We’ll See Your Executive Order and Raise You a Real Regulatory Review

On January 18th, President Obama announced an executive order in the Wall Street Journal directing that federal agencies amend or repeal regulations unnecessarily impeding economic growth. The president wrote that the effort is intended to “…root out regulations that conflict, that are not worth the cost, or that are just plain dumb.”

The president’s announcement is welcome. It marks a substantial shift for an administration that spent its first two years in office trying to convince the nation that the federal government can successfully direct private economic activity. But is this anything more than a mid-term pivot to placate the business community? It won’t take long to tell.

The volume of pending regulation from laws passed by the 111th Congress is staggering by any measure. An early test of the president’s pro-business conversion will be how these new rules are written. If the administration’s old way of doing business is to change, the change should start right here.

Unfortunately, the president’s executive order doesn’t seem to be directed at the current rule-making binge. In fact, from his rhetoric, it seems clear that President Obama is not as interested in “…writing rules with more input from experts, businesses and ordinary citizens” when it comes to this spate of rule-making.

Even if the president limits the regulatory review to existing rules only, it’s hard to see how any administration can effectively review, in depth, the regulatory structure supporting federal government programs. Unless the Office of Management and Budget makes the president’s initiative a core priority in 2011 the executive order won’t be worth the paper it’s printed on. This means harassing Cabinet officials and other politically-appointed staff across the government to make the review a priority, something that OMB—backed by the White House—can do.

The cynic in all of us knows this is overblown pre-election year hype, right? You bet it is. But there is some real potential if Congress decides to get in on the act, too.

Can Congress really help the process along? Of course it can.

House Committee on Oversight and Government Reform Chairman Darrell Issa has already put significant pressure on federal agencies to justify how programs are operated. The topic of the House Financial Services Committee’s first hearing of the 112th Congress was the uncertainty that American businesses face due to the changing regulatory landscape.

The House and Senate Appropriations Committees can also have a major impact by requiring all federal agencies subject to annual appropriations to implement a rigorous regulatory review. The power of the purse has significant potential to make the president’s executive order have teeth.

What type of impact could a regulatory streamlining have on economic output? Dr. Chad Moutray, former Chief Economist for the Small Business Administration’s Office of Advocacy does a good job of telling us. Writing in the Washington Post, Dr. Moutray says that federal regulations cost the American economy $1.75 trillion every year. These costs are disproportionately borne by small businesses, which shoulder higher per employee regulatory compliance expenses.

While it is self-evident that regulation matters, Dr. Moutray helps bring this into focus by putting a price tag on how the federal government conducts business, so to speak. Even a casual review of the federal regulatory burden could have a substantial economic impact.

Why is this important? Small businesses employ just over half of all private sector employees. If employment is going to grow in 2011, this is where the growth will take place. Dr. Moutray’s regulatory price tag tells us that how we regulate does matter and it matters a great deal. This is why a regulatory review across the federal government can make a real difference in the economy.

Take the Federal Housing Administration as an example. FHA requires condominiums to meet certain standards before the agency will agree to insure mortgages on units in the development. This is good public policy. It protects condominium owners from poor management and it protects taxpayers from losses. As a result many condominium boards have adopted rules that mirror and enforce FHA program requirements.

That’s where the common sense stops. FHA has recently decreed that all condominiums that have adopted FHA’s own safety and soundness requirements are ineligible for FHA’s mortgage insurance programs.

Let me say that again: if a condominium adopts the same rules that FHA uses to qualify the development for its programs, FHA prohibits all owners in the condominium from receiving FHA-insured mortgages.

If you own a condo, that’s a big deal. FHA accounted for approximately 38 percent of all home purchase loans and 9 percent of mortgage refinances nationwide according to its fiscal year 2010 report to Congress.

Going back to President Obama’s editorial in the Wall Street Journal, FHA’s condominium rules seem to fit the bill for regulations that are “…just plain dumb.”

This is the type of regulatory nonsense that businesses across the country are subject to. The more of these types of regulations the president can eliminate the better. American businesses and workers (and condo owners, too) could use that kind of stimulus.

The president is on to something; Congress, it’s up to you to see he follows through.

Last month the Senate voted unanimously to have the federal government become the nation’s home loan officer. Senators Landrieu and Isakson spearheaded an amendment to have the federal financial regulators create a new mortgage product called a “qualified residential mortgage”, and Senator Crapo expanded this task by including commercial mortgages as well. If the amendment becomes law, most financial or housing regulatory agencies in the federal government will determine which consumers will qualify for a mortgage and those who will not.

What is so stunning about this is that it wasn’t but a few months ago when the very same groups that support this amendment were opposing Administration efforts to create the “plain vanilla” mortgage. Who else remembers the calls for more individual consumer control, opposition to government mandated consumer products and dare I say it, death panels? Oh sorry, wrong bill. But, same Senators, right?

Why do lenders want to pass the credit decision buck on mortgage lending? Lenders want avoid the risk retention requirements of the regulatory reform bill that force loan originators to maintain skin in the game.

If a lender is required to retain risk on its books it has to hold capital to offset that risk. And it gets worse for financial institutions since they can no longer create special purpose entities to move these risks off balance sheet. Consolidated balance sheet requirements mean the more you lend the bigger GAAP-induced capital headache you get. Lenders also don’t want to tie up funds that would otherwise be available to support and stimulate economic recovery and growth. Get used to seeing “qualified residential mortgages” and not much else.

This approach makes good sense on paper. But there are other benefits, too. A big one is that lenders will get to push adverse credit decisions back on the government. If a borrower on the margins can’t meet the government standard, it’ll be Congress’ fault. If a lender can’t find enough “qualified residential mortgages” to meet Community Reinvestment Act requirements, it’s Congress’ fault. If HMDA reports shows credit is not widely available, it’s Congress’ fault. Note to members of Congress, get ready for the phone calls because they’ll be coming. Trust me.

This all adds up to a big win for lenders, right? Maybe not.

The process of joint rulemaking by five or more agencies will be—well there is an expression for it that I won’t use. Getting two agencies to issue joint rules is hard enough (see Gramm-Leach-Bliley) but cluster together five agencies and getting the job done will be a sight to behold.

Unfortunately, just the number of agencies involved won’t be the only problem. If the current language becomes statute, it will be a broad, vaguely defined grant of authority to set underwriting criteria for residential and commercial loans. For a preview of what that looks like, check out what Fannie Mae, Freddie Mac and the Federal Housing Administration have done on underwriting requirements for condominium loans.

Between the three of them, Fannie, Freddie and FHA have near universal command of the mortgage market. What they dictate applies across the entire country. There was no justification for the condominium underwriting standards that were imposed nationwide. There was no meaningful opportunity for public comment. There is no appeal. And, no one is looking over their shoulders to see if they got it right.

If Congress wants the agencies to set underwriting standards for residential and commercial mortgages, it’s not enough to say, “The world is your oyster, now get to it!” If Congress adopts the Senate’s residential and commercial mortgage underwriting language, it must also require the regulators to consider that not all housing is the same.

For example, condominiums, cooperatives and manufactured housing are all different from single family housing and each may require specific underwriting standards. If Congress wants to ensure lenders will originate mortgages for low- and moderate-income borrowers, the agencies must be directed to create “qualified residential mortgage” standards for these borrowers. And, Congress must ensure the agencies rely on quantifiable, testable data made public for review and research. Unless the agencies are required to justify each underwriting criterion and are required to periodically review the standards they create Congress will be back to repeal or substantially revise this grant of authority and soon.

Or, Congress could save itself the trouble and tell lenders to manage their own business.


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