CFPB “Plain Vanilla” Through the Back Door

For those who recall the initial proposal for the CFPB, one of the cornerstones of the agency’s agenda would be the power to provide preferential treatment for so-called “plain vanilla” financial products that lenders would be required to offer to consumers.  This proposal was a non-starter on Capitol Hill and was quickly dismissed from the legislation.

Despite Congress’s clear intent to reject the “plain vanilla” concept, I have argued that the CFPB appears to remain committed to the concept and is likely to try to impose “plain vanilla” preferences for certain products through the back door: rather than requiring lenders to offer plain vanilla products on a preferred basis, CFPB instead will simply create safe harbors from liability and other incentives to offer plain vanilla products rather than other products.  Thus, whether by affirmative mandates or by back-room incentives, the effect is the same, which will be to prefer so-called plain vanilla products over other products.  I cited the CFPB’s rule-making on “Qualified Mortgages” as an example of this dynamic at work.

Thus, it was interesting that Alan Blinder seemed to acknowledge as much yesterday in the WSJ, that the mortgage rule-makings create plain-vanilla through the back door:

 Mortgages and securitization. Piles of unconscionably bad mortgages—underwritten by irresponsible bankers, permitted by somnolent regulators, and passed on like hot potatoes to investors via securitization—were a major contributor to the financial crisis. One response in Dodd-Frank was a “risk retention” rule requiring issuers of asset-backed securities to retain at least 5% of the credit risk, rather than pass it all on to investors. The idea was that a little “skin in the game” would make Wall Street firms a bit more cautious about what they securitized.

But there was a catch. The 5% requirement does not apply to “qualified residential mortgages” (QRMs)—a term left to regulators to define, but intended to exempt safe, plain-vanilla mortgages with negligible default risk. Dodd-Frank does not ban mortgages that do not qualify as QRMs, nor even does it prevent such mortgages from being securitized. It only requires that lenders retain a tiny portion of the credit risk.

Also, leaving aside the apparent effort to impose “plain vanilla” through rule-making is Blinder’s misunderstanding of the underlying facts itself: the majority of foreclosures from 2007-2010 were on fixed-rate mortgages–59% according to this estimate (which is pretty typical).  And, as I have noted, the underlying foreclosure problem in the end was a matter of lack of equity in houses and the incentives that created–yet the QM rulemaking, at least, did nothing about requiring higher downpayments, thus is it largely irrelevant to the underlying dynamics that caused the foreclosure crisis in the first place or the ability of homeowners to refinance their mortgages (in fact, Dodd-Frank does exactly the opposite).

As an aside, since I linked to the original Obama Administration White Paper above, it is worth pointing out (again) that one of the key features of the original proposal was that the CFPB would be structured as a multi-member board and at least one seat on the new entity would be reserved for a prudential regulator (p. 58):

The CFPA should be structured to promote its independence and accountability. The CFPA will have a Director and a Board. The Board should represent a diverse set of viewpoints and experiences. At least one seat on the Board should be reserved for the head of a prudential regulator.

Apparently all those arguments are inoperative now and the only way to run the CFPB is through a single director with no background in financial services or financial services regulation.

Update: Robert Pozen has more along the same lines in today’s WSJ:

Most of the remaining home mortgages would be considered QRMs—qualified residential mortgages—under the recent proposals. QRMs are supposedly high-quality mortgages whose originators would retain any risk of loss if the mortgages were sold.

In 2011, federal regulators initially defined QRMs to include two critical conditions—that the borrower make a down payment of at least 20% of the home’s value, and that the total debt payments not exceed 36% of the borrower’s income. Both conditions were condemned by the mortgage industry, and in response, the definition of a QRM no longer requires any down payment. The new regulatory proposal also increased a borrower’s debt-to-income ratio to 43% from 36%.