Docstoc

fitzpatrick

Document Sample
fitzpatrick Powered By Docstoc
					 Home Loan Securitization: Implications for
 Consumers & Consumer Protection
                                       Consumer Protection in Financial Product Markets
                                       September 11, 2009
                                       Thomas J. Fitzpatrick IV, Esq.
                                       Economist, Office of Policy Analysis


The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank
of Cleveland of Board of Governors of the Federal Reserve System.
Disclaimer: Don’t Blame my Employer

   The views expressed here are mine, and do not
necessarily reflect the views of the Federal Reserve Bank of
Cleveland, the Board of Governors, or other Banks in the
Federal Reserve System.




2
Overview


1. Revolution in Home Mortgage Lending
2. Incentives of the Parties to a Securitization
3. Implications for Consumer Protection
4. Realigning Market Incentives




3
Revolution in Home Mortgage Lending:
Historic Mortgage Lending


                  $ Loan



                   Mortgage



                $ Payment Stream




4
Revolution in Home Mortgage Lending:
Securitization’s Structural Changes


                        Lender

                        Lender   Arranger
    Borrower   Broker
                        Lender   Arranger

                        Lender




5
Revolution in Home Mortgage Lending:
Setting Loan Terms is a Top-Down Process

                    Arranger
                               Terms Important to
                               Securitization &
                               Desirable to Investors
                    Lender
      Rate Sheets

                    Broker
                                Loan Terms & Disclosures

                    Borrower


6
Incentives of the Parties to a Securitization:
Why Don’t Borrowers Negotiate Loan Terms?
 Do Disclosures Facilitate Negotiation?
    - Often criticized for being numerous, late, incomplete, complex,
      and do not encourage loan shopping
    - Less than 50% of prime borrowers shop interest rates “a lot”,
      less than 33% of subprime borrowers do the same
       Marsha J. Courchane, Brian J. Surette & Peter M. Zorn, Subprime Borrowers: Mortgage Transitions and Outcomes, 29 J. of
        Real Estate Fin. and Econ. 365 (2004)

    - Nearly 70% of consumers disagree that most people read TILA
      statements carefully
       Thomas A. Durkin & Gregory Elliehausen, Disclosure as a Consumer Protection, in The Impact of Public Policy on
        Consumer Credit (Thomas A. Durkin & Michael E. Staten eds., 2002)

    - Over 40% of American adults believe that lenders are required
      by law to give them the best possible rates
       Fannie Mae Foundation, Understanding America's Homeownership Gaps: 2003 National Housing Survey (2004)




7
Incentives of the Parties to a Securitization:
Why Don’t Borrowers Negotiate Loan Terms?
 Borrowers Outsource Decision Making to Brokers
    - Common when faced with complex decisions
       Robert B. Cialdini, Influence: Science and Practice 9, n.5 (4th ed. 2001); Howard Latin, “Good” Warnings, Bad Products, and
        Cognitive Limitations 41 UCLA L. Rev. 1193, 1209 nn. 55-57

    - Nearly 70% of consumers agree that TILA makes people more
      confident dealing with creditors
       Thomas A. Durkin & Gregory Elliehausen, Disclosure as a Consumer Protection, in The Impact of Public Policy on
        Consumer Credit (Thomas A. Durkin & Michael E. Staten eds., 2002)

    - Brokers are considered Trusted Advisors, yet unlike other
      brokers of other products, there is no duty to help the borrower
      select a suitable product




8
Incentives of the Parties to a Securitization:
Mortgage Brokers/Loan Officers
 Financial Incentives: High Volume, Repeat Business
    - Yield spread premium (illusion of no charge)
    - Closing costs (numerous “junk fees”)
    - Loans that result in refinance
 What About Pleasing the Customer?
    - Price shopping not important for customer satisfaction
    - Customer service & convenience in obtaining the loan listed
      first, interest and closing costs listed last




9
Incentives of the Parties to a Securitization:
Lenders & Arrangers
 Volume & Specific Loan Terms
     - In securitization transactions, everyone gets paid on volume:
       each party gets a piece of the payment stream and/or fees
       generated with each deal
     - Prepayment penalties, arbitration clauses
 Use Information Asymmetry to Extract Rents?
     - Securitized loans do not perform as well as loans held on book
        Benjamin J. Keys, Tanmoy Mukherjee, Amit Seru, Vikrant Vig, Financial regulation and securitization: Evidence from
         subprime loans, 56 J. of Monetary Econ. 700 (2009); Antje Berndt & Anurag Gupta, Moral Hazard and Adverse Selection in
         the Originate-to-Distribute Model of Bank Credit http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1290312


