The CFPA Controversy: Asking the Tough Questions

by Jonathan Foxx

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is the President and Managing Director of Lenders Compliance Group.

As published in the October 2009 Edition of National Mortgage Professional Magazine.

The Consumer Financial Protection Agency (CFPA) is on the way and its gestation stage will not be as long as many expect.[1] Although its nascence will endure the inevitable crucible of politics churned out by the Congress, federal and state regulatory bodies, bank and non-bank industry lobbyists, and eminent legal scholars,[2] the actors in this drama seem to argue, at one extreme, for a CFPA with robust oversight and regulatory enforcement authorities, and, at the other extreme, some kind of oversight agency that reviews financial products and consumer protection statutes, but without the authority to create new guidelines or enforce such protections. What is coming could be a witches’ brew of regulatory authorities migrated from various existing regulatory venues, along with a red hot dash of new authorities especially aimed at regulating the non-bank industry. The Consumer Financial Protection Agency Act of 2009 (Act), H.R. 3126, is viewed by politicians and many in the main stream media as the antidote to preventing another toxic “mortgage meltdown.” [3]

Whatever newly legislated agency we are eventually confronted with, it is important to understand the implications of the many features being suggested for the CFPA. There are cogent arguments on both sides of this issue, given industry orientation and political bias. More deliberative, though, would be to ask some tough (and perhaps disturbing) questions, the answers to which will help us to evaluate the proposed and even final legislative results. It’s time to ask those tough questions now, however impolitic they may seem, in order to be able to evaluate the import of the legislation. What follows is a set of probing questions, along with some tentative answers, that should help us to manage our expectations for the CFPA.

Will the CFPA improve the current regulatory framework?

Recent events have demonstrated that the existing regulatory framework is either dysfunctional or in need of a complete overhaul. In many cases, just enforcing current regulations might have stemmed or slackened the mortgage crisis; however, there were challenges for which the regulations were not adequately responsive. The Obama Administration announced its intention to revamp the regulatory framework.[4] In a white paper, wistfully titled Financial Regulatory Reform - A New Foundation: Rebuilding Financial Supervision and Regulation[5] (Plan), the Administration suggested new regulatory schemes to prevent a recurrence of another financial crisis. Admitting that the “government could have done more” to prevent the crises that ensued throughout the financial system, the Plan declares:

“We must build a new foundation for financial regulation and supervision that is simpler and more effectively enforced, that protects consumers and investors, that rewards innovation and that is able to adapt and evolve with changes in the financial market.”[6]

Some believe that any improvement is better than no improvement at all. Given the dismal enforcement of existing regulatory mandates, there seems to be some systemic dysfunction. Indeed, a “report card,” issued by the House Financial Services Committee, demonstrated “the poor record of the Federal Reserve in using the tools provided by Congress to protect consumers from abusive financial industry practices,” and asserting that “consumer protection has long been overlooked by federal regulators, and their motivation to protect consumers has been driven more by congressional pressure rather than a sense of duty to protect the American public.” [7]

The basis for creating the CFPA rests on the assertion that “as abusive practices spread, particularly in the market for subprime and nontraditional mortgages, our regulatory framework proved inadequate in important ways.”[8] Systemic risk is supposed to be remedied through the CFPA by consolidating into it certain authorities from other regulatory bodies as well as by having it raise the standards between and among financial intermediaries.

Will regulatory consolidation lead to greater consumer financial protections?

It should be noted that there are three (3) areas of divergence between the Act and the Plan. First, the Act does not transfer oversight and enforcement authority over the Community Reinvestment Act to the CFPA;[9] second, the Act does not eliminate the thrift charter, and, by extension, the Office of Thrift Supervision; and third, the Act makes reference to “the head of the agency responsible for chartering and regulating national banks”[10] but not an oversight supervisor. However, the Plan calls for the transfer of CRA enforcement authority to the CFPA, eliminates the thrift charter (converting thrifts to state or national banks),[11] and suggests the establishment of a National Bank Supervisor.

Consolidation of regulatory authorities will be considerable. The Plan is actually proposing to transfer and consolidate within the CFPA primary enforcement authority over the consumer financial protection functions currently performed by the Federal Reserve's Board of Governors, the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA) and the Federal Trade Commission (FTC). This includes exclusive authority over all related research, rulemaking, guidance, supervision, examination and enforcement activities.

At least sixteen (16) existing consumer protection laws will be included in the transfer, giving new exclusive rulemaking and examination authority to the CFPA. These laws include:

• Alternative Mortgage Transaction Parity Act (AMTPA)[12]
• Community Reinvestment Act (CRA)[13]
• Consumer Leasing Act (CLA)[14]
• Electronic Funds Transfer Act (EFTA)[15]
• Equal Credit Opportunity Act (ECOA)[16]
• Fair Credit Billing Act (FCBA)[17]
• Fair Credit Reporting Act (except with respect to sections 615(e), 624 and 628) (FCRA)[18]
• Fair Debt Collection Practices Act (FDCPA)[19]
• Federal Deposit Insurance Act, subsections 43(c) through 43(f)(12) (FDIA)[20]
• Gramm-Leach-Bliley Act, sections 502 through 509 (GLBA)[21]
• Home Mortgage Disclosure Act (HMDA)[22]
• Home Ownership and Equity Protection Act (HOEPA)[23]
• Real Estate Settlement Procedures Act (RESPA)[24]
• SAFE Mortgage Licensing Act (S.A.F.E. Act)[25]
• Truth in Lending Act (TILA)[26]
• Truth in Savings Act (TISA)[27]

Although the CFPA would be assigned primary authority to enforce these laws, other federal regulators, including the banking agencies and the Federal Trade Commission, would retain overlapping, secondary enforcement authority over certain requirements. And state attorneys general would be empowered to enforce federal laws under the CFPA (subject to any existing limitations in the laws to be transferred to the CFPA's authority). State consumer financial protection laws would not be preempted, except to the extent that they are inconsistent with federal law (although such state laws could be stricter than the federal laws, in which case they would not be preempted by federal law).

A quick look at the list of affected laws indicates that the CFPA’s authorities will be coming for the most part from federal banking statutes. Therefore, this begs the question: how does it benefit the consumer by transferring these existing authorities from their current regulators, who already are or should be enforcing these laws, to a new primary regulator to do the very same enforcement measures? Two views are generally held in response. The first maintains that there is an inherent conflict between encouraging institutional profitability and availability of credit, but also offering risky, complex, and high cost loans to borrowers which can, at times, lead to abuse. An opposing view would be that adding yet another layer of regulatory control does nothing really to alter the fact that broad and robust measures of consumer protection are already in place. Presumably, the CFPA’s mandate should be over time to eliminate bureaucratic waste and duplicative procedures, and bring about the further streamlining of authorities. The goal, apparently, would be to create an agency that has the capacity to proactively enforce existing and new powers as well as respond quickly and deliberately to critical financial conditions.

Does the CFPA thwart financial innovation?

Winston Churchill wrote that “if you have ten thousand regulations you destroy all respect for the law.” One might also add, perhaps, that you could destroy all respect for innovation as well! At least that is the argument against allowing the CFPA to regulate consumer financial products. Both price discovery and innovation in financial products often come through the arbitrage created in a dynamic and open market. Although a regulator might have no immediate concerns with respect to the exercise of its prudential function, such exceptional, dynamic market activities as price discovery and innovation could be viewed with much apprehension by an agency whose specific mandate is to provide consumer protection.

