Federal Preemption on Appraisal Laws Not a Sure Thing

Nathan Brown JUN 6, 2012 2:08pm ET

Ignoring state appraisal laws may subject bank employees or third-party service providers to fines or even criminal penalties. National banks relying on federal preemption for appraisal laws should take another look at that assumption in light of Dodd-Frank.

The primary federal regulatory agencies recognize that financial institutions appreciate the flexibility in the revised Interagency Appraisal and Evaluation Guidelines permitting the use of less-formal real-estate evaluations in lieu of more-costly appraisals in certain low-risk transactions. Those guidelines do not require that an evaluation be prepared by a licensed or certified appraiser. But the appraisal acts in many states – passed in the wake of the savings and loan crisis in response to a mandate in the Financial Institutions Reform, Recovery and Enforcement Act – do not provide that flexibility.

Many states created “mandatory” licensing regimes that purport to prohibit any person from attaching any opinion of value to real property without an appraiser license. Some recognized the need for banks to perform evaluations and enacted exceptions that specifically allow banks to perform and obtain evaluations using qualified but unlicensed internal staff or agents of third-party providers.

However, the exemptions in some mandatory states – including Alabama, Arkansas, Kansas, Louisiana, Minnesota, Mississippi, and North Carolina – extend only to full-time, salaried employees. Under that structure, community banks may be at a significant disadvantage against large banks with substantial in-house collateral valuation staff.

Some “mandatory” licensing states – Michigan, Connecticut, Florida, Pennsylvania and South Carolina for example – appear to make no exception for evaluations, whether performed internally by bank employees or externally by a third party. In those states, any person preparing an evaluation without a license could be subject to criminal penalties, fines, and even jail time.

Licensed appraisers are presumably the most qualified – why not offer evaluation assignments to them? Reporting requirements and scope of work rules in the uniform appraisal standards (USPAP), which most states require all licensed appraisers to follow, make it more difficult, especially since the Appraisal Standards Board removed the departure rule and the concept of the limited scope appraisal from USPAP. The ASB has promised additional guidance by 2014, but it’s a gray area for now.

And what about federal preemption? FIRREA itself does not preempt state laws that regulate appraisers. To the contrary, FIRREA generally recognizes the ability of states to regulate appraisers and supervise appraisal-related activities.

So the general rule is that federal law will preempt state laws for a federally-chartered bank if the state laws “prevent or significantly interfere with” the bank’s exercise of its powers. A good argument could be made that a state law which says “a lender may order XYZ type of valuation only from a state-licensed appraiser who follows USPAP” is preempted. (That said, one court has held that a law that requires a national bank to use a state-licensed appraiser does not “prevent or significantly interfere with” a national bank’s exercise of its powers). However, most state laws that require state-licensed appraisers do not target the lender directly – they target the person who would perform the valuation.

Enter Dodd-Frank. Section 25(b) provides in general that neither the National Bank Act nor the Home Owners Loan Act will preempt state law for an agent of a federally-chartered bank. And Section 1465(a) applied national bank preemption standards to federal savings banks.

The thought that NBA and HOLA would not protect the agent of the national bank from prosecution under a state law, even assuming the state law is preempted for the bank, seems like a peculiar result. But courts have not yet had the opportunity to interpret the agent preemption provision in Dodd-Frank, so banks should anticipate that states might argue that there no longer is any preemption for agents.

An employee of a bank who performs a valuation for the bank in contravention of state law would appear to have an especially strong claim to be protected by the bank’s “preemption umbrella.” But in reality, banks might have difficulty finding people willing to risk severe personal consequences based on an abstract preemption argument. And of course, regardless of the ultimate resolution of issues surrounding preemption for federally-chartered banks, state-chartered banks will still be forced to face the issue.

Nathan Brown is the chief legal officer of MountainSeed Advisors, which provides valuation-related products and services to financial institutions.

