Mortgage companies and the new regulatory regime

Introduction

Everyone knew it was coming. With all the turmoil in the American financial system, a push for re-regulation was inevitable. The Obama administration’s sweeping plan, announced today, includes the creation of a Consumer Financial Protection Agency (CFPA). And tucked into that section of the 85-page white paper is a critical detail: For the first time, non-bank mortgage companies would be subject to regulation from the federal government.

These aren’t just fly-by-night companies making a few small loans. Almost half of the subprime loans issued between 2005 and 2007, at the height of the bubble, were made by non-depository mortgage lenders, currently regulated at the state level.

Non-depository lenders were responsible for more than $677 billion dollars in subprime loans during that three-year period, according to a Center for Public Integrity analysis of 7.2 million mortgage records. That included companies like Ameriquest, New Century Financial, and Option One, which, unlike traditional lenders, don’t take deposits from borrowers. They traditionally have made mortgage loans, and typically rebuilt their capital by selling those loans, bundled into mortgage-backed securities, on the secondary market.

Loans from those companies dwarf the totals made by institutions overseen by the five federal regulators — the Federal Deposit Insurance Corporation, the Federal Reserve, the Office of Thrift Supervision, the Office of the Comptroller of the Currency, and the National Credit Union Administration.

The Office of Thrift Supervision regulated the next largest group of lenders, which made $220 billion in subprime loans. OTS regulates federal thrifts, including IndyMac, which was seized by the FDIC in July 2008. Also on the OTS roster was Washington Mutual, whose collapse in September 2008 stands as the single biggest bank failure in American history. The agency is slated to fold into the Office of the Comptroller of the Currency under the administration’s plan.

The Federal Reserve was responsible for regulating entities that made more than $200 billion in subprime loans.

Under the administration’s plan, the CFPA’s enforcement authority would apply not only to the federally-regulated institutions, but also to the mortgage companies that, it states, now “fall into a regulatory ‘no man’s land.’” The plan emphasizes that federal regulation would be a “floor, not a ceiling,” and the states would remain “the first line of defense” for supervision of non-bank lenders. But enforcement of the major fair lending laws, including the Truth in Lending Act and the Fair Debt Collections Practices Act, would rest with the CFPA.

All lenders share in the blame for the current foreclosure crisis, says Terry Straub, the director of the Division of Finance at the Florida Office of Financial Regulation. “I don’t think you can isolate one group,” he says. “You’ll see [people] being foreclosed on by a mortgage lender in the state, by subsidiaries of bank holding companies around the nation.”

“Everyone tried to get in on the good times,” Straub continues. “They’re not so good any more.”

Now, all those lenders will be subject to the same rules – if the administration’s plan passes Congress. The CFPA has a head start on the hill: A bill to create a similar agency was introduced by Senator Durbin in March. And Elizabeth Warren, the Harvard University law professor running the Congressional Oversight Panel on TARP – the Troubled Asset Relief Program – has long endorsed the creation of a Financial Products Safety Commission.

Regulation of the non-bank lenders may be a bit late: 9 of the 11 non-depository mortgage companies featured in the Center’s Subprime Top 25 are no longer lending. But the administration seems to be following the advice of Elizabeth Duke, a member of the Federal Reserve Board of Governors, who noted in early June that “the key to successful policy formulation is to resist the temptation to regulate the problem of the moment.”

Sarabeth Sanders and David Donald contributed reporting.