Millions of homeowners facing foreclosure dodged a bullet when the Federal Reserve Board changed course on proposed changes to mortgage rules, instead deferring to the nascent Consumer Financial Protection Bureau in the first skirmish over regulatory authority under last year’s sweeping financial reform legislation.
A coalition of consumer groups took the unprecedented step of asking the Fed to withdraw two sets of rule proposals on consumer mortgages and turn them over to the new bureau created by the Dodd-Frank Act. In a brief statement this month, the Fed cited more than 5,000 comments received on the matter and said it plans to wait for the bureau, which will take over authority on consumer mortgage rules in July 2011.
If the Fed had finalized the rule proposals, it would have eliminated a longtime consumer right to void a mortgage under certain circumstances, one of the best tools homeowners have to halt foreclosure. Consumer advocates say the rule also would have opened the door to risky reverse mortgages, and would allow changes in advertising that would permit false statements.
Nearly 11 million Americans owe more on their homes than the properties are worth, and 3.4 million homes have been lost to foreclosure since the recession began, according to CoreLogic. The foreclosure crisis has spawned accusations that lenders used improper documentation and procedures to seize homes, prompting investigations by state attorneys general and members of Congress, as well as lawsuits estimated to end up costing banks as much as $52 billion.
The Fed’s proposed rules "would have been disastrous for homeowners … At the time of the worst foreclosure crisis in anyone's memory, they were pulling the rug out from the most vulnerable consumers this law intended to protect," said Nina Simon, director of litigation at the Center for Responsible Lending, which filed joint comments with the National Consumer Law Center, the National Fair Housing Alliance, Consumers Union, the National Community Reinvestment Coalition and other consumer groups.
At Risk: Right of Rescission
At issue is the right of rescission, which gives homeowners up to three years to cancel a mortgage refinancing if they discover that the lender lied or made a mistake in truth in lending disclosures. Many overloaded courts have recently restricted consumers' ability to fight foreclosure in court by invoking this right, most significantly by requiring them to certify up front that they can repay the loan before allowing a court case to proceed, Simon said. That's impossible for many homeowners who are underwater, and a departure from prior practices that let homeowners repay the loan after the case ended, with money refunded from the voided mortgage or a new refinancing.
Under the Truth in Lending Act passed in 1968, the Fed is responsible for implementing and enforcing the law, and it periodically reviews its TILA rulemakings. Courts rely on current Fed rules to determine whether a lender violated the law. For instance, the Fed specifies exceptions and innocent mistakes in the law's acceptable margin of error, such as in the lender's statement of payments to be made over the life of the loan, and the courts look at a particular situation to determine whether the rule was followed.
"The rescission remedy has been an important tool for a lot of homeowners dealing with claims of mortgage fraud and predatory lending, which was one part of the crisis," said Alan White, a law professor at Valparaiso University. "Previously, the Fed had not gotten that involved in writing rules about remedies and private lawsuits. They tried to set the rules of the road and left the rest to the courts."
The Mortgage Bankers Association had urged the Fed to finalize the rules on the right of rescission. “Claims for rescission of mortgage loans have increased markedly as a tool to stop foreclosures, regardless of their merit, making the need for guidance in this area particularly urgent," the group said in a December comment letter. "Unlike the board's proposals on disclosure and Dodd-Frank requirements that should await the bureau, greater clarity in this area is needed today to help avoid unnecessary litigation and reduce costs that are borne by borrowers who day in and day out make payments on their mortgages."
Spokespeople for MBA and the Treasury, which is responsible for implementing the bureau, didn't respond to requests for comment. A Fed spokeswoman declined to comment beyond the press release.
The Consumer Financial Protection Bureau is likely to take a stance less sympathetic to banks and mortgage lenders eager to end the right of rescission, White predicted. "They are recruiting people from the attorneys general’s offices and the Federal Trade Commission and places that have a culture of enforcement," he noted. "The new agency is going to be much more amenable to writing rules that promote enforcement and strong remedies, and less about convincing and cajoling banks into compliance."
The New Enforcement Bureau
White House adviser Elizabeth Warren, a former Harvard law professor known for her blunt public statements about the financial crisis, is overseeing formation of the bureau, with a goal to be operational by July and a mission to promote clear information about financial products and services, educate consumers and crack down on fraud. Early high-profile hires include:
In addition to the right of rescission, the rule proposals now awaiting bureau action include simplified mortgage disclosure documents, rules for the sale of reverse mortgages and differing treatment of original mortgages, refinancings and home equity credit. For now, the Fed's proposal to loosen the acceptable margin of error on Truth in Lending disclosures, which cut to the heart of rescission, has been squashed. It's unclear how quickly the bureau could draft new rules, release them for comment and then finalize them.
"Elizabeth Warren has been working with her usual prodigious energy," said Diane Thompson, of counsel with the National Consumer Law Center. "They've got a lot on their plates."