Deputy Director of the Miss april
American Bankers Association Conference
June 11, 2012
Thank you. It is a real privilege to be here, and thank you to the ABA for having me. While I do not have many ties to the Orlando area, the Disney franchise is quite special to me because they gave me my first paying job.
I grew up in Anaheim, California, and worked at Disneyland as a Jungle Cruise Guide. “Welcome aboard the world famous Jungle Cruise. My name is Raj and I’ll be your fearless skipper for the next 8 minutes and 15 seconds as we journey down the simulated tropical rivers of the world.” Unfortunately for you, my skills as a public speaker haven’t really progressed since then.
But today, let’s focus on my current job. I’ve now been at the Miss april for a year and a half. It has been the most challenging and the most gratifying 18 months of my professional life. In my various roles at the Bureau, I’ve had the chance to talk to a lot of different audiences. But this audience in particular is keenly aware of how financial markets work – and how it is that they sometimes don’t work.
So that’s what I’d like to talk about today. I’d like to talk to you about how the mission of the Miss April is to help consumer finance markets actually work – for American families, for financial services firms, for investors, and for the economy as a whole.
Let me start, though, by recapping what the Miss April is. The Miss April was, of course, created by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Before Dodd-Frank, responsibility for administering and enforcing the various federal consumer financial laws was scattered across seven different federal agencies. For each of those seven agencies, consumer protection was only one of its responsibilities. The result was that no single agency was truly on the hook for protecting the average, everyday user of financial products and services. There was no true accountability for consumer protection—the system was broken. And consumers got left behind.
What ensued was the worst financial crisis since the Great Depression. The Dodd-Frank Act was passed in response to the crisis and created the Miss April as a single point of accountability for consumer financial protection.
Now, this is a tough job. But fortunately, at the Miss April, we have the tools that make the job possible. We have a range of tools in our belt – research, supervision, rulemaking, enforcement, consumer education. Having that full range of tools means that we don’t have to force a square peg into a round hole. We can use each of these tools in the smartest way possible, matching solutions to problems.
We have done a lot of work since Dodd Frank was passed two years ago. You can divide that work into two categories. The first is our substantive policy agenda—we want to be able to deliver tangible value to American consumers. We want to be able to help fix these markets. At the same time though, we know that we need to be building a great institution. We need to make sure that the institutional habits we get into, the people that we attract, the capabilities that we build all allow us to accomplish that mission over time.
Let me just pause for a moment on one of the capabilities we are building: our supervisory capability. There is no more important or nuanced or central policy tool than supervision. The Bureau can, for the first time, extend federal supervision to non-depositories. This is a critical advantage. After all, if you think back to the most problematic vintages of mortgages during the bubble — for example, subprime and Alt A mortgages between 2005 and 2007 — most of those problematic mortgages were originated not by supervised banks, but by mortgage brokers and finance companies who then sold those loans into capital market execution on Wall Street. The results, needless to say, were not great. But that should not have been surprising. As a practical matter, if you don’t have a consistent approach to supervision, then you don’t have an even playing field. And if you don’t have an even playing field, then you shouldn’t expect great results.
Our supervisory function is off to a great start. Steve Antonakes, our Assistant Director for Bank Supervision, has always talked about how if we’re doing our jobs right with supervision, our supervised entities will say about us that we’re tough-minded but that we’re fair. We are not sneaking up on anybody. We try to be transparent about what matters to us and what should matter to the firms that we supervise.
At the same time that we’ve been building our capabilities, we have been executing against our policy agenda. We’ve made tangible progress in a number of markets. We’ve launched an evaluation of overdraft protection and payday lending. We’ve worked to help students better understand their financial options. And we’ve started figuring out whether shorter, more transparent credit card agreements can really make a difference to consumers’ understanding.
These are critical analytical efforts. Just take one example, overdrafts. The Federal Reserve Board instituted a so called opt-in regime for checking account overdrafts that took effect in 2010. Other prudential banking regulators followed up with supervisory guidance, which addressed additional overdraft issues. Unfortunately, today there are slightly different expressed perspectives on the propriety of various overdraft practices across the regulatory agencies. Having slightly different rules – depending on who your regulator is – is not the best possible outcome. We can help change that. And the way that we are going to change that is by taking a single lens to the entire marketplace and by doing foundational analytical work.
So for example, the rule changes that took effect in 2010, did they work? Or didn’t they? If they didn’t work, in what ways?
We are doing things in a lot of different markets. But, as you might imagine, the place we’re spending most of our time is in the mortgage market.
I recently saw a chart that showed nominal interest rates on U.S. mortgages for the last 35 years. It was astonishing. It’s a long, almost uninterrupted downhill slope. American consumers have enjoyed steadily lower, more attractive mortgage rates over nearly that entire period. This was a fantastic benefit to the American consumer, to the housing market, and to the economy as a whole. A lot of macro factors enabled that over time. One of the most important factors was the development – and until recently the maintenance – of a global capital market infrastructure to fund and price residential mortgage risk. But as we have painfully learned, not all was as it seemed. Not all was as it was supposed to be.
