Posts filed under ‘Regulatory’

What Is the True Cost of Fraud?

How much is cyber theft costing us? The question is crucial because, to simple country lawyers like me, we are facing the electronic equivalent of a man-made Ebola virus. Is it possible that fraud is a manageable cost of doing business? I don’t think so, but I’m afraid many policy makers, merchants and large financial institutions might.

One place to look for the answer is in the Fed’s biannual report on the cost of debit card interchange costs mandated by the Durbin Amendment. The latest installment was issued September 18th.  Fraud resulted in $1.57 billion in losses in 2013. Furthermore: “. . . the majority of fraud losses were absorbed by issuers and merchants (61 percent and 36 percent respectively); cardholders absorbed only 3 percent of losses.”

Most importantly, the cost of fraud is rising.  “Although overall fraud losses as a percentage of transaction value did not change much between 2011 and 2013, there were substantial changes in the incidence of fraud, as well as in average losses per fraudulent transaction.”

But since overall transaction costs are going down, the Fed won’t be proposing a change to the existing cap, which is currently 21 cents plus 5 basis points multiplied by the value of the transaction, plus a 1-cent fraud-prevention adjustment, for institutions that take mandated fraud prevention measures.

Something doesn’t quite past the smell test. In the same week, Home Depot concludes that a mere 56 million consumers had their credit and debit card information stolen by malware imbedded onto its card readers, the Federal Reserve concludes that there is no need to recommend raising the cap on interchange fees for institutions with $10 billion or more in assets.   We may have one of those situations where economists can tell us the price of fraud but not its true cost. Remember the cap just applies to institutions with $10 billion or more in assets.

Why should credit unions care? Because, while cyber fraud may be an acceptable cost of doing business for the big guys who can absorb the costs, it’s not for your smaller institution. Furthermore, the Fed can’t monetize consumer anger and mistrust. Your average consumer is going to get fed up sooner or later. They will turn to the larger, more sophisticated institutions that they believe are better able to protect them – a trend that will be accelerated by our good friends at Apple.

September 19, 2014 at 9:06 am 1 comment

Are CFPB’s Performance Reviews “Acceptable?”

Yesterday, the CFPB, which prides itself on being a statistics-driven, cutting edge agency of the 21st Century, announced a new rating system for its employees which deemphasizes statistics.  For several months now, the CFPB has been dogged by increasingly strident accusations that its managers engaged in discriminatory practices.  These accusations were bolstered by an internal report highlighted in yesterday’s CU Times showing statistical disparities based on race in the performance review process.  For example, 20.3 percent of white employees received the highest rating (a 5 on a 1-5 scale), while only 10.5% of African-American employees received this rating.  The CFPB is responding to this “proof” of racial disparity by implementing a pass-fail system of employee evaluations, doing away with those troublesome numbers.  Instead, employees will retroactively be classified as either solid performers or unacceptable ones. 

CFPB’s retreat speaks volumes about statistics and their limits.  Disparity impact analysis, where regulators and litigators argue that a facially neutral lending policy can be proven to discriminate against individuals based on statistical analysis, is predicated on the assumption that statistics don’t lie.  Advocates of this approach argue that at some point statistical disparities demonstrate that even facially neutral policies reflect discriminatory undertones and/or practices. 

On the other end of the spectrum, on which I would place myself, are those who take a jaundiced view of disparate impact analysis.  Statistics only tell a fraction of the story.  For instance, the CFPB’s statistical chart can’t tell you about how often an employee had to be pushed to get his work done.  Similarly, statistics alone can’t capture the full extent of negotiations that went on between a mortgage originator and a consumer who happened to be African-American.  Nevertheless, the explosion of data makes it more, not less, likely that statistics will be used to judge the effectiveness of anti-discrimination laws.  This is why I find the CFPB’s response so telling.  Rather than defend its evaluations, it implicitly assumes that its managers must be racially biased.  Remember, these are the same people who will ultimately be reviewing lending trends and using increased HMDA data to spot discrimination.   

