Recriminations about what caused the greatest mortgage meltdown in U.S. history continue to play out in various ways, from courthouses to press accounts of how mortgage lenders went wild during the housing boom.
It may be less exciting than some of the stories but the Consumer Financial Protection Bureau and Federal Housing Finance Agency have recently announced plans to tackle a lesser known but equally important element of the disaster. It’s the failure of regulators to have in place a system to identify looming problems in the mortgage market prior to the crisis.
The announcement by these two agencies that they will jointly establish a National Mortgage Database has been preceded by previous regulatory attempts to gain a comprehensive picture of the fragmented loan-manufacturing process.
Regulators’ challenge of overseeing the industry was made significantly more difficult by the way securitization severed the historical linkages between lenders and borrowers. No question, securitizing mortgages has brought many benefits to the market, but it has also helped facilitate a systemic, decades-long underinvestment in data management that ultimately contributed to the calamity a half-decade ago.
This took a number of forms. They include: the lack of understanding among borrowers of the mechanics of the option adjustable-rate mortgage, which became popular during the boom years; and a breakdown among lenders during the bust in their ability to trace links between first- and second-lien mortgages.
The CFPB and FHFA’s effort to build a comprehensive data repository and identify emerging mortgage lending risks is laudable. However, success will depend on how regulators handle four areas: collaboration, scope, privacy and the regulatory burden.
The mortgage industry includes numerous participants performing critical functions that touch borrowers at various stages in the home-buying process—and which should be represented in the design of the new mortgage database. Participants include regulatory agencies, such as the Office of the Comptroller of the Currency, which oversees the largest mortgage originators and servicers and will have a large stake in the new monitoring effort.
The CFPB and FHFA’s decision to join forces is a positive sign, but collaboration must extend beyond these agencies and Experian, the credit bureau they have contracted with to build a database.
For its part, the OCC has developed its own mortgage data repository that includes one hundred data fields describing each mortgage transaction. Its incorporation in the new monitoring program would leverage existing mortgage data collection efforts and could accelerate the development of the new, potentially comprehensive, system.
If a database is going to help regulators understand emerging risks, it needs to be comprehensive. That means including loans from Fannie Mae and Freddie Mac, the Federal Housing Administration and Department of Veterans Affairs, as well as loans that are part of private-label securities in held-for-investment portfolios.
Information on credit enhancement and other features of mortgages would provide an even more complete picture of their riskiness. Regulators who were armed with an understanding of differences in the risk profiles of loans held for investment and placed into securities, for example, would gain insights into potentially abnormal behavior, such as cherry-picking of loans.
The agencies need to ensure that their database includes these important market components as they work with Experian, data that becomes available through the Home Mortgage Disclosure Act and other information.
For the database to be useful in monitoring risk, it must include information at the individual loan level. That means placing into regulators’ hands borrowers’ credit, employment and income histories, marital status, net worth and other highly sensitive information. This, unsurprisingly, will give rise to concerns involving regulatory burdens and personal privacy.
The advantage of collecting such data is that it holds the prospect of improving on analysis of mortgage default behavior, which has traditionally relied on proxies for so-called trigger events that prompt defaults. Ideally, the new database would include information about the events themselves, including divorce, job loss, the death of a spouse and other personal catastrophes.
Collecting such information and other behavioral characteristics of borrowers is critical in developing more robust risk assessment capabilities, but protecting individuals’ privacy is of paramount importance.
When the Office of Financial Research was established, one of the greatest criticisms was that it was vested with the power to obtain private personal information. The same arguments can be made with the National Mortgage Database.
From a business perspective it is likewise important to protect portfolio lenders from the release of their proprietary information. The FHFA and CFPB must also be mindful of any additional reporting burdens they place on market participants. Regulators are often criticized for creating excessive regulatory burdens, and the costs of additional regulation could inhibit the industry from overcoming the malaise that has plagued the mortgage market since the crisis.
The many legitimate concerns aside, the effort to create a National Mortgage Database must go forward. Regulators and the industry have for too long relied on mortgage risk information that has failed to keep pace with the complexity and speed of product development and structured finance.
If the initiative is to fulfill its potential and become the definitive repository for mortgage risk assessment and monitoring, those in charge must expand collaboration as well as the scope of mortgage activities and the number of participants included in the project. Additionally, they must manage the regulatory burden and closely guard private information.
Clifford V. Rossi is the executive-in-residence and Tyser Teaching Fellow at the Robert H. Smith School of Business at the University of Maryland.