In a decision that surprised just about everyone, the U.S. Supreme Court rebuffed the Comptroller of the Currency’s expansive federal preemption claim, ruling that states have the authority to enforce their consumer protection laws against national banks.
That decision, in Cuomo v. The Clearinghouse Association, reversed a virtually unbroken stream of court rulings upholding and expanding the federal preemption principle established in the National Bank Act. The narrow (5-4) decision also boosts a provision of the Obama Administration’s proposed Consumer Protection Financial Agency, which would undercut federal preemption authority. (See related item, below).
The majority opinion, written by Justice Antonin Scalia, turned on the interpretation of the “visitorial powers” language in the National Bank Act. The majority rejected as “unreasonable” the OCC’s interpretation — that the language precludes state regulators from enforcing laws that are not otherwise preempted. States must be allowed to pursue enforcement actions against companies operating within their borders, the majority (an unusual coalition formed by Scalia and the court’s most liberal members) said, as long as no federal laws specifically prohibit them from doing so. But the decision also drew a line, holding that while states can pursue judicial enforcement actions against national banks, they cannot issue subpoenas compelling them to provide information to state regulators.
The minority opinion, written by Justice Clarence Thomas, argued that the meaning of “visitorial powers” was ambiguous, and, as a result, the courts should defer to the OCC’s interpretation of it.
The underlying case began when Elliot Spitzer, then the attorney general of New York, tried to investigate the mortgage lending practices of several large national banks. The Comptroller interceded, saying national banks were not subject to state scrutiny. A District Court and the U.S. Court of Appeals for the Second Circuit agreed, rejecting Spitzer’s contention that the OCC’s broad interpretation of the preemption authority established in the National Bank Act improperly tilted the balance of power between the state and federal governments.
Andrew Cuomo, who replaced Spitzer as attorney general, inherited the case and sought the Supreme Court review. Although the High Court considered the preemption question just two years ago (in Watters v. Wachovia) and decided it in favor of federal regulators, the court’s decision to revisit the question led some analysts to speculate that the justices were going to rethink the court’s position. That turned out to be accurate.
Although the decision affirms the right of state regulators to file suit against commercial banks to enforce fair lending laws, it also leaves their hands tied, to some extent, by precluding them from examining the banks or using subpoenas to engage in “fishing expeditions” to detect evidence of wrong-doing.
Banking industry executives have warned that the decision will subject financial institutions to a patchwork of potentially contradictory state enforcement actions, but some analysts say that vastly overstates the likely impact. “Obviously there’s going to be some additional burden on the big banks,” Seth Galanter, of counsel to the law firm Morrison & Foerster (who filed an amicus brief supporting the Comptroller’s position) told the Washington Post. “But civil litigation has always been available to private parties,” Galanter noted. “This just adds state attorneys general to the list of groups that can sue.”
CONSUMER PROTECTION BATTLE
Vowing to “level the playing field for consumer” and correct “a cascade of mistakes” responsible for the worst economic downturn since the Depression, President Barack Obama has proposed the creation of a new Consumer Financial Protection Agency (CFP) with sweeping authority to regulate a broad spectrum of financial products and services.
Part of the massive overhaul of financial regulatory infrastructure the Obama Administration has outlined, the new agency would strip consumer protection responsibility from federal bank regulators. Separating the safety and soundness and consumer protection functions in this way will ensure “a consolidated focus on consumer and investor protection,” Obama said in a series of media interviews promoting his initiative. He blamed the “divided attention “of regulators in part for the subprime mortgage crisis and the financial unraveling it triggered.
Consumer advocacy groups have lined up quickly to support the proposal, which the banking industry is gearing up to oppose. Donald Ogilvie, chairman of the Deloitte Center for Banking Solutions, summarized the unfolding debate succinctly, telling the New York Times, “The argument for doing this is you’ll have an agency focused on protecting consumers. The argument against is, you’ll have an agency that is only interested in protecting consumers.”
