Ed. #52: Outrage, Empathy and Policymaking

Head vs. Heart

Outrage and empathy drive human behavior and interest a lot more than reason and data. Social media algorithms and traditional media outlets exploit this human tendency to capture your attention and to drive revenues. I’ve written about this degenerative phenomenon previously. For example, every time I open a new page on my web browser, I get barraged by headlines piquing those emotions to the point where I often forget why I launched the browser in the first place.[1] Politicians have learned this too as can be seen in the messaging of nearly every political ad you see on TV or online today. Outrage and empathy drive eyeballs, but they are no way to run a railroador to achieve optimal diverse community outcomes. Maybe try rational compassion instead: thinking and acting more with your head and less with your heart.

Outrage at the Jones Act

The Department of Homeland Security recently approved a Jones Act waiver for Puerto Rico to allow the immediate delivery of U.S. energy to a hurricane-ravaged U.S. location that desperately needs it. If you are unfamiliar with cabotage laws such as the Jones Act, it is a 100-year-old protectionist law that restricts the domestic shipping of waterborne goods to vessels that are U.S.-built, U.S.-owned, U.S.-flagged, and U.S.-staffed. So, if you want to ship something on water from one U.S. port to another, everything must be American. If you live on the coasts or on an U.S. Island in time of supply chain problems, labor shortages and inflation, the Jones Act is a terrible law that interferes with the market’s ability to adapt.

Protecting and supporting the American shipping industry may have been important to people in the 1920s and may have even been a good idea from a collective action perspective at the time. There’s no good collective action argument today for the Jones Act, but Congress won’t repeal it and even getting a waiver for humanitarian purposes is ridiculously difficult. Only empathy and outrage can only highlight the stupidity of application of this law against current situations.

Rhetorical questions

Prior to the DHS waiver, Duke professor and The Dispatch writer, Scott Lincicome wrote, “If it were Arkansans or Vermonters yet again suffering from this law and begging for relief therefrom, and if it were truck-fulls of diesel idling at their borders, would the law still be in force?” That’s called a rhetorical question; used to sarcastically (and, in this case, empathically) demonstrate a point, not to really ask the question. I like that literary device.

“The Jones Act is outrageous!”, you say? “How could a law designed to protect the American shipping industry prevent suffering people from getting the help they desperately need?” Surely, we should be able to easily make exceptions when the outcomes shock our sense of fairness. Why am I talking about this Jones Act waiver issue? Because it illustrates what often drives government to act…, and that often isn’t data.

Data driven or driving data?

The CFPB, however, was going to be different. In its own statements about its mission and methods, CFPB has consistently trumpeted they are a “data driven agency”[2]. While it is true that CFPB collects and analyses massive amounts of data[3], is it also true that the agency is driven by the data? Sometimes it seems that empathy and outrage causes the CFPB (and other governmental agencies and rulemaking bodies) to reverse the roles and drive the data to support its actions. For example, I have commented on fair lending enforcement efforts where the CFPB seems to be driving the data rather than the other way around.

Refinancing/Loss Mitigation RFI

Meanwhile, the CFPB recently issued a Request for Information (RFI)[4], asking for insights on how to make refinancing easier for borrowers. Making refinancing easier makes a lot of sense for existing borrowers[5]. In the same RFI, CFPB also asked how to make it easier to offer streamlined loss mitigation options available to borrowers in distress. This too is a good idea for existing borrowers. Specifically, CFPB noted that “Today’s request for information seeks innovative and timely ideas to address persistent market failures and to help borrowers access beneficial refinancing along with short- and long-term loss mitigation assistance.” [emphasis added]

According to the CFPB, “research has suggested that frictions in the refinance process, including potentially documentation requirements under the ATR-QM rule, may limit some refinancing opportunities that could benefit consumers. In the course of the Bureau’s market monitoring, some stakeholders have asserted that it may be appropriate to address those frictions in some circumstances in which borrowers would receive a demonstrated benefit from refinancing, such as lower interest rates or lower monthly payments, and where other protections are in place, such as protections against serial refinances.” [emphasis added]

Cause and effect

What’s up with this RFI language? The CFPB is asking for data that it appears they may already have (from “research” [6]and “market monitoring”[7]) and they seem to have already figured out that the problem is due to “persistent market failures”. Except as far as I am concerned, those alleged “frictions” are not a result of “persistent market failure” at all. Rather, what CFPB just described are some regulatory impediments[8]to the market’s operation that the CFPB implemented in response to an entirely different set of concerns that were driven by outrage: namely all of the consumer protections and regulatory requirements imposed by the Dodd Frank Act.

