A massive overhaul: the new law called the Dodd-Frank Wall Street Reform and Consumer Protection Act may be the ultimate example of the law of unintended consequences. Its massive scope will have many unknown repercussions in the mortgage market.

Author:Milligan, Jack
Position:Legislative / Regulatory - Legislation

The Dodd-Frank Wall Street Reform and Consumer Protection Act may have an impressively long handle, but its impact on the mortgage banking industry can be summed up in one word: transformational. * The act is a direct result of the subprime crisis that nearly tanked the U.S. economy more than two years ago, and it reflects the determination of congressional democrats and the Obama administration to reign in what they concluded was a runaway mortgage industry. The new law will impose so many changes on the industry, and some of the changes will be so profound, that it might be years before its full impact is known. * But if one overriding objective was to wring risk out of a mortgage market that seemed to be saturated with it at the height of the bubble in U.S. housing prices, the law's proponents might have done their job too well. As now written, the new rules take a punitive approach to the kinds of innovative--but also risky--mortgage products that proliferated during the housing boom, including subprime, pay-option adjustable-rate mortgages (option ARMs), interest-only and alternative-A loans. * While these non-standard mortgages were widely employed by lenders and borrowers alike during the boom, they were originally designed to fill a narrow niche of legitimate needs by providing credit to homebuyers who, for whatever reason, could not qualify for a standard 30-year fixed-rate mortgage (FRM) or adjustable-rate mortgage. * Under the Dodd-Frank Act, many mortgage lenders may be reluctant to offer anything other than a plain-vanilla mortgage loan--including the country's largest commercial banks, which dominate the origination market with their huge balance sheets and large brick-and-mortar distribution systems.



"The Dodd-Frank Act has taken all the innovation out of the market," says Tom Brown, president and founder of New York-based Second Curve Capital, a hedge fund that specializes in financial services stocks.

Large banks have traditionally been willing to test and experiment with new consumer products because they have more money to invest and their larger balance sheets give them a greater ability to absorb loan losses than smaller companies, according to Brown. But the Dodd-Frank Act has introduced so much uncertainty into the home loan market that Brown doubts whether even the largest banks will be willing to experiment with a new product for the foreseeable future. "There really is no testing and learning going on," he says.

Brown is not alone in his apprehension about the new law. Mortgage experts who have dug into the law's 2,300-plus pages also fear it could have a chilling effect on the availability of credit, thereby making it harder for people at the economic margins to qualify for a home loan.

Larry Platt, a partner at the Washington, D.C.--based law firm K&L Gates LLP, says the act provides a disincentive for banks to make loans to people with less-than-stellar credit histories, and unless those individuals can qualify for a federally insured home loan like those offered by the Federal Housing Administration (FHA), "they will be living in apartments," says Platt.

"We've had the world's best housing system for years," adds Platt. "But now we've moved backwards, and for the next several years only the affluent will be able to get mortgages."

In its entirety, the Dodd-Frank Act is the most sweeping overhaul of the nation's financial regulatory system since passage of the Glass-Steagall Act in the years following the Great Depression. Named after its chief architects--Sen. Christopher Dodd (D-Connecticut), chairman of the Senate Banking Committee; and Rep. Barney Frank (D-Massachusetts), chairman of the House Financial Service Committee--the act creates a new regime for handling systemic economic crises and the failure of systemically important companies, calls for a streamlining of the federal bank regulatory agencies and tightens regulation of the over-the-counter derivatives market and hedge fund advisers.

But it was the collapse of the home loan market in 2007 that precipitated the U.S. economy's worst downturn since the 1930s, and much of the Dodd-Frank Act was aimed at rectifying what its proponents saw as serious deficiencies in how the mortgage industry was regulated.

Some of the act's more important provisions include:

* Creation of a new independent federal regulator--the Consumer Financial Protection Bureau (CFPB)--to police the consumer finance market in much the same way that the Securities and Exchange Commission (SEC) watches over the retail...

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