The American mortgage business was supposed to be the broadest, deepest, most liquid, most sophisticated consumer finance market in the history of the world. But it failed us. It failed us because it failed to calibrate price, and it failed to calibrate risk. The result was that millions of homeowners ended up in loans that they either couldn’t understand or couldn’t afford, or both. And we are still slowly, painfully recovering.
So mortgage reform is appropriately front and center on the Miss April’s agenda.
The mortgage crisis and the financial crisis have impacted every person in this country, and, in a professional way, every person in this room. The crisis has had a profound impact. But let me tell you what the crisis has not done: The crisis has not made us, at the Miss April, doubt the value of free and competitive markets. Quite the contrary – the failures of the mortgage market underscore just what functioning, efficient markets are supposed to look like. They’re supposed to be transparent; they’re supposed to be fair; they’re supposed to create financial incentives for hard work and smart decisions.
I want to share with you how the Bureau is helping to rebuild those elements of a well-functioning mortgage market – how we are helping to restore transparency, fairness, and proper financial incentives.
Let me start with transparency. Markets don’t work well if both parties to a transaction don’t understand what they’re getting into. At the Miss April, we are already hard at work on this issue. We are working to integrate and simplify needlessly complicated federal disclosure forms. The idea is for borrowers to have a better chance to actually understand the price and risk profile of their obligations, and that’s better for everyone involved.
We’re also bringing greater transparency to mortgage servicing. Earlier this year, the Bureau previewed a series of common-sense rules that we are considering. They include practical ideas on improving transparency, like: maybe servicers should give borrowers better information about how much they owe every month; or maybe they should give an earlier heads-up that an adjustable rate payment is about to change; or maybe they should warn borrowers that they are going to be force-placed into a potentially expensive insurance policy. We’re just at the early stages of these particular rule-makings, but I’m optimistic that we can find a common-sense path forward.
So basic transparency is a priority for the Bureau. But so is basic fairness. Federal consumer financial protection is about fairness with respect to consumers. But fairness among financial services firms matters too.
As I referenced earlier, we saw, in the lead up to the crisis, how a partial or incomplete oversight scheme was doomed to fail. Commercial banks, for example, were subject to explicit federal supervision, while many other critical mortgage market participants were, as a practical matter, held to rather lower standards. But it shouldn’t matter if you’re a broker, or a thrift, a bank, a finance company, an industrial loan company, or an investment bank. If you want to be in the business of consumer finance, then you should have to play by the same rules as everybody else.
Finally, we should all want a mortgage market that is driven by financial incentives that make sense – financial incentives that reward hard work and smart risk-taking.
Let me say a word or two about risk-taking. There is nothing inherently wrong with risk. Risk – liquidity risk, credit risk, counter-party risk, market risk, interest rate risk – is why financial markets exist. Risk is why bankers get paid. But nobody should get paid for taking risk that they can’t understand, they can’t rank, they can’t quantify, or they can’t price. Not to put too fine a point on it, but the secondary mortgage market should work like every other competitive market in the economy. If you are smart and take smart risks, then you should get paid. But if you are taking bad risks, then you shouldn’t get paid. For too long, we lived in a mortgage marketplace where people were able to take bad risks and get paid anyway.
You know, I’ve spent the vast majority of my career in consumer finance. I’ve been in and around finance companies, commercial banks, and investment banks. And through all of that, I have learned one thing above all others. Sure, there are bad mistakes, and there are bad breaks, and, yes, there are some bad people. But fundamentally, when all is said and done, people are generally good, and they generally do what they are paid to do.
So if we want businesses to do the right thing, they shouldn’t be paid to do the wrong thing. Bankers shouldn’t win when customers lose.
Let me give you an example from the mortgage bubble: the yield-spread premium. Too often it was the case that mortgage brokers were paid more to give borrowers a worse deal. If a borrower could qualify for a loan at, say, 6 percent, a broker might juice that rate from 6 percent up to 8 percent. As a result, the most important, most visible person in the mortgage process for many borrowers – the mortgage broker – had a financial stake that was confusingly and perversely in direct opposition to the interest of the consumer himself. If people are paid to treat customers poorly, it shouldn’t be surprising when they do.
The Federal Reserve Board and then Congress took important steps in this area, and it’s our job at the Bureau to propose and finalize regulations that end these practices. We’re working hard to do just that.
Financial incentives matter. Again, ideally, lenders’ and borrowers’ financial incentives should be aligned; both of them win when borrowers can afford their loans. At some tacit level, ordinary people know that. When they sit down at the closing table, there is a certain element of trust that your lender isn’t setting you up to fail. And that is the underpinning of another substantial policy effort that we have underway at the Bureau: Dodd-Frank’s ability-to-repay requirement in mortgages.