‘Disparate Impact’: Regulators Need a Lesson in Statistics

James P. Scanlan JUN 5, 2012 3:19pm ET

In April the Consumer Financial Protection Bureau issued a statement that it was adopting the “disparate impact” concept in its enforcement of the anti-discrimination provisions of the Equal Credit Opportunity Act. It is doing so in a manner consistent with an Interagency Policy Statement issued in 1994 by the Department of Justice and other federal agencies involved with the enforcement of fair lending laws.

This is one new chapter in a remarkably perverse episode of federal law enforcement. The problem is that federal agencies’ failure to recognize a fundamental statistical concept results in encouraging lenders to take actions that make them more likely targets for litigation.

The disparate impact concept has its origin in employment discrimination cases going back to the late 1960s, where plaintiffs challenged tests and educational requirements that disproportionately disadvantaged black applicants or employees. The concept was formally legitimized for employment cases in the Civil Rights Act of 1991.

In the employment setting, disparate impact doctrine essentially holds that, even though an employer does not intend to discriminate against a protected group, it cannot use a device or practice that disproportionately disadvantages such group unless the device or practice serves a sound business interest. Further, there must be no less discriminatory alternative that equally serves that interest.

Beginning in 1989, lenders were required to keep records reflecting the race of applicants for home mortgages. Studies immediately appeared showing large differences between rates at which minorities and whites were denied mortgages. Often rejection rates for minorities were several times those of whites. Initially, these rejection rate differences were attributed to willful discrimination by lenders. But in the early 1990s, there emerged a recognition that differences in rejection rates resulted in significant part from that fact that minorities were less able to meet standard lending criteria just as minorities were often less able to meet certain employment criteria.

In March 1994, that recognition led ten federal agencies involved with monitoring or enforcing fair lending laws to issue an Interagency Policy Statement citing the disparate impact lenders’ policies may have on minorities and stating that the agencies regarded unjustified disparate impacts to violate federal lending laws. The statement cited minimum loan amounts as an example of a practice that might have greater adverse impact on minorities than whites, and it generally called into question all unnecessarily stringent lending criteria.

The discouragement of unnecessarily stringent lending criteria accorded with thinking in the employment testing context where one universally recognized way of reducing a test’s disparate impact on a protected group was to lower cutoff scores. That worked like this. Suppose that at a particular cutoff point pass rates are 80% for an advantaged group and 63% for a disadvantaged group. At this cutoff the advantaged group’s pass rate is 27% higher than the disadvantaged group’s pass rate. If the cutoff is lowered to the point where 95% of the advantaged group passes the test, assuming normal test score distributions, the disadvantaged group’s pass rate would be about 87%. Thus, with the lower cutoff, the advantaged group’s pass rate would be only 9.2% higher than the disadvantaged group’s pass rate.

Lending criteria operate just like test cutoffs, and, as with the lowering of test cutoffs, relaxing those criteria tends to reduce relative differences in meeting them. The extent to which lenders relaxed their criteria in response to the Interagency Policy Statement or other discouragements of unduly stringent lending criteria is unknown. But assuming some lenders did so, one can also assume that relative differences between rates at which whites and minorities secured mortgages decreased.

Simple enough so far. But, while lowering the cutoff tends to reduce relative differences in passing rates, it also tends to increase relative differences in non-passing rates.

In the situation just described, the disadvantaged group’s non-passing rate was initially 1.85 times the advantaged group’s non-passing rate (37%/20%). With the lower cutoff, the disadvantaged group’s non-passing rate would be 2.6 times the advantaged group’s non-passing rate (13%/5%).

This pattern is not peculiar to test score data or the numbers I chose to illustrate it. Lowering a credit score requirement will reduce relative differences in meeting the requirement but increase relative differences in not meeting it.

Nevertheless, regulators and others concerned about disparities in lending outcomes continued to measure the size of those disparities in terms of relative differences in mortgage rejection rates. Thus, lenders that were most responsive to the encouragement to relax criteria – hence, more so than other lenders, tending to reduce relative differences in approval rates while increasing relative differences in rejection rates – were regarded as the most discriminatory lenders. The actions of the DOJ and other regulators were akin to pressuring employers to lower test cutoffs and then singling out for litigation the employers who lower their test cutoffs the most.

