Bank Lawyer's Blog

Variations On The Theme of "Pet Parakeet"

Every once in a while, I receive an email that threatens to expand the level of parody and sarcasm beyond the ability of the human mind to contain it without erupting in cornucopia of burst cranial blood vessels like a bag of Orville Redenbacher Kettle Korn in the microwave after 45 seconds on "high." A recent post in which I envisioned the CFPB "telling an auto loan lender that if a dealer from which it buys paper ever causes emotional pain to a buyer's pet parakeet, the lender is on the hook for the vet's bill," inspired one bank executive's inner snark blossom to fully bloom. He or she shall remain anonymous, primarily because this most excellent rant was communicated, without naming names, by a friend of this banker. This banker obviously has a full grasp of the new paradigm in consumer lending.

Enjoy!

"How clearly illustrative of the hell I live in every day:  “…if a dealer from which it [a bank] buys paper ever causes emotional pain to a buyer's pet parakeet, the lender is on the hook for the vet's bill…”.  Don’t forget that asking the borrower to honor the terms of the loan to which he or she agreed is in fact considered an unnecessary infliction of emotional distress.  The parakeet will pick up those vibes in the house and stop singing.  This will only further depress the borrower, who is still by the way driving the $80,000 car for which he or she is not paying, because the parakeet’s song is what keeps that buyer motivated to get up every day.  If the borrower doesn’t get up and go to work every day, the bank can’t get paid for its loan.  So the bank has a vested interest in keeping the parakeet happy and in this case a vet may not be enough.  This parakeet needs a behaviorist.  A parakeet whisperer, who understands the parakeet and can help restore the parakeet’s emotional well-being, only after which there can be a hope for the bank to be repaid for its loan. The borrower should retain the car, because after all the car will be necessary to transport the parakeet to its bird shrink, without which the loan on the car can’t be repaid.  Now you can clearly see why it’s in the bank’s best interest not only to not be paid on the loan, but to in fact pay all expenses for a parakeet psychiatrist to get that parakeet singing again.  And there is no way to make sure this happens unless a government bureaucrat has a nice office from which to read all the reports the bank will be required to produce justifying that the bank has done all it could and spent money on everything possible to get that parakeet happy, or to otherwise force the bank to do more to help the parakeet.  Doing so from a cube would be, well, inhumane – though I can’t resist pointing out that I see a few parallels between the parakeet and the bureaucrat (both are sitting miserable and silent in a small cage and pooping on everything that crosses their paths….)"

Arbitrary, Instrusive, and Ubiquitous

Inspired by last night's post, a regular reader pointed me to last Friday's post by Tom Brown, who was off to the races over two recent utterances by high-level CFPB officials. The post's title, "The Beginnings of Overreach at the CFPB. Whatever happened to personal responsibility?" gives you a clue that he and I (and Marvin Umholtz) are singing from the same songbook.

The first object of Tom's ire was Stacy Canan, deputy assistant director of the CFPB’s Office for Older Americans, who stated in an NPR interview that “There absolutely are some financial advisors that are using the designations just for marketing purposes...and they don’t really have the substantive expertise and training to back up what that designation implies to investors,” and "Seniors deserve the right to understand whether they’re entrusting their life savings to someone who’s only had a weekend seminar versus spent months or even years of training to learn how to give adequate financial advice.”

Canan's solution is that the CFPB should become involved in establishing standards for the accreditation of financial advisers. This drove Tom to a fits of sublime snark.

Seniors can ask. “What does it take to become a Chartered Retirement Planner anyway?,” they might say. Or “What’s does becoming a Certified Investment Advisor involve?,” would be another good one. Now that I think of it, a prospective client might have other questions as well, such as about the planner’s prior experience and educational background. She might also ask for references. Back in the days before the CFPB, this sort of preparation was referred to as “common sense,” and Americans were actually pretty good at using it.

Canan made another pronouncement that I had to read twice to make certain that she said what I thought she said. “Seniors in particular often mistakenly believe that their financial advisor is looking out for their best interest. That is rarely true.” Tom's response to that wholesale slander of an entire profession was pithy.

