Now that’s how to regulate!

Excellence in Public Service Award 2014

David Dayen has a piece in the Financial Times that explains another reason Republicans want the Consumer Financial Protection Bureau to fail: Because they can shut down bad banks in a way the Department of Justice can’t:

After This American Life recently removed the mystery from the New York Federal Reserve’s cozy relationship with Goldman Sachs, multiple writers have offered their take on what financial regulators in America do wrong. But this week, we got an example of a regulator getting something right. If others follow their lead, we could finally get a more stable financial system.

The Consumer Financial Protection Bureau’s new rules on mortgage servicing took effect this year. Servicers collect monthly payments from homeowners, and make decisions on loan modifications and foreclosures. And they happen to be universally terrible at it, for reasons I’ll explain later.

On Monday, CFPB cited Michigan-based Flagstar Bank with violating the new rules.

And it violated them in earnest. In 2011, years after the start of the foreclosure crisis, Flagstar had 13,000 active loan modification applications, but only 25 full-time workers and an application review center in India. The backlog became unbearable, taking up to nine months to assess an application. And Flagstar would deal with applications that contained outdated information by simply throwing them out. These actions continued to the present day.Flagstar frequently failed to tell borrowers their applications were incomplete. It prolonged the decision-making process, despite specific CFPB deadlines for telling a borrower if it would modify their loan. Flagstar illegally denied loan modifications when borrowers qualified under its rules. It gave no explanation for the denials, a violation of CFPB rules. And it lied to customers about their rights to appeal the denials, another violation.

“Struggling homeowners paid a heavy price, including losing the opportunity to save their homes, as a result of Flagstar’s illegal actions,” said CFPB director Richard Cordray, who announced the enforcement action.

CFPB has in the past sanctioned mortgage servicers for similar violations, with limited success. This time, in addition to fining the bank $37.5 million (the bulk of which will go to victims of Flagstar’s bad servicing, who also must be offered new loan modifications), CFPB banned the company from acquiring new mortgage servicing rights, particularly for defaulted loans, until it can demonstrate its ability to comply with the law.

This is enormous. There’s a healthy trade in the right to service loans in default, because new capital rules make them less attractive to large banks, and because CFPB’s regulations are costly to follow. Because servicers don’t originate a massive amount of loans themselves, and because consumers constantly refinance, pay off, or lose a loan to foreclosure, servicers must constantly purchase new servicing rights to refresh their supply and stay in business. But CFPB ordered Flagstar to not purchase any more default loan servicing until it figures out how to do it properly. This “benching remedy,” as Georgetown law professor Adam Levitin calls it, can change the calculations for financial institutions over whether to commit a fraud, where the potential penalty is usually less than the profit they can make. In this case, Levitin writes, “compliance can be costly, and being taken out of the market can really squeeze the firm’s market position and potentially even its cashflow.”

Imagine applying this model to other parts of the financial services industry. Firms guilty of securities fraud could be barred from issuing that set of securities. Companies making high-risk corporate loans outside regulatory guidelines could be stopped from making corporate loans entirely. Banks caught laundering money for sanctioned organizations could be barred from U.S. dollar clearing operations, or from taking new deposits.

The message would come through clearly: Violate the law and you no longer get to participate in the business until you prove you can do it legally.

Go read the rest, it’s a rare bit of good news.

H/t Peter Biberstein.

One thought on “Now that’s how to regulate!

  1. We live in an autocracy. The massive sums of money being spent on this election and more importantly the people spending it proves that. France had an autocracy once. Eventually neither the King nor the Queen were able to swallow cake. French aristocrats were stacked up like cordwood. “We” got rid of our autocracy in 1787. Or so we thought. Somehow they’ve bee resurrected, these vampire zombies. In this incarnation they survive on money. No money, no beast.

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