Ed. #63: FHFA's Pricing Grid and the Importance of Process

I often complain about how the CFPB seeks to implement its policy goals without following proper procedures or seeking input from industry or others who might question their regulatory wisdom. My typical complaint[1]is to accuse them of “regulation by enforcement[2]” and that the process they followed was unconstitutional. But, I’m not going to make another legal Constitutional argument[3]in this Musing.[4] Instead, I’m just going to discuss why when regulators free themselves[5]from the "time consuming, inefficient and inconvenient" constitutional constraints of due process and the opportunity to be heard, that these supposedly “data-driven”[6] all-knowing[7]technocrats still fail to design policies that are beneficial and durable.

Gorsuch's Statement

In Musings No. 58 I foreshadowed the topic of this Musing, but I didn’t realize I would feel compelled to write about it so soon thereafter. Process is more important than the outcome. In fact, unilateral and non-inclusive[8]policymaking is so dissatisfying that policies are doomed even if they may actually be good ideas. I will provide an example later to illustrate the psychological point, but first I will offer the non-legal opinions of Supreme Court Justice Neil Gorsuch about the importance of process in policymaking from his statement in a recent Denial of a Writ of Certiorari (the case is unimportant, but it involved the exercise of government power during the pandemic):

“… The concentration of power in the hands of so few may be efficient and sometimes popular. But it does not tend toward sound government. However wise one person or his advisors may be, that is no substitute for the wisdom of the whole of the American people that can be tapped in the legislative process. Decisions produced by those who indulge no criticism are rarely as good as those produced after robust and uncensored debate. Decisions announced on the fly are rarely as wise as those that come after careful deliberation. Decisions made by a few often yield unintended consequences that may be avoided when more are consulted. Autocracies have always suffered these defects. Maybe, hopefully, we have relearned these lessons too.”

Unfortunately, even Justice Gorsuch’s weak “maybe, hopefully,” optimism about pandemic era policymaking seems misplaced. Rather, the regulatory hubris by all-knowing technocrats[9]seems as emboldened as ever.

FHFA rescinds its DTI grid

Recently, the FHFA carefully constructed a detailed plan to adjust loan level pricing to subsidize certain borrowers using a complex and often counterintuitive grid of debt to income (DTI), loan to value (LTV), and credit score adjustments. National MBA President and CEO, Bob Broeksmit aptly characterized the DTI portion of the plan as “totally unworkable”[10]at the recent Annual Meeting of the Mortgage Bankers Association of Hawaii.[11] Broeksmit also expressed frustration that he was only permitted to explain that characterization to the FHFA after the grid was announced. Nevertheless, when the grid was released and industry, press and political voices were finally heard in response, thankfully, the DTI portion of the grid was shelved[12]. FHFA could have avoided this embarrassing retraction of its hard work had they simply included industry in its development. Kudos to them for at least taking the industry’s advice once given.

Maybe the FHFA’s plan would have been good had they been given a tabula rosa to create a mortgage market pricing model that consumers and industry would simply accept. CFPB also could have also designed TRID disclosure rules to allow DTI and LTV changes to facilitate subsequent rate changes and redisclosure and those same consumers wouldn’t care that their pricing changed for a variety of reasons after initial disclosure and application. Finally, systems would be readily customized to allow for such changes and redisclosure.[13] Alas, the realities of the markets as they exist (and not just as we wish them to be) is only one example of why durability and effectiveness are jeopardized when the process for regulation is not inclusive of disconfirming ideas. Unfortunately, such humility is in short supply in DC with today’s outcome-oriented regulators.

Liberal democratic capitalism depends on process

But it’s not just regulators who succumb to the allure of using power to achieve outcomes over maintaining fair processes. A certain Republican Presidential candidate (and former President) has frequently demonstrated his willingness to dispense with process to achieve his desired outcomes.[14] But the same can be said of Barack Obama’s immigration policies, Joe Biden’s student loan efforts, and a whole host of current political actors on the right and the left.

The bad examples set by these politicians and regulators[15]is unfortunately infecting (or reflecting?) current social order thought leadership on many levels. One need only look at ideas such as common good constitutionalismwhich advocates certain outcomes from Constitutional interpretation or certain versions of critical race theory that identify structural racism as the cause of everything. These ideas, however, are fundamentally nothing new. They are just fancy ways of saying, “We know better, we should be in charge.” In fact, the authoritarian, illiberal instinct to use government power without due process is ancient and innate. Yet, since its inception around 300 years ago, liberal democratic capitalism has caused the most incredible decline in human misery in history. So why do we keep forgetting the lessons of history only to return to our tribal and authoritarian impulses which do not result in the betterment of humanity?[16]

The psychological case for process

I said I wasn’t going to depend on legal Constitutional arguments in favor of fair processes in this Musing. Instead, I want to highlight the importance of process as a human psychological need. Tension in the peaceful negotiated interactions between humans results in durable results. So, I love the following example to illustrate why process is more important than outcome to peaceful solutions.[17]

Let’s say you are highly knowledgeable and sophisticated house hunter who knows how to do your own homework. You can analyze the market better than any realtor and determine market value like an experienced appraiser. You are also a master home inspector and remodeler, and research data like a PhD student to find your dream house in your dream neighborhood. You knock on the door of your selected home and offer the owner[18]a written contract saying, "I am a cash buyer ready to close tomorrow and will not pay a penny more than the price noted." The owner looks at you, quickly glances at the agreement, blinks twice and immediately, without another word, signs it, hands it back and says, "See you tomorrow at the closing table".

