Obama Regulatory Reform: Right Idea — Not Far Enough

The President’s new effort at regulatory reform ought to be applauded, at least for the reason that we once-again have a president who believes that regulation is a legitimate government activity. That said, the President’s 89-page regulatory reform proposal falls short because it does address two issues: Getting regulators to regulate and creating a fiduciary obligation to borrowers at the federal level.

The Federal Reserve, under section 129(i) of the Home Ownership and Equity Protection Act (HOEPA) has had the authority since 1994 to banish loan products which it defines as “unfair and deceptive acts or practices (UDAP).” Had the Fed used this authority in 2002, 2003 or 2004 it could have outlawed option ARMs, interest-only mortgages and loans made with stated-income loan applications — the applications where lenders do not check income. The result would have been far fewer toxic loans in your neighborhood and mine, far fewer toxic assets on Wall Street and little or no mortgage meltdown.

The Fed Didn’t Act

However, the Fed, under Alan Greenspan, didn’t act. The Fed did nothing to protect the public even though appropriate regulations were on the books and in place.. No additional action or authority by Congress or the President was required. Instead of a small problem, a crucial opportunity to end the mortgage mess before it got out of hand was lost.

Understand that the problem of toxic loans was well known. As one example, I wrote at the time that:

“What’s obviously best is to get the numbers right when making a loan application,” it said here in November 2004. “It’s equally obvious that ’stated income’ mortgages open the vault to temptation. Such no-tell loans ask borrowers what they earn and the borrower then puts down a number. Unlike a typical mortgage application, the lender usually does not verify the figure with tax returns, pay stubs or calls to employers.”

Of course, if it happens that those self-estimates of income are off a touch then lenders will have problems.

“With a growing number of stated income loans on the books, financing with exaggerated numbers could quickly become a lender concern if home values dip, the economy slows and monthly payments don’t show up. That’s the point at which stated income loans will come home to roost.” (See: How Much Is Too Much? November 16, 2004)

Rules and regulations are worthless if you have officials who do nothing. The new regulations ought to include a provision for firings, fines and jail for federal officials who fail to act in the public interest.

Real Consumer Protection Is Missing

There is a way to clean up the mortgage industry — make loan officers have a fiduciary obligation to get the best rates and terms for borrowers. The lending industry is opposed to such a standard, or at least much of the lending industry is opposed.

What is a “fiduciary” obligation? It’s merely the requirement that when you hire someone they will act in your best interest; that they will put your needs ahead of their opportunity to sell you the most expensive product or service they can find. Generally, a “fiduciary” obligation can be defined by remembering these four initials: C-O-A-L:

Care for the client’s interests.

Obedience to the client’s lawful instructions.

Accountability for the client’s money and paperwork.

Loyalty to the client by not working for a competing interest.

The President’s proposal seeks to protect investors on Wall Street but not mortgage borrowers. This means when you go to get a mortgage you cannot be certain that the loan officer on whom you depend for information, ideas, advice, counsel and product options is going to do anything but sell you the loan with the highest-possible mark-up. If you think this sounds like dealing with a car salesman, you’re partially right — auto buyers in many states are protected if they are sold a lemon but the same is not true for mortgage borrowers.

Fiduciary Obligations

Doctors have an obligation to their patients, lawyers have an obligation to their clients, buyer brokers and listing brokers have an obligation to their buyers and sellers respectively but loan officers have no obligation to borrowers under federal rules. Until this obvious and overt problem is corrected the process of getting a loan will never offer a fair and even playing field for borrowers.

Many in the mortgage industry would like to see the situation changed. There are honest and ethical institutions and loan officers. They would welcome government regulation to protect their clients and themselves — and because they would sleep better at night.

The President is right to try and regulate Wall Street but he needs to go further. He needs to help folks on Main Street who don’t have millions of dollars or lots of lawyers, accountants or PAC money. Think of the President’s announcement as step one on the road to real reform.

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