Signage at the Consumer Financial Protection Bureau (CFPB) headquarters in Washington, DC
andrew kelly | Reuters
A court last week threw out a regulation crafted by the Consumer Financial Protection Bureau for payday lenders, saying the agency’s funding was unconstitutional and therefore lacked the ability to curb the industry.
The U.S. Court of Appeals for the Fifth Circuit struck down a CFPB rule that prohibited payday lenders from debiting the accounts of customers who miss a payment without first obtaining their consent. While the ruling applies only to this regulation, financial services lawyers say it blurs the agency’s authority and has the potential to change all of its rules.
“The Fifth Circuit’s decision potentially calls into question all rules, guidelines and orders issued by the CFPB — as they all have their origins in the CFPB’s unconstitutional self-funding structure,” regulatory attorneys Anthony DiResta and Luis Garcia of Holland & Knight wrote. in a note to clients on Tuesday.
Rules for subprime mortgages
Undermining the agency’s legal authority could have a profound effect on mortgage markets — an industry prone to disruption when the laws are unclear, especially when interest rates rise.
“Anything that disrupts the mortgage market will potentially make it even more difficult for homebuyers to qualify for a loan,” said Boston College law professor Patricia McCoy.
McCoy points to Georgia, after the state passed a law in 2002 to protect consumers from lending by allowing them to seek damages from the lender and the person who purchased the loan. This widened the potential damage to Wall Street banks as well as mortgage investors Fannie Mae and Freddie Mac.
Major credit rating agencies declined to rate mortgage-backed pools containing Georgia-originated loans, which had a chilling effect on the MBS market. Fannie and Freddie, which buy mortgages and present them as securities for sale to investors, have stopped buying mortgages in the state. The following year, the Georgian legislature amended the law and removed the liability provisions.
“The Fifth Circuit’s decision threatens to cripple mortgage lending in Mississippi, Louisiana and Texas because lenders will lose certainty about the law that applies to future mortgages they originate,” McCoy said, referring to the Fifth Circuit states. She was part of the original CFPB leadership team during the Obama administration.
Established after the 2008 financial crisis, the CFPB created a series of rules for the mortgage industry, including standards for a “qualified mortgage” based on a borrower’s ability to repay a loan. These two rules give mortgage investors and lenders legal protection against borrowers who claim they were tricked into taking out a loan they couldn’t afford, as long as it meets this standard.
If the Fifth Circuit’s decision is upheld, it could challenge these longstanding mortgage rules.
Many legal observers expect that the decision will ultimately be appealed to the Supreme Court. Although the High Court is not required to hear a case, it raises important constitutional questions. It could be a years-long process that could cause further challenges to the CFPB’s authority to be halted or delayed until the case is resolved.
A call would take time to play. The mortgage association has informed its members that the ruling is currently limited to the CFPB payday loan rule.
“We like to put in place rules that give us safe havens for the way we do mortgage lending, and we don’t want any of that to go away,” Mortgage Credit Council President and CEO Robert Broeksmit said Monday during the annual conference for the professional association. . Still, he vowed to continue fighting what he called the office’s legislative overreach. “Now is not the time for you to hire more lawyers trying to figure out what the office is doing.”
While industry groups have filed lawsuits against several CFPB rules, the loss of repayment capacity and qualified mortgage rules would be “devastating,” said Richard Andreano, an attorney who leads the firm’s mortgage practice group. Ballard Spahr Attorneys.
“The loss of CFPB mortgage regulation and the impact on the market would be catastrophic,” Andreano said. He believes the potential ramifications would mean the court or Congress would address the situation before it had an impact. “But it obviously adds uncertainty if you’re in the mortgage business now,” he said.
Impact on Securitizations
The protection afforded by the ability to repay and the qualified mortgage rules also apply to the mortgage bond market, where home loans are pooled into securities and sold to investors. Without set guidelines, the decision raises questions about how credit rating agencies and mortgage bond investors will treat loans.
“They don’t want loans in their loan pools that have an increased risk of default exposure because that exposure will extend to investors who buy the securitized bonds,” McCoy said.
S&P Global Ratings and Moody’s Investors Service had no comment, but Fitch Ratings said it would monitor any changes that have an immediate effect on the mortgage market.
“Mortgage originators and managers are subject to the rules and regulations of a myriad of regulatory bodies at the state and federal levels,” said Roelof Slump, who manages structured finance operational risk at Fitch. “Potential changes to how the CFPB is funded are unlikely to have an immediate effect on the mortgage market.”
How the CFPB is funded by the Federal Reserve instead of Congress is the root of the problem. The design was deliberate – to keep the agency free from political pressure. However, the court said the funding was unconstitutional because the agency was accountable neither to the people nor to Congress.
“I think the court’s ruling on the illegality of the CFPB’s funding mechanism is correct, and so is its governance structure,” said Bill Isaac, a former head of the Federal Deposit Insurance Corp. who headed the bank regulator during the savings and the credit crisis of the 1980s. “What this means in terms of the legality of the CFPB’s past actions is difficult to predict.”
No quick fix
Andreano expects the courts to find a temporary solution, but that Congress will ultimately have to change the funding structure for the CFPB, “I can see that there is a solution, but I think the lobbyists will be very busy in some time.”
Jared Seiberg, managing director of Cowen Washington Research Group, told investors earlier this week that if Republicans gain control of one or both houses of Congress in the Nov. 8 election, it could complicate efforts to fix the agency’s funding.
In fact, he said the GOP might try to fully fund him.
“We appreciate the industry’s frustrations with the CFPB, but an unfunded agency could be worse, as the laws would still apply, but the advice and safe harbors that financial firms rely on to defend against lawsuits could be disabled,” he wrote .
The CFPB, meanwhile, said the ruling would not prevent it from scrutinizing consumer lenders.
“The CFPB will continue to fulfill its statutory mission of enforcing federal law and protecting Americans from unscrupulous financial institutions. Illegal practices remain illegal, and the CFPB will hold companies accountable when they break the law,” the agency said in a statement. .