Really? Advisors only rarely look out for their clients’ best interest? One wonders how they’ve managed to stay in business. Canan seems to believe that the investment advisory business is simply systematic, organized thievery. Worse, she seems to think consumers are too stupid to recognize that. But not to worry! She’s from the federal government and is here to help. I’ve got a better idea. How about we assume that consumers are capable of taking personal responsibility for their decisions, and can be expected to make the right ones? Decisions related to one’s finances are among the most personal an individual can make. It’s outrageous that a government agency, the CFPB, is scheming to get involved in them.

Apparently, we have folks at the highest levels of this agency whose regulatory bona fides isn't sullied with the grime of actually having any first-hand knowledge of the businesses they currently regulate and seek to regulate. If ignorance is bliss, they're perpetually orgasmic. Moreover, the desire to infantilize entire segments of the American populace and require them to look to the CFPB as their paternal (or matriarchal) protector is palpable.

Tom also takes off on the recent pronouncements by the CFPB on student lending, especially that the solution to the student loan crisis is for lenders to forgive and/or modify indebtedness and to extend more of it to students who don't pay it back. Throwing good money after bad appears to be a dead end to those of us with a actual lending experience. As another of my readers put it in an email to me, "I don't even know where to start with this bad idea." On the other I do know where to start: with the trash can.

In the end, he articulates well a frustration that many of us feel.

The people who run the CFPB seem to have the basic view that under no circumstances should  people have to live with the consequences of their own freely made decisions or bear their own personal responsibility. Instead, the government should always be able to intrude itself in people’s lives to “fix” things. The trouble with allowing the government to insert itself into every part of your life is that, well, the government is going to end up inserting itself into every part of your life. There’s a word for that: tyranny. The CFPB tries to portray itself as a paternalistic entity that’s only trying to help people. In fact, it’s bureaucratic monstrosity, funded directly by the Fed, that is accountable to exactly nobody. The ideas that people at the CFPB come up with sound benign enough now. But as they accumulate (and they will, trust me) they’ll seem arbitrary, intrusive, and ubiquitous—and, of course, expensive.. But by then it will be too late. The time to start objecting to the agency’s intrusiveness is now.

There Ain't No "There," There

Last week, an article by Andy Peters in the American Banker hit a nerve. It profiled a California bank that had tried to make small dollar loans work as an alternative to payday lending, but had decided to give up the effort.

One PacificCoast Bank in Oakland, Calif., is regrouping as it looks to battle payday lenders in the San Francisco Bay area.

The $282 million-asset thrift recently pulled the plug on its One Pac Pal loan, which it tailored to offer low-income clients short-term credit at reasonable rates and terms. The program, which began 18 months earlier, lost too much money, says Kat Taylor, One PacificCoast's chief executive.

"We have not yet found an economically sustainable product that's sufficient to save enough people" from payday lenders, she says.

I hate to say "I told you so," but...Oh, who am I kidding. I TOLD YOU SO!From August 1, 2007:

In June, when the FDIC issued its final Affordable Small-Dollar Loan Guidelines and FDIC Chairman Sheila Bair was pressing commercial banks to compete with payday lenders for the "Mini Me" loan biz, even banks in states like North Carolina, which kicked out the bottom feeders, were rolling their eyeballs in disdain at the prospect of rushing in to fill the breach. Among other problems, the Guidelines "encourage" banks to cap the APR at 36 percent.

[...]

The North Carolina banks banks profiled in the linked article didn't believe that there was enough bang for the buck to justify dipping their toes in the shallow water. Even the lone credit union that offered a payday loan-like product wasn't making any money on it because it was barred by state law from charging more than an 18% APR and it was actually requiring the loan to be paid back in 90 days. If it had only rolled the loan over (and over and over) and neglected to comply with the usury laws, it might, like Madonna, have been able to "get into the groove" and make some real payday lender-like money.

Lyndsey Medsker, spokesperson for the Community Financial Services Association of America, which, according to another article, represents about 60 percent of the payday loan industry, said the 36% annual percentage rate cap was a non-starter for commercial banks.

