Acting Superintendent Neiman Delivers Keynote Address at Banking Department's Inaugural Summit to Halt Abusive Lending Transactions and Mortgage Fraud.
April 11, 2007
Good morning. And yes, I am the “Acting” Superintendent.
For those of you unfamiliar with the superintendent appointment process, you may be asking about the reason for the term “acting”. It’s not what my kids think.
My 7 and 9 year-old daughters tease me that I am not the “real” Superintendent. I am only “acting” - like a part in their school play.
To set the record straight, the term “acting” means that though the Governor has appointed me, I have yet to be confirmed by the State Senate, which I expect, should happen later this month.
So here I am giving my first speech as Acting Superintendent of Banks for the State of New York: before an overflowing crowd of more than 250 bankers, brokers, representatives from community organizations, and regulatory and enforcement agencies, on what I believe to one of the most serious consumer issues facing our nation today.
To be honest, being so new to the office, I feel quite humbled standing before you today sharing my thoughts and observations.
Before I accepted this job, I reached out to a number of former superintendents -- some even dating back over 30 years – to seek guidance on what I might expect.
In almost every instance, I was told that some type of incident or crisis -- sometimes a major bank merger, conversion or financial emergency – struck within the first few weeks of their tenure. I suspect that the recent developments in the subprime market will be my baptism by fire - something that will not only have a lasting impact during my term, but that may also result in significant market changes long after I am gone. I hope that I will be a better Superintendent because of it, though I suppose I should let you all be the judge of that.
So why are we here?
Every day we read articles in the press about the subprime market.
- Some describe it as a “Crisis”.
- Others as “Market in Turmoil”.
- Still others describe it as a “Correction.”
Though not the main objective of today’s conference, I believe some initial thoughts on what is behind these market dynamics is instructive and can better frame why we are here.
I see four primary contributing factors:
The First Factor is the Housing Bubble:
The loss of value in the stock market a few years ago made real estate an appealing investment alternative. As a result, the renewed market focus on residential real estate, coupled with lower interest rates, fueled growth in property values and refinancings.
The Second Factor is the Mortgage Securitization Process:
An increasing appetite for debt investments with higher yields drove innovation within Wall Street to create ever more complex forms of securitized assets and investment vehicles. The role of the investment banks in this process cannot be overstated. They are facilitators – and earn fees -- at multiple stages of the process. Investment banks act as wholesale funding vehicles for originators, as packagers of asset backed securities, and as managers and underwriters of Collateral Debt Obligations.
There are some who have compared the role of the investment banks in promoting these complex products and client relationships to their role in S&L crisis. You may recall Wall Street helped thrifts raise significant amounts of brokered deposits and at the same time created high-yield junk bonds to be sold to those same institutions. I am certainly not saying this will rise to the same level, but I find the comparison interesting.
The Third Factor is Product Risk:
With Wall Street now looking for higher rates of return, mortgage originators delivered in the form of riskier high rate loans. In response, lenders created new products and marketing strategies directed toward the subprime sector. This rapid growth was also coupled with new technologies -- such as electronic application processes which include automated underwriting models.
Because these models rely on past behavior as an indicator of future performance, they may not take into consideration the borrower’s ability to repay the debt or withstand the stress of future payment shock.
The new and innovative products being directed toward the subprime market include products you know well:
- Payment Option ARMS
- Interest Only mortgages
- Hybrid ARMs like:
Many of these types of products were originally intended for high net worth customers who could better withstand and understand the unique risks associated with these products, such as the potential for negative amortization.
The Fourth Factor is Underwriting Risk:
Product risk directed to the subprime market was layered with additional underwriting risks such as 100% financing and reduced income verification and documentation.
Having moved away from 80% loan-to-value ratios and other traditional underwriting methods, it was possible to fit customers into loans for which they previously would not have qualified.
