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Adam J. Levitin is professor of law and finance at Georgetown Law. He is the author, with Susan Wachter, of The Great American Housing Bubble.
For a moment it looked like we had learned our lessons from the 2000s housing bubble caused by lax lending regulations and the financial crisis that ensued. But no . . . .
After the whole 2008 mess, Congress enacted a comprehensive set of laws regulating the entire mortgage market. It also created a muscular new federal agency — the Consumer Financial Protection Bureau (CFPB) — to implement and enforce both the new mortgage laws and other laws governing consumer financial products and services.
And it worked! Mortgage delinquencies are at their lowest level in since 1979, and the CFPB has obtained $16bn consumer relief in little over a decade for nearly 192mn Americans, a record that far surpasses the achievements of the CFPB’s predecessor agencies.
Now, however, the CFPB and the protections it provides for Americans face a threat that could once again undermine the whole housing market. This time, however, the threat to financial stability is not from permissive lending standards, but from the Supreme Court.
This autumn, the Court will be hearing a case called CFPB vs. Community Financial Services of America regarding the constitutionality of the CFPB’s funding. Although the case has been little followed outside of legal circles, its ramifications could be enormous.
If the CFPB loses, the result could be anarchy in housing markets, as financial institutions will not know what rules apply and whether certain legal safe harbours they rely upon will still shield them from liability.
The origin of the case is almost accidental. CFSA originally challenged the CFPB’s regulation of payday lending. It did so mainly on procedural grounds, but it also threw in an argument that the CFPB’s funding structure — and therefore everything it has done with the funds — is unconstitutional.
It’s an argument that eleven courts (including two federal circuit courts of appeals) have rejected, but CFSA found a more-than-receptive audience in a Fifth Circuit panel whose members were spoiling to smack down the CFPB after having been outvoted in an earlier decision in which the entire Circuit declined to address the CFPB’s constitutionality.
Thus, despite having received all of 808 words of briefing on the constitutionality issue — roughly the same length as this Alphaville post! — the Fifth Circuit panel declared an entire federal agency’s funding unconstitutional.
The panel’s reasoning was that the CFPB’s funding was infirm because it does not flow through the annual appropriations process. Instead, according to the Fifth Circuit, the CFPB receives funding from the Federal Reserve Board, which in turn is funded by an assessment on the Federal Reserve Banks. This arrangement, the Fifth Circuit said, provided impermissible “double insulation” of the CFPB’s funding from legislative control (even though Congress can change the funding at any time with a simple majority vote).
Unfortunately, the Fifth Circuit’s reasoning was based on a factual error that it might have avoided if it had requested full briefing of the issue. Contrary to the understanding of the Fifth Circuit, the CFPB is funded in exactly the same way as the Federal Reserve Board — through a direct assessment on the Federal Reserve Banks: there is no double insulation.
The Supreme Court would do well to beware of unintended consequences should it nonetheless decide to rule against the CFPB. If the Court requires federal agencies to be funded through the appropriations, the implications would be far reaching because most financial regulators are funded outside of the appropriations process.
If the CFPB’s funding is unconstitutional because it is not appropriated, well then so too is that of the Federal Reserve itself, as well as the Farm Credit Administration, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency and more. Requiring that these agencies be funded through appropriations would produce a financial and political crisis.
Even if the Court can somehow differentiate the CFPB from all the other assessment-funded financial regulators, ruling against the CFPB would still cause upheaval
The CFPB’s regulations are essential for the smooth operation of financial markets. Congress often passes statutes broadly prohibiting various acts, but authorises the CFPB to promulgate regulatory safe harbours from legal liability. If the CFPB’s funding is illegal, none of those safe harbours exist.
For example, virtually all lenders use the CFPB’s model disclosure forms because they are deemed to be in compliance with Truth-in-Lending Act requirements. Without the CFPB, there is no deemed compliance, so every lender’s disclosure forms are vulnerable to legal challenge.
Another safe harbour deems certain home mortgages in compliance with the statutory requirement of verifying the borrower’s ability to repay. Most of the mortgage market depends on this safe harbour instead of attempting to actually verify borrowers’ repayment capacity. Without the CFPB’s safe harbours, reputable lenders will pull back on consumer lending because of concern about their exposure to litigation. With borrowers finding it harder to get mortgages, housing prices could crater, triggering a recession and impairing the value of the mortgages on banks’ books, resulting in bank lending further contracting.
As an amicus brief by the Mortgage Bankers Associations, the National Association of Home Builders, and the National Association of Realtors — not normally cheerleaders for regulation — observed, if the Court rules against the CFPB, “chaos would ensue.” A judicially-created financial crisis is the last thing America needs.
