Mortech LLC Blog

Consumer Financial Protection Bureau Asks for More

The new federal agencies are costing a bloody fortune; so to speak, that’s only “half of it.” Last month, the Consumer Financial Protection Bureau released a notice for a request for comments on private student loans and lenders to be published in the Federal Register. This is part of the CFPB and Department of Education gathering of information on private student loans and related services.
The inquiry likely will focus on such basic issues as use of loans, loan solicitation processes, and repayment terms.
I should say that all of this shows that the newly formed regulatory bodies formed since Dodd-Frank do not have a requisite understanding of the activities they are to regulate.
Remember back to when Elizabeth Warren requested more than $300 million in her first budget. There was scant justification, a superficial swag at any potential benefit from spending so much money, and little credible argument to justify such an outrageous budget request.
Now the agency is set off on an expedition to duplicate the knowledge certainly resident at Sallie Mae – and known by them for years.
In addition to direct costs, the new regulators are consuming time and resources from the regulated constituencies. This is a painful example of how It cost much more to regulate than is made known to taxpayers. This is no way to run a business.

Misuse, Mis-conception

I have to admit it. I have become very impatient with the bastardization of concepts that comes with popularization. So many terms commonly used by managers have a history and a deeper meaning than is known when they are batted about at corporate conference tables.
Think of paradigm, tipping (inflection) point, disruptive technology, strategy.
And now cloud computing. Sometime in their history, these concepts had profound and specific meanings.
Casual and undisciplined use has obliterated their fundamental attributes and their original intent.
Between you and me, it’s the misuse of the word “strategy” that irritates me the most. Let me leave this argument by saying that daily managing and strategy are not synonymous. Public relations firms, can you hear me?

Deputy Secretary of the Treasury, Neal Wolin, is Persuasive, Not Factual

Last week, April 19, 2011, Deputy Secretary Neal S. Wolin answered critics of the Dodd-Frank Act. Wolin set up his remarks by characterizing Dodd-Frank as a well-reasoned antidote to the effects of “a financial panic of a scale and severity not seen in decades.  The crisis was brought about by fundamental failures in our financial system.” He draws the very general conclusion that “There was no alternative to reform.” Reform? Or, Dodd-Frank specifically? The distinction between a general need for reform and a particular complex of new rules is not made clear in his speech.

He seemed to say that what we have is Dodd-Frank calls for popular support to neutralize critics of the legislations. Wolin wants to rally the public by making the consequences of the 2008 financial crisis personal to Americans. “Not only our economy, but also the lives and livelihoods of tens of millions of American families were devastated by the (financial) crisis.”

Wolin makes this speech an occasion to rebut very specific and selective criticisms made of Dodd-Frank. (It is not obvious who are the complainants).

Wolin takes on the following criticisms:

1. Some say that there’s a lack of coordination by the regulators.

2. Some argue that transparency in the derivatives markets will harm liquidity, or that margin requirements will unnecessarily tie up capital.

3. Some complain that our reforms will unfairly disadvantage U.S. firms as they compete globally.

4. Some say the new consumer agency will stifle consumer choice and innovation, that it will interfere with existing regulators, or that it’s not accountable to anyone.

5. And some even say we can’t afford to pay for reform.

I will deal briefly with two aspects of Wolin’s comments. First I will address the idea that the strictures of reform will make US financial institutions less competitive. Then I will critique the cost of forming the Consumer Financial Protection Bureau (CFPB), a creation of Dodd-Frank.

Competitive Stance

Much of what passes as legislation or policy is abstract. Input to the reform generally comes from academic financial models or from hearings held by legislators or their staff.

Neither politicians nor regulators systematically collect the views of the ultimate interpreters of financial reformation (the FI’s). Those that appear at hearings usually are “self-selected.” If they are representative of the industry, they are so by accident. If regulators want public input, there is more scientific way to get what is useful.

MORTECH 2010, a stratified random sample of mortgage lenders, shows that lenders are supportive if reform in general. The survey shows that lenders are skeptical of the potential results of reform. Wolin and his colleagues really should address the added expense of complying to reform, the operational complexity caused by sets of new rules, and lenders reduced ability to qualify deserving, but idiosyncratic loan applicants.

Consumer Financial Protection Bureau (CFPB)

The Bureau of Consumer Financial Protection was created in July 2010 as part of the Dodd-Frank financial reform legislation. The arguments to establish a new bureaucracy never seemed cogent to me. In this posting, I won’t visit all of the issues. I merely want to comment on the cost of elusive benefits expected from the CFPB.

The CFPB is a regulatory body. It is not an organization that can facilitate the identification of worthy borrowers, shepherd intelligent underwriting, or distribute borrowed funds more efficiently.

