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Bank investors and consumers got some good news yesterday: New mortgage-origination rules finalized by the Consumer Finance Protection Bureau offer banks protection from homeowner lawsuits and may keep the newly rekindled home-lending fires burning. As part of the deal, consumers will also get protection from the kind of predatory lending practices that crashed the housing market and the U.S. economy, along with so many people's personal finances.
The CFPB ruling seems to be that rarest of things in our uber-polarized world: a win-win.
Back to basics
The new CFPB rules shield banks from homeowner lawsuits in the following manner: So long as a bank issues a mortgage that follows "qualified mortgage" guidelines, as set down by the new CFPB rules, homeowners who find they can't make their monthly payments will have a more limited ability to sue the lender than they previously would have.
This isn't as restrictive and unfair to consumers as it first sounds. For mortgages to qualify as, well, qualified, banks will have to follow strict issuing guidelines, considering at least eight underwriting factors:
1. Current or reasonably expected income or assets.
2. Current employment status.
3. The monthly payment on the covered transaction.
4. The monthly payment on any simultaneous loan.
5. The monthly payment for mortgage-related obligations.
6. Current debt obligations, alimony, and child support.
7. The monthly debt-to-income ratio or residual income.
8. Credit history.
If your reaction to reading this list is, "Well, duh," consider that it was the the lack of attention to such rudimentary underwriting standards that led to the subprime lending boom, which added significantly to the housing bubble and was the direct cause of the subsequent crash.
And more than mere lack of attention, it was many banks' and mortgage originators' blatant disregard of these basic underwriting standards that led to the subprime lending boom, which, again, led directly to the housing-market crash and near collapse of the U.S. economy.
This final rule -- a.k.a. Regulation Z, a.k.a. the Truth in Lending Act -- implements sections 1411, 1412, and 1414 of Dodd-Frank. The rule will go into effect on Jan. 10, 2014.
The middle path
The CFPB was set up under the authority of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to do just this sort of thing: protect consumers from predatory lending practices. The CFPB is also involved in the regulation of credit cards -- really, any financial product that comes in direct contact with consumers.
But Regulation Z has been a bit of a cliffhanger for both banks and consumers. Banks naturally wanted as much protection as possible from potential homeowner lawsuits, but they expected to get hammered by the CFPB on the new rules anyway. Consumers naturally feared they would be thrown under the financial-industry bus, whose lobby has great influence over politicians and regulators in Washington.
Given that both consumer watchdog groups and banks are giving the finalized rule guarded praise, I would venture to say that the CFPB has truly trod the middle path with Regulation Z. As such, I believe it's a win for both sides.
Protecting people, and banks, from themselves
Ever since the financial crash, credit standards have naturally tightened up regardless. In this resurgent home-lending market, this way forward will allow banks to keep lending at about the rate they have been. "It's entirely consistent with how we think about basic underwriting [now]," Wells Fargo (NYSE: WFC ) deputy general counsel David Moscowitz told Reuters.
And there's definitely money being made in home lending right now. In the third quarter of 2012, JPMorgan Chase (NYSE: JPM ) made $50 billion in home loans, up 29% year over year. Wells Fargo made $141 billion in home loans for Q3. Some big banks remain gun-shy about home lending, however.
In the third quarter of 2012, Bank of America's (NYSE: BAC ) mortgage originations declined 37% year over year. Citigroup's (NYSE: C ) home-lending numbers are off, too: down 5% YOY for Q3. Considering how badly the two of these banks were burned by the housing crash, their wariness in somewhat understandable. But in a QE3 world -- specifically designed to boost the nation's housing market -- this fear is something they and other lenders like them will have to get over if they want to prosper in the housing-driven U.S. economy.
Bank investors should feel good about this overall: Banks didn't get the blanket protection from lawsuits they were looking for, but they didn't get beat up in the way they expected to, either. Regulation Z will also add stability to the housing market, the financial system, and therefore the economy: The bubble wasn't good for anyone, and every game needs strong, thoughtful rules. Investors should ultimately be willing to put more of their money into the banks if they know the banks have incentive to lend well.
In the end, sometimes, people -- and institutions -- need to be protected from themselves. This is a good step in that direction.
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