It did not take long after the Silicon Valley Bank failure for politicians in Washington to rush to the next available microphone and lament the “loosening of bank regulations”. Instinctively the finger pointing began, and in many quarters ended up in the direction of the prior administration’s policy to generally roll back stringent business regulations and allow free market decisions to govern various industries. Chief among the complainants (no pun intended) was Sen Elizabeth Warren, who emerged out of the 2008 crisis as an architect and advocate for the Wall Street Reform Act and the creation of the vaunted Consumer Financial Protection Bureau ( CFPB), which she briefly directed. Just yesterday in DC’s The Hill publication, Sen Warren was reported as blaming the the collapse of Silicon Valley Bank on Republicans in Congress, which in 2018 helped pass a law to ease bank regulations put in place following the 2008 financial crisis. “No one should be mistaken about what unfolded over the past few days in the U.S. banking system: These recent bank failures are the direct result of leaders in Washington weakening the financial rules,” Warren is quoted as saying. According to The Hill piece, Warren, who voted against the 2018 bank deregulation bill, said that the crises would have been avoided if the banks were required to hold more liquid assets because the bill exempted banks with less than $250 billion in assets from rigorous Fed stress tests. Warren and other Democrats say the old rules could have caught the issues at SVB sooner. Given that politicians generally “never let a crisis go to waste,” many now suspect that the banking industry is about to be slammed with heightened regulatory scrutiny, tighter operational rules, more audits and exams, and larger and very public fines, penalties and consent orders. What does this mean for independent mortgage bankers (IMBs)? It means that they have to get back to the compliance mindset they were frightened into adopting between 2008 and 2018, and before the bottoming out of interest rates led everyone to believe that easy money was here to stay and that self-regulation meant hiring more loan officers. Keep those risk management officers and compliance directors close by folks, we are all in for a bumpy ride on the regulatory

An Interview with Hon. Kenneth M. Donohue, former HUD Inspector General

The following interview was conducted by Andrew Liput, CEO and President of Secure Insight, a New Jersey based vendor management firm specializing in identifying and monitoring settlement agent risk for mortgage lenders nationwide.  Mr. Liput sat down with Kenneth M. Donohue, former HUD Inspector General under Presidents George W. Bush and Barack Obama, to discuss how new vendor management rules help address consumer protection and loan quality assurance concerns of regulators and government agencies.

Liput:  As Inspector General at the US Department of Housing and Urban Development (HUD), you spent a good deal of time developing initiatives to combat mortgage fraud and loan quality issues which threatened high default rates for FHA insured mortgages.  What lapses in operational controls did you find when you looked at lenders who were subjects of investigation?

Donohue:  We found generally that lenders with high rates of defaults had very poor quality control platforms.  They were more concerned about closing any loan they could get rather than evaluating the risk of those loans defaulting due to the financial stability and other risk factors of the parties involved in the transaction.  Of course the prevalence of no documentation and low documentation loan programs gave some lenders the ability to look the other way when it came to loan quality assurance.  There were of course also some lenders who encouraged actual fraud.  In the end it comes down to greater risk management from origination through closing and transparency.  In addition to my time at HUD, I spent many years investigation fraud at RTC, TARP and as a member of the President’s Corporate Fraud Task Force where I learned that things hidden from view can often lead to bad conduct.

Liput:  The passage of Dodd-Frank initiated what appears to be a new era of accountability for mortgage lenders in consumer protection and loan quality assurance.  Is this a good thing for lenders or just another set of rules to make lending more difficult?

Donohue:  Ultimately I think it is good for everybody. Too many lenders started thinking less about the consumer as an individual and more about increasing volume, and so consumer protection rules and greater accountability helps to encourage better business decisions.  We saw what happened in an environment where anything goes: there is a brief period of large profits followed by a collapse caused by the consequences of poor lending decisions.  When I spoke at the MBA’s Annual Convention in Chicago in October 2011, I emphasized that the loss of public trust in the mortgage banking industry needed to be addressed, not by pointing fingers but by crafting proactive solutions including monitoring, accountability and transparency.  There may be some initial pain for some lenders however in the end consumer confidence can be restored and greater financial rewards will follow

Liput:  In April 2012, the Consumer Financial Protection Bureau (CFPB) published Bulletin 2012-3 establishing third party vendor management rules for non-bank entities.  The initial reaction was confusion, why?

Donohue:  I’m not sure, especially because there were vendor management guidelines and directives published by the Office of Comptroller of the Currency (OCC) since 2001, Fannie Mae (FNMA) since 2005 and the National Credit Union Administration (NCUA) since 2007. My guess is that lenders had not really focused on vendor management in the past, and the Bulletin did not really define who or what was a third party subject to scrutiny.  Today there should be no confusion or uncertainty as the CFPB, FDIC, OCC and others have been pretty clear about what lenders must do to manage third party service provider risk for consumer protection and establish greater transparency in all aspects of the loan process.

Liput:  And what would that be, for those still unsure about regulatory expectations?

Donohue:   Independent evaluation of risk, ongoing monitoring, real time reporting. Those are basics.  The key to me is the monitoring.  You cannot have proper risk management unless you continually monitor entities and individuals.  Behavior changes, risk changes, fraud can arise at any time.  Lenders need to keep track of professionals, especially those who have direct access to consumers and their private information, so that they can pull the plug on a relationship and even stop a loan from closing if there is a change in risk.