You got exactly what you wanted, but are you thrilled you got that outcome? Instead, are you now thinking, “OMG! I WAS RIPPED OFF! I MUST HAVE MADE A TERRIBLE MISTAKE. THIS IS HORRIBLE.”

In fact, what just happened was that because there was no negotiation, your process was flawed and now you don’t trust the outcome you got. Despite getting exactly what you wanted, the outcome is now dissatisfying and not durable. What you missed was that the process of homebuying is more important than outcome because, notwithstanding your research, your psychological satisfaction with that outcome depends on the process used to reach it. You got no process-only the result, and so you are unhappy.

Sometimes outcome is all that matters

That said, I will admit that, sometimes, the outcome is all that matters. For example, if you are a criminal defendant facing incarceration, you aren’t going to say, “well, all I want is a fair trial”[19]. But for the rest of us, faced with a future where we don’t know if we or a loved one will be a victim or an alleged perpetrator, a fair process for criminal cases is exactly what we want. So, fair process is what ensures durability on a forward looking basis.

The importance of fair processes extends to the legitimacy of government. The problem is that government must always balance competing interests. Without a fair process, the exercise of government power is not durable. That is, if my side always loses (or wins) the process isn’t fair, so why should I consent to be governed? The Constitution is what grants us a fair process and we should remember and be grateful for its wisdom because the alternative is to continue hitting each other on the head to find out who wins.

Post Script

I had one person unsubscribe from my email list immediately after recieving this Musing edition. It was a person with an email address @fhfa.gov. Ah, the price of pundit hubris (see footnote #7).

[1] E.g., https://mortgagemusings.com/f/ed-60-kim-newby-and-3-cfpb-hot-takes

[2]CFPB Director Chopra recently denied the CFPB engages in regulation by enforcement at a Congressional hearing saying, “I’ve actually continued a practice of my predecessor, Director Kraninger to issue these advisory opinions and other guidance documents. They do not create any new obligations. They simply restate what the existing laws are.” At best he is being disingenuous about the types of so-called guidance issued under his watch at CFPB that in fact do create new obligations. See e.g., RESPA's neutrality concept. He is also unfair to Kathleen Kraninger who actually did restate existing law when her administration issued the RESPA FAQs. Guidance should be written for the companies who want to comply. Not designed to give maximum flexibility to the enforcers who will go after the companies who don’t read the guidance anyway. How about some guidance that tells you what to do, not what not to do?

[3]But I am going to defend the wisdom of the framers in establishing our system of due process and separation of powers.

[4] Nevertheless, the regulatory trend to act outside of statutory rulemaking powers is headed straight into a judiciary moving in the opposite direction; particularly at the Supreme Court. See e.g., https://mortgagemusings.com/f/ed-61the-wreck-of-chevron-deference. The next SCOTUS term will be very interesting to watch unfold with the process-oriented judges (as opposed to outcome-oriented) who I believe will control the swing votes on administrative law matters.

[5] Like when CFPB Director Rohit Chopra cites his latent and/or dormant powers for authority or when NY Times columnist Thomas Friedman wishes to be China for a day.

[6] Please show your work. https://mortgagemusings.com/f/ed-54-better-show-your-work

[7] I think certain regulators don’t realize how little they actually know about how the markets they regulate operate or overestimate their ability to change behavior. This is a form of hubris. The recent bank failures were all easily predictable and preventable had regulators only made sure these banks followed rudimentary interest rate risk management. Yet they couldn’t or didn’t take decisive action. See, https://mortgagemusings.com/f/ed-59-bank-runs-are-badOf course, IRR was management’s responsibility in the first place, but my point here is about regulatory hubris. Management hubris is another story entirely. So is pundit hubris which I may have to come to grips with eventually.

[8] By “inclusive” I am referring to being inclusive of different perspectives, not DEI-type inclusiveness (although that can sometimes help bring different ideas too).

[9] CFPB recently announced a study of pricing in the mortgage market in which it discovered that different lenders might have different pricing. This was shocking news to Rob Chrisman on June 9, 2023 who also realized it could apply to other purchases he makes. For their next study, CFPB might want to find out how different lenders also might offer different levels or types of service delivery, speed, consumer communication, expertise, products or underwriting flexibility.

[10] Broeksmit accepted responsibility for the apt “unworkable” characterization of the FHFA’s pricing grid although he was not sure he coined it.

[11] Hawaii MBA hosted an outstanding substantive conference, but, beyond that, they demonstrated unmatched hospitality with the spirit of Aloha on full display to me and the other speakers. The work they put into their conference and the care they showed their speakers was truly memorable. Top that off with a beautiful beach/harbor location and the rainbow that greeted me and my wife in the morning outside our hotel window. I am grateful to have been invited and for the new friends I made. Mahalo, Hawaii MBA!

[12]For now?

[13] He says with sarcasm, ...

[14]See e.g., January 6, 2021, or classified document handling.

[15] The obstructionist behavior of the CFPB’s enforcement division towards its obligations to deliver due process in this recent 11th Circuit case is particularly reprehensible. See also this good summary from Ballard Spahr.

[16] See generally, “Suicide of the West” by Jonah Goldberg. A great read by a great writer.

[17]Hat tip to Northwestern Business School and negotiation expert Professor Victoria Medvec for this example.

[18]You have even done a title search and can ID the owner at the door.

[19] Donald Trump definitely does not want a truly fair trial, but he’ll take a jury that can be convinced his process was unfair (because of whataboutism or anything else leading to jury nullification). Two wrongs don’t make a right, but apparently that’s what a lot of people think.