"There's an effort to cap loans at 36 percent annual rate, which the FDIC guidelines suggest. How that works into two- week loans is $1.38 per $100," she says. "I know payday lenders can't make money on that, so banks couldn't possibly either."

Mr. Peters' latest article also quotes a consultant as correctly noting that at the same time these loans pose a high risk of nonpayment, they bear a high regulatory compliance risk and, because credit scores must be thrown out the window (or reliance on them reduced), a high underwriting risk. Peters also notes that the FDIC ended its small dollar loan pilot program in 2009 because banks couldn't make a return sufficient to cover the risk.

One PacificCoast bank's experience is in line with the consistent experience of other FDIC-insured banks who've tried to beat payday lenders at their own game over the past six years. Basic business principles don't change. However, they've never ceased to be ignored in the service of an ideological agenda, one which holds that payday loans are evil because they have high fees that "trap" poor people in a never-ending spiral of debt, people who are too stupid and/or unsophisticated and/or desperate to think for themselves, and who must be protected from their inherent deficiencies by those who know better. Guys like Recess Richie and the Payday Slayers.

It's obvious that trying to use traditional banks as payday lending alternatives is not going to work. Unless, of course, you let them earn the same return that payday lenders earn.Which kind of thwarts the "higher purpose," doesn't it?

That's right Liz, reality bites.

Camden Fine Fires Off A Fine Salvo

In  recent opinion piece for Bloomberg News, ICBA CEO Camden Fine was in fine fettle, ranting about his favorite topic: new regulatory burdens are strangling community while the largest banks are doing just fine, thank you very much. Among his salient points are the following:

The megabanks are benefiting from what Bloomberg View calculated is an $83 billion annual taxpayer subsidy, the value of implicit guarantees by the U.S. Treasury. Bloomberg View was correct to characterize the too-big-to-fail subsidy as “a major driver of the largest banks’ profits.”

Perversely, Federal Deposit Insurance Corp. data show that large banks have both the lowest credit quality and the lowest cost of funds in the industry. Community banks rank the highest in both categories even though they have had to compete for years against the megabanks’ access to cheaper money in pricing loans. In addition, community banks must compete against the big lenders’ lower comparative costs in handling regulatory paperwork.

While Cam complains that this is "morally wrong," I suspect that in a nation overrun with Pontius Pilates who sneer in the throes of their born-again relativism "What is 'truth'?," appealing to "morality" as a behavior influencer will have as much impact on Congress as a stern talking to by Pope Francis would have on Charlie Sheen. More effective on the morally challenged is likely to be his economic arguments.

Community banks should be putting their capital to work in the small towns, rural communities and middle-class urban enclaves they know well. Instead, they are focusing too many of their precious human resources on onerous paperwork and time-consuming compliance measures.

Community banks are the source of almost 60 percent of all small-business loans of less than $1 million, as well as mortgage and consumer loans tailored to the needs of their local communities. Large banking organizations with more than $50 billion in assets hold almost 40 percent of outstanding small loans to businesses, according to the Federal Reserve, but loans to small businesses aren’t a significant portion of large-bank lending. Small-business loans represent less than 5 percent of the large banks’ total domestic lending.

Cam outlines five specific steps Congress and the federal regulators could take to help community banks (and credit unions, for that matter, although Cam would choke on his own tongue before admitting it). They include:

• Easing up on some of the more onerous residential mortgage lending and servicing rules.
• Eliminating the requirement that community banks report on every new small business loan application.
• Requiring a cost-benefit analysis for all new regulations and prohibiting the issuance of any regulation where the cost exceeds the benefit.
• Raising the threshold to $350 million in assets for the requirement for an audit of a bank's internal controls.
• Eliminating the annual requirement for sending no-change privacy policies.

These are all helpful suggestions, but  I'm frankly surprised that he didn't also call for the carpet bombing of CFPB's D.C. headquarters and insist that Jamie Dimon's king-size bed be short-sheeted. Oh well, the year is not even half over. There's still time to get down to the really important stuff.

