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In Their Own Words: Regulators Signal Significant Actions in 2012

Friday, December 30, 2011

Sonia Persaud | Bloomberg Law


The financial reform legislation enacted in 2010 was only the first act. Now, more than a year after the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)1 was signed into law by President Barack Obama, federal banking agencies are scrambling to perform their duties under this law while simultaneously working to reduce inefficiencies and disparities in the financial system. In this article, we explore four topics the federal banking agencies addressed this year and will diligently continue to pursue in 2012. The Bureau of Consumer Financial Protection (CFPB), Federal Deposit Insurance Corporation (FDIC), Board of Governors of the Federal Reserve System (FRB), and the Office of the Comptroller of the Currency (OCC) (collectively, Agencies) have each signaled, through speeches or testimony, certain improvements they would like to make within the financial system. While there are many topics that the Agencies discussed throughout the year, we believe that in 2012 they will focus on (i) mortgage servicing, (ii) systemically important financial institutions (SIFIs), (iii) community banking, and (iv) consumer education and credit. Each of these topics contributed meaningfully to the financial crisis, and the Agencies have signaled that these are areas of major interest to them. We will address how these four topics contributed to the financial crisis and why it is important that the regulators hold steady to reform and change in these areas.

Mortgage Servicing: Improving and Simplifying a System Askew

Prior to the financial crisis, the U.S. financial industry stretched and sliced a single financial product—the humble mortgage loan—in ways that had far-reaching implications. Mortgage loans were originated by financial institutions that never intended to retain them and, instead, used the process of securitization to sell them to other financial institutions, where they were often subsequently bundled and sold to investors.2 As the number of mortgage loans and securitizations increased, other actors became necessary. Mortgage servicers were one such group. Without a single financial entity with a financial interest in the mortgages, mortgage servicers were used to manage the day-to-day tasks of administering mortgage loans on behalf of securitization investors. As the financial crisis spread, the outer boundaries of securitizations to generate profits were realized. Worse yet, both residential and commercial real estate began to see increasing foreclosures as property values plummeted and unemployment increased—and the U.S. financial industry has been unable to manage the process efficiently and fairly. Misaligned incentives in the securitization, mortgage servicing, and foreclosure process created a system where no one had a stake in the main product—the mortgages.3 The Agencies have signaled their intent to tackle the problem directly. While it will by no means happen quickly or easily, the Agencies have identified at least one way to rebuild the mortgage system. To ensure significant change occurs, in 2012 the Agencies must assist mortgage servicers through guidance while monitoring their actions.4

Mortgage Servicers

The Agencies have had much to say about mortgage servicers in 2011. They have discussed the economics of mortgage servicing, the lack of sufficient training and staffing, and the development of national servicing standards. For 2012, the Agencies should focus on correcting the deficient servicing practices identified in their foreclosure reviews.5 The development of uniform national servicing standards will be a high priority for the Agencies in 2012. If done properly, these standards will address the management of both performing and non-performing loans, foreclosure avoidance strategies, and improving foreclosure processing. If the Agencies can implement these standards, servicers will be assessed through the same standards, regardless of their regulator.6 Uniform standards for mortgage servicing would emphasize that mortgage servicing is a vital aspect of the mortgage industry and promote practices that benefit both borrowers and the broader housing market. At a minimum, the Agencies have indicated that any such standards will require that mortgage servicers designate a single point of contact for borrowers7 to increase transparency and reduce borrower confusion about the servicing of their mortgage. Further, to remediate some of the problems in the mortgage servicing industry, servicers will likely be required to implement more detailed policies and procedures that precisely describe the standards and processes by which internal operations are assessed. The Agencies have noted that senior executives must emphasize compliance and must discuss quality control and audit procedures.8 Further, they have stressed that corrections must be made where needed.9 It is this push for corporate leadership that the Agencies also need to focus on next year to ensure that performance expectations that emphasize accountability are communicated.10 Beyond uniform national servicing standards for the mortgage industry and implementation of policies and procedures by mortgage servicers, the industry will also face pressure to improve the documentation that governs mortgage servicing. While the Agencies may have little input to the contracts between private entities, they have signaled that they would prefer that pooling and servicing agreements (the documents that govern mortgage servicing in a securitization) are more detailed. They have suggested that these agreements provide clear instructions regarding actions servicers can take in the course of their duties.11 The Agencies have also recommended that pooling and servicing agreements include procedures for loan modifications and other non-foreclosure workout actions if, in the aggregate, such actions would not result in a greater loss than a foreclosure.12

