The Consumer Financial Protection Bureau (CFPB) recently marked its first year in operation. Given the unusual structure of the CFPB — one that I believe reduces transparency and accountability — and the questionable manner in which its current leadership was put into place, diligent and constant Congressional oversight is badly needed.
Had Congress fulfilled its responsibilities in previous years in regards to such entities as Fannie Mae and Freddie Mac, we might have avoided the recent financial crisis. As the CFPB runs the same risk of politicizing our consumer credits markets in a manner similar to which our mortgage market was so highly politicized, I believe aggressive congressional oversight is needed in order to both avoid future financial crises and to maintain a healthy economy.
The problem facing our housing market is a combination of weak demand and excess supply. One of the constraints on housing demand is mortgage availability. If one is a prime borrower and is able to make a substantial down payment, then mortgages are both cheap and plentiful. If one is not, then a mortgage is difficult, if not impossible, to get.
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According to the Federal Reserve Monetary Report to Congress, "Access to mortgage credit is among the important factors that affect the demand for housing and thus the recovery in the housing sector. Lending standards appear to be considerably tighter than they were even before the housing boom, likely preventing many households from purchasing homes. According to the Senior Loan Officer Opinion Survey on Bank Lending Practices, from mid-2007 into 2009, many lenders tightened their standards for residential mortgages originated to borrowers with prime credit scores, and very few have eased standards since then.
"Moreover," the report says, "the market for nontraditional mortgages continues to be impaired, while the market for subprime mortgages remains effectively closed. Similarly, the range of credit scores on newly originated prime mortgages has remained elevated since lenders shifted toward higher-rated borrowers in 2008. The upward shift in credit scores is also evident for prime borrowers who refinanced their mortgages and for Federal Housing Administration (FHA) mortgages."
This decline in mortgage availability derives from a variety of factors, some good, and some bad. For instance the most irresponsible lending, with the exception of FHA, is gone, at least for the moment. That is a good thing.
As the Federal Reserve, however, has noted, mortgage lending standards are tighter than those witnessed pre-boom, indicating that we are not simply seeing a correction in reaction to the boom, but a restriction in credit beyond what would be expected. As noted, much of the Alt-A and higher quality subprime lending is also gone. That is not such a good thing. By my estimate, about a fifth of the mortgage market has disappeared, holding back housing demand. The reduction in mortgage availability is illustrated by the dramatic increase in median credit scores on new prime loans, which have increased from just under 720 in 2007 to almost 770 today.
Most of this increase has been driven by an increase in the bottom of the credit score distribution. Recall that this considers prime loans only. Of course, there are substantial differences in default probabilities within prime. Lenders appear to be reducing credit to those borrowers within prime that are most likely to default, and hence most likely to invoke various "consumer protections" in order to avoid foreclosure.
These are the loans that would entail the largest regulatory and litigation costs, so it is not surprising that lenders have reacted to these increased costs by limiting credit to borrowers most prone to litigation and regulatory enforcement. Reductions in subprime and Alt-A credit have been even more dramatic.
One of the factors contributing to that disappearance is the combination of Federal Reserve interest rate policy with federal mortgage regulation. Under the Home Owner's Equity Protection Act, whose administration has transferred from the Federal Reserve to the CFPB, any mortgage over 5.5% is considered "high cost" in the current interest rate environment. Such mortgages now carry considerable regulatory, reputation and litigation risk. Historically speaking, 5.5% is a great rate, not a predatory one.
Standards for regulatory consideration
Under Section 1022(b)(2)(A)(i) of the Dodd-Frank Act, the CFPB is required to consider "the potential benefits and costs to consumers and covered persons, including the potential reduction of access by consumers to consumer financial products of services resulting from such rule." Without question the CFPB is required by statute to consider the impact of its rules on consumer access to credit. Unfortunately I believe the CFPB has failed in this regard, giving little consideration to reductions in access.
Part of the problem is the CFPB's structure where the research area — which conducts cost-benefit analysis — is under the same associate director responsible for the rulemaking. The cost-benefit analysis will not be independent of the rule-making process under such circumstances.
I would urge the CFPB to establish an independent economics/research function that reports directly to the director. As we have repeatedly seen with other agencies, the cost-benefit analysis has simply been an after-the-fact box checking exercise, rather than a serious attempt to inform the rule-making process.
I would like to emphasize that the CFPB is only one of the many obstacles to job creation and consumer credit in our economy. Restructuring or eliminating the agency would certainly improve outcomes, both for our economy and consumers in general, but such a change alone would be insufficient to cure everything holding back our economy.
The CFPB's structure is only part of its problem. Of greater concern is the flawed body of consumer protection law inherited by the CFPB. This body of law did not prevent the financial crisis, despite the fact that during the pre-crisis our mortgage and credit markets were extensively regulated. In fact, it was this extensive regulation that contributed to the crisis. Eliminating or restructuring the CFPB in the absence of significant change to the underlying statutes would offer only modest improvements.
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