The debacle is made even more clear when the Plan advocates for a “plain vanilla” financial product – whatever that is supposed to mean! Presumably, this is a financial product which offers the legislation’s motifs of transparency, simplicity, fairness, accountability, and access to all.[28] These types of products could be “standardized” fixed term mortgages without prepayment penalties, and would require financial institutions to offer them alongside the institution’s other products. Such standards are “simpler and have straightforward pricing,” and these products are to be disclosed “prominently, alongside whatever other lawful products” a provider chooses to offer.[29]

The premise, of course, is that there is no efficient market upon which to base a regulatory framework. To put it bluntly, the need to codify the “plain vanilla” product and promulgate its regulatory management through an oversight agency is a rejection of the consumer as a rational, informed actor in the marketplace. It is an embracing of the rule that consumers need to be protected from themselves and regulations provide that protection. However, it is often the case that regulations must necessarily exclude certain activities, even though it may include other activities. What may be excluded, though, could be the very kinds of innovations that allow a market to evolve, grow, and be responsive to public need. The dampening effect of restrictive, consumer protection regulations might eventually leave the consumer with less financial options. Unexpected consequences, as we all should have learned recently, cannot be regulated away.

Evaluating the CFPA: Key Questions

There are other components to the CFPA legislation that could derivatively impact many aspects of the mortgage industry. The Plan is complex, nuanced, and far-reaching. For example, the preemption provisions in the Act itself, if narrowly interpreted, could have a detrimental effect on a bank’s financial products and services on a multi-state basis, thereby increasing administrative costs. On the other hand, if the CFPA broadly interprets its authorities, the same provisions could lead to multi-state companies having a single set of rules, thereby depriving consumers of the kinds of full protection from predatory products that they otherwise would be receiving under a state’s own statutory framework.

The complexity of this new legislation – especially because it creates a new government agency – is structured to provide the following five (5) stated objectives:[30]

1. Promote robust supervision and regulation of financial firms.

2. Establish comprehensive supervision of financial markets.

3. Protect consumers and investors from financial abuse.

4. Provide the government with the tools it needs to manage financial crises.

5. Raise international regulatory standards and improve international cooperation.

The means by which the CFPA accomplishes the above-enumerated objectives will determine both its longevity and efficacy. Nevertheless, how will you evaluate the implications of the Consumer Financial Protection Agency Act of 2009, as it makes its way through committees, hearings, votes, and eventually to the President’s desk? Your answers to the following five questions can guide your judgment. Will the CFPA:

A. Improve the transparency and fairness of financial products and services?

B. Provide transparent and uniform enforcement of regulations?

C. Focus on the safety of credit products, features, and practices?

D. Protect consumers from discriminatory, deceptive, or fraudulent loans?

E. Contribute to long-term sustainability of lenders and the economy as a whole?

Each member of the mortgage industry will need to research and answer these questions individually, and, as market participants, decide collectively how to prepare for the substantial and fundamental changes soon to become the law of the land.

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[1] Foxx, Jonathan: The Birth of an Agency, in National Mortgage Professional Magazine, Volume 1, Issue 5, September 2009, pp. 24-27

[2] On September 29, 2009, more than seventy law scholars who teach in fields related to consumer law and banking law issued a detailed “Statement of Support” demonstrating their strong views in favor of passing H. R. 3126 and the creation of the CFPA. Hyperlink: http://law.hofstra.edu/pdf/Media/consumer-law%209-28-09.pdf

[3] Consumer Financial Protection Agency Act of 2009, House Bill 3126. The Financial Services Committee in the House, chaired by Barney Frank (D-MA), commenced hearings on the CFPA in September 2009.

[4] U.S. Department of Treasury, June 17, 2009, TG-175: President Obama to Announce Comprehensive Plan for Regulatory Reform.

[5] Financial Regulatory Reform – A New Foundation: Rebuilding Financial Supervision and Regulation, issued by the U.S. Department of Treasury on June 17, 2009, and updated on August 11, 2009.

[6] Ibid. p. 2.

[7] The Federal Reserve’s Record on Consumer Protection, issued by House Financial Services Committee, Chairman Barney Frank (D-MA). Press Release: September 23, 2009.

[8] Op.cit. 5, p. 55.

[9] H.R. 3126 § 101(16).

[10] H.R. 3126 § 112(a).

[11] Opt.cit. 3, pp.30-31.

[12] 12 U.S.C. §§ 3801 et seq.

[13] 12 U.S.C. §§ 2901 et seq. Not included as an “Enumerated Consumer Law” in H.R. 3126, but enforcement authority over this Act is transferred to the CFPA. H.R. 3126 § 184(b)(2).

[14] 15 U.S.C. §§ 1667 et seq. Not specifically referenced in H.R. 3126’s definition of “Enumerated Consumer

Law, but enforcement authority over this Act is transferred to the CFPA. H.R. 3126 § 184(b)(2).

[15] 15 U.S.C. §§ 1693 et seq.

[16] 15 U.S.C. §§ 1691 et seq.

[17] 15 U.S.C. §§ 1666-1666j. Not specifically referenced in H.R. 3126’s definition of “Enumerated Consumer

Law;” but enforcement authority over this Act is transferred to the CFPA. H.R. 3126 § 184(b)(2).

[18] 15 U.S.C. §§ 1681 et seq.; and, 15 U.S.C. §§ 1681m(e), 1681s-3, 1681w.

[19] 15 U.S.C. §§ 1692 et seq.

[20] 12 U.S.C. § 1831t(c)-(f).

[21] 15 U.S.C. §§ 6802-6809.

[22] 12 U.S.C. §§ 2801 et seq.

[23] 15 U.S.C. § 1639.

[24] 12 U.S.C. §§ 2601-2610.

[25] 12 U.S.C. §§ 5101-5116.

[26] 15 U.S.C. §§ 1601 et seq.

[27] 12 U.S.C. §§ 4301 et seq.

[28] Op.cit. 5, pp. 63-67.

[29] Op.cit. 5, p. 15

[30] Op.cit. 5, pp. 3-4.

The Birth of an Agency: Consumer Financial Protection Agency

by Jonathan Foxx

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is the President and Managing Director of Lenders Compliance Group.

As published in the September 2009 Edition of National Mortgage Professional Magazine.

We are about to get a new federal agency. Historically speaking, federal agencies come into existence infrequently. A recent agency, the Financial Crimes Enforcement Network (FinCEN), was founded in 1990. Yet, the Federal Aviation Administration (FAA) was founded in 1958, the Food and Drug Administration (FDA) came into existence in 1937, and the Federal Reserve in 1913. The Federal Deposit Insurance Corporation (FDIC) was founded 76 years ago. Often federal agencies are founded as a reaction to, rather than in anticipation of a crisis. Regulation follows where the supposedly unpredictable has happened. But there is a kind of arrogance about our ability to predict, given our proclivity to believe narratives, basing our actions on retrospective considerations, or relying solely on precedent to foresee the future. Regulation follows where the dangerously obvious has been obscured by the opacity of politics and power. We seek the comfort of a government protector, a means to be kept safe (or safer) when we take an airline flight, eat our food, ingest our medicine, bank our money, or borrow money to buy a home. And when the protector fails to protect, as when the Securities and Exchange Commission (SEC), founded in 1934, fails to enforce existing regulations, resulting in the loss of billions of investors’ dollars in a ponzi scheme, the government’s response is still reactive – still not anticipatory – and thus likely to result in many more regulations.

We are about to get a new agency, called the Consumer Financial Protection Agency (CFPA),[1] yet another reactive response to the dangerously obvious. There will be turf wars between the federal agencies to keep their respective, existing authorities away from the CFPA; there will be debates about what and who will be regulated; and politics and power will work very hard to obscure the facts and muddle the solutions. Though congress will now debate when it will become law and how much authority it will have, the CFPA is on the way. As it makes its ascent on the regulatory horizon, let’s take a close look at what we have been told about it.