SIFIs: Resolution Plans

One of the causes of stress most visible to the public during the financial crisis in 2008 was the failure of Lehman Brothers. Its demise disrupted financial markets and demonstrated the inadequacies of the Bankruptcy Code for resolving complex, interconnected financial institutions. The U.S. government reacted to the near failure of other SIFIs like AIG and Bear Stearns by providing financial assistance or hastily arranging (and financially supporting) takeovers by healthier institutions. To avoid a recurrence of such ad hoc solutions, the Dodd-Frank Act requires financial institutions to be responsible to develop a plan for their "rapid and orderly resolution in the event of material financial distress or failure" (Resolution Plan).13 These Resolution Plans will describe how SIFIs may be unwound under the Bankruptcy Code in a quick and organized manner upon their failure14 so that important financial relationships are preserved and losses are the responsibility of shareholders and creditors.15 In 2012 FDIC and FRB will receive the first batch of Resolution Plans from the largest financial institutions operating in the U.S. and must ensure that the plans outline credible resolution strategies as required by the Dodd-Frank Act. Detailed Resolution Plans will promote a frank exchange of information, which was missing during the financial crisis of 2008.16 Without a detailed Resolution Plan, there is a real danger that the complexity of some SIFIs could make their resolution costly and difficult. To that end, FDIC and FRB issued final regulations to implement new resolution planning and reporting requirements which became effective on November 30, 2011. The Dodd-Frank Act required these regulations to be finalized within 18 months.17 However, it is important that FDIC and FRB continue to develop and refine a thoughtful and substantive process for reviewing a Resolution Plan to determine whether it is both credible and ensures an orderly resolution under the Bankruptcy Code.18 It is crucial to the safety and efficiency of our financial system that the management and stakeholders of SIFIs are aware that the government may allow it to fail.19 This can only be accomplished if the Agencies ensure compliance with regulations and they review each Resolution Plan critically.

Community Banking: Developing Main Street's Greatest Asset

Officials from each Agency have, throughout the past year, highlighted the importance of community banks to the U.S. financial system.20 These officials have noted that community banks are uniquely positioned. Although they provide fundamental services to large numbers of Americans, they often bear regulatory burdens that are disproportionate to their size. Regulators also frequently observed that the 2008 financial crisis was caused largely by large banks and non-bank financial institutions rather than community banks. The Agencies noted that macroeconomic problems were less likely to arise when community banks are the source of credit because they are keenly aware of the credit needs of their communities and generally act accordingly.21 In 2012 the Agencies must rise to the challenge of supporting Main Street's greatest asset—the community bank. There are unique challenges faced by community banks, including decreased profits from weaknesses in the commercial real estate market and the scrutiny of overdraft protection programs' income.22 While the new regulations and changes brought about by the Dodd-Frank Act may affect them disproportionately, community banks are expected to do what they do best: serve the community, act prudentially, and manage costs.23 The Agencies recognize that regulation can often be a burden to community banks. Many policies and proposals focus on safety and soundness and regulatory burdens of community banks.24 Regulators have signaled that it will be important for them to ensure that regulatory changes reflect differences between community banks and large banks, thereby allowing community banks to become more competitive.25 The Agencies have recognized that an important regulatory goal should be to ensure that community banks are well-run institutions and regulations and examinations serve to improve their internal systems.26 At least one agency has recognized that it was the government’s failure to set rules and scrutinize large banks and non-bank financial institutions that hurt community banks' competitiveness because they were subject to more regulation than the larger institutions.27 The Agencies must focus on working with the community banks to ensure their range of services and options remain competitive and are not overly burdened.28

Consumer Education and Credit: Increasing Financial Awareness and Access to Mainstream Credit

Consumers have discrete financial needs. They need access to safe and affordable savings, depository, bill payment, and check cashing services. They need access to credit. They need access to long-term savings. They need access to non-cash payment services. In 2011 the Agencies signaled that they understand consumers' frustrations with limited access to financial services and products and discussed increasing financial education of consumers.29 In 2012 the Agencies will push financial institutions to develop products and services that will foster economic inclusion of all consumers and encourage consumers to educate themselves. Although the Agencies have recognized that products and services that serve core financial needs are not available to all Americans, there are few efforts to increase their availability. Unfortunately low- and moderate-income consumers may not meet banks' mandatory minimums for access to these financial tools or may not be able to afford the fees associated with them. The Agencies have signaled that they intend to encourage alternate programs that will allow underbanked consumers access to these financial tools. FDIC has made efforts in this area through programs over the past few years that tested offering small-dollar products to consumers.30 Financial tools that include access to mobile banking and prepaid cards with alternate payment structures may help consumers to access mainstream credit.31 Consumers also need a working knowledge of basic financial terms and concepts. A better understanding of our financial system and the ways it can benefit the consumer may foster better economic decisions for individuals in the long run. In addition, there is a correlation between an individual's financial decisions and the financial stability of our economy.32 The Agencies recognize that certain vulnerable consumers do not necessarily rely on mainstream financial services, and, consequently, are more apt to use alternative financial products.33 The Advisory Committee on Economic Inclusion, created by FDIC, has provided recommendations for expanding access to mainstream banking services to underserved consumers.34 Other agencies can explore using this model to implement similar committees to support their financial institutions' increased products and services for consumers. Further, CFPB was directed by the Dodd-Frank Act to support increased consumer education and access to credit.35 CFPB is also tasked with, among other things, preventing unlawful discrimination, promoting a fairer marketplace, and promoting credit availability.36 With such a mandate, the Agencies should collaborate to prioritize increasing consumer financial products and services and consumer education to ensure that all consumers have the right financial information at the right time to make the best possible financial choices.37


If the Agencies are creating New Year's resolutions, the issues identified in this article must surely be an integral part of their plan for 2012. With a little persistence and a measure of endurance they can achieve their goals—minimizing inefficiencies and disparities in the financial system while addressing the specific flaws that contributed to the financial crisis. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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