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   ARTICLE   |   From Scotsman Guide Residential Edition   |   September 2014

The Future of Dodd-Frank Reform

The historical ebb and flow of regulation may indicate where legislation is headed

A few readers may be familiar with the bayan, which is essentially the Russian equivalent of an accordion. Similar to any accordion, the bayan produces music by the constant motion of compressing and expanding its bellows while its keys are being pressed.

Mortgage-industry regulation follows a rhythm similar to the bayan. When its bellows are contracted, pressure is applied on financial institutions through reform and regulatory law. The bellows expand again when compliance rules are deemed too strenuous or ineffective. After laws become deregulated, gutted or otherwise changed, this expansion produces an almost laissez-faire-like quality in the industry — and gives room for fraudulent conduct. Then, the process repeats.

This ebb and flow is the pattern of regulation. Today, financial institutions are experiencing the bellows’ contraction via the Dodd-Frank Wall Street Reform and Consumer Protection Act. From seemingly every corner of the industry, lenders are murmuring about government compliance. Many industry professionals have forgotten, however, that only a decade has passed since the market experienced a similar series of regulatory reform through the Sarbanes-Oxley Act, a piece of legislation that ultimately underwent a number of modifications.

Before 2002, the market had been generally self-regulated for more than 100 years. This open bellow, although mostly successful, allowed companies like Enron Corp. and WorldCom to take advantage of recently deregulated industries. Their world-famous scandals garnered the attention of Congress, which approved the Sarbanes-Oxley Act in July 2002. Like Dodd-Frank, Sarbanes-Oxley represented a regulatory reform that drastically changed the landscape of a profession that had been untouched for many years.

"Unfortunate consequences often accompany the contraction of regulation. Specifically, increased regulation and decreased loan-origination volume go hand-in-hand."

Although this act is often lauded today, the contraction from self-to government-regulation was initially received with scrutiny and criticism. Specifically, the financial sector directed its attention aggressively toward several internal controls that appeared to discourage enterprises from going public. Their complaints were valid and the data appeared to prove it. The substantial decrease in initial public offerings in the following years spurred new discussions that labeled Sarbanes-Oxley as too bureaucratic, costly and cumbersome. Although this act was never overturned, a series of legislative actions amended sections 404 and 302 to become less stringent and decreased the act’s voluminous procedures. The regulatory bellow had expanded, in other words, as its natural rhythm would suggest.

As was the case with Sarbanes-Oxley in 2002, few would have argued against reform in 2008. At the burst of the housing bubble, the subprime-mortgage crisis shed light on a financial system that operated on little oversight for many irresponsible creditors. Although many would argue that Dodd-Frank is maligned, it was clear then that some form of law was needed to prevent a system that had become self-serving in many ways.

Dodd-Frank’s detractors, like Sarbanes-Oxley’s detractors before them, responded to the bellow contracting with frustration, fear and a sense of confusion because of the over-complexity of compliance requirements. While the government seeks to pull together the fragmented financial system, however, the mortgage industry will likely continue to see more developments introduced. When new laws are phased in, financial institutions will be pressed harder to adapt and comply.

Unfortunate consequences often accompany the contraction of regulation. Specifically, increased regulation and decreased loan-origination volume go hand-in-hand. In light of Dodd-Frank, Mortgage Bankers Association Chief Economist Jay Brinkmann predicted 2014 origination levels to drop about 35 percent year over year.

The reasons for this decline are many and complicated — as are the consequences. Productivity of underwriters will likely fall because of additional work and checking required. Mortgage products may continue to be conservative until new rules are absorbed and their real impact is known.

Because the finance sector produces a wide array of American jobs, the decrease in loan volume will lead to the termination of banking employees. The regulation of banking institutions also creates parallel consequences for borrowers, because credit could become even tougher for applicants and the middle class could be further squeezed.

Is there a lesson to learn from all this? Dodd-Frank has become one of the largest financial reforms in the history of the United States. Its rules are strenuous, its reach is sweeping and its fines can be substantial. But for better or worse, the bayan will expand again. All or some of Dodd-Frank will inevitably be gutted, changed or deregulated. It remains to be seen if Dodd-Frank will prevent another financial crisis, but if the accordion analogy is at all accurate, it probably won’t. At best, the next financial crisis simply won’t be as far-reaching as the recession.

Of course, the contraction and expansion of regulation is not as simple as two fluid motions. Like a seasoned accordion player who pivots the bellows to apply pressure at different intervals, regulation also contains periods of lighter contraction and less expansion. On a macro level, the direction of regulation remains the same.

Originators, for their part, should not be mislead when the industry experiences periods of lighter regulation if the trend is toward contraction. In fact, brokers and bankers may place their companies at risk if they relax their compliance policies during these periods. Unfortunately, however, interpreting the direction of the market is something that may only be understood in hindsight. Until time has shown that the bellow has expanded, mortgage professionals must continue to tread lightly.

The future regulatory environment remains unclear. It is also uncertain if Dodd-Frank is the beginning and end of stricter regulation. If the bayan teaches us anything, however, it’s that change will always happen. And if Dodd-Frank follows the same regulatory pattern as Sarbanes-Oxley before it, mortgage professionals should expect stricter guidelines to eventually ease — but not entirely.  


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