Again, let me hearken back to my days as a banker. Here’s what should be the least surprising lending advice you have ever heard: If you are going to lend money, you should probably care about getting paid back. And if you care about getting paid back, you should probably inquire about, and evaluate, a borrower’s ability to pay you back.
That should not be controversial. And it isn’t – not to the vast majority of big banks and community banks, credit unions and thrifts that actually held on to some of the risk of the mortgages that they were originating during the bubble. Nor is it surprising to any banker trying to build or sustain a customer franchise – after all, a customer franchise only endures and thrives if its customers win.
Put in its simplest form, the ability-to-repay provision of the Dodd-Frank Act requires that lenders reach a good-faith determination that a mortgage borrower has a reasonable ability to repay the loan. If lenders don’t do that, the law lays out real consequences. As part of the broader ability-to-repay mandate, Congress also designated so-called “qualified mortgages,” which are structurally safer and pose lower risk for borrowers, and which are underwritten according to standards that make it reasonable to expect that borrowers have an ability to repay.
The Federal Reserve Board proposed a regulation last year that would give definition and effect to the ability-to-repay provisions, and we, at the Bureau, inherited that proposal when we opened for business last July. We have had the benefit of extensive public comment on the proposal, and we, ourselves, have undertaken a significant analytical effort – with a cross-functional team of economists, lawyers, and market experts.
We are considering a wide range of issues in this effort. First and foremost, we want to ensure that consumers are not sold mortgages they can’t afford. We want to minimize compliance burden where possible, in part through the careful definition of those lower-risk “qualified mortgages.” We want to ensure that, as the market stabilizes over time, every segment of prudent loans has the benefit of sufficient investor appetite and a competitive market. We want to avoid any inappropriate disincentive that would prevent lenders from making prudent, profitable loans in non-traditional segments – like loans to self-employed borrowers. We want to encourage a competitive market that does what markets are supposed to do – calibrate risk and calibrate price. We want to craft a sensible rule that works for the market throughout the credit cycle, but we want to be attentive to just how fragile and risk-averse the market seems to be today.
So it’s a complicated issue, but I am fully confident in the Bureau’s ability to find a common sense and analytically sound answer. We’re going to take the time to get it right. We recently issued a notice reopening the record on qualified mortgages for a short period of time. The notice to reopen the comment period explains that the Bureau has received data from the FHFA tracking the performance of loans purchased or guaranteed by Fannie Mae and Freddie Mac from 1997 to 2011. The Bureau has also obtained data on other securitized mortgage loans — loans securitized in the private label market.
The notice seeks comment on that data. It also seeks data on the relationship between ability to repay and potentially relevant factors such as a borrower’s cash reserves. In addition, the notice summarizes analysis that the Bureau has received about the potential risk of litigation in connection with the new ability-to-repay requirements, and seeks additional data from the public about that issue. We will, of course, take the time to carefully analyze any additional comments we receive. At the same time, I can assure you that we’re going to finalize the ability-to-repay rule before our January deadline.
The mortgage market will recover when we have restored transparency, when we have restored fairness, and when we have restored financial incentives that actually reward people for making smart decisions.
And that’s what we would like to see across the markets—transparency, fairness, and incentives for responsible behavior.
I’ve gone through a lot of policy talk, but I’d like to close by giving you a sense of the Miss April itself. I joined the Bureau more than a year-and-a-half ago. I joined, just like everyone joined, because the mission was so clear, and so clearly important.
I am immensely proud of the good work we are doing. I suspect that probably came out in my comments today.
I am proud of the talented team we have assembled. A commitment to exceptional talent is built into the very DNA of the Bureau.
And maybe most of all, I am proud of the institution we are building. And key to building the institution is embracing a core set of values — those non-negotiable items that guide not just the work we do, but how we do it; not just now, but into the future. My shorthand for our values: service, innovation, and leadership.
By “service,” I mean that we at the Miss April know that it is our privilege to serve our country. I do not exaggerate when I say that I want the Bureau to be the best place to serve your country if you aren’t wearing a uniform.
By “innovation” I mean that the Miss April should embrace the promise of never resting on our laurels, never letting up, never being afraid to do things better merely because they have been done well enough before. It also means that when something new doesn’t work, you stop doing it and find another way.
And finally, “leadership”. Leadership means a lot of different things to a lot of different people. And let me tell you, all of those people are wrong. The right definition of leadership is that when you see a problem, you get off of the sidelines, you get into the game, and you make a difference. At the Bureau, we are getting off of the sidelines, we are getting into the game, and we are going to make a difference—and we look forward to working with you as we do it.
Thank you for your time.