Why IS there a Regulation C?
As anyone in compliance can attest to, there are myriad
consumer compliance regulations. For financial institutions, these
regulations are regarded as anything from a nuisance, to the very bane of their
existence. However, in point of fact, there are no consumer regulations
that that have not been earned by misbehavior in the past. Like it or not these
regulations exist to prevent bad behavior and/or to encourage certain
practices. We believe that one of the keys to strengthening a
compliance program is to encourage your staff to understand why
these regulations exist and what it is the regulations are
designed to accomplish. To further this cause, we have determined that,
from time to time throughout the year; address these questions about various
banking regulations. We call this series “Why is there….”
Introduction-
The Home Mortgage Disclosure Act and its implementing
regulation, Regulation C are one of the regulations that were enacted as the
result of past bad behavior. This law came into being during a time when
a great deal of attention was being paid to the lending practices of financial
institutions in urban areas. In the late 1950’s and early 1960’s Congress
conducted several hearings on the lending practices of banks and financial
institutions. In particular, many financial institutions were engaged in
practices that were starving some communities from mortgage credit. One of the most pernicious practices was
called “redlining”. It was called
redlining because some government agencies and financial institutions would
literally take a map of a city and draw red-lines around neighborhoods that
were not to be considered for mortgages.
The areas that were red-lined were neighborhoods that had majority racial
minorities. Without proper mortgages and
stable home-owners, neighborhoods decline, decay and eventually become what we
know as ghettos. Economists noted that
the practice of redlining caused “disinvestment “in the redlined
communities. In other words, deposits were being taken in from the
redlined area, but those same funds were being loaned out in other areas.
Money was flowing from one community and then distributed elsewhere.
A second practice that received attention was the refusal to
grant credit to women without the co-signature of a spouse or male
relative. Single women that would
otherwise qualify for mortgages were being denied consideration by policy of
financial institutions. During this
time period both single women and minority families were being denied mortgages
simply by the policies of lending institutions.
The government hearings on mortgage lending resulted in the
passage of several pieces of legislation aimed directly at opening the mortgage
credit market to women and minorities. Among the legislation that passed
during this period were the Fair Housing Act and the Equal Credit Opportunity
Act.
The net effect of these two powerful pieces of legislation
was to help to open the credit application process for minorities and
women. However, unfortunately, just the opportunity to apply for credit is not a guaranty of fair treatment
or a positive outcome. It soon became evident that financial institutions
had taken a different approach to denying credit.
Financial institutions began taking applications for women
and minority applicants and changed
written lending policies so that neighborhoods
weren’t excluding in writing. Despite
these changes, the experience of women
and minorities remained the same; little to no credit was granted. As a result, Congress decided in 1975
that that the experiences of minority and women borrowers who apply for mortgages
should be recorded. Towards that end, HMDA
was created.
HMDA 1.0
The practice of redlining and disinvesting in communities
was the first target of HMDA. The initial idea was to get banks to
disclose the total amounts of loans that they made in specific
areas. Congress theorized that redlining would be quickly unmasked
as banks would have to show the places where the loans were made. It
would become evident that certain neighborhoods were getting no
loans. The problem here was that the Banks did not have to
show individual loans; only the total amount of loans in a given census
tract. Financial institutions did not have to show the individual loans,
and as a result, a few loans strategically placed could give the impression of
strong community service when this was not that case at all. For example,
a one million dollar loan to a business in the census tract could give the
impression that a bank was investing this in the community.
Ultimately, the first version of HMDA proved to be ineffective in addressing
redlining.
HMDA 2.0
Starting in the late 1970’s the mortgage industry experienced
significant change. Banks and Savings & Loans that had dominated the
market began to experience competition. Finance companies, mortgage
bankers and other financial institutions began to enter the home loan
market. These lenders were aggressive and as a result many of the
redlining and disinvestment practices that had been in place were simply
overrun by the demand for more and more mortgages.
However, this did not end the need for disclosure of lending
information. The experience of women and minorities in getting
mortgages was still less than satisfactory. The focus of regulatory
agencies changed from redlining to the lending practices of individual
institutions. By collecting information about the experience of borrowers
at individual institutions, the regulatory agencies theorized
that valuable information could be gleaned about how people in protected
classes were being treated.
Information collected had to account for the fact that, more
than just banks were providing mortgage funding. In the late
1980s, HMDA was amended and the information that all lenders had to collect was
increased to include racial, ethnic, and gender information, as well as
income for each applicant. In addition, both rejected and accepted
applications for loans that did not close was added to the information that
financial institutions must collect. [1]
HMDA 3.0
The mortgage industry continued to grow and change and as it
did, the types of mortgages being offered also changed. By the turn of
the century, the question wasn’t about people in protected classes being
denied credit. Instead, it was more the type of credit being
offered. In the early part of the decade the number of adjustable rate
mortgage ballooned. Many of these products had “teaser rates” which were
significantly below the actual rate that would be paid on the loan. This
decade saw “predatory lending” practices explode. Predatory
lending is in essence, the practice of making loans with complicated
high rates and fees to unsophisticated borrowers. The unsuspecting
borrower believes that he/she is paying a low loan rate when in fact, at the
time the loan adjusts, the rate is several times higher. A huge number of
these loans were included in the financial meltdown of 2008.
The third iteration of HMDA was then, the result of changed
practices by mortgage lenders. In early 2000 the main issue was no longer
discrimination in approvals or denials, but in pricing (predatory
lending). HMDA was again amended to add the information about pricing and
lien status. In an effort to improve the quality of HMDA data, the
revised regulation also tightened the definitions of different types of loans
and required the collection of racial and ethnic monitoring information in
telephone applications
HMDA 3.5
The most recent changes in HMDA don’t necessarily represent
wholesale change in lending practices.
Instead additional data is being collected with the idea that more data
points can be used to study differences in the experiences of women and minorities
when they apply for mortgages. These
changes are a reflection of the fact that the data form HMDA is actually being
reviewed and used for studies of lending behavior.
So What Do
They Do With the Information?
When the information is collected by the regulators, it is
actually used by many different agencies for various purposes. Community
advocacy groups use the information to bolster arguments about various issues
they wish to emphasize. The government uses the information for economic
studies and as a basis for amending regulations and laws. HMDA
information has been at the heart of many studies about lending
discrimination. Many argue that the information collected by HMDA doesn’t
tell the full story of whether or not a borrower suffered discrimination.
It does however, raise a threshold issue and it is often the case that HMDA is
used to determine whether further study is indicated. As recently
as last week, a study was published that, unfortunately concludes that there
are still severe racial disparities in the granting of mortgages.[2]
The HMDA LAR is used to create the database that is
used by all of these agencies and for all of these studies. This is
why the examiners are so fussy about getting those entries correct!
HMDA to the
Defense
The same information can be used to defend an institutions
record. When compliance programs work
the way that they should, the experiences of all who apply for credit will look
the same. By using the information from
the HMDA LAR it is possible for a
financial institution can show that each and every applicant gets the same
consideration.
So at the end of the day, when you are frustrated with those
picky regulators insisting that each entry is correct, remember that you are
adding information to a very important and consequential study. It really is important that we get it
right.
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