The Treasury released a white paper, on June 17, 2009, in tandem with President Obama’s announcement of a comprehensive plan for regulatory reform. Entitled Financial Regulatory Reform - A New Foundation: Rebuilding Financial Supervision and Regulation [2](Plan), the proposal outlines the Administration’s requirements to reform the U.S. financial regulatory system. If adopted in its entirety, this robust and complicated document will become the blueprint for significant changes to the financial world.[3] The goal of the Plan is to remediate the following four (4) perceived, regulatory deficiencies that purportedly caused the recent financial crisis: (1) regulators imposed insufficient capital and liquidity requirements (off-balance sheet and trading assets); (2) regulators did not take into account the harm that the failure of a large, complex financial institution could have on the economy; (3) supervisory authority of large firms was granted among many agencies and amongst a number of bank charter types, causing industry fragmentation and uncoordinated oversight between the regulators; and, (4) insufficient or no specific oversight of significant non-bank financial enterprises such as investment banks, money market funds, hedge funds, lenders, mortgage originators, and other private pools of capital. It is this fourth regulatory deficiency that meets the mortgage industry directly and unequivocally through the creation of the CFPA.[4]

A New Framework

The fourth aspect of the Plan, indicated above, centers on building a consumer protection agency to oversee the kinds of financial products heretofore outside of the purview of banking regulations. Such products as non-traditional and subprime mortgages, it is alleged, were often unsuited for consumers’ needs. Banks and thrifts offered these products, leading to widespread abuse. The Plan, in effect, asserts that the mission of federal and state bank regulators to promote safety and soundness potentially conflicts with consumer protection goals. Thus, the remedy proposed is a new framework, consisting of regulatory, legislative, and administrative reforms. Its goal will be to “reduce gaps in federal supervision and enforcement; improve coordination with the states; set higher standards for financial intermediaries; and promote consistent regulation of similar products.”[5] This single, regulatory agency, to be known as the Consumer Financial Protection Agency, will be a federal consumer advocacy agency, focused on consumer protection with respect to financial products and services. By becoming the primary federal financial consumer protection supervisor, the new agency is expected to provide accountability. The Plan seeks for the agency broad authorities to enable the fulfillment of its mission, such as by expanding jurisdictions and implementing new regulatory guidelines to eliminate abuse, extending even to providing new authorities to the Federal Trade Commission (FTC) and the Securities and Exchange Commission (SEC).

The CFPA Structure

The Plan’s recommendations to implement the CFPA are premised on granting “consolidated authority over the closely related functions of writing rules, supervising and examining institutions’ compliance, and administratively enforcing violations,” with the goal being to “reduce gaps in federal supervision; improve coordination among the states; set higher standards for financial intermediaries; and promote consistent regulation of similar products.” [6]

There are eleven (11) features of the Plan, which can be summarized in the following table.[7]

Proposal	Purpose	Authorities and Benefits
1) A single primary federal consumer protection supervisor to protect consumers of credit, savings, payment, and other consumer financial products and services, and to regulate providers of such products and services.	Better promote accountability and help prevent regulatory arbitrage. Federally supervised institution no longer able to choose its supervisor based on any consideration of real or perceived differences in agencies’ approaches to consumer protection supervision and enforcement.	Supervisory, examination, and enforcement authority. Should have the ability to act comprehensively to address emerging consumer protection concerns.
2) Broad jurisdiction to protect consumers in consumer financial products and services such as credit, savings, and payment products.	Consumers have the information they need to make responsible financial decisions, and be protected from abuse, unfairness, deception, or discrimination. Markets operate fairly and efficiently with room for sustainable growth and innovation, and traditionally underserved consumers have access to lending, investment and financial services.	Jurisdiction covers consumer financial services and products (i.e., credit, savings, and payment products) as well as institutions that issue, provide, or service these products and provide services to the entities providing the financial products.
3) An independent agency with stable and robust funding.	Director and a Board, with the Board representing a diverse set of viewpoints and experiences. At least one seat on the Board reserved for the head of a prudential regulator.[8] A stable funding stream could come in part from fees assessed on entities and transactions.	Appointments and compensation of officers and professional, financial, and technical staff on terms commensurate with those currently used by other independent financial regulatory agencies.
4) Sole rulemaking authority for consumer financial protection statutes, as well as the ability to fill gaps through rule-making.	Sole authority extends to promulgating and interpreting regulations under existing consumer financial services and fair lending statutes (i.e., Truth in Lending Act (TILA), Home Ownership and Equity Protection Act (HOEPA), Real Estate Settlement and Procedures Act (RESPA), Community Reinvestment Act (CRA), Equal Credit Opportunity Act (ECOA), and Home Mortgage Disclosure Act (HMDA), and the Fair Debt Collection Practices Act (FDCPA).	Rulemaking authority under any future consumer protection laws addressing the consumer credit, savings, collection, or payment markets. Broad authority to adopt tailored protections – such as disclosures or restrictions on contract terms or sales practices – against unfairness, abuse, or deception, subject to the notice and comment procedures of the Administrative Procedure Act.
5) Supervisory and enforcement authority and jurisdiction over all persons covered by the statutes that it implements, including both insured depositories and the range of other firms not previously subject to comprehensive federal supervision. Work with the Department of Justice to enforce the statutes under its jurisdiction in federal court.	- Supervisory, examination, and enforcement authority over all entities subject to its regulations, including regulations implementing consumer protection, fair lending, and community reinvestment laws (i.e., Community Reinvestment Act (CRA)), as well as entities subject to selected statutes for which existing rule-writing authority does not exist or is limited (i.e., Fair Housing Act to the extent it covers mortgages, the Credit Repair Organization Act, the Fair Debt Collection Practices Act, and provisions of the Fair Credit Reporting Act). - Promote compliance by publishing supervisory guidance indicating how it intends to administer the laws it implements. - Able to use other tools to promote compliance, such as publishing best and worst practices based on surveys, mystery shopping, and information collected from supervision and investigations.	- Assumes all responsibilities from the federal prudential regulators for supervising banking institutions for compliance with consumer regulations (federal or state chartered). Jurisdiction extends to bank affiliates that are not currently supervised by a federal regulator.[9] - Interaction between itself and all prudential regulators of major matters and share confidential examination reports with them, with action taken by the CFPA or regulators. - Supervisory and enforcement authority over nonbanking institutions, including enforcement powers (with subpoena authority), over nonbanking institutions within its jurisdiction. - Able to request that the U.S. Attorney General bring any action necessary to enforce its subpoena authority or to bring any other enforcement action on its behalf in the appropriate court.
6) Regulatory Reviews: - Pursue measures to promote effective regulation, including conducting periodic reviews of regulations, an outside advisory council, and in coordination with the Council.[10] - Establish an outside advisory panel, akin to the Federal Reserve’s Consumer Advisory Council, to promote the CFPA’s accountability and provide useful information on emerging industry practices.	Required to complete a regulatory study of each newly enacted and existing regulation at least every three (3) years after the effective date, to assess the effectiveness of enacted regulation, and allowing public comment on recommendations for expanding, modifying, or eliminating a regulation.	Interact with other agencies through the Council to promote consistent treatment of similar products and to assure no product goes unregulated merely because of uncertainty over jurisdiction. Through the Council, coordinate efforts with the SEC, the CFTC, and other state and federal regulators to promote consistent, gap-free coverage of consumer and investor products and services. Agencies required to report their work to Congress.
7) Strong rules promulgated to serve as a floor, not a ceiling. States have the ability to adopt and enforce stricter laws.	Federally chartered institutions to be subject to nondiscriminatory state consumer protection and civil rights laws to the same extent as other financial institutions. States to be able to enforce these laws, as well as regulations of the CFPA, with respect to federally chartered institutions, subject to appropriate arrangements with prudential supervisors.	States to have concurrent authority enforce regulations of the CFPA. CFPA promulgated federal rules under a pre-existing statute or its own organic rulemaking authority should override weaker state laws, but states should be free to adopt stricter laws. With respect to state banks supervised by a federal prudential regulator, the CFPA to be the primary consumer compliance supervisor at the federal level.
8) Coordination of enforcement efforts with the states.	Maintain consistency among fifty states’ supervisory and enforcement efforts. The CFPA assumes responsibility for federal efforts to help the states unify and strengthen standards for registering and improving the quality of providers and intermediaries.	Authorized to establish or facilitate registration and licensing regimes for other financial service providers and intermediaries (i.e., debt collectors, debt counselors or mortgage modification companies). The CFPA and state enforcement agencies to use registration systems to help weed out bad actors.
9) A wide variety of tools to enable it to perform its functions effectively: Research and Data Complaints Financial Education Community Affairs	- Research and Data: Information used to improve regulations, promote compliance, and encourage community development. - Complaints: Responsible for collecting and tracking complaints about consumer financial services and facilitating complaint resolution with respect to federally-supervised institutions. States retain primary responsibility for tracking and facilitating resolution of complaints against other institutions. - Financial Education: Streamline existing financial literacy, educate consumers about financial matters, improve their ability to manage their own financial affairs, and make their own judgments about the appropriateness of certain financial products. - Community Affairs: Promote community development investment, fair and impartial access to credit.	Engage in a wide variety of activities to help financial institutions, community-based organizations, government entities, and the public understand and address financial services issues that affect low and middle-income people across various geographic regions.
10) Improve incentives for compliance by restricting or banning mandatory arbitration clauses.	Gather information and study mandatory arbitration clauses in consumer financial services and products contracts to determine to what extent, and in what contexts, they promote fair adjudication and effective redress. If CFPA determines that mandatory arbitration fails to achieve these goals, establish conditions for fair arbitration, or, if necessary, ban mandatory arbitration clauses in particular contexts, such as mortgage loans.	Authority to restrict or ban mandatory arbitration clauses, since consumers often waive their rights to trial when signing form contracts in taking out a loan, and that a private party dependent on large firms for their business will decide the case without offering the right to appeal or a public review of decisions.
11) The Federal Trade Commission (FTC) given better tools to protect consumers.	FTC retains authority for dealing with fraud and sale of services like advance fee loans, credit repair, debt negotiation, and foreclosure rescue/loan modification fraud.	CFPA authority is in coordination with FTC, with FTC remaining the lead federal consumer protection agency on matters of data security. Front-end privacy protection on financial issues moved to the CFPA.[11]