Charlie Munger: A Favorite Curmudgeon

Warren Buffet's long-time running buddy, Charlie Munger, agrees with Cam Fine about one thing: it's time to break up (or at least "simplify") the big banks.

In an interview with CNN at Berkshire Hathaway's annual meeting, Munger, who is Warren Buffett's chief lieutenant, said he thinks the big banks are still too complicated and dangerous for the economy. But he doesn't think a recently proposed bill by Senators Sherrod Brown and David Vitter, which has gotten praise from others who want to rein in big banks, is the answer.

"I think if you increase the capital requirements and let them do what they want, they will just get in trouble again," says Munger.

Munger's preferred prescription sounds like a stricter version of the Volcker Rule, which was meant to limit risky trading at the banks and was included in Dodd-Frank, but has yet to be implemented. He would force the banks to get out of their business of underwriting and trading derivatives, financial contracts that allow you to speculate, some say hedge, on commodities, interest rates, and other things. About a year ago, JPMorgan Chase (JPM) announced it had lost billions on a credit derivative hedge that had not worked out as expected.

As CNN reporter Stephen Gandel notes, Munger's words carry additional weight, because he's calling for action against banks like Wells Fargo and Bank of America, institutions in which Berkshire Hathaway has sizable investments.

Munger thinks that big banks should be more heavily regulated, and that more regulation will be just what the profit doctor ordered. "By getting out of risky businesses, banks may end up giving back much less of their bull market gains in the down years" He thinks that banks should stick to their knitting, lending. "The ideal bank is pretty boring." I agree.

Gandel thinks that if Munger actually believes that more regulation and smaller size lead to greater profits, then he has a fiduciary duty to Berkshire's shareholders to press banks like Bank of America to pare down their size and accept tighter regulation (instead of unleashing the lobbyists on Congress).Munger thinks that's the job of the regulators. I'd argue it's the role of Congress, but I'd also agree with Munger that Berkshire Hathaway isn't going to persuade Bank of America to accept being broken up or buried under an avalanche of more regulation.

Munger said he and Buffett make investment decisions based on the world they are in, not what they wished it to be, which is fair.

Like Buffet, Munger has always pretty much said what he thinks. As he ages, he's not becoming any less candid. It makes for an interesting interview.

A Bad Idea That Refuses To Die

Even though municipalities like San Bernardino have come to their senses and dropped a make-your-investment-banker-rich-quick scheme to seize underwater mortgages from mortgage lenders and wrote down the principal balances, the scheme refuses to completely die. I guess we'll have to use holy water, garlic, mirrors, fire, crucifixes and wooden stakes to stamp it out. In the interim, SIFMA continues to publicly pummel it.

In a recent post on its Pennsylvania + Wall blog, SIFMA's Timothy Cameron reiterates why those municipalities still considering this likely unconstitutional scheme to abandon it.

The proposals being touted target a very narrow slice of homeowners – those that are in private-label MBS and who are current on their existing mortgages, have good credit, and ideally don’t have existing home equity loans or other liens on the property. Those who are behind on their mortgage payments or have poor credit (which is the vast majority of homeowners needing help) will get no relief.

Within the small pool of qualifying homeowners, the proposal, on its face, will substantially undervalue their homes. In one example, the mortgage that investors would get paid $160,000 for is refinanced shortly thereafter for $190,000, with much of the additional $30,000 going to the plan’s backers after costs and a kickback to the municipality are accounted for. This is not fair compensation, since the amount paid is well below the face value of the taken note, and significant profits accrue to private parties.

In addition to the legal issues, the use of eminent domain will also be immensely destructive to U.S. mortgage markets in general and to specific communities using eminent domain, in particular. If the sanctity of the contractual relationship between a borrower and a creditor is undermined by the use of eminent domain, both lenders and investors will be reluctant to provide funding in the future. The result will be a significant contraction of credit availability, particularly in communities that have exercised eminent domain to seize loans. It will be much harder to get a loan: any loans that are granted will likely require much larger down payments, stronger credit scores and higher interest rates to compensate for this new and unprecedented risk. This contraction of credit availability would likely serve to halt any recovery in the municipality’s housing market, and could further depress housing values in the cities using eminent domain.

