Special Inspector General for TARP, Neil Barofsky, reported to Congress that the biggest banks had grown larger as a result of all of the financial reform and there is now more danger of having to engineer another bailout than when we started TARP.

And then, of course, there is the whole problem of the housing market and access to mortgage credit.  Surprisingly, this discussion is missing from DeMint's announcement.  (I say that not as a criticism but merely as an observation).  The housing market is extremely important to the economic recovery of the U.S., and the rules being implemented today are going to prevent a housing recovery in the near future and are ultimately going to prevent many responsible credit worthy Americans from having the opportunity to own a home of their own. 

Greenspan's article in "Financial Times" is followed by pages of vitriolic comments reviling Greenspan, the banking community and all financial services providers in general.  And I think this public perception problem is the reason that "The Financial Takeover Repeal Act" does not have a lot of widespread support.  Too many Americans see Dodd Frank as a necessary bill which protects the financial interests of the middle class.  They do not recognize that it creates a massive new bureaucracy which is crushing small businesses, gobbling up financial products, and cutting off many Americans' access to credit.

Making regular people understand that the credit crisis today, and especially the mortgage credit crisis, is not just a result of the recession but that it is a result of massive regulations which are squeezing the life out of mortgage lending has to be our job.  I realize that mortgages and mortgage lending are only one small piece of Dodd-Frank, but they are a critical piece affecting millions of Americans.  And no one is in a better position to tell the story of housing than we (the loan originators working in the housing markets.)

I know that many of us are still trying to figure out how to deal with the Fed Rule on loan originator compensation since the stay was lifted on Tuesday.  I have been seeing the various videos floating around from NAMB about future lawsuits.  The real truth of the matter is this--without repeal of Dodd Frank we have no chance of winning a lawsuit to change the Fed Rule because the basic provisions of the Fed Rule regarding compensation are also written into the new law.  And with the Consumer Financial Protection Bureau going into regulatory effect this July and qualified residential mortgages around the corner, our problems are only just beginning.  If we want to see anything improve, the underlying law has to be repealed.  Then, and only then, can we expect to win a lawsuit to make the Federal Reserve change its rules.

Neither of my two Senators supported the Repeal measure, nor will they.  I emailed both of them frequently when Dodd Frank was being debated last year and they both smugly assured me that the bill was necessary to prevent another financial crisis. But I plan to email Senator DeMint today and express my support, and I urge anyone who wants to continue to have a career in any aspect of financial services to do the same. If your Senators are more openminded than the two from New Mexico, where I make my home, I would recommend contacting them as well.  Only with a full repeal are we ever going to have any hope of earning a living, running our small businesses, and continuing to assist our fellow Americans in realizing their dreams of homeownership..

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How Will Financial Reform Affect the Future of HVCC? Part II

When I wrote Part I of this article, I had hopes that the financial reform bill would sunset HVCC--the Home Valuation Code of Conduct--which was the agreement made between Andrew Cuomo and Fannie Mae and Freddie Mac in order to get Cuomo to drop a criminal investigation against both entities. HVCC was the code adopted which legislated that mortgage loan originators would no longer have contact with appraisers and that appraisals would be ordered through appraisal management companies.

The reason that I had hopes that the code would be sunseted was that the house version of the bill did sunset the provisions of the code. However, the Senate bill did not, and the final bill does not. While the bill does call for a study of the provisions of the Home Valuation Code of Conduct and its impact on the housing market, the bill does not eliminate it and it does require that originators not have contact with appraisers. If anything, the final version of the bill actually strengthens the provisions of the HVCC, because HVCC only pertained to loans sold to Fannie Mae and Freddie Mac, while the new Dodd-Frank Wall Street Reform and Consumer Protection Act, as it has been been renamed, applies to all residential mortgage lending.

As those of us who work in real estate are well aware, the Home Valuation Code of Conduct prohibits a loan originator from hiring an appraiser or having any contact with the appraiser. It also prohibits ordering a second appraisal if the buyer and seller disagree with the valuation of the house. The only way to correct a low valuation is to start over with a new lender and a new loan and order a new appraisal. And in real terms, the Home Valuation Code of Conduct means that is a loan is denied for any reason, the appraisal is not really transferable, even if the reason for the denial had nothing to do with the property. This can get very expensive, especially on appraisals for investment properties where additional schedules are required, since the AMCs set the price. A borrower can end up spending close to $1000.00 to get a second appraisal with an operating income statement for an investment property if his loan is denied.

This is one reason that many of us in the lending and real estate communities were hoping that HVCC would be ended in the financial reform bill and replaced with language guaranteeing appraiser independence. But instead, HVCC goes on. The Dodd-Frank Act deals with the problem of HVCC much the way that it deals with the problem of Fannie Mae and Freddie Mac and many other problems--it calls for a study. "12 months after the date of enactment of this Act, the Government Accountability Office shall submit a study to the Committee on Banking Housing and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives, and 90 days after the date of the enactment of this Act, the Governmment Accountability Office shall provide a report on the status of the study and any preliminary findings to the Committee on Banking, Housing and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives."

And what will this study cover? "The study required by this section shall include an examination of the following...The prevalence, alone or in combination, of certain appraisal approaches, models and channels in purchase money and refinance mortgage transactions; The accuracy of these approaches, models and channels in assessing property as collateral; Whether and how these approaches, models and channels contributed to price speculation during the previous cycle; the costs to consumers of these approaches, models and channels, the disclosure of fees to consumers in the appraisal process; to what extent the usage of these approaches, models and channels may be influenced by a conflict of interest between the mortgage lender and the appraiser and the mechanism by which the lender selects and compensates the appraiser...How the HVCC affects mortgage lenders' selection of appraisers; How the HVCC affects state regulation of appraisers and appraisal distibution channels; how the HVCC affects the quality and cost of appraisals and the length of time to obtain an appraisal; and how the HVCC affects mortgage brokers, small businesses and consumers."

Actually the government does not need to spend taxpayer dollars to do a study on this. The mortgage broker community and the appraisal community have all weighed in on HVCC, and the regulation has received more than its fair share of bad PR since it went into effect in May of 2009. Opponents of HVCC organized a petition which received over 100,000 signatures asking that HVCC be repealed last year.

In addition, the Dodd Frank Bill authorizes a second study, which shall include an examination of, "the Appraisal Subcommittee's ability to monitor and enforce State and Federal certification requirements and standards including by providing a summary with a statistical breakdown of enforcement actions taken during the last ten years, and whether existing Federal financial institutions exemptions on appraisals for federally related transactions needs to be revised; and whether new means of data collection, such as the establishment of a national repository would benefit the Appraisal Subcommittee's ability to perform its functions." Last but not least the Dodd Frank Bill will amend RESPA by adding that a new combination good faith estimate and truth in lending form, which is mandated to be developed by the new Bureau of Consumer Financial Protection, may provide a clear disclosure of "the fee paid directly to the appraiser by such company (an AMC) and the administration fee charged by such company (the AMC)."

In other words, watch out. After the Feds complete their study of the models, processes and procedures for appraising properties and whether those models and processes led to the last real estate boom, they can rewrite all of the rules of appraising to make sure that we never have another boom again. And it is apparently okay to make small business owners work for Appraisal Management Companies as long as the consumer is fully aware that much of the money he is paying for his home valuation is going to the AMC taking the order and not to the individual doing the work.