Disclosures

The Plan suggests a “proactive” approach to consumer disclosures, with an emphasis on transparency, consisting of three (3) dimensions:

1) Make mandatory disclosure forms clear, simple, and concise, and test them regularly.

2) Require that disclosures and other communications with consumers be reasonable.

3) Use technology to make disclosures dynamic and relevant to the individual consumer.

The CFPA would be authorized to require that all disclosures and other communications with consumers be reasonable, balanced in their presentation of benefits and clear and conspicuous in their identification of costs, penalties and risks. Consequently, the Plan calls for all mandatory disclosure forms to be clear, simple and concise. (The CFPA would determine which risks and costs should be highlighted.) The Plan also recommends that the CFPA establish standards and procedures for testing disclosures (including immunity from liability) for providers of consumer financial products and services. A reasonable communication would balance the presentation of risks and benefits and have a clear and conspicuous description of significant product costs and risks. This standard would apply to communications with customers, marketing materials, and all mandatory disclosures.

The CFPA would be authorized to implement a process under which a provider, “acting reasonably and in good faith,” could obtain the equivalent of a “no-action” letter for disclosures and other communications for new products. (For example, the CFPA could adopt a procedure under which a provider petitions the CFPA for a determination that its product’s risks were adequately disclosed by the mandatory model disclosure or marketing materials. The CFPA could approve use of the mandatory model or marketing materials, or provide a waiver, admissible in court to defend against a claim, for varying the model disclosure.) Violations would be subject only to administrative action, rather than civil liability.

Finally, the Plan recommends utilizing technology to improve disclosures, such as requiring Internet (on-line) calculators to compare the overall cost of a mortgage. The CFPA is expected also to promote adoption of innovations in point-of-sale technology (i.e., allowing consumers who use a credit card to choose a payment plan for the purchase).

Simplicity

The Proposal recommends that the CFPA be authorized to define standards for “plain vanilla” products, such as “standardized” fixed term mortgages without prepayment penalties, and require financial institutions to offer such “plain vanilla” products alongside the institution’s other products. Such standards are to be “simpler and have straightforward pricing,” and these products are to be disclosed “prominently, alongside whatever other lawful products” a provider chooses to offer.

Higher Cost Loans

The CFPA would assume responsibility for the Federal Reserve Board regulations that impose extra protections and higher penalties on alternative or higher cost loans. For instance, the CFPA could be authorized to add other mortgage types to the class of products that receive additional scrutiny, leaving only products which meet the “plain vanilla” standards in the less scrutinized class. And the CFPA would be empowered to impose a strong warning label on alternative products, require applicants to fill out a financial experience questionnaire, or mandate that providers obtain a written opt-out to “plain vanilla” products.

A New Fairness Doctrine

The CFPA would have the authority to regulate unfair and deceptive acts or practices for all credit, savings, and payment products. The Proposal also calls for the CFPA to have the authority to address overly complex financial contracts.

Perhaps this should be called the New Fairness Doctrine. It consists of the following three (3) authorities, in which the CFPA is authorized to:

1) Regulate unfair, deceptive, or abusive acts or practices.

2) Impose empirically justified and appropriately tailored duties of care on financial intermediaries.

3) Apply consistent regulation to similar products.

The CFPA could ban certain practices, such as prepayment penalties, for certain types of contracts or payments to mortgage originators, including Yield Spread Premiums, if disclosures were found to be an inadequate protection. The CFPA could also adopt a “life of loan” approach to mandate consumer protections through the servicing and loss mitigation stages of the loan. Indeed, the Plan even suggests that the CFPA could consider requiring mortgage originators to receive a portion of their compensation over time, contingent on loan performance, rather than in a lump sum at the time of origination.

There are recommendations in the Plan to grant the CFPA the authority to impose “duties of care” on financial intermediaries (i.e., a duty of ‘best execution’ on mortgage brokers with respect to available mortgage loan types and pricing). The Proposal also calls for the CFPA to apply consistent regulation to similar products, taking into consideration “consumer perceptions” of such products.

Community Reinvestment Act (CRA) and Access

As described in the above-outlined table, a key feature of the CFPA would be the administration of the CRA, and the Plan recommends that the CFPA should have sole authority to evaluate financial institutions for CRA compliance. This is in keeping with the claim that a critical part of the CFPA’s mission is to promote access to financial services, especially households and communities that traditionally have had limited access.

The CFPA, therefore, would now determine if a financial institution had a record of meeting the lending, investment, and services needs of its community under the CRA, and in connection with the approval of a merger application by the institution’s prudential supervisor. Additionally, the Plan calls for the CFPA to maintain a fair lending unit with attorneys, compliance specialists, economists, and statisticians; and, importantly, it is to have primary fair lending jurisdiction over federally supervised institutions, and concurrent authority with the states over other institutions. To promote fair lending, the CFPA would have the authority to collect data on mortgage and small business lending, including expanding the required data to be reported under HMDA. Critical new fields would be added to HMDA data, such as a universal loan identifier that permits tying HMDA data to property databases and proprietary loan performance databases, or a flag for loans originated by mortgage brokers, or information about the type of interest rate (i.e., fixed vs. variable).