CFPB has as a major object the unification of seven federal agencies under the Consumer Financial Protection Bureau. The novel undertaking of the CFPB is to focus on consumer protections. None of the seven agencies had consumer protection as its singular objective. How much are the protections worth to taxpayers?

When speaking of the operating budget of the CFPB, Elizabeth Warren, Special Advisor to the Secretary of the Treasury for the Consumer Financial Protection Bureau, refers to The President’s Budget for Fiscal Year 2012. The Federal Budget estimates CFPB operating funds of $142.8 million for FY2011 and $329 million for FY2012.

A $500 million investment over two years in a start-up with an uncertain return simply is “mind-blowing!”  A much more rational approach is to prototype the workings of the CFPB. Experimental programs would provide a bench mark against which Washington (the Federal Reserve Board in the case of the CFPB) can make future budget decisions.

The CFPB, after all, is a regulatory agency. Their mission is not to make markets for loans more efficient nor to maximize the welfare of US households. The profit accruing to a government organization like the CFPB is nearly impossible to estimate. This is all the more reason to invest carefully and with progressively more evidence of the effectiveness of the CFPB. There is no support for creating a massive agency all at one time.

 

Government siphons mortgage funds

Banks face $3.6 trillion “wall” of maturing debt: IMF — One of the most far reaching problems affecting the mortgage business is not discussed nearly enough.  Reuters reports the IMF statement that “These bank funding needs coincide with higher sovereign refinancing requirements, heightening competition for scarce funding resources,” the IMF said.

Central banks around the world have been flooding the financial markets with liquidity. This helps considerably the re-funding of debt both public and private.

I have speculated recently that an important motivation – or, perceived benefit — of the federal government’s takeover of Fannie Mae and Freddie Mac was to give Treasury complete control over treasury and agency debt management.

I remember the urgent and critical tone as Treasury and the OMB attempted to suppress GSE note issuance in the early 1980’s.

The problem in the 80’s was characterized by the Reagan administration as “crowding out.” Treasury had large debt refunding to manage. OMB and Treasury concluded that the GSE’s were attracting fixed-income investors who otherwise would be buying Treasury notes and bonds. They had perceived that GSE competition made it more difficult and more expensive for Treasury to manage its refunding operations.

Crowding-out is back. Daniel Fuss, vice chairman of Loomis Sayles, was quoted by Forbes Magazine as having said: “There is no immediate danger to corporate credit. Eventually, however, U.S. government borrowing may begin to “crowd out” corporate borrowing. The cascade of U.S. Treasury bonds sold to pay for budget deficits will drive government and corporate yields higher.”

In a striking reversal of government’s perception of what is important for the nation, Treasury and the Federal Reserve Bank again are trying to repress or reallocate capital from housing to refunding of the federal budget deficits. It is thirty-years later and the problems are the same. Under cover of the financial markets crisis of 2007-2008, Treasury has wrested control of the largest financial markets in the county. Homeowner’s will have to do with less.

 

e-Mortgage, business intelligence less often used by lenders

Lenders are increasing IT spending – we have documented that. The mortgage industry could increase IT expenditures 15% or more.

IT objectives are largely inward focused. Lenders tell MORTECH 2010 that they want investments in IT to reduce costs, integrate workflow, reduce paper, modernize processing infratructure. These largely are measures to imprive operations. We can’t see any break-away activities.

Lenders are giving some technologies attention and funding. Some often discussed innovation seem to face postponement and lack of funding in 2011.

Look for widespread use of  mobile (smart phone), PPE engines, AUS, AVM, Electronic Document Management, Fraud Detection.

Technologies less used include e-Mortgage, Business Intelligence (BI), Pipeline Rate Risk Management, and Servicing Portfolio Risk Management

Jeff Lebowitz

More Impact of Financial Reform

I am concerned that the crisis-driven financial reform may be guilty of being too task driven and not knowing about the impacts on companies ever innocent of imprudent behavior.

After-the-fact regulations are presented with the urgency of the already-past financial crisis. While certain to reduce systemic risk in the future, tighter regulations born of crises do not differentiate between the guilty and the bystander, do not discover the harm to profitability caused by heightened vigilance and more frequent auditing.

To my reading of the role and impact of financial reform, I see harm done that was not contemplated by the authors of reform. The extreme focus on avoiding the effects of excessive risk taking will make it difficult and expensive for smaller financial institution to do business and always stay in compliance. The expense of reform will fall disproportionately on smaller lenders. It is clear to me that this is not the social or structural result intended by the regulators.

One important shortcoming of  new regulations is that the regulators do not calculate the cost of compliance. A complete cost benefit analysis is not performed. The goals of regulations rarely include ease of implementation.

For example, let’s look at lender response to the well-intended federal Home Affordable Moddification Program. In our recently released MORTECH 2010, we surveyed lenders’ views on HAMP. The question we asked was, “Would you say that HAMP compares favorably or unfavorably with other loss mitigation alternatives such as short sales, deeds in lieu, and R-E-O? (On) Ease of execution.”