DFA history lesson

Before the Dodd Frank Act and the CFPB fundamentally changed how the mortgage lending industry originated, underwrote and serviced mortgage loans, you could get a stated income mortgage loan without even having to show that you had the financial ability to pay it back.[9]Similarly, you could pay a loan originator less to originate less profitable loans[10], (or more for expensive subprime loans) and as long as you complied with state law and Fannie/Freddie/FHA guidelines, you could pretty much design your own loss mitigation escalation process leading to foreclosure and sale of the mortgaged property in a matter of months on borrowers who failed to make their monthly payments (in most non-judicial foreclosure jurisdictions). While that could result in borrower horror stories of unfairness and lack of notice and chance to cure[11], it also meant some local banks who serviced their own loans would send out Joan from servicing with a plate of fresh homemade cookies to previously good paying local borrowers to make sure they were ok.[12]

Many consumers and communities were harmed by this state of affairs during the Great Recession when property values plummeted, unemployment and default rates spiked over 10% and distressed property sales approached 50% of the market. Families lost their homes due to these unsustainable loans and neighborhoods were blighted by the foreclosures and empty housing. At the same time, the relaxed underwriting standards of the pre-Great Recession period increased homeownership opportunities for minorities which materially lowered the racial housing gap[13]. These laws all arose from the outrage and empathy over what clearly were too many unacceptable borrower outcomes regardless of any progress on the racial gap or ease in obtaining mortgage finance.

Since the CFPB’s ATR-QM Rule became effective in January 2014, however, making a home mortgage loan without confirming that the borrower has sufficient income to pay it back allows the borrower sue the lender for damages and avoid foreclosure. As a result, stated income loans to a homeowner are illegal and subprime loans have virtually disappeared from the market[14]. The rules around what it means to have the ability to repay have changed a bit over time, but homeowner income must always be confirmed when making a mortgage loan.

So DFA went too far

The RFI is seeking ideas to reduce unfair and consumer unfriendly outcomes that the CFPB’s own rules create for existing borrowers to refinance or obtain streamlined loss mitigation options. Regardless, I applaud the CFPB for looking to pare back (or eliminate) any regulation that prevents better consumer outcomes and encourage CFPB to look further at other DFA era laws (especially at the LO Comp Rule)[15]. Like all reactionary legislation, DFA went too far, and parts are either now totally unnecessary, or in need of some modifications to avoid throwing out too many babies with the bathwater.

The downside of changes

To be clear, however, making refinancing easier will do nothing to reduce the racial homeownership gap because it will only help existing borrowers[16]. Even more problematic (especially for low balance borrowers), easier refinances could potentially[17]increase interest rates and costs for new and existing borrowers as that will make mortgage loans less valuable by increasing expected investor duration risk (i.e., easier refinancing will tend to shorten the expected duration of all mortgage loans making them less valuable to investors, so higher rates will be needed to offset the shorter expected term).

You got chocolate in my peanut butter!

A couple years ago I wrote a comment letter to a CFPB rulemaking that doubled as Mortgage Musing post (or was it a Musing that doubled as a comment letter?). I don’t know if that was well received by CFPB (format or substance) but perhaps this blog format is better in connection with a “Request for Information” than a comment on specific rulemaking. Maybe I’ll submit it as such for this RFI, but since I’m fairly certain that a few folks at CFPB occasionally read this anyway, maybe not.

[1]Like, why did I feel compelled to read this excellent article about Lizzo playing James Madison’s flute?

[2] I’m pretty sure Elizabeth Warren used to say that a lot.

[3] Even though it might seem that way, contrary to what one observer claimed at a recent industry conference, CFPB is not seeking data from consumers on how junk fees “made them feel” in another CFPB Request for Information.

[4]They seem to do that a lot. That is good!

[5]Perhaps not as much for future homebuyers. See infra.

[6]What research? This research? Foreclosure Prevention & Refinance Federal Property Manager's Report - 2Q2022 (fhfa.gov)

[7] Market monitoring is good for policymaking!

[8] “[i]ncluding potentially documentation requirements under the ATR/QM Rule”. Potentially? C’mon CFPB. These aren’t “market failures”. The documentation requirements of ATR/QM are what put the friction in refinancing and the servicing rules put friction in loss mitigation. If CFPB has evidence otherwise, they should show their work.

[9] That was bad! Technically, borrowers had to claim that they could pay the loan back by “stating” their income was above a certain level, but nobody checked to see if they were lying (until later when the losses got sorted out).

[10]And you could pay them less when they screwed up or you wanted to offer a lower price to consumers.

[11]Then again, there are borrowers who can game the system too: See e.g., California couple held off foreclosure for 13 years in mortgage servicer nightmare. I use this example to show how outrage and empathy can distort optimal policymaking in every direction.

[12] Obviously, that level of service is unrealistic today because the CFPB’s highly prescriptive servicing rules would have to dictate what kind of cookies could be delivered and when. Chocolate chippers are always good. Peanut Butter has allergy issues. No oatmeal raisin after 10 am because that is really breakfast, etc. I want to write that cookie regulation.

[13]That was both good and bad. I guess it depends on what drives your empathy and outrage more. Improving the racial housing gap also meant increased risk of bad outcomes for minority homeowners.

[14]The private mortgage-backed securities market for non-QM loans remains tremendously small (less than 5% of all loans) and much of that are jumbo loans. The vast majority remain Fannie/Freddie or FHA/VA.

[15] As I have urged in previous Musings, CFPB could easily do similar “research and market monitoring” (or ask for RFI) on the LO Comp Rule, which is not only unnecessary, but also harms consumers by increasing costs and preventing discounts.

[16]This may explain CFPB’s focus on small balance refinances in the RFI.

[17] I can use that word too.