There is now little doubt a major cause of the Great Recession was the mortgage loan industry running amok.
Mortgage loans were, regularly and often, made to people having the creditworthiness of a turnip. When housing prices fell, loan defaults soared. Since these loans had been pooled and sold to investors throughout the country (and the world), the consequences of massive loan defaults were catastrophic. In the aftermath of all this, mortgage lending went from being largely unregulated to being one of the most regulated consumer finance industries around, right up there with credit card issuers.
The push to regulate the mortgage loan industry began with the Federal Reserve Board and the Department of Housing and Urban Development in 2008 and was then taken to a higher level in 2010 by the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Voluminous and detailed regulations implementing the Dodd-Frank Act continue to pour out of Washington, with the Consumer Financial Protection Bureau (CFPB) now in charge of the effort. An example of this occurred in January when, with a 541-page document, the CFPB issued amendments to Regulation Z. (Regulation Z interprets the Federal Truth in Lending Act, which was amended by the Dodd-Frank Act.) These amendments primarily focused on how mortgage loan originators are compensated and their competency.
Before the Great Recession, the mortgage loan industry had a compensation system in place, hidden from the view of borrowers, that created a blatant conflict of interest. Under this system, loan originators would make more money by steering borrowers into loans with higher interest rates, higher front-end costs and other terms (such as prepayment penalties) that were good for lenders but bad for borrowers. All the while, borrowers were led to believe their loan originator was their friend, working diligently to get them the best deal possible.
As matters now stand, compensation paid to mortgage loan originators cannot be based on the terms of a loan, except that compensation can be determined as a fixed percentage of the loan amount. If a loan originator is being paid compensation directly by the borrower, the loan originator cannot also receive compensation from the lender.
On the competency front, the new amendments to Regulation Z require mortgage loan originators to be qualified to make mortgage loans. If they are required to be licensed or registered under state or federal law but fail to do so, they will be violating Regulation Z and subject to the wrath of the CFPB.
Although the amendments to Regulation Z were available in draft form for many months before final adoption in January, they have created a sufficient uproar within the mortgage loan industry that the CFPB was forced in June to issue proposed amendments to the amendments. Those are pending. The CFPB has a list of other regulatory actions in the pipeline affecting the loan industry, including regulations that would change what, under Regulation Z, constitutes a finance charge in the context of a mortgage loan. This would, in turn, affect the annual percentage rate of a loan, a key metric used by borrowers when deciding which loan to accept.
Jim Flynn is a private attorney with Flynn Wright & Fredman LLC.