Mortgage Overhaul Begins With Borrower Scrutiny Measure

The publication of a rule requiring mortgage lenders to confirm a borrower’s ability to repay is the start of an effort by U.S. regulators to reshape the market blamed for sparking the 2008 financial crisis.

The Consumer Financial Protection Bureau is set to follow yesterday’s rule on mortgage underwriting with a second mortgage-related rule, this one on servicing, at a hearing in Atlanta on Jan. 17.

The rule is “a key first step of housing finance reform” by this and other agencies, said Tim Ryan, the outgoing head of the Securities Industry and Financial Markets Association.

“Balanced reform is essential to revitalizing the flow of capital to the private securitization markets and increasing the availability of credit to American consumers,” Ryan, who will leave the group next month to head up policy and regulatory lobbying at JPMorgan Chase & Co., said.

Consumer groups that fought for the creation of the CFPB in the Dodd-Frank law of 2010 say they want the new rules to curb the abusive practices of the housing bubble.

The groups split on the merits of the ability-to-repay rule. The Center for Responsible Lending, a Durham, North Carolina-based advocacy group, applauded the measure, while Alys Cohen, a staff attorney with the National Consumer Law Center, said that the bureau’s new requirement “invites abusive lending” and undermines goals of the Dodd-Frank law.

“The safe harbor the bureau has afforded for prime loans provides absolute shelter to lenders who knowingly make unaffordable loans, in direct violation of congressional intent,” Cohen said in an e-mailed statement.

Legal Protection

The rule, mandated by Congress in response to lax underwriting standards before the 2008 financial crisis, will also offer some legal protection for lenders who follow guidelines for so-called qualified mortgages. The measure also insulates issuers of qualified mortgages at prime interest rates from future lawsuits -- a so-called safe harbor -- while preserving the ability of consumers to sue under other federal statutes.

A coalition of consumer groups, civil rights organizations and labor unions in October asked the CFPB to scrap its proposed mortgage-servicing rules and focus on stopping the practice known as dual-tracking, in which lenders pursue loan modifications and foreclosures at the same time. The groups also sought stronger requirements to modify unaffordable mortgages.

The rule finalized yesterday marks a crucial step in establishing a framework for mortgage regulation, said Ron Peltier, head of the real-estate brokerage business at Warren Buffett’s Berkshire Hathaway Inc.

‘Clear Pathways’

“You’ve got some clear pathways to be able to do business, which I think has been lacking,” Peltier said in a phone interview. Banks “loaded with capital” didn’t want to lend because rules weren’t defined, he said in a telephone interview.

Richard Cordray, the CFPB’s director, said it will complete new simplified mortgage documents in the third or fourth quarter, after it finishes quantitative testing on forms it has developed.

“I think that will be a game changer in the market because consumers will be able to see in a single document the main key points they need to know without all of the fine print that has often obscured and confused consumers,” Cordray said in a Bloomberg Television interview yesterday.

Dodd-Frank Mandate

Dodd-Frank required the bureau to propose by July 21, 2012, a simplified mortgage shopping sheet designed to make comparisons easier. The 1,099-page proposal subsequently drew strong criticism from lawmakers and smaller banks.

David Moskowitz, deputy general counsel at Wells Fargo & Co., the biggest U.S. home lender, said that the consumer bureau’s new rule is “Basic Underwriting 101” by his company’s standards. Even so, he cautioned that a new rule on risk retention would also affect the re-emerging mortgage market.

Dodd-Frank required most lenders and bond issuers to keep “skin in the game” -- that is, an ownership stake -- in loans they pool and sell. Under the law, residential mortgage lenders must bear some of the loss if a loan they’ve sold goes bad, unless their mortgages carry very low risk. The rule is designed to curb the practice, widespread before the financial crisis, of making and securitizing pooled mortgages without regard to the quality of the underlying loans.

GSE Restructuring

The Federal Reserve, the Securities and Exchange Commission and four other regulators will write this so-called qualified residential mortgage regulation.

Another major issue, Moskowitz said, is the push for the restructuring of Fannie Mae and Freddie Mac, the government-sponsored enterprises that buy and back mortgages to provide liquidity in the market.

Together, those companies and the Federal Housing Administration, a government agency that insures about 15 percent of mortgages, either own or guarantee more than 90 percent of home loans in the U.S.

The Obama administration is finishing a proposal to maintain a government safety net for housing finance while allowing private capital to take on the up-front risk. A date for the plan’s release hasn’t been set. Meanwhile, Republicans and Democrats in Congress are preparing to introduce bills next year to wind down Fannie Mae and Freddie Mac.