Lenders told us that HAMP was more difficult to work with than the more conventional methods of resolving defaulted loans.

Experience with HAMP	% of MORTECH Respondents
Easier execution	17%
More difficult execution	64%
Not sure	19%
Source: MORTECH 2010

The consensus opinion of lenders is that HAMP placed a greater operational burden on lenders than did short sales, deeds in lieu, REO, etc. According to our evidence, well-intended federal programs with impacts not fully considered is likely to be more expensive than imagined and will not obtain the benefits intended for the industry or for society.

Jeff Lebowitz on February 28, 2011

Lesser Financial Reform Without A Technology Vision

So, What about Financial Reform?

Every academic, bank CEO, and politician has their own idea about reforming the financial and mortgage systems in America. The Dodd Frank Act is the objective and catalyst for the debate on reform.

Like Dodd Frank, opinion leaders offer structure without vision. Their intellectual concepts do not consider the capabilities of lenders to survive, nevertheless prosper after reform. The most far reaching financial services legislation in eighty years has been passed without benefit of an impact.

My main issue with the legislation is that financial reform does not consider the technology available to lenders. Here, I refer to technology in the larger sense. Technology in my thesis means the combination of knowhow and the application of machines, software and people to manage under new rules.

Our MORTECH data has shown over many years that most lenders do not have the risk and business intelligence systems to run their business effectively. Lenders are underinvested in business intelligence and risk management systems. The effect of financial reform undoubtedly will be diluted unless and until lenders conform to professional management standards enabled by (decision) technology.

Solutions Offered by the Experts

The Mortgage Bankers Association of America (MBA) has jumped into the melee with both feet. MBA says that they have assigned an inordinate, but appropriate set of resources analyzing and influencing rule-maker response to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (The Dodd-Frank Act).

The MBA recommends that the centerpiece of federal support for the secondary mortgage market would be a new form of mortgage-backed security issuer – the mortgage credit guarantor entity (MCGE). The MBA sees that a mortgage backed security (MBS) would have two components:

a) A security-level, federal government guaranteed “wrap” and

b) A private, loan-level guarantee from a MCGE, something that functions similarly to Ginnie Mae.

The mortgage credit-guarantor entities (MCGEs) would be privately owned, but government-chartered and regulated. The guarantees of on-time time payment of principal and interest would be secured by a federal insurance fund, fueled by risk-based fees charged for the securities at issuance and on an ongoing basis.

Underlying the MBA concepts is a minimally encumbered flow of credit to qualified borrowers. The MBA also would preserve “reasonable levels” of lender discretion when originating low-risk loans.

The Private Market Alternative

Stumping from their rostrum at the American Enterprise Institute, Peter Wallison, Alex Pollock and Edward Pinto think they have a solution to reform – removing government almost entirely. In their new paper “Taking Government Out of Housing Finance . . . .” the three intellectual powerhouses show how they would push mortgage finance away from government involvement. The most salient point in their thesis for a new secondary mortgage is: “To the extent that regulation is necessary, it should be focused on ensuring mortgage credit quality.” The government’s stake in the business would be focused on a higher standard of lender identification and management of risk.

The MBA and Mssrs. Wallison, Pollock and Pinto differ markedly about the government involvement in its liability for carrying and managing credit risk. The AEI team holds that investors will buy mortgage paper not guaranteed by the US government. Liquidity in the market would occur organically. MBA thinks a government pool to guarantee mortgages is a more workable alternative to private or public-only guarantees.

The Middle of the Road Alternative

Dr. Mark Zandi of Moody’s Analytics has considered a range of reform models – nationalization, privatization, and, well, a “hybrid” solution.

The hybrid mortgage finance system features risk sharing. Initially, Zandi would allow private operators to bid for basic GSE transaction and processing systems needed to replicate secondary market operations. Administrative, oversight and review functions would be ceded to the federal government.

The private operators would invest their own capital in the credit enhancement and portfolio businesses. They would originate, own, and manage the mortgage assets and the insurance portfolios.

Such a system holds the most promise for delivering consistent, affordable mortgage loans on prudent terms to borrowers, with minimal costs to taxpayers.

According to Zandi, the private operators would absorb first losses and operating cost. The federal government would backstop in case of catastrophic losses. Zandi believes that this system retains the incentives for the operators to run a prudent book of business with loans priced appropriately for cost and risk. And, what of the government’s role? The government backstop would lower asset risk premia, lower borrower costs and keep mortgage credit flow freely.

The Role of Technology

It never fails! No one offers the complete solution to reform or for any other matter of magnitude.