One would think a perverse situation where, in enforcing fair lending laws, the federal government encourages lenders to engage in conduct that makes them more likely to be sued for discrimination could not persist for long. But the situation has existed for 18 years with no sign of abating.

The DOJ’s complaint filed in conjunction with the record $335 million settlement of lending discrimination claims against Bank of America’s Countrywide Financial Corporation last December sent lenders one clear message: once aware that their practices lead to racial differences in adverse lending outcomes, lenders must seek out less discriminatory alternatives.

And the complaint specifically criticized the defendant for practices that increased the frequency of such things as assignment to subprime loans. As indicated above, however, measures that reduce adverse outcome rates, while reducing differences in favorable outcome rates, tend to increase differences in adverse outcome rates on which lenders are judged.

There exist many situations where the failure to understand fundamental statistical concepts leads to distorted interpretations of data on group differences. But, as reflected by the size of the Countrywide settlement, it is in the lending industry that the financial consequences of the failure may be the most severe.

James P. Scanlan is a lawyer in Washington, D.C. He specializes in the use of statistics in litigation.

Regulatory Uncertainty Prevents Meaningful Housing Recovery

By Clifford Rossi JUN 5, 2012 2:00pm ET

Washington just keeps kicking the can down the road.

Last week’s announcement by the Consumer Financial Protection Bureau that it would to delay issuing final Qualified Mortgage rules for the mortgage industry and the Treasury Department’s comments that housing reform requires further study are just the latest in a string of policy deferrals that prolong meaningful recovery in housing.

The premise for this statement is simple: too much regulatory uncertainty persists in the market for credit to flow more freely.

The Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices for April 2012, for example, suggests no real movement in banks’ willingness to “open” the credit box much wider than it has been over the last couple of years, although lenders reported a pick-up in demand for residential mortgages overall.

While no single factor explains the industry’s reticence to expand credit availability, regulatory uncertainty over mortgage origination, servicing and financing holds back the return of private capital to mortgage markets.

To their credit, the various agencies tasked with creating rules that will redefine the mortgage industry of the future have taken a deliberative approach, recognizing the complexity and significance of what such changes may usher in. However, these delays point toward a systemic policy malaise threatening to make the housing recovery since the crisis a decade-long process.

Since it defines what type of mortgage products will generally be available going forward, the QM rule has a lot riding on it. For example, the Qualified Residential Mortgage rule, a separate part of the reform introducing risk-retention provisions into the securitization process, is effectively on hold until the CFPB introduces the final QM regulations.

Beyond QM and QRM lie other major policy issues that have yet to be addressed which contribute to market uncertainty. Nearly four years after both enterprises went into conservatorship, a firm transition plan for Fannie Mae and Freddie Mac has yet to be announced or the details on what ultimately replaces these companies. The enterprises’ regulator, the Federal Housing Finance Agency, has been proactive in positioning a strategic plan for handling legacy mortgage issues with the two firms, maintaining stability in securitization activities and working to develop the systems needed to support the future secondary market. However, politics on both sides have stymied efforts to provide any concrete action plan for moving beyond the caretaking activity that has effectively cast mortgage finance adrift in a sea of regulatory uncertainty.

One way to reduce this uncertainty, while strengthening the focus and resources on key strategic issues for FHFA, would be to merge the two enterprises and reorganize the businesses around three functional areas coinciding with the FHFA’s strategic plan: legacy asset management; ongoing securitization; and future data and system infrastructure development. But this plan can only be put in place if a viable replacement to Fannie and Freddie can be put forth.

Clearly the issue is one of great complexity. However, too much time has elapsed now for there not to be a definitive game plan for reforming the secondary mortgage market.