 Disincentives to Investigate Legal Quality of Loans
     - Auditing loan files is expensive
     - Modeling: refis & prepayment penalties
10
     - Holder in Due Course rule penalizes investigation
Revolution in Home Mortgage Lending:
Implications for Consumer Protection
 Holder in Due Course Rule
     - Strips borrowers of defenses to payment when the loan is sold
     - Originates in the 1700s
     - Historically it rarely applied to home loans
     - Borrowers are often unable to recover from unscrupulous
       brokers, who have powerful tools to avoid liability
     - Discourages loan purchasers from investigating underwriting
       quality and origination practices
 Borrowers May be Overpaying for Credit
     - YSPs do not offset upfront costs
     - Lack of transition from subprime to prime


11
Realigning Market Incentives:
Brokers
 Brokers owe Limited Duties to Borrowers
     - Must not commit fraud, violate UDAP laws, but no duty to
       ensure borrower’s obtain suitable products
     - Effectively economic agents of lenders/arrangers, who influence
       with loan purchases
 Duty of Care to Borrowers Balances Broker Financial
  Incentives
     - Allows borrowers to collect, ex post, for violations
     - Duties highly customizable, exist almost everywhere else
 Duty of Care Alone Not Sufficient
     - Thinly capitalized corporations can be abandoned
     - Some jurisdictions imposed them
12
Realigning Market Incentives:
Lenders & Arrangers
 Removing HDC Rule: Imposing Assignee Liability
     - Would make loan purchases liable for unlawful originator
       conduct
     - May allow offensive claims, defensive claims, or both
     - Requires minimal government intervention in markets
 Federal Trade Commission took Similar Action
     - In the 1970s, the sale of promissory notes arising out of
       consumer goods purchases led to a similar market structure &
       problems
     - FTC imposed assignee liability to encourage the market to police
       itself & optimize costs of unlawful actions
     - Effective in accomplishing its goals
        Termination of Review, 57 Fed. Reg. 28,814 (June 29, 1992)

13
Realigning Market Incentives:
Impact on the Parties
 Pure Conjecture: What Impact Might We Expect to See?
     -Appropriate access to innovative products
     -Increased costs for brokers & lenders
     -Change in methods of broker compensation
     -Should not run “honest brokers” out of business
     -Should run “dishonest brokers” out of business
     -Should result in the cost of credit reflecting the total cost of
      lending




14
Realigning Market Incentives:
Impact on Parties
 Past Research: What Do Studies Tell us?
     - Studies on the FTC Rule’s impact on consumer credit are mixed,
       at best
        William H. Lawrence & John Minan, The Effect of Abrogating the Holder-in-Due-Course Doctrine on the
         Commercializatoin of Innovative Consumer Products, 64 B.U. L. Rev. 325, 338 n.51 (1984)

     - Studies of the impact of “predatory lending” laws imposing
       assignee liability in home mortgage markets suggest little impact
       on the flow of credit
        Keith D. Harvey & Peter J. Nigro, Do Predatory Lending Laws Influence Mortgage Lending? An Analysis of the North
         Carolina Predatory Lending Law, 29 J. of Real Estate Fin. & Econ. 435 (2004); Giang Ho & Anthony Pennington-Cross,
         The Impact of Local Predatory Laws on the Flow of Subprime Credit: North Carolina and Beyond, (Federal Reserve Bank
         of St. Louis March 2006); Raphael W. Bostic, Kathleen C. Engel, Patricia A. McCoy, Anthony Pennington-Cross, Susan M.
         Wachter, State and Local Anti-Predatory Lending Laws: The Effect of Legal Enforcement Mechanisms (Aug. 2007)




15
Realigning Market Incentives:
Impact on Parties
 Future Research: What Questions Remain Unanswered?
     - Do a duty and/or assignee liability reduce instances of consumer
       abuse?
     - What impact will a duty and/or assignee liability have on new
       entrants in the market?
     - What impact will a duty and/or assignee liability have on the
       cost of credit?
     - What impact will a duty and/or assignee liability improve
       borrower outcomes?
        Raphael Bostic, Souphala Chomsisengphet, Kathleen C. Engel, Patricia A. McCoy, Anthony Pennington-Cross, Susan M.
         Wachter, Mortgage Product Substitution and State Anti-Predatory Lending Laws: Better Loans and Better Borrowers?
         (Institute for Law and Economics Research Paper No. 09-27)




16

				
DOCUMENT INFO
Shared By:
Categories:
Stats:
views:36
posted:1/2/2011
language:English
pages:16