Reinforcing Consumer Protection

By creating the CFPA, the Administration hopes to bring new means to bear on consumer protection, allowing it broad authority to implement its initiatives through various enforcement mechanisms. There are five (5) principles that guide its formation: transparency, simplicity, fairness, accountability, and access.[12] To accomplish these principles, consumer protection mandates will be transferred to the CFPA from the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Board of Governors of the Federal Reserve System (FRB), Office of Thrift Supervision (OTS), Federal Trade Commission (FTC), and the National Credit Union Administration (NCUA). The regulations impacted by the CFPA’s new authorities will include the Equal Credit Opportunity Act (ECOA), Fair Credit Reporting Act (FCRA) (except sections 615(e), 624, and 628), Alternative Mortgage Transaction Parity Act (AMTPA), Electronic Funds Transfer Act (EFTA), Fair Debt Collection Practices Act (FDCPA), Federal Deposit Insurance Act (FDIA) (subsections 43(c) through (f)), the Gramm-Leach-Bliley Act (GLBA) (sections 502 through 509), Home Mortgage Disclosure Act (HMDA), Community Reinvestment Act (CRA), Real Estate Settlement Procedures Act (RESPA), Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act), Truth in Lending Act (TILA), and the Truth in Savings Act (TISA). Given such broad and sweeping responsibilities and authorities, the new Consumer Financial Protection Agency will bring about new modalities of regulatory guidance and enforcement methodologies, fundamentally altering the financial products and services industries.

---

[1] Consumer Financial Protection Agency Act of 2009, House Bill 3126

[2] U.S. Department of Treasury, June 17, 2009, TG-175: President Obama to Announce Comprehensive Plan for Regulatory Reform.

[3] Examples of substantial revisions, to name but two, include altering or eliminating the so-called “functional regulation” regime of the Gramm-Leach-Bliley Act (1999) and the interstate branching approval process of the Riegle-Neal Interstate Banking and Branching Efficiency Act (1994).

[4] The discussion provided herein is based on a review of the Financial Regulatory Reform – A New Foundation: Rebuilding Financial Supervision and Regulation, issued by the U.S. Department of Treasury on June 17, 2009, and updated on August 11, 2009.

[5] Ibid. Pg. 55

[6] Ibid. Pg. 56

[7] Ibid. Pp. 57-63

[8] Prudential regulation is regulation of deposit-taking institutions and supervision of the conduct of these institutions and set-down requirements that limit their risk-taking. The aim of prudential regulation is to ensure the safety of depositors' funds and keep the stability of the financial system.

[9]In a departure from the current framework of federal bank charter preemption of state laws, the Plan recommends that federally-chartered institutions be subject to nondiscriminatory state consumer protection and civil rights laws to the same extent as other financial institutions. States would have the ability to enforce these state laws against federally-chartered institutions as well as state-chartered institutions and the ability to enforce the regulations of the CFPA against federally-chartered institutions.

[10] To address the need for coordinated agency oversight and identification of emerging risks, the Plan would create a Financial Services Oversight Council (Council). The Secretary of Treasury would serve as the Council’s Chairman, and membership would include representatives of a many agencies, including the SEC, the Commodity Futures Trading Commission (CFTC), the Federal Housing Finance Agency (FHFA), and the new federal banking and consumer protection agencies proposed in the Plan itself.

[11] It is asserted that the FTC has a clear mission to protect consumers but generally lacks jurisdiction over the banking sector and has limited tools and resources to promote robust compliance of nonbank institutions. To quote the Plan itself, “mortgage companies not owned by banks fall into a regulatory ‘no man’s land’ where no regulator exercises leadership and state attorneys general are left to try to fill the gap.” Op. Cit. Note 3, Pg. 56.

[12] Strengthening Consumer Protection, a synopsis of the five principles, is available on the FinancialStability.gov website. It is one of several Additional Resources to the Plan.

Service Release Premium versus Yield Spread Premium: Match or Mismatch?

by Jonathan Foxx

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is the President and Managing Director of Lenders Compliance Group.

Published in the August Edition of National Mortgage Professional Magazine.

What’s in a Name?

Juliet says, in Shakespeare’s “Romeo and Juliet:”

“What’s in a name? That which we call a rose
By any other name would smell as sweet.”[1]

Is a name just a contrived and meaningless convention?

Is the undisclosed income paid to a bank when it sells an above par residential mortgage loan into the secondary market elementally distinguishable from the disclosed income paid to a mortgage broker when it sells an above par loan to a bank? The former, known as the Service Release Premium (SRP), and the latter, known as the Yield Spread Premium (YSP), seem to share similar functionality, but may soon have quite different fates. The YSP will virtually cease to exist if the Mortgage Reform and Anti-Predatory Lending Act, passed by the House of Representatives on May 7, 2009, and sent to the Senate, is eventually signed by President Obama into law. [2]

But the SRP will live on and on, with no regulatory change affecting its use. Call each one what you will “by any other name,” though characteristically the same, the destinies of the SRP and the YSP diverge right at the point where an entire class of loan originators, the mortgage brokers, will be effectively trounced by another class of loan originators, the banks! Rarely has the power of the banking lobby been more apparent in its quest to eliminate competition.

Match or mismatch?

Bicameral Rivalry

In addition to the House’s foray into attacking the YSP, while still surely preserving the SRP, there is yet another shark in these controversial waters!

Seemingly not to be outdone by the machinations of Barney Frank’s (D-MA) House Financial Services Committee, which was the architect of the afore-mentioned legislation,[3] two new Senate bills were introduced by Oregon Senator Jeff Merkley (D-OR). Each of these two new Senate bills, if made into law, would adversely affect the mortgage brokerage community. The first is slyly called the Promoting Mortgage Responsibility Act,[4] which prohibits prepayment penalties,[5] and the second is ironically called Transparency for Homeowners Act of 2009,[6] which specifically prohibits Yield Spread Premiums, but does not prohibit or give transparency whatsoever to the Service Release Premium. The word “transparency” has been bandied about quite a bit recently by certain politicians, but Senator Merkley’s understanding of transparency clearly does not extend to requiring the disclosure of the Service Release Premium.[7] As Alice cried, this is becoming “Curiouser and curiouser!”[8]

The YSP has been villanized and compared to a “kickback.” As recently as April of this year, a New York Times editorial ominously declared that the “first step must be to outlaw the kickbacks” and “the most clearly unethical form of payment is the so-called yield-spread premium.”[9] The SRP was not mentioned even once in this editorial. The typical opinion of the political and media castes is that the YSP is anathema. In previous articles, we argued that the YSP is not a kickback under existing law[10] and can be saved so that it will continue to provide important benefits to the consumer.[11] Why destroy the YSP and keep the SRP, when there is not a single factor representative of YSP abuse that cannot also be representative of SRP abuse? Let’s look just a bit closer at these parallels.

“You say either and I say eyether, You say neither and I say nyther;
Either, eyether, neether, nyther, Let's call the whole thing off!”[12]

“Either, eyether, neether, nyther,” however the mortgage brokers and banks may choose to agree or disagree about the roles played by two succinctly similar premiums, it is readily apparent that one of them is surely not accessible to the consumer’s purview. Maybe it’s time to consider making both the YSP and the SRP available to the public, create full transparency, and give control to the borrower with respect to their application.

The YSP has been criticized because it can lead to price discrimination, thus not necessarily offering the borrower a savings and, therefore, can be used to increase the cost. Certainly, it has been statistically demonstrated that total loan costs are elevated in loans containing YSPs, discount points, and seller contributions to closing costs.[13] The U. S. Department of Housing and Urban Development (HUD) has given extensive guidance in determining the proper application of the YSP.[14] Furthermore, those who want the YSP permanently eliminated from residential mortgage loan originations argue that the YSP (1) can be used to charge borrowers more, (2) do not always provide a dollar for dollar financing offset, and (3) may represent compensation in excess of goods and services. But each one of the above-mentioned abuses can certainly occur in using the SRP. One exception does pertain to the YSP: the borrower is given information about the YSP on the Good Faith Estimate (GFE) and the HUD-1 Settlement Statement,[15] but otherwise denied any and all information about the SRP on any loan application document or disclosure![16]

Note, however, that charging a higher YSP without providing a financing offset is prima facie violative of the Real Estate Settlement Procedures Act (RESPA);[17] and, in any event, not providing a dollar for dollar financing offset[18] and excessively charging for goods and services are violations of HUD’s long-standing policies as well as its well-known “Two-Part Test.”[19]

Although HUD has given clear guidance on the proper application of the YSP, it has provided virtually no similar guidance to banks regarding the SRP. There’s a reason for this: RESPA does not actually govern a bank’s use of the SRP. To be sure, being exempt from RESPA, this is not a statute that a bank must comply with; though, of course, every mortgage broker must adhere to RESPA’s requirements. HUD, therefore, even in its administrative oversight of RESPA, takes no position on the SRP’s use by banks!