The pre-eminence of disparate analysis is going to have real life consequences.  For instance, the reality is that as lenders heighten their underwriting standards to make sure that they can document why a borrower can repay a mortgage loan or decide to only make so-called qualified mortgages, these decisions will have a disproportionately negative impact on minority groups that, in the aggregate, have less income. 

What will be the response of legislators and regulators?  Will they look at these statistics and realize that they reflect deep-seated, complex problems that simply can’t be assumed to only reflect racial animus?  Or will they do what the CFPB has done and simply water down evaluation standards so that the difficult issues raised can be “solved” instead of addressed.   

August 28, 2014 at 8:43 am 1 comment

Why We All Need To Know More About Mortgages

The SEC was literally asleep at the switch during the early days of the mortgage meltdown. Although it has made some marked improvements in its oversight of the financial industry, its glacial movement in implementing Dodd-Frank mandated reforms makes it quite clear that it is as reluctant to impose requirements on its regulated entities as the CFPB is zealous in dreaming up new and creative ways to protect the American consumer from himself.

So it’s big news whenever the SEC finally gets around to implementing Dodd-Frank requirements and even bigger news when, on balance, the proposal is one that makes a lot of sense. In fact, at the risk of insulting the CFPB, the proposal the SEC is reportedly finalizing today should nudge the CFPB to take a second look at its proposed revisions to HMDA regulations. Humor me a little bit and you will see where I am going on this one.

Asset-backed securities are a broad categorization of bonds comprised of pools of assets ranging from student loans to car loans to everyone’s personal favorite in the industry — mortgage backed securities. Purchases of these bonds are repaid with the revenue from consumer loan payments. These bonds are typically broken into tranches with more conservative investors getting less of a return but being first in line to get paid in the event that the loans start going delinquent.

As credit unions are painfully aware, in the pre-financial crisis days regulations permitted institutions like the corporate credit unions to rely on ratings agencies when deciding whether or not it was safe to buy an asset backed security like one comprised of mortgage loans. With 20-20 hindsight, we all know that this assumption was dangerously naïve. For the last several years, the question has been with what should the old system be replaced? New regulations require that institutions, including credit unions, no longer rely exclusively on rating agency determinations when buying securities, but as I have complained in previous blogs, it is unrealistic to think that most institutions have the expertise or access to information necessary to make the type of decisions for which they relied on the rating agencies. In addition, remember that all this is taking place against the backdrop of litigation in which credit unions have billions of dollars at stake in which the primary issue is the extent to which the bundlers and underwriters of mortgage-backed securities knowingly provided inaccurate information when selling securities that faded quicker than the Yankee’s playoff hopes. (Hey, at least we have the Jets and Giants to look forward to…Right?).

According to several news reports, the SEC will be finalizing regulations mandated by Dodd-Frank that require the issuers of asset-backed securities to provide more loan-level data about the assets that are being bundled and sold into securities. As a result, before an institution purchases a mortgage-backed security, for example, it will be able to examine the individual mortgage loans comprising the security.

Similar proposals have been floating around since 2010. So why the holdup? According to press reports, privacy groups have been concerned about how regulators planned on protecting such a huge treasure trove of personal financial data and a way that protects the individual homeowner. These are, of course, legitimate concerns, particularly since hackers have demonstrated on an almost daily basis that it is about as easy to steal computer-protected data as it is to find a first-term Senator who thinks he should be President. As legitimate as this concern is, the benefits of the proposal far outweigh its harms. By putting buyers on notice that the information is available to assess a loan’s quality, we’re creating a mechanism to improve credit quality before bonds go bad as opposed to trying to deter recklessness almost exclusively with after-the-fact law suits.