The last reason may be the most telling. Good luck with the future availability of affordable residential mortgage credit in your soon-to-be dustbowl of a community if you enact this scheme. The investment fund gets wealthy, of course, which is the impetus for this half-baked plan. All to help, but not so much, a narrow slice of the community.

Bad ideas never die. They never seem to fade away, either, unfortunately.

Florida Continues To Pummel Stern

Nearly two years ago, we noted that the Florida Bar had filed a complaint against former Florida Foreclosure King David J. Stern over alleged ethical lapses related to the meltdown of his foreclosure mill firm in the wake of a robosigning scandal. The wheels of justice grind exceedingly slowly (at least, they do in The Sunshine State), but last week, the Bar filed another whopper against Stern.

It took two years, but the Florida Bar has finally dropped a doozey of a complaint against former foreclosure king David J. Stern.

The 80-page complaint includes 17 counts or charges that Stern violated the Bar’s rules of professional conduct. The Bar alleges that Stern failed to properly supervise lawyers and non-lawyers at his firm and failed to halt regular violations of Bar rules.

The article summarizes the allegations made in the long complaint. Most have them appear to have been made public previously.

According to the newspaper, neither Stern nor his attorneys could be reached for comment (although another article states that Stern's lawyer, Jeffrey Tew, "told the newspaper Thursday that Stern has done nothing to warrant discipline"). Unfortunately for Stern, a former nemesis was ready and willing to pipe up with an opinion.

Former assistant state attorney general Theresa Edwards, who investigated Stern several years ago before being fired by the AG's office, said she thinks the bar should have acted sooner. (Contacted by the newspaper, the Bar declined, through a spokeswoman, to comment.)

"Considering the amount of money he's made, his bar license will be of little concern to him," said Edwards, who is now in private practice.

Biting off more than you can chew, then trying to gulp it down by cutting corners, appears, in retrospect, to have been a bad business plan. Then again, perhaps Ms. Edwards is correct. Perhaps he's made so much money that he won't care what the state does with his law license.

We'll see. At this rate, it may be another two years before this plays out. By that time, only crackpot bloggers may even remember who Stern was.

Second-Guessing the Second Guessers

Every once in awhile, the blustering blunderbuss known as Senator Liz ("She-Reams-For-Sport") Warren fires a scattershot salvo that strikes a worthy target. You know, like when Dick Cheney shot a lawyer in the face.

The other day, Princess Rides-Bankers-Like-A-Burro was grilling some representatives of the big-time independent foreclosure review firms at a hearing that only Democrats attended (so you know it wasn't going to be pro-banker) and, as related by Larry Doyle, she struck oil.

Senator Warren: I just want to take a look at the Independent Foreclosure Review Payment Agreement details. I think you’ve probably all seen this one page agreement that lists all of the things that the banks did wrong and then boxes for how many people fall into each category and how much money they’re going to be paid. Is that right? You’ve all seen this? [Panel indicates they have seen it.]

And this was put out – who put this out? I think this is put out by the OCC and Federal Reserve. Is that right? As part of the settlement details. So I just want to ask you about this.

It has some pretty amazing categories here. The first category is about service members who were protected by Federal law whose homes were unlawfully foreclosed. It’s got people who were current on their payments whose homes were foreclosed. It’s got people who were performing all of the requirements under a modification who lost their homes to foreclosure.

And it tells how many people fall into each category and how much money the people in that category will receive. And, it ultimately resolves what will happen to 3,949,896 families.

So the question I have is having resolved this nearly 4 million families, who put the people, the families, into each of these boxes. Is that what your firms did. Mr. Ryan?

Owen Ryan, Partner, Deloitte & Touche LLP: No, Senator, we did not.

Senator Warren: So who put them in.

Ryan: I’m not sure how that schedule is prepared. I saw it for the first time yesterday.

Senator Warren: Mr. Flanagan?