As described in a Treasury Department white paper summarizing the proposal, the agency would have “full supervisory and enforcement authority” over banks and non-banks with the power to enforce fair lending laws , including RESPA, HOEPA and HMDA and some components of the Community Reinvestment Act (CRA). The broad authority “ensures that banks, nonbanks, and independent mortgage brokers will all play by the same rules and that no lender or broker falls between the cracks of supervision or enforcement,” the Treasury summary explains. The new agency will have the authority to:
- Dictate consumer disclosures
- Require mortgage lenders to include “plain, vanilla” loans with fixed rates and straightforward terms, among their other products
- Limit or ban prepayment penalties
- Prohibit mandatory arbitration clauses in financial products
- Require originators to retain some credit risk in the loans they sell
- Create a fiduciary duty for mortgage brokers, requiring them to offer the “best available” products for consumers
- Protect consumers from abusive and discriminatory lending practices and ensure access to financial services and products for underserved consumers and communities.
- Impose “tailored” restrictions on product terms and industry practices “when the benefits of the restrictions [for consumers] are deemed to outweigh the costs [for financial institutions.]”
Unnerving to banking industry executives, the breadth and reach of the new agency are applauded by consumer advocates, who say a strong consumer protection hand is an appropriate and essential response to the financial crisis from which the economy is struggling to recover.
Industry executives are questioning both the “unprecedented” grant of power to the new agency, and the premise that the consumer protection and safety and soundness functions of bank regulators should be separated. Credit unions, which don’t often agree with banks, agree on that point. In a letter to the House Financial Services Committee, Fred Becker, president of the National Association of Federal Credit Unions, noted the need to ensure that the regulators responsible for consumer protection “have knowledge of the institutions they are examining and guidance on consumer protection [as well].” This is especially important for credit unions, Becker said, “as they are regulated and structured differently than other [financial institutions].”
Becker suggested as a compromise, giving the new consumer protection agency authority over non-depository institutions, while establishing separate consumer protection offices within each of the regulatory agencies, with responsibility for ensuring that regulators “are looking out for consumer concerns.”
Rep. Barney Frank (D-MA), chairman of the House Banking Committee, has said he expects his committee to mark up the CPFA legislation before the August recess. While banking industry lobbyists are hoping the opposition will gain traction before then, they also recognize that, with both Frank and Sen. Christopher Dodd (D-CT), chairman of the Senate Banking Committee, supporting the Administration proposal, they face an uphill battle.
Public opinion, turned negative by the multi-billion-dollar bail-out of the banking industry and the perception that banks were at least partly to blame for the economic melt-down will make that climb even steeper. The recent adoption of legislation to curb credit card abuses (and the widely shared public perception that the curbs were needed) certainly won’t help the industry’s argument that an agency charged with protecting consumers from dangerous financial products is a bad idea. Even ignoring that background, the industry’s position is less than comfortable. As one industry executive told recently, “Opposing a consumer protection agency sounds really terrible, no matter how you try to spin it.”
MORE REVERSE MORTGAGE WARNINGS
The mandatory HUD counseling programs designed to make sure consumers understand the complexities and risks of reverse mortgages are not providing the protection the borrowers who obtain these loans need, a report by the Government Accountability Office (GAO) has concluded.
Most of the reverse mortgages are insured by the Federal Housing Administration under HUD’s Home Equity Mortgage Conversion (HECM) program. HUD officials say the federal program provides more protections for consumers -- including limits on up-front costs and the mandatory counseling – than private sector alternatives. But the GAO report found that HUD “lacks effective controls” to ensure that the counselors are providing the information borrowers need.
In an “undercover’ survey of 15 counseling sessions GAO testers found that while counselors “generally conveyed accurate and useful information,” none covered all the information HUD requires. Nearly half (7 of the 15) neglected to discuss alternatives to reverse mortgages and some “overstated” the length of the sessions, implying that they were more comprehensive than they actually were. Because of weaknesses in HUD’s internal controls, the report found, “some prospective borrowers may not be receiving the information necessary to make informed decisions” about reverse mortgages.
GAO undertook the study at the request of Sen. Claire McCaskill (D-MO), who has held several hearings on reverse mortgages (the most recent two weeks ago in Missouri) to explore her concern about potential abuses in the marketing of the increasingly popular loan product. The GAO study found evidence of some of the concerns she has expressed, noting, among other problems: “Potentially misleading” and “inaccurate” sales claims and “questionable sales tactics,” primary among them, the “inappropriate” cross-selling of reverse mortgages and products “such as annuities that are “unsuitable” for older borrowers.