Liput:  With so many new regulations coming down from Washington, why should lenders consider vendor management a priority?

Donohue:  Because who you choose to do business with defines who you are as a company.  The CFPB and OCC have made it clear that lenders will be held accountable for the company they keep, and that no one can turn a blind eye to the quality of those business partnerships.  Whether it is appraisers, settlement agents, mortgage brokers, or anyone else who could cause harm to a consumer through fraud, theft, or some other criminal activity, lenders simply must take appropriate measures to screen and monitor those relationships and be ready to prove they have an adequate policy in place when audited.  We have not yet heard of a lender facing an enforcement action or fine for mismanaging a vendor relationship, but it is only a matter of time when it will occur.

Liput:  It’s not just regulatory concerns that lenders should be concerned about though right? Consumer litigation against mortgage banks has been aggressive in the last few years.

Donohue:  Good point.  The so called robo-signing scandals we saw with the foreclosure crisis over the past several years resulted in almost a cottage industry of lawsuits against lenders seeking mortgage cancellation, money awards and even punitive damages.  There is every reason to believe that poor vendor management that results in consumer harm, whether from identity theft, theft of mortgage proceeds and other fraud could result in a rash of civil litigation as well.  Litigation costs can cripple any business.

Liput:   Exactly how does vendor management improve loan quality assurance?

Donohue:  Wall Street investors, HUD and the GSEs are all much more focused on how a loan was originated, as well as the parties to the transaction than ever before.  Vetting and monitoring the appraiser, broker, settlement professionals and even real estate agents, all of whom have a critical role in the loan process, helps to establish a comfort level, or expectation, that the loan is less likely to later be found to have been a subject of mortgage fraud.  The most egregious fraud cases we investigated while I was at HUD nearly always involved one or more of those professionals in the conspiracy to commit the fraud.  If you define loan quality assurance as the expectation that a lender has managed the loan throughout the manufacturing process, at each step evaluating the quality of the property, the borrower and the parties supporting the transaction, then of course third party management of appraisers, brokers, attorneys and others is critically important.

Liput:  Some opponents of expanded vendor management rules are concerned about invasions of their privacy; that is being forced to open up their business and private lives to scrutiny simply to be approved to conduct business with a lender.  Is this a fair argument?

Donohue:  I think it is to a degree.  Many people are understandably concerned about who has access to their private information. However the professionals who work in and around the mortgage industry must recognize that consumer protection is the real focus here.  That these professionals have the ability to cause significant harm to a borrower; some even have access to nearly every detail of a consumer’s life which is contained in the uniform loan application form that is at the closing table in every residential loan. It’s a balancing of rights and risks.  Certainly professionals deserve an expectation that whatever information they provide in connection with a vendor approval process is handled safely and securely, but the fear of providing the information in a professionally managed process does not outweigh the risk of harm to consumers who turn the handling of their own financial affairs to a group of people they have likely never even met before, let alone evaluated for risk.  Government seeks to protect the weakest among us.  In the mortgage process the consumer is at the greatest disadvantage dealing with a complex transaction involving many moving parts, voluminous documentation, and many different parties managing the transaction for them.  In the end lenders and vendors must place the rights and expectations of consumers first.

Liput:  Where do loan originators fit into the equation?

Donohue:  Most third party vendors are introduced because of referral relationships, and many referral relationships are controlled by loan originators.  MLOs need to understand the reason for vetting and monitoring because there can be a tendency to see it as interfering with the referral relationship, not enhancing it.  The truth is that a bad referral relationship, one that causes harm to a consumer, can have serious consequences for the originator…suspicion of involvement in fraud, financial losses from loan repurchases, and even damage to their professional reputation.  Everyone in a lender’s organization needs to be on board with supporting the issues of transparency and risk monitoring.

Liput:  So vendor management is here to stay?

Donohue:  Yes it is. This is an important issue for regulators and the CFPB will ensure that lenders understand the importance of how vendor management expectations should be managed. The issue is important for consumer protection and compliance is critical to overall loan quality assurance.

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Kenneth M. Donohue served as HUD Inspector General under Presidents George w. Bush and Barack Obama.   In addition to his service as HUD IG, Mr. Donohue had a distinguished 21-year career with the U.S. Secret Service as a special agent, culminating with an assignment to the assistant director’s CIA Counter-Terrorism Center, and later was appointed as assistant director, Office of Investigations, within the Resolution Trust Corporation (RTC). His staff was successful in uncovering fraud and abuse among directors and officers of failed savings and loan institutions. After the RTC, Mr. Donohue served in the FDIC Office of Legal Counsel’s Criminal Fraud Unit. He has also served as a member of the President’s Corporate Fraud Task Force, as well as the Troubled Asset Relief Program Inspector General Council (TARP-IGC). He most recently served as director and senior advisor of CohnReznick LLP Advisory Group – Government Services and is now a retired, private business consultant.

Andrew Liput is president and CEO of Secure Insight, a company he founded in 2012 after 10 years studying the problem of escrow and closing fraud and the risks for lenders and consumers associated with mortgage closing transactions.