*How Do We Deal With The CFPB?*
**By Rick Sharga**
***My son, a high school sophomore, has been an Honors Student since 6th grade. So it was a bit of a concern when recently his Chemistry and Algebra II grades dropped below what the Sharga household views as acceptable. My wife and I spoke with him about this and he assured us that he would work toward bringing his grades up. Considering his good track record, and his diligence in completing his homework and class assignments, we agreed to watch and wait for him to make good on his promise.
****While he likely had the right intentions, his approach wasn’t exactly … promising. As he’d done for the past few years, he completed all of his homework before getting home, so textbooks seldom made an appearance. He passed his time playing games on his X-box, surfing the Internet or watching TV, while assuring us that he was studying during his free period at school. Remarkably, his grades inched up, but unfortunately plateaued at a level that required one of those dreaded “Father and Son” discussions.
****I laid out a pretty compelling argument for him: to get into a decent college, you need good grades; to get a decent job in today’s market, you need to get a degree from a decent college; so unless you want to wind up like your uncle, we need to get those grades up. I’ll leave it to your imagination what “unless you want to wind up like your uncle” means, but suffice it to say that this was enough of a “Scared Straight” moment for my son that he actually asked for help. His way, he admitted, simply wasn’t working.
****So I’ve helped him establish some new guidelines and implemented some new rules. There’s a mandatory study period after school (which includes the use of textbooks), extra study time added to prepare for upcoming tests and quizzes, and a set cut-off time for all electronic devices in the evening. And, if there’s a need for more help, we’ll bring in a tutor, since Chemistry and Algebra II aren’t two subjects I have any desire to re-learn at this stage in my life.
****Our son is actually okay with these guidelines. He knew that he needed help creating a more structured approach to studying, and is happy that the program still gives him time for baseball, volleyball and his electronics. And he’s been assured that if his grades get better, there may be some more latitude in the guidelines as time goes on. We’ll see how this all works out, but for now we’re optimistic.
****“So what,” you may be asking, “does any of this have to do with the mortgage industry?” That’s a fair question.
****If you’re at all familiar with Aesop’s Fables, you probably already know the answer. Aesop’s Fables weren’t really about lazy grasshoppers and industrious ants; or disingenuous foxes and hard-to-reach grapes; or even about geese who were unfortunate enough to lay golden eggs in a town filled with greedy, shortsighted goose disembowelers. Aesop’s Fables worked on multiple levels. On the surface, they were nice little stories. Just below the surface, they revealed a fundamental truth—the moral of the story. And at yet an even deeper level, these stories might have spoken to issues of importance, which stated in a more straightforward manner might have landed our famous storyteller in hot water with the Grecian authorities of the day.
****Similarly, the story about my son’s issues with Chemistry and Algebra II aren’t really about a high school student and his grades any more than the story of the ants and the grasshopper was about how insects go about feeding themselves over the winter. His story was, at a deeper level, precisely the story of what the mortgage industry has gone through over the past few years.
****Historically, the mortgage industry has not only been an Honor Student, but an A+ student—mortgage loans have failed at a rate of less than 1%. When default rates increased, this was usually caused by something beyond the industry’s control—a lagging indicator that something catastrophic had happened to the economy. There have been exceptions—the Savings & Loan crisis comes to mind—but the fact that these exceptions have been so rare simply strengthens the argument that the industry has had a stellar performance record over the years.
****A big reason for that excellent track record is the way that lenders used to manage the process. You got your loan from a community bank, where the loan officer was someone who knew you. Maybe you belonged to the same church, or coached his son’s baseball team, or your daughters teamed up to sell Girl Scout cookies to the neighbors. There was a relationship between the lender and the borrower, and the lender knew with a great deal of certainty that the borrower had the ability and the intent to repay the loan. Since the lender was probably going to hold the loan in its portfolio, there was no way that the loan would be made if there was any inkling that the borrower might default. And since the borrower was likely to be a neighbor, the thought of having to foreclose was almost heresy.
****The world of lending has undergone a metamorphosis since those community-banking days, and those changes accelerated during the late 1990’s and early 2000’s. Originators took more risks and issued loans at higher and higher volumes to borrowers they knew less and less about, and sold off those loans to investors who didn’t understand the nature of what it was they were buying. Borrowers took on more risky behavior as well, trying to invest in the housing market as prices soared, and sometimes gaming the system—or even committing outright fraud—to get loans that they should never have qualified for.
****Default rates went from 1% to 4% and delinquency rates hit double digits during a period when home ownership rates peaked at 68%—a brutal combination of the highest number and highest percentage of distressed borrowers ever, and an industry that hadn’t prepared itself for such an eventuality.
****New Rules and Guidelines
****So we find ourselves with new rules and guidelines, and a new uber-regulator to make sure we comply with them. But it speaks volumes that the CFPB has issued its QM Rules, Ability-to-Repay guidelines and its National Servicing Standards, and the industry’s overall response has been a collective sigh of relief.
****The CFPB reasonably noted that lenders had already eliminated most of the risk in lending, so its QM Rules essentially codified practices currently in place. While it seems bizarre that a regulator would issue guidelines aimed at making sure that lenders don’t give loans to people who can’t repay them, the guidelines issued weren’t unreasonable, and actually offered some extra legal protection for lenders who followed them. The National Servicing Standards, while more prescriptive than many servicers would have preferred, were basically a replica of the guidelines issued last year as part of the National Mortgage Settlement, which virtually every special servicer in the industry is already in compliance with.
****Interestingly, while the charter of the CFPB is to make sure that loans are safe and available for consumers, these rules—and the QRM rules yet to come—will undoubtedly make it harder for marginally qualified borrowers to get a loan. And this, in the big picture, might not be the worst thing in the world.
****I’m certainly not a fan of extensive regulation, but it does us no good as an industry to bemoan the fact that we now have a powerful regulator to answer to. That’s simply where we are now, and it isn’t likely to change anytime soon.
****A more productive use of our time is to do what my son has to do—continue to improve our performance under these new rules and guidelines and earn back the right to have more latitude in how we approach the business. Whether we’re in agreement with it or not, the CFPB has given us a framework to build on, and to expand from. Now that we know what the rules of engagement are, we can use these guidelines to build new products and new processes to safely and effectively meet the needs of borrowers who may or may not fit exactly within the new parameters, and create a level of transparency and certainty that makes the secondary market an attractive opportunity for investors.
Rick Sharga is Executive Vice President at Carrington Mortgage Holdings, LLC. One of the country’s most frequently-quoted sources on foreclosure, mortgage and real estate trends, Rick has appeared on NBC Nightly News, CNN, CBS, ABC World News, CNBC, FOX and NPR. Rick has briefed government organizations such as the Federal Reserve and Senate Banking Committee and corporations like JPMorgan Chase, Citibank and Deutsche Bank on foreclosure trends, and done foreclosure training for leading real estate organizations such as Re/Max, Prudential and Keller Williams.