The GAO recommended that HUD and the bank regulatory agencies take steps “as appropriate, to strengthen oversight and enhance industry and consumer awareness of the types of marketing claims” highlighted in the report.
Separately, Comptroller of the Currency John Dugan also expressed concerns about reverse mortgages in a recent speech, likening them to subprime mortgages in the risks they pose for borrowers and lenders. “I believe the critical lesson here is the need to act early before problems escalate,” Dugan cautioned.
An article in Money magazine last month echoed these concerns, noting the dramatic increase in reverse mortgage originations (112,000 in 2008 compared with 22,000 in2003) and recent predictions that the FHA will lose as much as $800 million on its reverse mortgage portfolio in the next fiscal year. The article cautions consumers contemplating reverse mortgages not to “fall for a pitch from a salesman who cares more about a lucrative commission than determining whether a reverse mortgage is makes sense for you.”
CRITICIZING THE CODE
The criticism of the new appraisal code is growing louder, with many industry critics blaming the code – and appraisals generally – for exacerbating the housing downturn. Fannie Mae and Freddie Mac implemented the code – the Home Valuation Code of Conduct – in May, as part of an agreement with New York Attorney General Andrew Cuomo, who had threatened to subpoena the GSEs to determine whether they had purchased loan based on inflated appraisals.
Reps. Travis Childers (D-MI) and Gary Miller (R-CA) have introduced legislation that would suspend the code, which, among other restrictions, bars lenders and brokers from ordering appraisals directly from appraisers. Critics, including lenders, mortgge brokers, real estate brokers, home builders and appraisers, complain that the insertion of a middle-man (appraisal management companies) into the process increases costs for borrowers, slows the closing process and is producing inferior appraisals.
Other critics say declining home prices, a large volume of distress sales, and gun-shy appraisers (who were blamed, in part, for inflating hope prices during the bubble) are more of a problem. The National Association of Home Builders is calling for new guidelines that will restrict the use of foreclosures and distressed sales as comparables in market purchase transactions.
“Any home buyer can recognize the difference between a well-kept home and a distressed property that is damaged or not properly maintained,” Joe Robson, chairman of the NAHB, said in a recent press statement. “So it only makes sense that an appraiser should be required to consider the overall condition of a property and the specific factors related to a foreclosure or distressed property sale when selecting and adjusting the value of comparables,” he added.
Failure to distinguish between foreclosures and non-distressed sales artificially devalues new transactions, Robson said. “This practice must be corrected,” he urged, “because it contributes to the continuing downward spiral in home prices, forestalling the economic recovery.”
Here’s a study you aren’t likely to find highlighted by the National Association of Realtors (NAR): Grace Bucchianeri, a professor of real estate at the Wharton School of Business, has studied the relative happiness of home owners and renters, and concluded that homeowners rank lower on that gauge. Although owners regularly report “higher life satisfaction and more joy” derived from their homes and neighborhoods than renters, and “better moods” overall, Bucchianeri reported, “these promising differences become insignificant and much smaller in magnitude” after adjusting for key factors, such as household income, housing value and health status. Making those adjustments, Bucchianeri said, she finds “little evidence that homeowners are happier [based on] overall mood, overall feeling [and] general moment-to-moment emotions.” On the contrary, Bucchianeri reported, the barometers she used found that homeowners “consistently derive more pain (but no more joy) from their house and home.”
Her study is based on data collected from more than 600 homeowners in 2005 – before the housing crash, so the decline in home values and accompanying loss of equity were not factors in the responses. Among other indicators, Bucchianeri found that home owners on average spend less time pursuing leisure activities with friends, experience more negative feelings when interacting with friends, derive less joy from love and friendships, are less likely to enjoy being with people, and, on top of fall of that, tend to be 12 pounds heavier on average than renters.
Bucchianeri says her research doesn’t suggest that homeowners hip is a bad idea (she is, herself, a homeowner), but it does indicate that the link between happiness and the “American Dream” of homeownership is overstated and may be driving inappropriate government policies designed to encourage homeownership. “This romantic view of homeownership alludes to important private and external benefits of homeownership, separate from the benefits of housing consumption on its own," she writes. “Without more careful analysis,” she cautions, “important public policy matters, such as preserving the mortgage interest tax deduction or other support for housing programs, may be impacted by incomplete, or misleading, information.”