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Prepared Remarks by Raj Date
Deputy Director of the Consumer Financial Protection Bureau
Mortgage Bankers Association National Secondary Market Conference
New York, N.Y.
May 7, 2012
It is a real privilege to be back here with MBA. And I am glad to be back in New York City, which I called home for many years. And, despite the fact that I now live in D.C., and despite the fact that I am a diehard Red Sox fan, I have to grudgingly concede this is a great town. So thank you for having me.
I’ve now been at the Consumer Financial Protection Bureau for a year and a half. It has been the most challenging and the most gratifying 18 months of my professional life. In my various roles at the Bureau, I’ve had the chance to talk to a lot of different audiences, a lot of different groups. But this audience in particular is probably the most keenly aware of how U.S. consumer finance markets work – and how it is that they don’t work. So that’s what I’d like to talk about today. I’d like to talk to you about how the mission of the CFPB is to help consumer finance markets actually work – for American families, for financial services firms, for investors, and for the economy as a whole.
Let me start, though, by recapping what the CFPB is. The CFPB was, of course, created by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Before Dodd-Frank, responsibility for administering and enforcing the various federal consumer financial laws was scattered across seven different federal agencies. For each of those seven agencies, consumer protection was only one of its responsibilities. The result was that no single agency was truly on the hook for protecting the average, everyday user of financial products and services. There was no true accountability for consumer protection. And consumers got left behind.
The Dodd-Frank Act changed this by creating in the CFPB a single point of accountability for consumer financial protection.
Now, this is a tough job. But fortunately, at the CFPB, we have the tools that make the job possible. We have a range of tools in our belt – research, supervision, rulemaking, enforcement, consumer education. Having that full range of tools means that we don’t have to force a square peg into a round hole. We use each of these tools in the smartest way possible, matching solutions to problems.
We opened for business almost 10 months ago. Since then, we’ve made tangible progress in a number of markets. We’ve launched an evaluation of overdraft protection and payday lending. We’ve worked to help students better understand their financial options. And we’ve started figuring out whether shorter, more transparent credit card agreements can really make a difference to consumers’ understanding.
But, as you might imagine, the place we’re spending most of our time is in the mortgage market.
I recently saw a chart that showed nominal interest rates on U.S. mortgages for the last 35 years. It was astonishing. It’s a long, almost uninterrupted downhill slope. American consumers have enjoyed steadily lower, more attractive mortgage rates over nearly that entire period. This was a fantastic benefit to the American consumer, to the housing market, and to the economy as a whole. A lot of macro factors enabled that over time. One of the most important factors was the development – and until recently the maintenance – of a global capital market infrastructure to fund and price residential mortgage risk. But as we have painfully learned, not all was as it seemed. Not all was as it was supposed to be.
The mortgage industry was supposed to be the broadest, deepest, most liquid, most sophisticated consumer finance market in the history of the world. But it failed us. It failed us because it failed to calibrate price, and it failed to calibrate risk. The result was that millions of homeowners ended up in loans that they either couldn’t understand or that they couldn’t afford or both. And we are still slowly, painfully recovering.
So mortgage reform is appropriately front and center on the CFPB’s agenda.
The mortgage crisis and the financial crisis have impacted every person in this country, and, in a personal way and in a professional way, every person in this room. But let me tell you what the crisis has not done: The crisis has not made us, at the CFPB, doubt the value of free and competitive markets. Quite the contrary – the failures of the mortgage market underscore just what functioning, efficient markets are supposed to look like. They’re supposed to be transparent; they’re supposed to fair; they’re supposed to create financial incentives for hard work and smart decisions.
I want to share with you how the Bureau is helping to rebuild those elements of a well-functioning mortgage market – how we are helping to restore transparency, fairness, and proper financial incentives.
Let me start with transparency. Markets don’t work well if both parties to a transaction don’t understand what they’re getting into. At the CFPB, we are already hard at work on this issue. We are working to integrate and simplify two needlessly complicated federal disclosure forms – one under the Truth in Lending Act and the other under the Real Estate Settlement Procedures Act. The idea is for borrowers to have a better chance to actually understand the price and risk profile of their obligations, and that’s better for everyone involved.
We’re also bringing greater transparency to mortgage servicing. Earlier this month, the Bureau previewed a series of common-sense rules that include practical ideas on improving transparency, like: maybe servicers should give borrowers better information about how much they owe every month; or maybe they should give an earlier heads-up that an adjustable rate payment is about to change; or maybe they should warn borrowers that they are going to be force-placed into a potentially expensive insurance policy. We’re just at the early stages of these particular rule-makings, but I’m optimistic that we can find a common-sense path forward.
Better mortgage transparency, by the way, doesn’t just help borrowers. It helps investors too. When you invest in what can be a credit-intensive asset, it is good to know that the borrower made an informed decision about the obligation he or she was taking on. And, it is useful to know ahead of time what baseline obligations the servicer of that asset is going to have over time. By creating clear baseline rules that increase transparency for the whole life of a mortgage – from when borrowers begin to shop to when investors are paid the last dollar they’re owed – we begin to create a better system, a more transparent system, a system with more certainty, a system that helps investors actually measure and price risk.
So basic transparency is a priority for the Bureau. But so is basic fairness. Federal consumer financial protection is mostly about fairness with respect to consumers. But fairness among financial services firms matters too.