So, let’s compare the fully disclosed YSP with the fully undisclosed SRP.

Comparative Analysis

Potential for Abuse	YSP	SRP
Price Discrimination	Measurable	Not Measureable
Excessive Charges	Measurable	Not Measureable
No Dollar for Dollar Financing	Measurable	Not Measureable
Overpaying for goods, services, facilities	Measurable	Not Measureable

There is a potential for either the YSP or the SRP to be applied in an abusive manner. I have suggested elsewhere that the abuse of the YSP can be largely curtailed by crediting it to the borrower, thereby permitting the borrower to choose how it is to be used in accordance with the borrower’s own interests.[20] Once borrowers agree to how the YSP will be used and on what terms, market forces will take over. But, the borrower has no idea what the value of the SRP is, because it is an entirely undisclosed premium and, therefore, a consumer cannot hope to control how or if it is to be applied. Indeed, a bank provides no information for the consumer to determine whether the SRP complies with fair lending laws, avoids excessive charges, offers dollar for dollar financing opportunities, or avoids overpayment for goods, services, and facilities. Those important aspects of consumer protection are relegated to the transparent domain of the YSP.[21] The SRP’s lack of transparency masks from public scrutiny each one of these criteria.

"If you don't know where you are going, you will wind up somewhere else."

– Yogi Berra

The borrower is ultimately paying both the YSP and the SRP, so why not disclose each of them and let the consumer determine how they are to be used? Without properly regulating the SRP, a bank can use it to increase its profit, though providing no incremental benefit to the borrower. The above-mentioned House legislation and the two new Senate bills are clearly based on the premise that the YSP disadvantages borrowers, whereas the SRP does not. Or, at least, that is the most generous conclusion to be reached. Given the strength of the banking lobby, other conclusions can be easily conceived.

Doing away with the fully disclosed YSP, but keeping intact the undisclosed SRP obviously gives an advantage to banks and, presuming the passage of the aforesaid legislation, the continuation of the SRP as a de facto mark-up tool further emboldens and strengthens banks – but certainly weakens mortgage brokers. And such an outcome will also weaken the public’s ability to use the benefits which the YSP offers, such as providing a dollar for dollar financing offset by legitimately reducing the up-front cash requirements to borrowers.[22]

The borrower has heretofore benefited from the YSP, when properly applied. Eliminating it, but retaining the SRP, does not end the potential for abuse, but actually magnifies it by exposing consumers to potentially adverse effects, due to the SRP being undisclosed. It is generally axiomatic that lack of disclosure often leads to abusive practices. By fully disclosing both the YSP and the SRP to borrowers, greater control over pricing and services will be vetted by market forces and create a truly competitive environment. Borrowers should receive a credit for each premium and allocate it according to their own interests. This will bring about a reliable standard and eliminate unfair competition between banks and mortgage brokers. The public would benefit with full disclosure of both the Yield Spread Premium and the Service Release Premium, and the mortgage industry’s regulators, in their role as consumer advocates, will be better able to adopt and enforce new means to effectuate appropriate oversight.

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[1] Romeo and Juliet (II, ii, 1-2), William Shakespeare

[2] H. R. 1728: “ Mortgage Reform and Anti-Predatory Lending Act”

[3] There’s probably no connection between Congressman Frank’s position on this legislation and the fact that one of the largest sectors donating to his campaign committee is the banking industry. See: OpenSecrets.org’s composite, compiled from the 2009-2010 election cycle and based on Federal Election Commission data available electronically on July 03, 2009.

[4] Senate 911, April 28, 2009, 111^th Congress

[5] Very few residential loan products these days contain prepayment penalties, having almost entirely ceased to exist due to their abuse in subprime loan originations. Legislating to abolish a practice that is already abandoned seems somewhat frivolous and unavailing.

[6] Senate 912, April 28, 2009, 111^th Congress

[7] There’s probably no connection between Senator Merkley’s legislation and the fact that the largest sectors donating to his campaign PAC have been Finance, Insurance, and Real Estate. See: OpenSecrets.org’s composite, based on Federal Election Commission data available electronically on Monday, June 29, 2009.

[8] Carroll, Lewis, Alice's Adventures in Wonderland and Through the Looking-Glass, Chapter 2, Grosset & Dunlap, 1946

[9] Editorial Opinion, The New York Times, 4/10/09, p. A22, New York Edition

[10] “Yield Spread Premiums: Compensation or Kickback?”, Jonathan Foxx, National Mortgage Professional Magazine, June 2009, Volume 1, Issue 2, pp 18-20

[11] “Saving the Yield Spread Premium”, Jonathan Foxx, National Mortgage Professional Magazine, July 2009, Volume 1, Issue 3

[12] From “Let’s call the Whole Thing Off”, 1937, a song by George and Ira Gershwin, written for the film “Shall We Dance”

[13] Research Works, Volume 5, Number 8, September 2008, p. 1

[14] See 24 CFR Part 3500 (RESPA): Statement of Policy 1999-1, U.S. Department of HUD, 2/22/99, and Statement of Policy 2001- 1, U.S. Department of HUD, 10/18/2001

[15] Indeed, the new Good Faith Estimate and HUD-1Settlement Statement, required to be implemented beginning January 1, 2010, contain no information about the SRP.

[16] The new GFE contains the following statement on the bottom of page 3: “Some lenders may sell your loans after settlement. Any fees lenders receive in the future cannot change the loan you receive or the charges you paid at settlement.” The Mortgage Bankers Association has asserted that this may be a “rationale” for not disclosing the SRP. See: Preliminary Information on HUD’s Forthcoming RESPA Rule, 11/12/08, “Good Faith Estimate”

[17] 24 CFR 3500, Real Estate Settlement Procedures Act

[18] “Yield spread premiums permit homebuyers to pay some or all of the up front settlement costs over the life of the mortgage through a higher interest rate. Because the mortgage carries a higher interest rate, the lender is able to sell it to an investor at a higher price. In turn, the lender pays the broker an amount reflective of this price difference. The payment allows the broker to recoup the up front costs incurred on the borrower’s behalf in originating the loan. Payments from lenders to brokers based on the rates of borrowers’ loans are characterized as “indirect” fees and are referred to as yield spread premiums.” See: 24 CFR Part 3500 (RESPA), Statement of Policy 2001-1, Part A, U.S. Department of HUD, 10/18/01

[19] HUD offered a “Two-Part Test,” in its Statement of Policy 1999-1, to determine if a loan origination is RESPA compliant: (1) whether services were actually furnished and actually performed for the compensation paid, and (2) whether the compensation payments are reasonably related to the value of the services actually furnished and performed. See: 24 CFR Part 3500 (RESPA), Statement of Policy 1999-1, U.S. Department of HUD, 2/22/99

[20] Foxx, op.cit., Note 11.

[21] In fact, all fees and payments received by a mortgage broker from a lender and a borrower – including YSPs and even SRPs – must be recorded on the GFE and listed in the 800 series on the HUD-1 Settlement Statement. See: 24 CFR Part 3500 (RESPA), Appendix B to Part 3500 (13) Commentary. Mortgage Bankers are not required to disclose the SRP.

