Bloomberg has an absolutely amazing story this morning about political economy and going the extra mile to build a successful business. Specifically it’s about a guy who
- worked as a mortgage banker,
- left to be a senior banking consumer-protection regulator,
- wrote regulations prohibiting big banks from providing certain kinds of mortgages because they were too predatory, and
- then left to start his own company to provide those mortgages.
That’s pretty much the American dream is it not?
The story is unimprovable so go read it; I have exaggerated but only slightly.1 The guy is Raj Date, a former Capital One and Deutsche Bank2 banker who became deputy director of the Consumer Financial Protection Board, wrote rules making it hard for banks to make mortgages that don’t satisfy certain bright-line requirements, and then left to start a company called Fenway Summer LLC that will do what banks can’t:
“There are plenty of borrowers who are eminently responsible people but fall outside of the bright-line boundaries,” Date said in a telephone interview. “And there’s a meaningful-sized business that can be quite good for borrowers and for lenders and investors to be able to satisfy that need.”
Heeheeheeheehee how pissed would you be if you were the bank lobbyist who came to Date last year and said “There are plenty of borrowers who are eminently responsible people but fall outside of the bright-line boundaries, can you change the boundaries?” and Date was like “No that’s crazy talk”? Pretty pissed, right?
What if you’re not a bank lobbyist, should you be mad? Meh. I wouldn’t worry that he’s actually planning to make predatory loans. That does not seem to be the plan. There are bright-line rules that some loans are not predatory; other loans you have to do your own underwriting, make your own conclusion that they’re not predatory, and be prepared to live with the consequences. “Consequences” is, as always, a synonym for “lawsuits.” As he puts it:
“The basic rule of the road applies to everybody, which is you have to make a loan to somebody with the ability to repay it,” Date said. “The difference is just that there’s a safe harbor for certain kinds of loans and there’s not for others. If there’s no safe harbor, then you have to be especially confident in your ability to calibrate and price for credit risk. Frankly, that’s what the differentiator is going to be for the firm we’re trying to build.”
So his differentiator versus mortgage banks is going to be that he’s better at calibrating and pricing for credit risk. I mean, maybe? You don’t hear a lot of people accusing mortgage banks of being great at that. Though another differentiator might be “we can better handle the lawsuits and general regulatory scrutiny of our non-qualified loans because we are run by the former deputy director of the CFPB.” But, sure, it could be both.
Should you be mad that, at the CFPB, he made it too hard for big banks to make those non-predatory, good, but non-qualified loans? If you’re not a lobbyist I mean. Substantively I don’t think so – the rules don’t make it all that hard3; after all he’s doing it – and politically, what, you’re gonna get mad at a regulator for being a bit too zealous about preventing banks from making predatory loans? Good luck with that.
So, really, no reason to begrudge Raj Date his dream of driving competitors out of a line of business and then taking it over himself. Mostly I’m just telling you about it because it’s such a beautiful piece of business and I wish I’d thought of it.
But also because, y’know, he could have gone back to Deutsche Bank. The financial services industry is largely a creature of regulation and its avoidance, and focusing your competitive energy on regulatory capture, regulatory arbitrage, and regulatory tinkering is at least as rewarding as focusing it on, like, customer service. If that troubles you, the revolving door between big banks and their regulators should also trouble you. And efforts by former regulators to compete with banks, rather than join them, might make you sort of happy. It’s a weird form of competition, but it’s better than nothing.
1. Or, like, a medium amount. Basically the CFPB has a rule that prohibits lenders from making mortgage loans “without regard to the consumer’s ability to repay the loan.” Certain “qualified mortgages” are presumed to comply. (Here is an official summary, here is a law firm summary.) Officially you need to make a bunch of multi-factor determinations if you’re making a non-qualified mortgage; from the official summary:
At a minimum, creditors generally must consider eight underwriting factors: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; (6) current debt obligations, alimony, and child support; (7) the monthly debt-to-income ratio or residual income; and (8) credit history. Creditors must generally use reasonably reliable third-party records to verify the information they use to evaluate the factors.
On the other hand “qualified mortgages” are presumed (conclusively, if they’re not “higher-priced” mortgages, or rebuttably, if they are) to comply. Qualified mortgages are basically vanilla ones:
The final rule implements the statutory criteria, which generally prohibit loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years from being qualified mortgages. So-called “no-doc” loans where the creditor does not verify income or assets also cannot be qualified mortgages. Finally, a loan generally cannot be a qualified mortgage if the points and fees paid by the consumer exceed three percent of the total loan amount, although certain “bona fide discount points” are excluded for prime loans. The rule provides guidance on the calculation of points and fees and thresholds for smaller loans.
The final rule also establishes general underwriting criteria for qualified mortgages. Most importantly, the general rule requires that monthly payments be calculated based on the highest payment that will apply in the first five years of the loan and that the consumer have a total (or “back-end”) debt-to-income ratio that is less than or equal to 43 percent. The appendix to the rule details the calculation of debt-to-income for these purposes, drawing upon Federal Housing Administration guidelines for such calculations. The Bureau believes that these criteria will protect consumers by ensuring that creditors use a set of underwriting requirements that generally safeguard affordability. At the same time, these criteria provide bright lines for creditors who want to make qualified mortgages.
There is also “a second, temporary category of qualified mortgages that have more flexible underwriting requirements so long as they satisfy the general product feature prerequisites for a qualified mortgage and also satisfy the underwriting requirements of, and are therefore eligible to be purchased, guaranteed or insured by” Fannie, Freddie, etc., even at a debt-to-income ratio above 43%. So any conforming loan is fine, for now.
Basically: if you make qualified (or conforming) mortgages, defaulting borrowers can’t sue you on ability-to-pay grounds; if you make non-qualified mortgages, they can, and you’ll have to make a multifactor squishy argument about all the things you looked at. Which is easy to do, if you’re an ex-regulator set up for this purpose, but harder if you’re a giant bank who can barely keep track of the mortgages you’re making.
There’s another reason that big banks might prefer qualified mortgages, which is that Dodd-Frank requires “that a ‘securitizer’ retain 5 percent of the credit risk unhedged on any securitized asset unless the securitization consists solely of ‘qualified residential mortgages.’” QRMs are a subset (perhaps an improper subset) of CFPB “qualified mortgages,” so anything that isn’t a qualified mortgage can’t be sold off 100% to a securitization. This is not a huge deal because (1) it doesn’t restrict conforming mortgages sold to Fannie and Freddie, (2) it’s unlikely to restrict a lot of jumbo mortgages that much (as they’re likely to be qualified), and (3) it will restrict private-label subprime securitizations but hahahaha other things restrict those too. In that private-label subprime securitizations don’t exist right now and probably won’t for quite some time. But eventually they could (and also non-qualified jumbos really), and big banks would probably rather make loans that they can securitize than loans that they can’t.
3. I guess now would be a good time to read footnote 1 if you haven’t already. I mean there’s never really a good time to read footnote 1 but if you care about whether the CFPB rules are too restrictive you might as well know what they say.