Signage at the Consumer Financial Protection Bureau (CFPB) headquarters in Washington, DC
Andrew Kelly | Reuters
A court last week overturned a Consumer Financial Protection Bureau regulation for payday lenders, saying the agency’s funding was unconstitutional and therefore unable to contain the industry.
The US Court of Appeals for the Fifth Circuit has invalidated 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 attorneys say it clouds the agency’s authority and has the potential to turn all of its rules upside down.
“The Fifth Circuit’s ruling potentially calls into question every single rule, guidance and order the CFPB has issued – since they all have their roots in the CFPB’s unconstitutional self-financing structure,” wrote Holland & Knight Oversight Attorneys Anthony DiResta and Luis Garcia in a note to customers Tuesday.
If the agency’s legal authority is undermined, it could have a profound impact on home loan markets — an industry prone to disruption when laws are unclear, especially when interest rates rise.
“Anything disrupting the mortgage market is potentially going to make it even harder for homebuyers to qualify for a loan,” said Patricia McCoy, a law professor at Boston College.
McCoy points to Georgia after the state passed legislation in 2002 designed to protect consumers from bad debt by allowing them to seek punitive damages from the lender and the buyer of the loan. That widened the potential damage to Wall Street banks and mortgage investors Fannie Mae and Freddie Mac.
Top rating agencies refused to rate pools of mortgage-backed residential securities that included loans originating in Georgia, which had a chilling effect on the MBS market. Fannie and Freddie, who buy mortgages and package them as securities to sell to investors, stopped buying mortgages in the state. The next year, the Georgia legislature changed the law, retiring the liability provisions.
“The Fifth Circuit’s decision threatens to cripple mortgage lending in Mississippi, Louisiana and Texas because lenders lose certainty about which law applies to future mortgages they issue,” McCoy said, referring to the states within the Fifth Circuit. During the Obama administration, she was part of the CFPB’s original leadership team.
Formed after the 2008 financial crisis, the CFPB created a set of rules for the mortgage industry, including standards for a “qualifying mortgage,” which is based on a borrower’s ability to repay a loan. These two rules provide mortgage investors and lenders with redress against borrowers who claim they have been deceived into taking out a loan they cannot afford as long as it meets this standard.
If the Fifth Circuit decision is upheld, these longstanding mortgage rules could be called into question.
Many legal observers believe the decision will eventually be appealed to the Supreme Court. Although the High Court is under no obligation to take a case, it raises significant constitutional issues. It could be a year-long process, with other CFPB agency challenges halted or delayed until the case is resolved.
A complaint would take some time. The Mortgage Bankers Association has advised its members that the ruling is currently limited to the CFPB’s payday loan rule.
“We like to set rules that give us some safe havens for the way we underwrite mortgages, and we don’t want that all to go away,” Robert Broeksmit, president and CEO of the Mortgage Bankers Association, said on Monday the annual meeting of the trade association. Still, he vowed to continue fighting what he called the Bureau’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 challenging several CFPB rules, losing the ability to repay and qualifying mortgage rules would be “devastating,” said Richard Andreano, an attorney who heads the mortgage practice group at law firm Ballard Spahr.
“The loss of CFPB mortgage regulations and the impact on the market would be catastrophic,” Andreano said. He believes the potential ramifications would mean that either the court or Congress would resolve the situation before it had any repercussions. “But of course it increases the uncertainty when you’re in the mortgage business now,” he said.
The protections afforded by repayability and qualifying mortgage regulations also apply to the mortgage bond market, where home loans are packaged into securities and sold to investors. With no established guidelines, the ruling raises questions about how loan assessors and bond investors would treat the loans.
“They don’t want loans in their loan pools that have an increased risk of damage because that risk would extend to the investors buying the securitized bonds,” McCoy said.
S&P Global Ratings and Moody’s Investors Service did not comment, but Fitch Ratings said it would monitor for changes that would directly impact the mortgage market.
“Mortgage originators and service providers are subject to the rules and regulations of a variety of state and federal governing bodies,” said Roelof Slump, who manages operational risk for structured finance at Fitch. “Possible changes in CFPB funding are not likely to have an immediate impact on the mortgage market.”
How the CFPB is funded, by the Federal Reserve rather than by Congress, is at the root of the problem. The design was intentional – to keep the agency free from political pressure. But the court said the funding was unconstitutional because the agency failed to respond to the people or Congress.
“I believe the court’s decision on the illegality of the CFPB funding mechanism is correct, as is its governance structure,” said Bill Isaac, former head of the Federal Deposit Insurance Corp., which oversaw banks during the savings and credit crisis of the 1980s years led . “What that means in terms of the legality of past actions by the CFPB is difficult to predict.”
Andreano expects that the courts will find an interim solution, but that Congress will ultimately have to change the CFPB financing structure: “I can see that there is a solution, but I think the lobbyists will be very busy for some time.”
Jaret Seiberg, executive director of Cowen Washington Research Group, told investors earlier this week that efforts to repair the agency’s funding could be complicated if Republicans gain control of one or both houses of Congress in the Nov. 8 election take over.
In fact, he said the GOP might try to debase them altogether.
“We appreciate the industry’s frustration with CFPB, but a defunded agency could be worse as the laws would still apply but guidance and safe havens that financial firms rely on as a defense against litigation could be invalidated,” wrote he.
The CFPB, meanwhile, said the ruling will not stop it from monitoring consumer lenders.
“The CFPB will continue to fulfill its statutory mandate of enforcing federal laws and protecting Americans from predatory financial institutions. Illegal practices are still illegal, and the CFPB will hold companies accountable if they break the law,” the agency said in a statement.