Court ruling on payday loans could affect mortgage markets

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Signage at the headquarters of the Consumer Financial Protection Bureau (CFPB) in Washington, DC

Andrew Kelly | Reuters

A court threw out a regulation written by the Consumer Financial Protection Bureau for payday lenders last week, saying the agency’s funding was unconstitutional and therefore lacked the ability to rein in the industry.

The US 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 applied only to that regulation, financial services lawyers say it clouds the agency’s authority and has the potential to change all of its rules.

“The Fifth Circuit’s ruling potentially calls into question every rule, guidance and order the CFPB has ever issued, as they all stem from the CFPB’s unconstitutional self-financing structure,” wrote regulatory attorneys Anthony DiResta and Luis Garcia of Holland & Knight. . in a note to clients on Tuesday.

Mortgage standards at risk

If the agency’s legal authority is undermined, it could have a profound effect on mortgage lending markets, an industry prone to disruption when laws are murky, especially when interest rates rise.

“Anything that disrupts the mortgage market will potentially make it even more difficult for homebuyers to qualify for a loan,” said Patricia McCoy, a law professor at Boston College.

McCoy points to Georgia after the state passed a law in 2002 meant to protect consumers from predatory lending by allowing them to seek punitive damages from the loan originator and whoever bought the loan. That spread the potential damage to Wall Street banks as well as mortgage investors Fannie Mae and Freddie Mac.

Major credit rating agencies refused to rate pools of residential mortgage-backed securities containing loans originating in Georgia, which had a chilling effect on the MBS market. Fannie and Freddie, which buy mortgages and package them as securities to sell to investors, have stopped buying mortgages in the state. The following year, the Georgia legislature changed 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 about which law applies to future mortgages they make,” McCoy said, referring to states within the Fifth Circuit. He was part of the original leadership team at the CFPB 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. Those two rules provide legal protection for investors and mortgage lenders against borrowers who claim they were duped into getting a loan they couldn’t afford as long as it met that standard.

likely appeal

If the Fifth Circuit’s decision is upheld, it could challenge those longstanding mortgage rules.

Many legal observers hope the decision will eventually be appealed to the Supreme Court. While the high court is not required to take a case, it raises important constitutional questions. It could be a year-long process, in which other challenges to the CFPB’s authority may be stopped or delayed until the case is resolved.

An appeal would take some time to develop. The Mortgage Bankers Association has been informing its members that the ruling is currently limited to the CFPB’s payday loan rule.

“We like to put in place rules that give us some safe harbors for how we do mortgages and we don’t want that to go away,” Mortgage Bankers Association President and CEO Robert Broeksmit said Monday at the Mortgage Bankers’ Association’s annual convention. the trade association. Still, he vowed to continue fighting what he called the office’s regulatory overreach. “Now is not the time to make you hire more lawyers to try to understand what the office is doing.”

While industry groups have filed lawsuits against various CFPB rules, losing the ability to pay and qualified mortgage rules would be “devastating,” said Richard Andreano, an attorney who heads the mortgage practice group at the law firm. Ballard Spahr.

“The loss of the CFPB mortgage standards and the effect on the market would be catastrophic,” Andreano said. He thinks the possible fallout would mean the court or Congress would fix the situation before it had an impact. “But it adds uncertainty, obviously, if you’re in the mortgage business now,” he said.

Impact on securitisations

The protections provided by the qualified mortgage and ability-to-pay rules also apply to the mortgage bond market, where mortgage loans are packaged into securities and sold to investors. With no set guidelines, the ruling raises questions about how credit raters and mortgage bond investors would treat the loans.

“They don’t want any loans in their loan pools that have a higher risk of damage exposure because that exposure would extend to the investors who buy the securitized bonds,” McCoy said.

S&P Global Ratings and Moody’s Investors Service did not comment, but Fitch Ratings said it will monitor any changes that have an immediate effect on the mortgage market.

“Originators and servicers in the mortgage market are subject to the rules and regulations of myriad state and federal governing bodies,” said Roelof Slump, who heads structured finance operational risk at Fitch. “The potential changes in the way CFPBs are financed 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 at the root of the problem. The design was intentional: to keep the agency free from political pressure. However, the court said the funding was unconstitutional because the agency was not accountable to the people or to Congress.

“I think the court’s decision on the illegality of the CFPB’s funding mechanism is correct, as is its governance structure,” said Bill Isaac, the former head of the Federal Deposit Insurance Corp., who led the banking regulator during the crisis. savings and loans from the 1980s. “What that means in terms of the legality of the CFPB’s past actions is difficult to predict.”

no quick fix

Andreano hopes that the courts will find an interim solution, but that Congress will ultimately have to change the CFPB’s funding structure: “I see there is a solution, but I think the lobbyists will be very busy for quite some time.”

Jaret Seiberg, managing director of Cowen Washington Research Group, told investors earlier this week that if Republicans take control of one or both houses of Congress in the Nov. 8 election, it could complicate efforts to fix agency funding.

In fact, he said the GOP might try to defund him entirely.

“We appreciate the industry’s frustrations with the CFPB, but an unfunded agency could be worse as the laws would still apply, but the guidance and safe harbors that financial firms rely on as litigation defenses may become invalid,” wrote.

Meanwhile, the CFPB said the ruling won’t stop it from policing consumer lenders.

“The CFPB will continue to carry out its statutory mission by enforcing federal law and protecting Americans from predatory financial institutions. Illegal practices remain illegal, and the CFPB will hold companies accountable when they break the law,” the agency said in a statement. a statement. .

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