Similarly, the trend toward not escrowing for taxes and insurance caused monthly payments to appear lower, but created another risk -- namely that the borrower will be unable to afford the year-end taxes.
With automated underwriting systems, low or no documentation requirements, no down payment, and no escrow accounts, a loan could be generated for a much wider range of consumers, but with reduced emphasis on their ability to repay.
So what would motivate lenders to do this and incur this increased risk?
Because the lenders were conduits to the investors and were not holding the loans in their portfolios, they could pass on this increased risk to investors with limited recourse. This assemblyline approach to mortgage origination differs from traditional banking where mortgages are retained and where banks intend to have long-term relationships with borrowers.
The allocation of risk of mortgage loan defaults therefore has become more dispersed through complex contractual arrangements that begin with the mortgage broker and end with the institutional investor. This dispersal of risk – and we still don’t know where it all lies – has created opportunities and incentives for some players in this process to engage in weak underwriting and even fraud.
One clear example of fraud is evidenced by the increasing amount of first or early payment defaults. Think of it – in many situations the borrower did not even make his first scheduled payment!
There are also concerns from a fair lending perspective. Many of us can recall the discriminatory practice in the 1970’s known as “redlining” which gave rise to the adoption of the Community Reinvestment Act – now celebrating its 30 th anniversary. “Redlining” drew its name from a practice in which lenders would literally draw a red line around entire neighborhoods – mostly minority – where they would not extend mortgage credit. Some are now questioning whether today we are seeing a form of “Reverse Redlining” where lenders are targeting minority neighborhoods and senior citizens to push higher rate mortgage products.
The demand by Wall Street for higher rate mortgage loans has also motivated some mortgage originators to approve as many customers as possible in order to maximize profit. This push to expand approvals has the potential to create a conflict of interest between the lender’s business goals and the customer’s personal financial needs – particularly when a broker’s compensation includes a yield spread premium.
So how bad is the current situation?
Many subprime borrowers, particularly those with hybrid ARMs whose rates are fixed at low -- often teaser -- rates for the first 2 years, are now starting to see their mortgages reset based on a percentage over a short term benchmark like LIBOR.
With the significant increases in short term rates over the last 2 years, many of these borrowers will experience resets beyond their financial means. It has been reported that over one million subprime loans are scheduled to reset this year.
With today’s home values either flat or declining, many who anticipated refinancing at lower long-term rates may find that option is now closed to them.
The big question will be whether delinquencies and defaults continue to accelerate as further resets are triggered later this year and next.
An even bigger question is whether there will be a contagion – or spillover effect -- into other sectors beyond subprime. Just yesterday there were additional reported concerns about the ALT “A” market.
As data begins pouring in, there continues to be disagreement as to both the scope of the problem as well as its root causes.
But, if there’s one thing that I think we can all agree on upfront, is that there’s been a lot of finger pointing. Some blame Wall Street and investment bankers for providing the liquidity without sufficient discipline. Others blame those originating the loans for allowing 100% financings and unverified income, thereby failing to assess a borrower’s ability to repay.
I think we need to start off this morning by acknowledging that there’s enough blame to go around – and just about everyone involved in this industry shares in this blame for the situation we’re faced with today.
However, today’s event is less about assigning blame and more about looking forward – that’s why I can’t thank everyone enough for participating today.
So what are we here to do?
First of all, we’re here to listen. My understanding is that today’s audience is comprised of an equal number of industry representatives, and community and advocacy groups – along with regulators, enforcement agencies and academics. That’s a good start.
When this event was first being organized, we reached out to community and advocacy groups and government agencies to identify what they needed in order to be better equipped to do their jobs.
The overwhelming response was that these groups wanted to better understand the role of government and to actually hear from the industry.
Let’s talk about the Role of Government.
It’s a question that I have been frequently asked over the last five weeks.
I see government initiatives following two separate tracks that require separate analyses:
- Initiatives to assist existing borrowers; and
- Initiatives to assist future borrowers.
