Henry Paulson and the Problem of State Law

Henry Paulson, as we have already noted, doesn't like regulation, preferring to leave matters to the market.  He has, however, been forced by the recent subprime/Bear Stearns crisis to reconsider.  One of his proposals has been to call for state licensing of mortgage brokers.

But, as we have already discussed, this is no solution. The laws of 50 states will allow large mortgage brokers to cherry pick the jurisdictions with the least amount of regulation. Moreover, national brokers may find themselves subjected to 50 state laws, each with differing requirements.

Paulson has apparently recognized the weakness of his own proposals.  His comprehensive reform repeats the call for state regulation but calls for the imposition of federal standards.  But what he proposes is a complex, unworkable structure.  It would start with the Mortgage Origination Commission.  The members?  

• The President should appoint a Director for the MOC for a four to six-year term. The Director would chair a six-person board comprised of the principals (or their designees) of the Federal Reserve, the OCC, the OTS, the FDIC, the National Credit Union Administration, and the Conference of State Bank Supervisors.

In other words, not a real Commission, but some type of inter-agency committee.  And would it be an independent commission?  A six year term for the chair suggests that it would, but the right of the OCC, the FDIC, and the Office of Thrift Supervision to include members (all executive branch agencies) suggest that it is not. 

And what would this Commission do?  It would apparently create federal standards for licensing mortgage brokers at state law.

• Federal legislation should set forth (or provide authority to the MOC to develop) uniform minimum licensing qualification standards for state mortgage market participants. These should include personal conduct and disciplinary history, minimum educational requirements, testing criteria and procedures, and appropriate license revocation standards.

But what about the fact that there are 50 states and standards/enforcement are likely to vary?  The proposals calls for the Mortgage Origination Committee to oversee all 50 states.

• The MOC would also evaluate, rate, and report on the adequacy of each state’s system for licensing and regulation of participants in the mortgage origination process. These evaluations would grade the overall adequacy of a state system by descriptive categories indicative of a system’s strength or weakness. These evaluations could provide further information regarding whether mortgages originated in a state should be viewed cautiously before being securitized. The public nature of these evaluations should provide strong incentives for states to address weaknesses and strengthen their own systems.

In other words, Paulson can't bring himself to do the obvious and call for federal regulation of mortgage brokers (something that could be limited to the largest brokers).  At the same time, there is probably universal agreement that the current system of financial regulation is too complicated.  Yet Paulson proposes a complex system of regulation involving 50 states and a federal agency, a federal agency made up of a bunch of other federal agencies.   

And, of course, the proposals do not even seriously address issues of enforcement.  For mortgage brokers attached to banks, enforcement authority should be clarified.  As for state mortgage brokers, which the proposal notes is the "sector of the industry responsible for origination of the majority of subprime loans in recent years," the proposal can do little more than provide that states should "have clear authority to enforce federal mortgage laws including the TILA [Truth in Lending] provisions concerning mortgage transactions."

To the extent the mortgage crisis rests with mortgage brokers, Paulson's proposal merely adds layers of complexity and provides no realistic method of ensuring enforcement.  It is a disappointment.  Rube Goldberg would have been proud.