So where does HMDA and the CFPB come in? Currently, the agency that never sleeps called a Bureau has out for public comment proposed revisions to Regulation C, which implements HMDA. These mandate that you log information about mortgage loans you provide. Dodd-Frank gives the Bureau the authority to mandate the creation of a truly universal loan identifier. In an ideal world, regulators and lenders could track every loan from its creation to its payoff.  This would benefit housing advocates who believe that, with just a little more information, they can prove that lenders are somehow to blame for every mortgage not given to anyone who wants one and every foreclosure that takes place. It would also benefit lenders, many of whom already have to comply with unique loan identifier requirements if they participate in the MERS system. But the Bureau notes in the preamble that it isn’t planning a formal universal identifier proposal at this time. It should reconsider.

Given the nationalization of mortgage finance and the benefit to the financial system of insuring that all parties to complicated financial transactions have as much information to perform adequate due diligence as possible, the CFPB should consider speeding up its timeline for implementation of a universal loan identifier system. I understand that this process won’t be quick but the sooner a mortgage tracking system is implemented the sooner consumers and lenders can benefit from a more transparent lending system and resulting efficiencies.

On that note enjoy your day and, if you are in the Albany area, I’m giving you permission to leave early and take advantage of this beautiful weather while it is still around.







August 27, 2014 at 9:31 am Leave a comment

Where is the Line Compliance Officers Must Not Cross?

Monday, New York State’s Department of Financial Services (DFS) announced that it was banning Price-Waterhouse-Cooper from providing financial consulting services to financial institutions for two years and imposing a $25 million fine.  The settlement resulted from charges that PWC helped a Japanese bank evade BSA and OFAC requirements to facilitate wire transfers through American branches to sanctioned countries.

In zeroing in not only on illegal bank activity but the consultants who provide them legal advice, DFS’s actions may amount to a watershed moment in bank regulation that impacts compliance officers not only at the biggest banks but the smallest credit unions.  If you think I’m exaggerating, you’re wrong.  Here’s why.

The documents released by the DFS on Monday included an amendment made to a report tracking the bank’s wire transfer activities.  The PWC consultant correctly highlighted the transaction in a report to the bank.  But the bank successfully pressured PWC to remove the offending finding since it directly contradicted what the bank was telling the DFS.  Now, don’t get me wrong.  This is a particularly egregious example and the DFS was right to take the action it did, but the kind of pressures placed on the consultant are the type that are placed on lawyers and compliance officers every day.  We live in a world of regulations and every time a regulation in interpreted in a given way, it could restrict the actions a credit union can take.  Not every one of these decisions should be fodder for increased regulatory scrutiny.

At its core, the responsibility of the person who handles compliance at your credit union is to lay out a plan for translating regulations and laws into an operational framework.  By definition, this means that banks and credit unions are confronted with legal barriers between what they want to do and what the law says they should do.

I think it is perfectly legitimate for boards and CEOs to weigh legal and compliance advice and decide that the cost of compliance outweighs its benefits.  What isn’t legitimate is for any organization to create an environment where people are rewarded not for providing the best legal advice they can, but for providing the legal advice that the boss most wants to hear.  Ultimately, the line that shouldn’t be crossed is almost never going to be as clear as the case highlighted by DFS this week. 

What we need is a robust discussion about creating a codified set of ethical rules that apply to compliance officers,  What we also need is to clarify the distinction between the responsibilities of compliance officers and attorneys.  Regulators like to think that regulations are so clear cut that any institution that doesn’t interpret them the way regulators intended is clearly violating the law.  But I would hate to see regulators scrutinize legal memoranda in which retained and in-house counsels creatively analyze defensible interpretations of regulations for evidence that institutions chose not to adhere to the “correct” answer. 



August 20, 2014 at 8:32 am Leave a comment

Separating Fact From Fiction On Auto Loans

I had a longer commute than usual into work today (if I wanted to spend an hour and a half in the car on a Monday morning I would live in Long Island and not in suburban Albany, thank you), but it helped me decide what I should do my blog on this morning.  Actually, the latest commercial from upstate’s ubiquitous car dealer bragging about how he once got credit for a dead person clinched it for me. 

