5 questions for former GSE regulator Armando Falcon

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A fully digital mortgage may lie in the mortgage industry's future, but while strides have been made, widespread adoption of this process remains elusive.

That said, mortgage lending is closer than ever to having a truly paperless process, according to Armando Falcon, a former regulator who is currently consulting with Ginnie Mae on its digital mortgage project.

Falcon was the director of the Office of Federal Housing Enterprise Oversight in the Bush and Clinton administrations between 1999 and 2005. Before heading up the Federal Housing Finance Agency's forerunner, he served for eight years as the general counsel of the House Committee on Banking and Financial Services.

Now he runs Falcon Capital Advisors, a consulting firm he founded in 2007.

Below are excerpts from a discussion with Falcon about the growth of digital mortgages at the Mortgage Bankers Association's annual convention in Austin, Texas. The questions and responses have been edited for clarity and length.

What are some of the trends you are noticing in the mortgage industry?
We're right in the middle of what we see as a transformation in the mortgage industry, from paper to paperless mortgages, the digital mortgage transformation. I think this is finally the time when it's going to be widely adopted in the mortgage industry. It will take some time, but all the right events have come together to make it start to happen.

Fannie and Freddie have allowed digital mortgages for about 10 years now but it's never taken off for a variety of reasons. A couple of those issues have resolved themselves. There's no longer real doubt about the enforceability of e-notes, that's been resolved. Warehouse lenders are now beginning to accept e-notes as collateral for their lines. I think the biggest event is the government deciding they're going to get behind e-notes and fully digital mortgages.

In all my time working in government and now doing consulting work, we see how powerful it can be when government policy aligns with industry desires. So when the two converge to say "we want to accomplish something," it makes things happen.

There was a lot of talk at the MBA convention about the growing use of artificial intelligence and machine learning to assist with internal processes. How do those impact the digital mortgage transformation?

I think they're a little related, but I think they're two separate developments. The AI adoption is meant to automate functions that are repeatable — the manual, almost administrative functions. If you can have AI perform those functions, it becomes more efficient. Digital mortgages are something different. It is the use of technology to create a mortgage asset that is paperless. AI might be able to play some part in the paperless mortgage origination process, so they can complement each other, but I see them as two separate developments.

When it comes to adopting digital mortgages, many in the industry have been worried about compliance. Are the regulators more open now to digital mortgages?

Yes. You've got use of technology on the front end, in the creation of the product, to try to make sure that there is full compliance with all of the regulations.

But there's another side to compliance that people aren't focused on, in this kind of economy, where there aren't a lot of borrowers that are defaulting.

During the financial crisis and the subprime meltdown, foreclosures were happening in a big way and people went to into loan files to try and figure out if they were going to foreclose. But there were key documents missing or they couldn't find the loan file at all. There were signatures that were missing on key documents.

All those problems that arose, that came to light as a result of the subprime mortgage crisis, those would be prevented in the digital mortgage world. The digital mortgage, paperless, closing process will make sure that every field that needs to be signed, is signed. And there will be digital copies created of a mortgage so that you don't have to worry about where's the file. They don't get lost, they don't fall off the UPS truck. In all the shuffle of papers, a key slip of paper can fall out, and then you don't have proof that the borrower signed a certain document.

So all these defects in loan files that came to light after the financial crisis — digital mortgages fix that. Digital mortgages protect the integrity of the loan file.

Given your past role as the regulator for the government-sponsored enterprises, what do you see happening with housing finance reform? Is there any chance of it happening in 2020?

There's nothing special about 2020 that there's going to be some epiphany in Congress. What's more likely to happen is, in a year or two or more, Congress fills what regulatory action alone cannot fill.

It was important that Treasury got the report out. I think that box had to be checked and now that that's happened and the administration's position been made clear, Director Calabria now is positioned to execute on using his powers to reform Fannie and Freddie.

I know Mark, I like him, I'm a fan of his, I think he's going to do a good job running the agency. I trust him to be very careful about properly reforming Fannie and Freddie rather than just recap and release. Because recap and release without reform is just recap, release, repeat. He understands that very well and I think he will recognize the need for very serious reforms at Fannie and Freddie in connection with taking them out of conservatorship.

So Congress needs to act, rather than the regulator taking this on itself?

Exactly, but I think we do need regulator to be a catalyst for Congress to act. You need the regulator to do as much as it possibly can to identify to Congress what it needs to do to fill the gaps. And Congress then is more capable of passing a more limited law to fill those gaps.

It will be very hard for any competitor to pull some market share from Fannie and Freddie. Given the difficulties in that, it would be difficult for investors to pour money into a competitor at the very unlikely prospect of pulling market share from Fannie and Freddie.

That's why I think most of the reforms that are well thought out include market caps for Fannie and Freddie. When (Senate Banking Committee) Chairman (Mike) Crapo put out a proposal two years ago, he had market caps in his bill.

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Digital mortgages GSEs GSE reform Originations Secondary market FHFA Fannie Mae Freddie Mac