Signage at the Consumer Financial Protection Bureau (CFPB) Headquarters in Washington, DC
andrew kelly | Reuters
A court last week threw out a regulation drafted 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 United States 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 only applies to that regulation, financial services lawyers say it blurs the agency’s authority and has the potential to upend all of its rules.
“The Fifth Circuit’s ruling 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,” wrote regulatory attorneys Anthony DiResta and Luis Garcia of Holland & Knight. in a note to customers on Tuesday.
If the agency’s legal authority is undermined, it could have a profound effect on home loan markets – an industry that is prone to disruption when the laws are murky, particularly when interest rates rise.
“Anything that disrupts the mortgage market is going to potentially make it even harder 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 predatory lending by allowing them to seek punitive damages from the loan originator and whoever purchased the loan. This extended the potential damage to Wall Street banks as well as mortgage investors Fannie Mae and Freddie Mac.
Major rating agencies declined to rate residential mortgage-backed securities pools containing Georgia-originated loans, which had a chilling effect on the MBS market. Fannie and Freddie, who 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, removing the liability provisions.
“The Fifth Circuit’s decision threatens to cripple mortgage lending in Mississippi, Louisiana and Texas because lenders will lose certainty of the law that applies to future mortgages they take out,” 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 offer mortgage investors and lenders legal protection against borrowers who claim they have been tricked into taking out a loan they could not afford as long as it meets this standard.
If the Fifth Circuit’s ruling is upheld, it could challenge those longstanding mortgage rules.
Many legal observers expect the decision to eventually be appealed to the Supreme Court. Although the High Court is not required to hear a case, it raises important constitutional issues. It could be a years-long process, which could see further challenges to the authority of the CFPB halted or delayed until the case is resolved.
A call would take time to play out. The Mortgage Bankers Association has informed its members that the ruling is currently limited to the CFPB payday loan rule.
“We like to set rules that give us safe havens for the way we grant mortgages and we don’t want all of that to go away,” Mortgage Bankers Association President and CEO Robert Broeksmit said Monday during an interview. of the annual convention of the professional association. Still, he vowed to continue to fight what he called the office’s regulatory 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, losing the repayment capacity and qualified mortgage rules would be “devastating”, said Richard Andreano, an attorney who leads the firm’s mortgage practice group. Ballard Spahr lawyers.
“The loss of CFPB mortgage regulation and the effect on the market would be catastrophic,” Andreano said. He thinks the potential consequences would mean the court or Congress would deal with the situation before it had an impact. “But that adds uncertainty, obviously, if you’re in the mortgage business now,” he said.
The protections provided by the repayment capacity and qualified mortgage rules also apply to the mortgage bond market, where home loans are bundled into securities and sold to investors. With no established guidelines, the decision raises questions about how credit assessors and mortgage bond investors would treat loans.
“They don’t want loans in their loan pools that have an increased risk of damage exposure, because that exposure would extend to investors buying 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 market originators and managers are subject to the rules and regulations of a myriad of governing bodies at the state and federal levels,” said Roelof Slump, who manages operational risk for structured finance at Fitch. “Potential changes to how the CFPB is funded are not likely 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 intentional – to keep the agency free from political pressures. The court, however, said the funding was unconstitutional because the agency was answerable neither to the people nor to Congress.
“I think the court’s ruling on the illegality of the CFPB’s funding mechanism is correct, as 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 loan crisis of the 1980s. “What this means in terms of the legality of the CFPB’s past actions is difficult to predict.”
Andreano expects the courts to find an interim solution, but that Congress will eventually have to change the funding structure of the CFPB, “I see there is a solution, but I think the lobbyists are going to be very busy for some time.”
Jaret Seiberg, managing director of the 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 funding.
In fact, he said the GOP might try to fully fund him.
“We appreciate the industry’s frustrations with the CFPB, but an agency without funding could be worse as the laws would still apply, but the advice and safe havens that financial firms rely on to defend themselves from litigation can becoming disabled,” he wrote.
The CFPB, meanwhile, said the ruling would not prevent it from policing consumer lenders.
“The CFPB will continue to fulfill its statutory mission of enforcing federal law and protecting Americans from predatory financial institutions. Illegal practices are still illegal, and the CFPB will hold companies accountable when they break the law,” the agency said in a statement. .