James Flanagan, Leader, U.S. Financial Services Practice, Pricewaterhouse Coopers LLP: Same response. We were not involved in the accumulation of that information.

Senator Warren: Mr. Alt?

Konrad Alt, Managing Director, Promontory Financial Group: Senator, I’ve seen the schedule but I’m not familiar with the basis for its preparation.

Senator Warren: So let me understand this. You ran the independent reviews, right. That’s what you got paid to do. And yet, I presume, the only one left is the banks must have put them in these boxes and you made no independent review of their going into these boxes. You were not asked to do that? Mr. Alt.

Alt: No Senator, we were not asked to do that.

Senator Warren: Mr. Flanagan. 

Flanagan: No we were not.

Senator Warren: Mr. Ryan.

Ryan: We were not Senator.

Senator Warren: So that leaves us with the banks that broke the law were then the banks that decided how many people lost their homes because of their lawbreaking. And, as a result, how many people would collect money in each of these categories. Is that right Mr. Alt?

Alt: Senator, I’m not familiar with the basis for the scheduling. 

Senator Warren: So far as you know, there’s no independent review of the banks’ analysis…you looked at 100,000 cases and the banks have now put 4 million people into categories and resolved finally how much they will get from this review by the OCC and the Federal Reserve.

Sweet!

As Mr. Doyle put it, "Bang up job on behalf of the American taxpayer from these individuals and their firms charged with an independent review of this settlement process. NOT!!"

But here's a word in defense of the consulting firms: when Mr. Alt said that it wasn't in the scope of their duties, he was not kidding. As one of my readers, a bank lawyer, advised me, the entire review process was FUBAR from the get-go.

I saw it up close and it was an absolute Rube Goldberg process with the scope, criteria and objectives changing constantly. Regulatory example 1001 of do as I say, not as I do.

It's always easy to use 20/20 hindsight to bash people, of course. However, since the regulators love to do it to bankers, I guess turnabout is fair play.

Tighten Up! No, Loosen Up!

The Obama administration’s recent call for mortgage lenders to loosen underwriting standards on residential mortgage loans to less-than-“Qualified Mortgagors” as long as the FHA (i.e., the American taxpayer) is taking most of the risk of default, generated some pretty strong reaction from the usual suspects.

"If that were to come to pass, that would open the flood-gates to highly excessive risk and would send us right back on the same path we were just trying to recover from," said Ed Pinto, a resident fellow at the American Enterprise Institute and former top executive at mortgage giant Fannie Mae.

[…]

"There's always a tension that you have to take seriously between providing clarity and rules of the road and not giving any opportunity to restart the kind of irresponsible lending that we saw in the mid-2000s," said a senior administration official who was not authorized to speak on the record.

Ya’ think?

The administration is also purportedly urging the Justice Department to ease up on lenders who make loans in accordance with the administration-encouraged looser and goosier FHA underwriting critera. The FHA also claims that it hopes to encourage "by example" Fannie Mae and Freddie Mac to follow along. It's as if the subprime meltdown never occurred and Dodd-Frank was never passed, except for the fact that the federal banking regulators, including the CFPB, are taking a directly contrary approach to mortgage underwriting. Moreover, loan originators live in mortal fear of Freddie and Fannie repurchase requests, which have been massive, since those two publicly-controlled giants are the conventional residential mortgage market.

This whip-saw of inconsistency evidences a major example of cognitive dissonance.

Private reaction from bankers and bank lawyers with whom I attended the recent Texas Bankers Association Annual Legal Conference in Austin, Texas, was even more derisive.  Much time during that conference was spent parsing the nuances of “Qualified Mortgages” and “Qualified Residential Mortgages,” which will make qualifying for a residential mortgage loan much more difficult for many potential homeowners. In addition, the plethora of new regulations being spewed out by the CFPB makes consumer lending, including making single family mortgage loans, riskier and more expensive. The bottom line for a number of community bankers is that they will be making few, if any, residential mortgage loans, at least not directly. In addition, bankers who decide to make residential mortgage loans are definitely not crazy about making anything other than loans that will fall under the QM safe harbor.