We saw, in the lead up to the crisis, how a partial or incomplete oversight scheme was doomed to fail. Commercial banks, for example, were subject to explicit federal supervision, while many other critical mortgage market participants were, as a practical matter, held to rather lower standards. Regulatory arbitrage through charter choice placed further pressures on the system. The result was that bad practices drove out good practices.
So it is notable that we are the first federal agency authorized to supervise nonbanks. That means, for example, that when it comes to the mortgage market, we will be able to ensure that originators and servicers play by the same rules regardless of their charter. It doesn’t matter if you’re a broker, or a thrift, a bank, a finance company, an ILC, or an investment bank. If you want to be in the business of consumer finance, then you’ve got to play by the same rules as everybody else.
Finally, we should all want a mortgage market that is driven by financial incentives that make sense – financial incentives that reward hard work and smart risk-taking.
Let me say a word or two about risk-taking. There is nothing inherently wrong with risk. Risk – liquidity risk, credit risk, counter-party risk, market risk, interest rate risk – is why financial markets exist. Risk is why you get paid. But nobody should get paid for taking risk that they can’t understand, they can’t rank, they can’t quantify, or they can’t price. Your market – the secondary mortgage market – should work like every other competitive market in the economy. If you are smart and take smart risks, then you should get paid. But if you are taking bad risks, then you shouldn’t get paid. For too long, we lived in a mortgage marketplace where people were able to take bad risks and get paid anyway.
In a marketplace that’s working, a mortgage borrower’s incentives are actually substantially aligned with an investor’s incentives. It should be in everyone’s best interest that loans get repaid, on time, and with no surprises.
You know, I’ve spent the vast majority of my career in consumer finance. I’ve been in and around finance companies, commercial banks, and investment banks. And through all of that, I have learned one thing above all others. Sure, there are bad mistakes, and there are bad breaks, and, yes, there are some bad people. But fundamentally, when all is said and done, people are generally good, and they generally do what they are paid to do.
So if we want businesses to do the right thing, they shouldn’t be paid to do the wrong thing. Bankers shouldn’t win when customers lose.
Let me give you an example from the mortgage bubble: the yield-spread premium. Too often it was the case that mortgage brokers were paid more to give borrowers a worse deal. If a borrower could qualify for a loan at, say, 6 percent, a broker might juice that rate from 6 percent up to 8 percent. As a result, the most important, most visible person in the mortgage process for many borrowers – the mortgage broker – had a financial stake that was confusingly and perversely in direct opposition to the interest of the consumer himself. If people are paid to treat customers poorly, it shouldn’t be surprising when they do.
The Federal Reserve Board and then Congress took important steps in this area, and it’s our job at the Bureau to propose and finalize regulations that end these practices. We’re working hard to do just that.
Financial incentives matter. Again, ideally, lenders’ and borrowers’ incentives should be aligned; both of them win when borrowers can afford their loans. At some tacit level, ordinary people know that. When they sit down at the closing table, there is a certain element of trust that your lender isn’t setting you up to fail. And that is the underpinning of another substantial policy effort that we have underway at the Bureau: Dodd-Frank’s ability-to-repay requirement in mortgages.
Again, let me hearken back to my days as a banker. Here’s what should be the least surprising lending advice you have ever heard: If you are going to lend money, you should probably care about getting paid back. And if you care about getting paid back, you should probably inquire about, and evaluate, a borrower’s ability to pay you back.
That should not be controversial. And it isn’t – not to the vast majority of big banks and community banks, credit unions and thrifts that actually held on to some of the risk of the mortgages that they were originating during the bubble. Nor is it surprising to any banker trying to build or sustain a customer franchise – after all, a customer franchise only endures if its customers win.
Put in its simplest form, the ability-to-repay provision of the Dodd-Frank Act requires that lenders reach a good-faith determination that a mortgage borrower has a reasonable ability to repay the loan. If lenders don’t do that, the law lays out real consequences. As part of the broader ability-to-repay mandate, Congress also designated so-called “qualified mortgages,” which are structurally safer and pose lower risk for borrowers, and which are underwritten according to standards that make it reasonable to expect that borrowers have an ability to repay.
The Federal Reserve Board proposed a regulation last year that would give definition and effect to the ability-to-repay provisions, and we, at the Bureau, inherited that proposal when we opened for business last July. We have had the benefit of extensive public comment on the proposal, and we, ourselves, have undertaken a significant analytical effort – with a cross-functional team of economists, lawyers, and market experts.
We are considering a wide range of issues with this. First and foremost, we want to ensure that consumers are not sold mortgages they can’t afford. We want to minimize compliance burden where possible, in part through the careful definition of those lower-risk “qualified mortgages.” We want to ensure that, as the market stabilizes over time, every segment of prudent loans has the benefit of sufficient investor appetite and a competitive market. We want to avoid any inappropriate disincentive that would prevent lenders from making prudent, profitable loans in non-traditional segments – like loans to self-employed borrowers. We want to encourage a competitive market that does what markets are supposed to do – calibrate risk and calibrate price. We want to craft a sensible rule that works for the market throughout the credit cycle, but we want to be attentive to just how fragile and risk-averse the market seems to be today.
So it’s a complicated issue, but I am fully confident in the Bureau’s ability to find a common sense and analytically sound answer. We’re going to take the time to get it right. And, I am confident that we’re going to finalize the ability-to-repay rule before our January deadline.
The mortgage market will recover when we have restored transparency, when we have restored fairness, and when we have restored financial incentives that actually reward people for making smart decisions. The Bureau is working hard, just like I am sure that everybody in this room is working hard, to enable a thriving mortgage market in the future.
Thank you for your time.