Other areas of mortgage policy also remain unsettled. One of these is the role of the Federal Housing Administration in mortgage markets and the health of its Mutual Mortgage Insurance fund. Just last week, Lender Processing Services reported a sharp increase in foreclosures resulting from the surge in the FHA’s market share during the 2008-2010 period. While this served a vital countercyclical role at the time, the large share of volume taken by FHA and general weakness in the MMI fund pose fundamental risks to taxpayers and further private capital’s reentry into mortgage markets. Changes in FHA loan limits, insurance premiums and fees play a significant role in determining the extent of the federal government’s direct participation in mortgage financing. Yet little movement in this policy area has been made, again reflecting a broader need for policy coordination on multiple fronts.

In addition, Basel III’s revised capital requirements for mortgage servicing rights and the efforts to overhaul servicing compensation add to the confusion for industry participants assessing the strategic value of owning a mortgage business.

A unifying thread between each of these policy deferrals is the lack of a coherent national housing policy and implementation plan and clear ongoing communication of important aspects in the execution of such a plan. There is no single voice for the administration for housing. Given how much time has elapsed since the crisis, it will be difficult not to have history refer to this period as the lost decade in US housing markets.

To have any hope at avoiding this outcome, the administration should announce the establishment of a U.S. Housing Stability Commission comprised of members representing the relevant federal agency representatives chaired by one of these members with a primary mission of creating, coordinating and disseminating housing policy. Further delay in setting the roadmap for mortgage markets threatens healthy recovery from taking place.

Clifford Rossi is an executive-in-residence and Tyser Teaching Fellow at the University of Maryland’s Robert H. Smith School of Business. He has held senior risk management and credit positions at Citigroup, Washington Mutual, Countrywide, Freddie Mac and Fannie Mae.

Settlement Monitor, Looking to Avoid Conflicts, Seeks Out More Consultants

By Kevin Wack JUN 5, 2012 3:56pm ET

WASHINGTON – The job of determining whether the nation’s five largest mortgage servicers are complying with the landmark 49-state settlement will be divided between several private-sector consulting firms, the settlement’s monitor said Tuesday.

Joseph A. Smith Jr., the former North Carolina banking commissioner who is now the settlement’s monitor, said it does not make sense for a single consulting firm to be responsible for assisting him in the oversight of all five banks, in part because of conflicts of interest.

“We didn’t think that any single firm had the capacity and the independence to handle all of them at the same time,” Smith said in an interview.

Those comments came one day after Smith announced that he had selected BDO Consulting, a division of BDO USA, as the primary professional firm that will assist him.

The settlement documents envision only a role for a primary professional firm, but Smith said that he has decided to hire secondary firms as well. Each of those secondary firms (he did not specify how many will be hired) will be responsible for reviewing work plans submitted by the five servicers.

The five companies that are part of the estimated $25 billion settlement are Bank of America, Citigroup, JPMorgan Chase, Wells Fargo and Ally Financial.

Part of BDO Consulting’s role will be to help develop uniform standards for determining whether the five banks are in compliance with the settlement agreement, which requires them to reduce principal on mortgages, among other provisions. The consulting firm will also help Smith as he selects the secondary firms, and later it will help oversee the work of the secondary firms.

Smith, who heads the Office of Mortgage Settlement Oversight, said that BDO Consulting was chosen from a list of dozens of interested firms in part because it has a track record on large public projects.

Most recently, the firm was hired by federal and state officials to conduct an independent analysis of the Gulf Coast Claims Facility, which was established to provide compensation to victims of the BP oil spill.

After being hired as the mortgage settlement’s monitor, Smith said in an April interview that he wanted to keep his own staff small while relying heavily on contractors to help him review the self-monitoring work that will be done by the five banks.

The process of selecting a contractor with sufficient independence from those five institutions was complicated by the fact that many of the large U.S. law firms and accounting firms have long-standing client relationships with the biggest banks.

BDO Consulting does not have anything approaching what would be considered a material conflict of interest, Smith said Tuesday.

“They don’t have much in the way of conflict with any of the servicers now involved in the settlement,” said Smith, who was hired in February by federal and state officials.

Carl Pergola, partner-in-charge of BDO’s consulting services, added in a separate interview, “We’re not aware of any active work that we provide for any of the five servicers.”