I would say that it’s amazing that the administration could talk so glibly out of both sides of its mouth, except that it’s not at all amazing. It’s what these cynical, pandering clowns do as naturally as breathing in oxygen and exhaling carbon dioxide.

Three Hurdles To Jump Pose No Obstacle To An Elephant

Banking compliance consultant Nancy Griffin thinks that bankers fear the "effects test" (i.e., "disparate impact"), which, I think, is correct. She also thinks that they should not be as afraid of disparate impact as they seem to be, because it's a three-part test and the "effect" is only one part.

The effects test is a three-part analysis:

1. The analysis starts with whether a policy or practice that appears neutral on its face has a discriminatory effect on a prohibited basis--disparate impact.

2. Next the test looks at whether the policy or practice that seems to discriminate on a prohibited basis actually has a business necessity supporting its use.

3. The final step is to determine whether there is a way to meet the same business necessity without such a discriminatory impact.

Obviously, step 1 has received all the press, and causes the most heartburn. The problem for bankers is that they rarely know what the "unintended" effects on a protected class of a facially bias-neutral practice might be. However, Nancy thinks that Step 2 is where the "real analysis" should begin.

The more accurate and effective the factors considered in evaluating credit are, the more accurately they will distinguish between good and bad credit risks. And, the accuracy of the factors becomes a powerful defense against any challenge of discrimination in effect.

Common sense should tell you that this works.

I have no problem with those statements.

As to step 3, Nancy claims that every banker should already be familiar with making this determination.

This type of analysis has been at the core of what is inaccurately referred to as "CRA lending."  The question in this phase is to figure out whether there is any other way to achieve the business purpose of distinguishing between good and bad credit risks than to use the factor that is challenged as discriminatory.

In looking for ways to make loans to low-income credit applicants, the industry has reevaluated almost all of the underwriting principles. Often, community groups asked banks to apply different debt ratios to low-income applicants or look instead to cash flow and proven ability to manage a high housing cost relative to income. In many situations, these loans could be supported by the alternative analysis. In these cases, there was an alternative way to make the loan that reduced any disparate impact of using ratios.

While she mentions the fact that many of these "alternative ways to make loans" went too far and resulted in some serious pain (in other words, the subprime mortgage meltdown), she claims this result has a "silver lining."

Some of the alternatives to basic underwriting principles have been tested and proven dangerous. This experience helps with the third step of the effects test. It makes clear that flexible underwriting is something to be done only with great care. Underwriting should not be changed simply to change the demographic effect. Before changes there should be careful research and testing.

I suppose that is true to some extent. However, I'm not as sanguine as Nancy that step 3 will be that easy to support in every case where the stricter underwriting standards that are used to achieve "QM" or "QRM" status are always employed. I can see the day, especially when the economy improves, when the fact that a bank is simply trying to meet the Dodd-Frank "safe harbor" underwriting standards is far from being a lock on satisfying steps 2 and 3. I especially think that an ideologically motivated Justice Department (and HUD) of the type we have in place currently, will remain unimpressed by any logical arguments that support a bank on steps 2 and 3 if they "find" that there's been a "disparate impact" on a protected class under step 1.

We need to remember that "disparate impact" itself is a questionable legal theory, so questionable that the US Justice Department fears its consideration by the US Supreme Court. Banks aren't scared of "disparate impact" claims only because they're so difficult to anticipate in the ordinary course of business, but because the federal government seems intent on using such claims to browbeat large settlements out of bankers on a cost-benefits basis (pay the government to end the pain), regardless of whether or not the highest court in the land would ultimately overturn the government. If the government is willing to use a questionable legal theory to serve ideological notions of "fairness" in credit redistribution (as it does in its quest for income redistribution), why would steps 2 and 3 deter it? If step 1 is bogus, why would objectively valid opinions that steps 2 and 3 favor the bank be impediments to simply alleging that they do not, and beating the bank over the head with litigation defense costs until it yields?

Yes, bankers fear the effects test. The fact that the test involves a three step process should provide only cold comfort to them.