As I pointed out in a previous blog, there has been increasing concern that subprime auto lending is the next mortgage crisis in waiting.  The argument goes that with larger banks increasingly securitizing auto loans, dealerships and banks, credit unions and financers they work with have a huge incentive to qualify even the most irresponsible borrowers. 

Is the perception reality?  An analysis performed by the Federal Reserve Bank of New York answers the question with a qualified yes.  Looking at data from the Fed’s Quarterly Report on Household Debt and Credit, researchers point out that there has actually been a smaller percentage of auto loans being originated for borrowers with credit scores below 620.  Currently, these borrowers represent 23% of all originated car loans, which is actually lower than the 25% to 30% witnessed in the years prior to 2007.  So, is the conventional wisdom wrong?  Not really.  According to the researchers “the dollar value of originations to people with credit scores below 660 has roughly doubled since 2009.”  What’s more, this gain in origination value reflects an increase in the average size of loans being made to these borrowers.  In other words, larger loans are being made to people with bad credit and financial institutions are more than willing to spread out the length of repayments.

However, it’s important to differentiate between banks and credit unions — which the analysis groups together — and auto finance companies.  Since the recession “ended” in 2009, finance companies have been the ones most aggressively catering to subprime borrowers while banks and credit unions have been lending to these borrowers at rates lower than historical trends.  Interestingly, the report indicates that the auto loan 30-day delinquency rate for banks and credit unions has been about 1% in recent years, but about 2.5% for finance companies.  Two take-aways from this report: one, it underscores the fact that Dodd-Frank missed the mark when it tied the hands of the CFPB to regulate car buying activity to the same extent it can regulate other consumer lending.  It also serves as a warning that examiners should not let media reports about a new subprime lending bubble drive them into placing more scrutiny on credit union car lending than is actually justified by the numbers. 

August 18, 2014 at 8:53 am Leave a comment

One small step towards housing reform

Yesterday the FHFA, which has oversight over Fannie Mae and Freddie Mac took another tentative step in what passes for housing reform in politically paralyzed Washington. It announced a Request for Comment on a proposal to begin offering a mortgage-backed security issued jointly by Fannie and Freddie Mac. This is both more important than you might think and less impressive than it sounds here is why.

Credit unions need a secondary market –somewhere they can sell their mortgages to. It makes their loans cheaper, it manages risk and it ultimately allows our smaller industry to provide more mortgages to our members. Since Fannie and Freddie imploded credit unions have had a huge stake in insuring that whatever mechanism replaces them provides a cost effectively venue to sell their mortgages. Some people argue that the government is too involved in the mortgage market and shouldn’t be in the business of buying selling and guaranteeing mortgages. Others concede that Fannie and Freddie need to be reined in but wouldn’t mind seeing most of the current system kept intact.

With Washington in the grips of political paralysis increasingly it appears that the advocates of more moderate reform may win by default. Fannie and Freddie are back making gobs of money buying your mortgages and packaging them into Mortgage backed securities and the Senate was unable to reach a consensus on housing reform legislation meaning that the only entity that can really bring about any changes is the FHFA which is the conservator of the GSEs.

Currently Fannie Mae and Freddie operate independently of each other. They buy mortgages, bundle them together and sell them (Freddie Mac technically sells participation certificates instead of securities but they work in much the same way as MBS’s). With yesterday’s announcement the FHFA is putting more meat on the bones of its plans to combine the operations of the two GSEs.

It is proposing to offer a security with standard characteristics. As envisioned by the FHFA, there would still be no commingling of Fannie and Freddie mortgages in these pools and either Fannie of Freddie-but not both-would guarantee the securities. What you would have is a security with standard characteristic such as general loan requirements such as first lien position, good title, and non-delinquent status and a  payment delay of 55 days.

