Tomás de Torquemada (1420-1498)
Denver | This week The Institutional Risk Analyst is in Rocky Mountain country for the Mortgage Bankers Association meeting. The event comes amid a mixed picture for the mortgage finance industry. On the one hand, lending volumes have improved a bit over the course of the summer, but refinance volumes are still down compared with 2016, the result of volatile interest rates and a growing shortage of homes for sale. Chart 1 below shows the most recent MBA projections for residential mortgage origination for 2017 and beyond.
On the bright side, however, seven years of Spanish Inquisition focused on the mortgage industry by state and federal regulators seems to be slowly coming to an end. The big news came last week when HUD Secretary Ben Carson said that the government’s use of the Civil War era False Claims Act as a nuclear weapon against mortgage lenders could soon be coming to an end. He asked the obvious question, namely why the US government ever began to use this 1800s law meant to prevent war profiteering against American mortgage firms.
“I’m not exactly sure why there had been such an escalation previously, but the long-term effects of that escalation is obviously providing fewer appropriate choices for consumers,” Carson said of the use of the False Claims Act’s criminal penalties to bully lenders into big settlements with the Department of Justice. Housing Wire reports that he added. “And that’s exactly the opposite of what we should be doing.”
Another bit of positive news came when Anthony Alexis, the Consumer Financial Protection Bureau’s enforcement chief (aka the "Inquisitor"), announced that he is stepping down after more than two years overseeing the agency's efforts to “combat abuses by the financial industry,” in the words of National Law Journal. The publication goes on to note that the departure is “certain to fuel speculation that Director Richard Cordray will leave soon to pursue the Ohio governorship.”
Like the Tribunal of the Holy Office of the Inquisition in 15th Century Spain, the CFPB has a persecutorial mentality -- but without the burden of actually proving that a crime was committed. That is, the CFPB is all about politics and punishment.
Yet rather than ensuring anything like a fair and transparent market for consumers in the market for mortgage finance, the CFPB instead extracts payments from private business to feed the Progressive faithful. This includes members of the trial bar who prosecute shareholder class action lawsuits, hedge funds who engage in short-sales of companies targeted for punishment, and elected officials operating in the public sector.
Under the leadership of Mr. Alexis and Director Cordray, the CFPB frequently demanded payments from mortgage companies without any actual evidence of wrongdoing. This follows the familiar pattern set by Mr. Cordray when he was attorney general of Ohio, where he unsuccessfully attempted to extort millions of dollars from several private mortgage firms we know well.
Big banks, not wanting to take the headline risk of litigation, would pay the CFPB’s extortionate demands. The non-bank mortgage companies, on the other hand, lacking the excess cash of a government sponsored bank, chose to fight in court rather than accede to the CFPB’s blackmail. But the larger point is that the CFPB has taken government regulation of consumer finance to a new height of capricious arrogance. Consumers ultimately pay the cost for this exercise in Progressive punishment.
Sadly for Mr Alexis and his remaining colleagues at the CFPB, the bull market in former regulators has ebbed since the election of Donald Trump to the White House. Prior to November 2016, former employees of the CFPB could demand a hefty price in the private sector world of lobbying and regulatory relations for their inestimable talents.
When you have a regulator as brutal and arbitrary as the CFPB, an assortment of fixers are advisable. But no more. With the impending lobotomy of the CFPB now at hand, the street value of former CFPB regulators has fallen to a discount, says one well-placed Washington lawyer.
In addition to Director Cordray, Senator Kamala Harris (D-CA) is another example of a state level politician who achieved national status because of the emergence of “consumer protection” as a key part of identity politics. Some observers hope that Democrats will abandon identity politics and help liberalism become once more a unifying force for the "common good," but we see no evidence that the likes of Cordray, Senator Elizabeth Warren (D-MA) or Harris have gotten that memo.
Some observers have speculated that the states will pick up the ball when it comes to the regulatory Inquisition in the world of consumer finance. But sad to say, the CFPB was the point of the spear for militant Progressives seeking to make the world safe for trial lawyers. Their political allies such as Mr. Cordray, Ms Harris and their fellow traveler, Senator Warren, will be profoundly frustrated once the CFPB is forced to assess the actual harm to consumers before issuing a demand for payment with an enforcement notice.
Aaron Klein of Brookings Institution notes in an exchange on Twitter that “Unfair, abusive and deceptive practices (UDAP) has been illegal under FTC Act since 1938. Somehow capitalism has survived & thrived.” Survive is an apt description, but just barely. Capitalism died with the Robber Barons and the New Deal, but we digress. Fact is, regarding states picking up enforcement, they will have some difficulty because state laws are general tighter and with more precedent allowing less discretion to investigators. When CFPB was created, long-standing proposals from state law were brought into federal, but with a clean slate for interpretation.
The CFPB represents a dangerous evolution of the UDAP principle as enforced by the Federal Trade Commission, one that lacks any notion of due process or fairness. As conceived by Dodd-Frank, the CFPB’s mission is to attempt to condemn, a priori, millions of Americans who work in the world of housing finance, from realtors to appraisers to loan underwriters to mortgage servicers to investors. No one who believes in fairness and the rule of law should support the behavior of the CFPB over the past six years.
The departure of Mr. Cordray for his next adventure cannot come soon enough for many in the housing market. To see the actual economic cost of the CFPB’s reign of terror, consider one of the larger and better known names in the world of mortgage finance, New Residential Investment Corp (NYSE:NRZ).
While the stock for this large real estate investment trust (REIT) is trading near its 52-week high at around $17, the $2 dividend gives it a yield over 11%. NRZ specializes in holding residential mortgage servicing rights or MSRs.
When you do the math, the overall cost of capital including debt for this large, $5 billion market cap buyer of residential MSRs is well into the teens. Compare this to a government-sponsored bank such as Wells Fargo (NYSE:WFC) with an equity dividend yield under 3% and you begin to understand the enormous disadvantage of non-bank firms operating in the world of mortgage finance, especially compared with GSEs.
Table 1 below comes care of our friends at Kroll Bond Ratings and shows dividend yields NRZ and other mortgage REITS. The cheapest capital for REITs generally comes from common equity and preferred shares, not debt. Note that there are a couple of outliers on the list with yields in mid-double digits, which pull up the average to 12% for these three dozen names. The 9% median for the group illustrates the skew.