As President Donald Trump settles into the White House, many financial industry executives are looking forward to celebrating what one has termed "the bonfire of the rule books," anticipating candidate Trump's promise to eliminate two existing regulations for every new one that is created. While this "ding-dong-the-witch-is-dead" reaction to the current regulatory environment is understandable, it should be tempered by our memory of the problems excessive deregulation has caused in the past.
No one wants to return to the Wild West environment in which financial institutions could do anything they wanted — and some did ― causing a financial crisis that wrecked the economy and the housing industry. There is a need for meaningful financial regulation, but the operative word is "meaningful," which implies both necessary and reasonable. Some of the mortgage regulations in place today are neither necessary nor reasonable.
Take the Real Estate Settlement Procedures Act's ban on referrals. The regulation, largely ignored in the past but enforced rigorously by the Obama administration, allows compensation in a mortgage transaction only for tangible products or services provided. It is designed to prohibit elaborate schemes, primarily involving mortgage companies, real estate brokers and title insurers, that provide no benefits to consumers and arguably increase their costs. But the regulation ensnares arrangements that potentially benefit consumers and don't harm them at all.
Members Mortgage Co., for example, originates loans for credit unions, either for their own portfolios or for sale in the secondary market. We help credit union members obtain loans and we pay the credit unions a fee for sending their members to us. The RESPA rule theoretically prohibits this arrangement, but it seems reasonable and justifiable to me.
The credit unions have relationships with their members and an obligation to lend to them. Members Mortgage provides lending expertise the credit unions don't have. The fee we pay simply contributes to keeping their lights on and paying the employees who manage their phones. It does nothing to harm borrowers or to increase their costs. The alternative is for credit unions to do lending they don't know how to do, which isn't going to benefit borrowers or the credit unions.
Regulators will admit, at the ground level, that the failure to accommodate arrangements like Members, in which financial institutions are working with other financial institutions, is a gap in the RESPA regulations. But no one wants to talk about that, so I end up struggling to defend a business model that has served credit unions and their members well for 25 years, with no adverse impact on either.
RESPA's referral ban is only one example of a regulation that sprays innocent industry bystanders with regulatory bullets aimed at others. The regulation that prohibits linking loan originator compensation to the profit on the loan is another.
The concern here is that originators will have a strong incentive to promote higher-priced loans that will produce the greatest compensation for the originators over alternatives that would be better for consumers. One doesn't have to look far beyond the recent Wells Fargo scandal (where bank employees, under pressure to generate fee income for the bank, opened accounts consumers didn't approve) to conclude that this concern is justified.
But does it apply to my operation or many others? Not really. We offer only one product, so my originators can't recommend one loan over another, and they have no discretion to set the loan rate.
We have historically paid originators a percentage of the gross profit on a loan by loan basis. This ensures that we never pay more to originate a loan than we make on it, which seems like a fairly sensible business plan. But under the structure the regulation requires, we have to pay a set fee for a loan regardless of how much we earn on it. While $500 for a loan that generates $1,000 is OK, $1,000 for a $500 loan is not at all OK — at least, not for long if Members intends to remain in business.
There is no question that a compensation structure based on profit can be abused; but just because a practice can be abused doesn't mean it will be. Prohibiting a practice that is abused by a few bad actors but works just fine for others is akin to the teacher keeping an entire class after school because one or two students have violated a rule.
While the regulators were obsessing about the risk that our loan originators might steer people to higher-margined loans we don't offer, Wells Fargo was running an incentive program the regulators never noticed that bilked thousands of consumers out of millions of dollars. This is not what is meant by "reasonable" regulation.
Reasonable regulation should target the abuse, not the practice. If we do anything to harm consumers, regulators should hit us hard. But if a company demonstrates, as Members has, that it can manage this compensation structure without harming consumers, the company should be left alone. Regulators certainly shouldn't force them into a structure that will make it difficult for us to operate profitably.
That's the problem with these one-size-fits-all regulations. They don't make any distinctions between the companies that amass hundreds of consumer complaints, and those that attract hardly any.
Unfortunately, there are bad actors in our industry, as there are in any industry, and they will fill a regulatory void with anti-consumer behavior. But financial regulation in this country has historically been crafted by a pendulum that swings from policies that are too lax or poorly structured at one extreme, spawning abuse that leads to overly restrictive, business-hampering policies at the other extreme.
But somewhere between not nearly enough regulation and far too much of it, there is a middle ground that restrains the individuals and entities who pose a real threat, without choking those who pose no threat at all.
Those of us in the latter category — and I think we are by far the majority — should be hoping not for a regulatory bonfire but for regulatory balance. Whether the Trump administration will achieve that remains to be seen.
Joe Zampitella is president of Members Mortgage Co., which provides mortgage lending services to credit unions throughout New England.