Done the road the FHFA envisions it being easy to swap these mortgages with existing GSE securities.   Remember FHFA wants to create a single GSE marketplace and that’s kind of hard to do when there are $4.2 trillion in Fannie and Freddie securities outstanding. So another goal FHFA is working towards is to create a unique standard GSE security s not so unique that can be traded with existing GSE securities.

Housing reform is one of the great pieces of unfinished business for Washington and the country. The FHFA is doing what it can to make changes around the edges but the country needs the type of big debate and big changes that only Washington can bring about. In the meantime this request for comment is worth keeping an eye on. Here is a link

August 13, 2014 at 9:07 am Leave a comment

When It Comes To Enforcement, NYS Is The New Sheriff In Town

In his first State-of-the State address, Governor Cuomo criticized lax state oversight of the banking industry as one of the reasons for the recklessness that led to the Mortgage Meltdown. He proposed to combine the State’s Insurance and Banking Departments into a Department of Financial Services and put one of his top aides, a former federal prosecutor, in charge of running the new department.  I would argue that there has been no area of public policy where the Governor has been better able to translate his vision into reality. A look at this morning’s news provides further proof for my case.

Yesterday, CFPB director Richard Cordray unveiled a consumer warning about virtual currencies. The CFPB isn’t telling people not to use bitcoins and other types of virtual currencies but … “Virtual currencies are not backed by any government or central bank, and at this point consumers are stepping into the Wild West when they engage in the market.” Oh boy, sign me up!

What’s the New York tie in? In a blog last week, I mentioned how New York’s DFS unveiled bitcoin regulations making it the first regulator in the country to propose a framework for the licensing of bitcoin activity. As surmised by this morning’s BankingLaw 360:

With the Consumer Financial Protection Bureau accepting complaints on bitcoin businesses and intimating that new rules for virtual currencies may be on the way, companies should expect increased federal scrutiny that will complement and strengthen regulations being developed in New York State. . .

Another Payday lending crackdown: Manhattan DA Cyrus Vance became the latest NY law enforcement official to crack down on payday lending. I haven’t seen a copy of the indictment, but media reports indicate that a Tennessee businessman is accused of establishing a network of companies with the ultimate goal of charging interest on loans in violation of the state’s usury laws at 25%. Both the AG and the DFS have already taken action against payday lenders, most notably companies associated with Indian tribes, which they accuse of violating New York Law.

BSA violations and foreign banks. If you look at the track record of BSA enforcement it seems clear that when it comes to the largest banks, the acronym is one letter too long. For years, behemoth banks have been able to ignore the BSA. In those rare instances where they got caught, they paid a fine large enough to get headlines without anything to prevent them from violating it again.

The DFS is changing this cycle by inserting itself into BSA investigations and threatening banks with the loss of their authority to conduct business in New York. The latest example that this aggressive approach is paying dividends comes from this article, which is reporting that the British bank Standard Chartered, which has already paid $670 million to state and federal regulators, is reviewing millions of transactions to insure it is not violating Bank Secrecy Act regulations yet again. A monitor installed by the DFS as part of the earlier settlement has apparently raised some red flags about some of the bank’s compliance practices.

As a result of the latest problem, Standard Chartered is once again under scrutiny from the DFS, the bank disclosed when announcing its earnings last week. A penalty of more than $100 million and an extension of the monitorship is possible beyond its anticipated end in early 2015.


The news that Robin Williams, my favorite comedian, committed suicide yesterday got me thinking about some of the funniest appearances I ever saw on TV.  Williams often teamed up with Johnathan Winters on either Johnny Carson’s or David Letterman’s late night shows.  Here’s a sample from YouTube of one such appearance.

August 12, 2014 at 9:01 am Leave a comment

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Authored By:

Henry Meier, Esq., Associate General Counsel, Credit Union Association of New York

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