In terms of past work the firm has done for the five servicers, Pergola said that BDO did anti-money-laundering work for Washington Mutual, but the relationship ended around the time that JPMorgan bought WaMu in late 2008.

He also said that BDO was previously hired by counsel for Countrywide, but the work ended about three years ago, or roughly one year after Bank of America bought Countrywide.

Pergola said that BDO’s experience in the mortgage industry is one of the chief assets it brings to the monitoring work. The settlement stemmed from widespread allegations of robo-signing and other servicing abuses.

BDO, which provides tax, financial advisory and consulting services to companies, has done work for one of the 14 servicers. That work is part of a separate foreclosure review process being conducted by federal banking regulators, Pergola said.

But he said the servicer is not among the five that are part of the multistate settlement.

Fannie Mae names Timothy Mayopoulos as new CEO

By Marcy Gordon

Fannie Mae, based in Washington, says Mayopoulos, 53, will become president and chief executive on June 18. He replaces Michael J. Williams, who announced in January that he would step down after a successor was found.

The government rescued Fannie and smaller sibling Freddie Mac in September 2008 after the two companies absorbed huge losses on risky mortgages that threatened to topple them. Since then, a federal regulator has controlled the two companies’ financial decisions.

So far, Fannie and Freddie have cost taxpayers about $170 billion – the largest bailout of the financial crisis. It could cost roughly $260 billion more to support the companies through 2014, after subtracting dividend payments, according to the government.

Mayopoulos will be the third CEO of Fannie Mae since the government takeover. Williams oversaw the restructuring of Fannie’s foreclosure-prevention efforts and managed the troubled company’s reorganization.

In his executive roles, Mayopoulos has managed Fannie’s human resources policies, communications and marketing, and government relations, the company said Tuesday.

Pressure has been building for the government to eliminate or transform Fannie and Freddie and reduce taxpayers’ exposure to further losses.

The Obama administration unveiled a plan last year to slowly dissolve Fannie and Freddie, with the goal of shrinking the government’s role in the mortgage system. The proposal would remake decades of federal policy aimed at getting Americans to buy homes and could make home loans more expensive.

Exactly how far the government’s role in mortgages would be reduced was left to Congress to decide. But all the options the administration presented would create a housing finance system that relies far more on private money.

Mayopoulos said Tuesday he will work closely with Freddie and the companies’ regulator, the Federal Housing Finance Administration, to help lay the foundation for a new system “that will be much more effective and reliable, and better for the country.”

At the same time, Fannie will continue to place high priority on helping distressed homeowners and reducing its losses on loans to benefit taxpayers, Mayopoulos said in a telephone interview.

Edward DeMarco, the FHFA’s acting director, said in a statement that Mayopoulos “brings a breadth of knowledge and experience in housing finance and financial services that is vital at this important time for Fannie Mae and the nation’s housing finance system.”

Fannie and McLean, Va.-based Freddie buy loans from lenders, package them into bonds with a guarantee against default and sell the bonds to investors. Together, the companies own or guarantee about half of U.S. home mortgages – about 31 million home loans – and nearly all new mortgages.

Before joining Fannie Mae in April 2009, Mayopoulos was executive vice president and general counsel of Bank of America Corp. He also has served as a senior executive at Deutsche Bank, Credit Suisse First Boston and Donaldson, Lufkin & Jenrette.

Last month, Freddie named Donald Layton, the former chief executive of discount brokerage firm E(asterisk) Trade Financial Corp., as its new CEO. He replaced Charles E. Haldeman Jr.

Under a new government policy, Mayopoulos’s and Layton’s salaries will be capped at $500,000 per year and annual bonuses will be eliminated for all employees. Those changes came after Congress pressured the government to stop big payouts at the bailed-out companies.

In December the Securities and Exchange Commission brought civil fraud charges against six former executives at the two companies, including former Fannie CEO Daniel Mudd and former Freddie CEO Richard Syron. They were accused of understating the volume of high-risk subprime mortgages that Fannie and Freddie held just before the housing bubble burst in 2007.

No current Fannie or Freddie employees were charged or implicated.