Track 1 – Initiatives to Assist Existing Borrowers
As to the first track, to help existing borrowers, we need to ask:
What can we be doing in the short-term?
Are there programs we should initiate that can assist borrowers facing foreclosure?
Where are the communities and neighborhoods that face the greatest risk of increasing foreclosures?
We all know the contagion impact that foreclosures can have on home prices and neighborhood economies. What type of additional data and analyses will be needed to make these assessments?
Next, what are the types of initiatives that can be directed toward these borrowers to keep them from foreclosure?
One topic I would like to hear your views on is the specific elements that could be included in a statewide foreclosure prevention strategy.
Some elements may already be in the New York State Banking Department’s arsenal: like the toll-free Consumer Helpline that can answer questions, make referrals or mediate between the consumer and the lender. This is complimented by New York City’s 3-1-1 system that provides similar referrals.
One law recently added to the books in New York is the Home Equity Theft Prevention Act, which became effective February 1, 2007. This act works to ensure that borrowers facing foreclosure aren’t harmed or victimized by fraudulent rescue schemes. You will be hearing more about the Act later this morning.
Another important thing we are doing is ensuring that we are not acting in isolation from other agencies and areas of state government.
It is for that reason, that the Governor’s Office led the way by establishing an interagency working group to pull together all of the statewide departments and agencies which touch the subprime issue. This working group coordinates efforts and brings the maximum amount of resources – including brain power – to address the situation. Represented in this working group, in addition to the Banking Department, is the State of New York Mortgage Agency (SONYMA), the Division of Human Rights, and the Secretary of State, who has jurisdiction over real estate brokers and licensed appraisers.
I think it is worth noting that SONYMA has taken a progressive stance. SONYMA is actively looking to expand its mission of helping people stay in their homes by developing products aimed at reaching borrowers who are in trouble or at risk.
For example, in May, SONYMA is planning to introduce a 40-year fixed-rate product for first time homebuyers, which is a product they would also consider for any refinancing program. We are very grateful that Marian Zucker, Senior Vice President for Programs and Policy at SONYMA, was able to join us today.
We are also coordinating efforts and providing support to the Office of the New York State Attorney General to bring enforcement cases where appropriate. You will be hearing more about this area this afternoon.
Track 2 –Regulatory Initiatives to Assist Future Borrowers
The second track of government initiatives is focused on the regulatory and statutory response going forward to assist future borrowers.
There is clearly a role for government here, but our response must be measured and thoughtful. It must take into consideration the overall impact on credit availability, particularly to the subprime sector. We must constantly remain aware of the risks of unintended consequences. We must remember that subprime lending is not synonymous with predatory lending.
I recognize that the increased availability of financing to borrowers with less-than-perfect credit has made the dream of homeownership a reality for many people who otherwise would not have received loan approval.
The intention of developing new and appropriate controls for the subprime sector therefore, is not about eliminating subprime. It is rather about making sure that a healthy subprime sector remains a viable part of the market.
One of the important new controls addressing mortgage fraud is the implementation of the Mortgage Loan Originators Bill, passed in December 2006 and effective January 1, 2008. The law requires that any person who originates loans on residential property in the State of New York be authorized annually by the Banking Department. All Mortgage Loan Originators, or MLO’s, must be fingerprinted, a background check must be conducted, and must complete an application that attests to that individual’s charter and fitness to work in this industry. As a result of this law, MLOs must also meet and maintain specific educational qualifications.
The market has begun to respond to the recent subprime crisis, and there are some initial signs of a self-correction, but that does not imply that regulatory solutions are not also necessary. Market self-corrections and regulatory initiatives can work in tandem, with the regulation intended to strengthen and reinforce positive steps taken in the private sector.
Without complementary regulations, companies that voluntarily adopt best practices may find themselves at a disadvantage compared to less scrupulous competitors. Industry leaders should therefore view new regulations that develop out of a constructive dialogue with their regulators, to be one means of leveling the playing field in a very competitive business.
