Qualified Residential Mortgages and Disparate Impact

By: Addison Pierce

In the cataclysmic knee-jerk response to the financial crisis, the Consumer Financial Protection Bureau (CFPB) was born.  Among the hundreds of pages of Public Law 111-203, better known as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), is Title X; The Consumer Financial Protection Act of 2010.  The complex code yields a simple mission: “To make markets for consumer financial products and services work for Americans.” To achieve this task, congress conferred in the CFPB the authority to:

Write rules, supervise companies, and enforce federal consumer financial protection laws; restrict unfair, deceptive, or abusive acts or practices; . . . research consumer behavior; monitor financial markets for new risks to consumers; enforce laws that outlaw discrimination and other unfair treatment in consumer finance.”

What could go wrong?  Clearly, the other financial regulators failed all of us leading up to the crisis, for which the Office of Thrift Supervision (OTS) was sentenced to death, and the Federal Reserve (Fed) was relieved of critical duties.

The creation of the CFPB could be seen as an attempt to increase protections for consumers by establishing a regulator who, unlike the Office of the Comptroller of Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), functions wholly to protect consumers. While the FDIC, OCC, and the other regulators always had the right to exercise consumer protection authority, they all occupied separate spaces within the broader financial regulatory field.  With the addition of the amorphous CFPB, regulatory pressure on consumer protection matters can be consistent. The CFPB is the only regulator “that has authority over national banks, state-chartered banks and non-depository institutions, in other words, [the only regulator that can provide] uniform protections for consumers and a level playing field for providers.” This new powerhouse, however, can also create a playing field that will leave some between a rock and a hard place, if not punitively smashed by the rock against the hard space. This issue is taking shape as the CFPB’s new Qualified Residential Mortgage (QM) rule is implemented and the CFPB’s “disparate impact” approach to mortgage lending litigated.

Specifically, the CFPB has issued its QM rule; effective January of 2014.  Aimed at ending the irresponsible no-doc loans, 2/28 loans, and 3/27 loans, the QM rule seeks to establish a floor for lenders extending financing for residential mortgages.  Under the rule, banks and other financial institutions have to adhere to the ability-to-repay doctrine, set in stone by a 43% debt-to-income ratio (DTI) maximum. While the banks may not have been in favor of the new rule, with the effective date only four months away they have all been required to adjust their lending practices. Again, what could go wrong?  A customer walks in, she applies for a loan, if she is over 43% DTI, decline, if not she is conditionally approved.

While many may welcome such a system, as the mortgage industry is largely responsible for the recent recession, others, including the maker of the rule, are sending a different message. PNC Financial Services has recently disclosed that it is being investigated by the CFPB and the Justice Department over its mortgage lending practices.  While financial service providers facing enforcement action is regular these days, the concern is that this is the first time the CFPB has focused an investigation on the theory of disparate impact.  The investigation is alleging possible violations by PNC on the grounds of discrimination, which under the theory of disparate impact means the discrimination is all that matters, regardless of intent.

To be sure, qualified mortgages are good and discrimination is bad—I’ll give the CFPB credit for that discovery.  The issue, however, lies in the glaring omission to reality by the CFPB in its rule-making process or in its enforcement action.  As the financial regulator that literally tracks or has access to every metric of financial consumer data out there, the CFPB is ignoring that the QM rule restricts access to mortgage financing for minorities.  Looking at the DTI requirements, minorities are more likely to be impacted by the rule.  When the CFPB shows up to examine a financial institution’s books to ensure compliance with the QM rule, it will see the disparity between approved non-minority and declined minority households.

While looking at the books will show that the QM is being effective at limiting access to those who lack the ability to repay, the disparity is unimpeachable. Because the CFPB’s action against PNC turns on disparate impact, meaning with or without intent, those who adhere to the QM rule will all be guilty of discrimination in their mortgage lending.  The CFPB’s piecemeal approach to post crisis regulation of the mortgage industry is leaving lenders with two choices: set aside money for enforcement settlements, or get out of the market.  Whatever the choice, we will all suffer as banks pass on added costs or further restrict credit.

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