[22] 24 CFR Part 3500 (RESPA) Statement of Policy 2001-1, Section I.A

Saving the Yield Spread Premium

By Jonathan Foxx
President and Managing Director

Published in the July Edition of National Mortgage Professional Magazine.

The ancient Roman god, Janus, was two-faced – his back-to-back visages looking at the past and into the future – a symbolic representation of ineluctable transitions through the passage of time, a reminder of essential change from one condition to another, whether for better or worse. Like it or not, the Yield Spread Premium (YSP) will be going through its own transition soon, and, depending on the politics – and not necessarily the facts – the essential change will be enduring and irreversible.

If the YSP is believed to be a legitimate financing tool, and proves to be a useful means in the service of borrowers, it may yet survive; if not, its demise is on the way. At this time, it is in danger of becoming extinct! The House recently passed the Mortgage Reform and Anti-Predatory Lending Act,[1] which will amend the Truth in Lending Act, and it has gone to the Senate.[2] Its provisions directly affect the fate of the YSP. If it passes on to the White House in its current form and President Obama signs it, this legislation will become law.

A key provision is the virtual removal of Yield Spread Premiums![3]

Prior to the enactment of the Real Estate Settlement Procedures Act (RESPA) in 1974, the US Department of Housing and Urban Development (HUD) and the Veterans Administration issued a report asserting, amongst other things, that “settlement charges often are based on factors unrelated to the cost of providing the services,” and advocated regulating settlement costs. This position was an underlying feature of the debate, beginning in 1972, which led up to the formation of RESPA.[4] Congress decided that RESPA should not implement price controls, such as setting maximum allowable costs, believing instead that proper disclosure and prohibiting certain practices were sufficient to avoid abuse. HUD has maintained that RESPA is not intended to be a rate-making statute. And it has indicated in various policy issuances that the YSP is not per se legal or illegal. Yet in the near future the YSP – a component of total compensation, and a means whereby a borrower, if properly empowered, could actually determine its use – will be heading to the dustbin of history.

This controversy can be considered by briefly exploring certain evaluative criteria.

Broadly, the following areas constitute the core of the debate:

• Can the YSP cause price discrimination?
• Can borrowers be charged more because of the YSP?
• Can the YSP provide a dollar for dollar financing offset?
• Does the YSP cover the cost of goods and services?

Let us briefly consider each of these questions. Afterward, a suggestion will be offered that, if implemented, would strongly empower the borrower, fortify the lender and broker relationship, preserve continuity and potency of market forces, and save the YSP.

Price Discrimination

Can the YSP cause price discrimination?

There is some evidence that less sophisticated borrowers and borrowers with certain racial profiles have paid higher loan costs. According to HUD’s Office of Policy Development and Research, “price discrimination has been known to occur,” whereby “loan fees are highly correlated to race and education characteristics, with African-American and Latino borrowers paying an average of $415 and $365 more, respectively, than other borrowers.”[5]

HUD’s recent, final version of Regulation X revisions,[6] designed to create a more level playing field, were in part a response to a regulatory impact analysis – required by the Regulatory Flexibility Act – that stated “there is strong evidence of information asymmetry between mortgage originators and settlement service providers and consumers, allowing loan originators to capture much of the consumer surplus in this market through price discrimination.”[7] Total loan costs are elevated in loans containing YSPs, discount points, and seller contributions to closing costs. The YSP may not necessarily offer the borrower a savings, though it can be used to increase the cost. “Research shows that borrowers saved only $20 in upfront cash for each $100 paid in YSP. Mortgage-brokered loans benefited the least, saving only $7 per $100 in YSP.”[8] Higher fees, lower savings, meaning increased costs to borrowers, can lead directly to price discrimination.

Higher Costs

Can borrowers be charged more because of the YSP?

Mortgage brokers can obviously increase their compensation by selecting for the lender that offers a higher YSP for a loan, though another lender may offer a loan with similar features, but at a lower YSP. It does not matter that the compensation is paid indirectly (i.e., YSP paid by lender), the consumer is ultimately paying for it. If such increased compensation is not used as a financing offset, the mortgage broker could be incentivized to choose the higher YSP, without having to provide any additional financing, products, or services to the borrower. This is a prima facie violation of RESPA,[9] because a borrower’s up-front cash requirements are not lowered, yet the mortgage broker’s compensation is increased in excess of what is reasonably related to the total value of the origination services provided by the broker.[10]

Offset Financing

Can the YSP provide a dollar for dollar financing offset?

HUD has consistently taken the position that the YSP can play a significant role in offsetting financing costs.[11] In its Statement of Policy 2001-1, HUD stated that “a yield spread premium can be a useful means to pay some or all of a borrower’s settlement costs. In these cases, lender payments reduce the up-front cash requirements to borrowers. In some cases, borrowers are able to obtain loans without paying any up-front cash for the services required in connection with the origination of the loan. Instead, the fees for these services are financed through a higher interest rate on the loan. The yield spread premium thus can be a legitimate tool to assist the borrower”[12] (Emphasis added.) Indeed, HUD believes this use of the YSP “fosters homeownership.”[13] Analogous to the case of the YSP having the potential to cause a higher cost loan, if the YSP is only used to increase the borrower’s interest rate as well as the broker’s overall compensation, but does nothing to lower up-front cash requirements for the borrower, this use of the YSP would not be a bona fide source of financing and certainly violates RESPA.[14]

Goods and Services

Does the YSP cover the cost of goods and services?

This is an area that has been litigated extensively and, even to this day, the outcome is uncertain.

The legal landscape has stretched far and wide, in various jurisdictions, from initially maintaining that the YSP is a referral prohibited by RESPA’s Section 8,[15] to the YSP being a form of compensation and not a violation of RESPA;[16] from the YSP being a permissible payment for goods (i.e., loans with YSPs),[17] to a reversal of that position, holding that the YSP was potentially a prohibited referral fee under Sections 8(a) and 8(c) of RESPA.[18] In that latter ruling, a case decided by the Court of Appeals for the Eleventh Circuit, in Culpepper v. Inland Mortgage Corp (“Culpepper”), the Court offered a two-pronged test to determine if the YSP was compliant with RESPA: (1) Are goods or services provided in exchange for the yield spread premium?, and, (2) Was the YSP a payment in exchange for those goods or services. First, the Court decided that the YSP was not a payment for the good itself (i.e., the “good” being the loans with YSPs, table-funded), because the lender, not the broker, actually owned the loan already. Second, the Court decided that the YSP was not a payment for the good itself, asserting that direct payments to the broker is the allowable compensation, and, in any event, given that the YSP is calculated on the basis of the loan’s interest rate, where there is no ostensible difference between a loan with a YSP and a loan without a YSP, the YSP had to be a prohibited referral fee.

HUD then weighed in, offering its Statement of Policy 1999-1, and in so doing offered its own Two-Part Test. Essentially, HUD’s position was (and still is) that a mortgage broker’s total compensation is RESPA-compliant (1) if “goods or facilities were actually performed for the compensation paid,” and (2) if the “payments are reasonably related to the value of the goods or facilities that were actually furnished or services that were actually performed.”[19] HUD provided a list of compensable services which, although it is not (and was not meant to be) exhaustive, clearly identifies numerous services that mortgage brokers render in return for direct and/or indirect compensation from the borrower. Importantly, HUD identified certain goods provided by a mortgage broker, but it made clear that the loan (i.e., a loan with YSP, table-funded) was not itself a “good.” Explicitly, HUD stated that, “while a broker may be compensated for goods or facilities actually furnished or services actually performed, the loan itself, which is arranged by the mortgage broker, cannot be regarded as a ‘good’ that the broker may sell to the lender and that the lender may pay for based upon the loan's yield's relation to market value, reasonable or otherwise.”[20] Even though HUD had answered key questions, many Courts still vacillate in their interpretations.

