How Will the New Financial Reform Affect You?by Tim Manni
If you follow the news, it’s inevitable that you’ve heard at least some mention of the Obama Administration’s massive overhaul of the country’s financial system. In what is being touted as the largest economic reform since Franklin Roosevelt’s New Deal, the “Financial Regulatory Reform: A New Foundation” has started out like many other reform proposals from the new administration: lengthy and with few concrete details.
The 89-page proposal is full of shake-ups, new regulations, regulators, rules, and changes. We’re going to concentrate on the portions which are likely to affect you the consumer the most.
Costs Expected to Rise
One aspect of the plan calls for the creation of the Consumer Financial Protection Agency (CFPA). The proposal notes “The CFPA should have a stable funding stream, which could come in part from fees assessed on entities and transactions across the financial sector, including bank and nonbank institutions and other providers of covered products and services.”
Given that all costs of making a product available (a loan, in this case) are generally built into the final cost of that product, and that the final cost of that product is paid solely by the end-user (consumer), the new entity would serve to raise the cost of consumer financial products, either in terms of interest rates, fees, or both.
The simple act of requiring a change in standard documentation, such as the forthcoming RESPA change, creates millions of dollars of costs across the industry, all which are ultimately paid for by the consumer.
Fewer Mortgage Products
Among other things, industry groups are also concerned about the new agency’s mandate to promote “plain vanilla” products. In whatever form, lenders would be required to offer such items above and before other choices. The proposal notes that consumers might have to pass some form of “financial literacy” test to have access “non-vanilla” products, and there might be considerable penalties and drawbacks for lenders who want to make them available — including possibly being required to hold 5% or more of the loan amount in reserves. With so much additional overhead, so many additional disclosure steps or requirements, many lenders will simply stop bothering to offer any “non-vanilla” products, and new product development — for good or bad — would likely come to a halt. Aside from making homeownership more costly, we may see the death of financial innovation in the name of consumer protection.
“Plain vanilla” loans already exist in the market, and are the dominant product today. With 30-year FRMs typically the most expensive loan in the market, how many potential future homebuyers won’t be able to qualify for a loan, and what would such a reduction in demand do to home prices and homeownership rates? Even if 50% of the ARMs originated over the past few years did go bad, 50% of them did result in a homeownership opportunity which might not otherwise have existed.
There are no doubt opportunities to streamline a messy, tangled regulatory mess strewn across a number of agencies, and a single regulator to manage them is probably a good idea, on balance. Improving documentation, improving disclosure and making financial products more understandable are all noble goals, but it’s important not to overreach — something the proposal seems to wish to do at its outset. As the “law of unintended consequences” remains in force at all times, completely overturning the market for mortgages and loans probably isn’t the best of ideas, especially given its already fragile state.
It’s also important to remember that the push to put more people in homes was as much a government-led effort as a market-driven one. Driving up the homeownership rate has been a social goal of the past few administrations. The policies and regulatory structures in place also served to help create the housing boom and bust, and products which developed during that time also served that goal.
The Financial Regulatory Reform proposal has been created to clean up after and to prevent another bubble. Yet, if this reform results in shrinking loan availability and raising costs, where will tomorrow’s borrowers turn when elected officials again start to beat the “homeownership is good” drum? The ‘homeownership at any cost’ mentality (lenders, borrowers and elected officials alike) is what helped create this mess in the first place, and with traditional lenders and banks restrained, it’s not too far fetched to think that a government ‘marginal borrower mortgage entity’ will be developed to promote “affordable” homeownership, probably at taxpayer expense. Expansion of the FHA anyone?
(Keith Gumbinger contributed to this article)