And to further ensure that good lenders in New York aren't placed at a similar competitive disadvantage in relation to regional and national institutions, we support the further development of national standards.
I envision that there will be a need for statutory anti-predatory standards at the national level that will apply to all institutions regardless of charter type or the state in which they are operating. These standards must address two critical areas: (1) the ability of the borrower to repay the loan and (2) the misleading marketing and disclosures that prevent borrowers from fully understanding the terms of the loan products.
I expect that you will hear much debate over the pros and cons of proposals to impose a “suitability” or “fiduciary” standard on mortgage originators.
I also expect you will hear about the need for expanded efforts in the area of disclosure reform – which I fully support. We need disclosures that are clear and uniform in order to make them truly effective for consumers.
While I do support strong national standards as a baseline, I also support the ability of states to adopt additional protections for their residents and to enforce their laws against those entities or individuals operating within the state.
States, including New York, have been leaders. We are well ahead of the federal government in many respects, and we don’t want to preclude that level of state involvement.
Cases in point are the progressive leadership that states have demonstrated on issues such as fraud prevention and anti-predatory practices. For example, New York’s law that limits pre-payment penalties to the first year of the mortgage is often cited as a key consumer protection. What this means is that a consumer cannot be penalized for refinancing his or her loan after the first year. When you look at 2/28 or 3/27 mortgages, where rates are resetting at the two or three year point, this becomes significant.
In the absence of prepayment penalty restrictions, a consumer just might be in an unaffordable loan with no way out unless they pay substantial fees. Unfortunately, this protection does not apply to national banks and their operating subsidiaries.
The issue of federal preemption being asserted by the Comptroller of the Currency with respect to national banks and their operating subsidiaries has created great inequity in the system. For one it means that national banks and their operating subsidiaries do not have to follow certain state laws like the prepayment rule. And two, it means that different lenders operating across the street from each other, dealing with the same consumer, may be bound by different consumer protection laws.
Fortunately, one aspect of federal preemption of state laws came to a head last November when the Supreme Court heard the case of Watters v. Wachovia. This case challenged the OCC’s preemption rule and addressed the State of Michigan’s ability to require licensing of mortgage subsidiaries of national banks. We expect that the outcome of this case, expected later this month, will drive much of the future dialogue on preemption and consumer protection.
Before I turn the floor over to our first panel, I’d like to specifically address the three groups that are here today.
To the community and advocacy groups that are here this morning, we welcome your contributions and hope today’s event will result in even greater coordination and collaboration among your organizations, the industry and government. Your consumer education and advocacy initiatives have been a great resource for New York’s consumers and I hope today’s event gives you even more tools and resources to use in this important endeavor.
To the industry representatives, I want to remind you of the important role you play in guiding consumers through the mortgage origination process. Mortgages aren’t just contracts on a securitization conveyor belt. Mortgages represent real families, whose dreams of homeownership form the foundation of our communities.
To the government representatives, I remind you that solving a problem as large and complex as mortgage lending abuse takes cooperation, and not just cooperation with lenders, although that’s key. It also takes cooperation and coordination between the various governmental agencies that are charged with supervising the finance industry and ensuring that the law is evenly enforced.
I’m so pleased that we have with us here this morning an outstanding collection of government speakers: from the Federal Reserve; the New York State Attorney General’s Office; the Department of State, and the New York State Division of Human Rights. I would especially like to thank Kumiki Gibson, the Commissioner of the Division of Human Rights, for participating on the panel.
When government leaders work together, we can achieve the goal of creating a safe and fair mortgage market for consumers with a minimum level of burden on the industry.
I want to thank you all for joining us and I look forward to your feedback. I plan on being here throughout the whole day and I hope to have a chance to meet many of you.
Working together, we can put a HALT to predatory practices and make mortgage abuse a distant memory. Thank you.