Indeed, litigation continued, bringing about an additional response from HUD. Its 2001-1 Statement of Policy [21] was issued, in part, to clarify HUD’s position on YSPs, due to a decision of the Court of Appeals for the Eleventh Circuit, in Culpepper v. Irwin Mortgage Corp which upheld certification of a class in a case alleging that yield spread premiums violated Section 8 of RESPA.[22] The Court had found that the lender, pursuant to a prior understanding with mortgage brokers, had paid yield spread premiums to the brokers based solely on the brokers’ delivery of above par interest rate loans. Furthermore, the court described HUD’s 1999-1 Statement of Policy as “ambiguous.” At the time, other courts were rendering conflicting decisions. HUD’s response asserted the legality of yield spread premiums, when services are actually rendered for compensation reasonably related to the value of the services and it makes clear the operational effectiveness and purpose of YSPs in increasing home ownership as well as identifying those areas where the YSP may be abused.

But how to determine that the compensation payments are reasonably related to the value of the services actually furnished and performed?

Suggestion

Implicit in each of the criteria given above is the view that the YSP can be abused, though it may serve a legitimate purpose. Many commercial transactions are subject to abuse, if left unregulated. To eliminate the YSP, when it is a useful means and legitimate tool to originating residential mortgage loans, would not only deprive the borrower of its application but also cause a pervasively destructive impact on the mortgage brokerage industry. This is clearly a case that cries out for better regulation.

HUD had recommended regulatory measures in 1997, when it published a proposed rule to give a qualified "safe harbor" for payments to mortgage brokers under RESPA’s Section 8.[23] HUD proposed that there would be no violation of RESPA – and a presumption would be made that broker fees, both direct and indirect, were legal – if a mortgage broker should enter “into a contract with consumers explaining the broker's functions (whether or not it represented the consumer) and the total compensation the broker would receive in the transaction, before the consumer applied for a loan.”[24]

Recent RESPA reform has been an attempt to remediate through increased disclosure. The new Good Faith Estimate (GFE), consisting of three pages, provides a rather thorough outline of the settlement charges. The GFE requires the YSP to be disclosed more comprehensively, requiring a “credit” field to be used to disclose a yield spread premium and a “charge” field to be used for discount points.[25]

However does this go far enough in determining the extent to which the YSP is applied to the loan and, importantly, establish the “reasonableness” of this particular compensation for goods or services actually rendered? After all, HUD’s remedy would simply be to require an enhanced disclosure of the YSP to the borrower. Indeed, the Mortgage Reform and Anti-Predatory Lending Act, mentioned above, will surely add a whole new set of mandatory disclosures to the already huge number of disclosures required by existing law. But the resolution will not be found in more and more disclosures or by allowing the government to interpose itself between the consumer and private enterprise through more disclosure forms and promulgating arbitrary standards.

An important piece is still missing, one that gives the consumer (and, therefore, market forces) the ability to set a fair market standard for compensation payments that are “reasonably related to the value of the services actually furnished and performed.”[26] In the long run, if appropriately implemented, it would also remedy many of the issues involving price discrimination, higher costs, and offset financing, because it would give the borrower control over the use of the YSP.

The missing piece is simply to credit the YSP directly to the borrower. The borrower would then have the choice to use the YSP in accordance with the borrower’s own interests. Once the borrower specifically authorizes how the YSP is to be used, a standard of “reasonableness” would be established. Market forces will respond accordingly, as borrowers agree to the utilization of the YSP. Placing the control of the YSP into the hands of the borrower and letting its use be determined by the borrower will protect the borrower and provide a true “safe harbor.”

Like the Roman god, Janus, we now occupy the middle ground between the past and the future, between how the YSP has been used in the past and how (or even if) it will be used in the future. As events unfold, however, saving the YSP by empowering the borrower to authorize its use may not go far enough! For the Service Release Premium (SRP), the undisclosed income paid to a lender when it sells an above par loan into the secondary market, is in some ways an analogue to the YSP. RESPA does not require a lender to disclose the SRP to the borrower, though it does require a mortgage broker to disclose the YSP. Should the YSP be revised or eliminated without concomitantly changing the application of the SRP? Legislation aimed at changing the YSP, but not the SRP, seems to favor the lender over the mortgage broker. Both the lender and broker serve the consumer! Borrowers will benefit from the proper use of the YSP and the SRP. In future articles, we will explore the role played by the SRP in originating residential mortgage loans, and, importantly, how revising the application of the SRP will benefit consumers, maintain a stable market, and preserve the vitality of all loan originators.

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[1] H.R. 1728

[2] Passed by the House on May 7, 2009; received in the Senate on May 12, 2009

[3] Amending TILA Sec 129B, inter alia, by inserting a new subsection after subsection (b): Sec 103(4)(A) “No provision of this subsection shall be construed as permitting yield spread premiums or other similar incentive compensation.”

[4] Hearing before the Subcommittee on Housing of the House Committee on Banking and Currency (1972), Real Estate Settlement Costs: FHA Mortgage Foreclosures, Housing Abandonment, and Site Selection Policies

[5] Research Works, Volume 5, Number 8, September 2008, pp 1-2

[6] Released: November 12, 2008

[7] FR-5180, Filed: 5/8/09

[8] Research Works, Op. cit., p.1

[9] 24 CFR 3500, Real Estate Settlement Procedures Act

[10] HUD offered a “Two-Part Test,” in its Statement of Policy 1999-1, to determine if a loan origination is RESPA compliant: (1) whether services were actually furnished and actually performed for the compensation paid, and (2) whether the compensation payments are reasonably related to the value of the services actually furnished and performed. See: 24 CFR Part 3500 (RESPA), Statement of Policy 1999-1, US Department of HUD, 2/22/99

[11] 54 FR 38646 (September 20, 1989), final rule in Deregulation of Mortgagor Income Requirements; HUD’s recognition in 1992 that the YSP must be disclosed, codified in “Fact Situations” 5 and 13 in Appendix B to 24 CFR Part 3500; see also, Op. cit. Statement of Policy 1999-1

[12]24 CFR Part 3500 (RESPA) Statement of Policy 2001-1, Section I.A

[13] Ibid.

[14] 24 CFR 3500.14 (g)(1)(iv), permits “a payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed.”

[15] Mentecki v. Saxon Mortgage, Inc., 1997 WL 45088 (E.D. Va. 1997).

[16] Barbosa v. Target Mortgage Corp., 968 F.Supp. 1548 (S.D. Fla. 1997).

[17] Culpepper v. Inland Mortgage Corp., 953 F.Supp. 367 (N.D. Ala. 1997)

[18] Culpepper v. Inland Mortgage Corp., 132 F.3d 692 (11^th Cir. 1998)

[19] HUD Policy Statement, 64 FR 10080, 10084, Op. cit., Note 10

[20] Op. cit., Note 10, Statement of Policy 1999-1, Section II.C

[21] Op. cit., Note 12, Statement of Policy 2001-1

[22] Culpepper v. Irwin Mortgage Corp., 253 F.3d 1324 (11^th Cir. 2001)

[23] Codified at 62 FR 53912

[24] Op. cit., Note 10, Statement of Policy 1999-1, Section F. This qualified “safe harbor” would only be available to those payments that did not exceed a test to preclude “unreasonable fees.” The test was to be established in the rulemaking.

[25] 24 CFR Parts 203 and 3500, FR: Vol. 73, No. 222, pp. 68204-68288 (11/17/08)

[26] Op.cit., Note 10, Statement of Policy 1999-1, “Two-Part Test”

Jonathan Foxx is a former Chief Compliance Officer of two publicly traded financial institutions and the President and Managing Director of Lenders Compliance Group.