We at MORTECH, LLC have long held that underinvestment in data and knowledge technologies chronically contributes to financial crises. The most telling is lenders’ lack of understanding of the risk they create when originating a loan or when investing in mortgage servicing rights.

For example, at the height of the credit crisis, only one-third of lenders had the ability to manage interest rate risk in their pipelines.

Source: MORTECH 2008 – ©MORTECH, LLC

Dodd-Frank, the MBA, and the American Enterprise Institute notwithstanding, financial reformers will have a rough go unless lenders have the tools and the knowhow to manage their businesses better.

The Dodd Frank Act is 848 pages long. In all of that, technology gets only 9 mentions throughout the whole Act. Essentially all of these refer to technology that might be used by regulators themselves.

Financial reform will be more successful if the Act had a complete vision supporting it. Then too, the interpreters and influencers for rule-making would be more persuasive armed with a model of business and with operational standards.

The industry certainly would be the better for it.

Jeff Lebowitz

January 26, 2011

National Mortgage News Features MORTECH 2010

National Mortgage News

Tuesday, January 18, 2011

MORTECH: Technology Spending by Lenders to Rise 15% this Year

Mortgage lenders of all sizes are expected to increase their technology spending by 15% this year to $4.11 billion, according to the new MORTECH study.

Jeff Lebowitz, president of MORTECH LLC, Bend, Ore., said that although production volumes will decline in 2011, mortgage firms will use the time to play catch up “on workflow integration and electronic document management.”

In a summary of the annual report, he notes that, “We will see investment, but not much innovation. Still, 2011 will be a good year for many mortgage technology application suppliers.”

A former Fannie Mae executive, Lebowitz has been issuing his MORTECH study since 1988. It covers not only technology, but asks lenders about other emerging business trends as well.

Lebowitz noted in his findings that mortgage technology spending began to collapse with the subprime implosion which began in 2007. “Subprime lenders had accounted for the bulk of the investment growth early in the decade,” he said.

Compliance Instead of Innovation

Reports from our latest MORTECH 2010 survey are in production – it is our 22nd annual survey of mortgage lenders, their businesses and their use of technology. The newest report module,  “Core Technology,” definitely confirms that lenders are consuming too much energy and resources complying with new and rapidly changing regulation.

“Core Technology” begins to tell the story of how lenders attention has turned away from creative competition toward conservative compliance. The operational analog of dealing with the rising costs of regulatory compliance is the menu of planned IT investments for 2011. Not in rank order, respondents to the survey plan to invest in:

• making operations more flexible and responsive
• reducing cost of operations
• integrating workflow across  the enterprise
• refining tools to identifying qualified borrowers
• improving the quality of borrower

The target of the major investments activities is to improve operations, not toward building market position nor filling out product portfolios.  No, lenders are becoming introverted under the scrutiny of regulators. The next year largely will be spent re-tooling and not innovating.

After all is said and done, the mortgage industry will be more efficient and better able to serve regulatory requirements. Error rates will be down. Document and case processing will be more efficient. Increasing home ownership once again — that will have to wait for another year or more.

Politics and Not Business

Politics and Not Business

Financial reform is political, difficult to comprehend, expensive to implement. Tragically, policy mavens give little consideration to the technology and financial resources required to implement their well-intended but not-in-the-world ideas. New regulations, but no business plan to guide their implementation. Disorder the result.

The Treasury Department and Congress were slow to recognize the complexity of implementing operational requirements implied by the passage of the Emergency Economic Stabilization Act of 2008 and Dodd-Frank.  Lenders, particularly, small-town community lenders feel unduly encumbered.

Involving themselves more deeply into community financing operations, the federal government has a new set of customers–mortgage originators nationwide. I believe these new customers doubt that the government empathizes with the business and management needs that result from policy pronouncements.

The government has become expert in measuring – the economy, unemployment, national demographic changes, etc. But, I fear it has taken little time to measure the effect political action has on its constituencies. Their process of understanding is political and not scientific. Outcomes are negotiated not derived from fact.

As an offset, MORTECH2010 has interviewed a stratified random sample of lenders. The study shows clearly that the political process and regulatory reform has distracted lenders countrywide from making loans, from serving their markets, and from running their businesses more effectively.

Most Pressing Issue      In 2011	% of All Lenders	% of Lenders  Under $100MM
Demanding Regulatory Environment	39.9%	44.7%
Adopting Federal Product Guidelines	28%	23.7%
Source: MORTECH 2010                                                                                                                                 © MORTECH, LLC

MORTECH 2010 shows clearly that lenders are preoccupied with changing Federal regulation. The effect sought by regulators may not be what they have achieved.

No, it would seem that more effective lender operations will be impeded by capital, resources, and time invested in reacting to what lenders interpret as the intentions of regulatory reform. The outcome remains in doubt and gotten with higher operating expenses. The data show just that.