The Supreme Court Could Upend the Housing Market

A legal challenge over the constitutionality of the Consumer Financial Protection Bureau (CFPB), should it be successful, could have a huge impact on the future of the mortgage industry.

Next month, the Supreme Court is set to hear arguments about a case on whether the way CFPB is funded violates the appropriations clause of the Constitution. The Fifth Circuit Court of Appeals ruled last year that since funding for the CFPB is not appropriated directly from Congress and comes from the Federal Reserve, its funding mechanism is unconstitutional.

The CFPB argued that that ruling was mistaken and asked the Supreme Court to adjudicate on the case in November. The case, titled Consumer Financial Protection Bureau v. Community Financial Services Association, will be heard on October 3.

The Bureau came into existence more than a decade ago following the mortgage and financial crisis of 2008 with a mandate as a regulator "focused on looking out for consumers," including in the mortgage market.

The agency was given the authority by Congress through the Dodd-Frank Act to develop regulations that include the governing of the mortgage market. Its funding is capped at 12 percent of the Federal Reserve's budget, according to Consumer Finance, and in fiscal year 2022, that funding was at $734 million.

Experts argue, as reported by institutions like the Financial Times, that the agency has helped lower mortgage delinquencies, as evidenced by second-quarter mortgage delinquencies dwindling reported by the MBA to their lowest level in decades. CFPB says its work for consumers has generated "approximately $14.4 billion in relief for consumers, and $1.7 billion in civil penalties."

Should the justices then rule against the CFPB and declare its rules invalid, which some legal analysts say is the most extreme possibility, could create huge uncertainty in the sector.

"Mortgage Lenders depend on a lot of exemptions and guidance that has been promulgated by the Bureau since its creation," John Coleman, a partner at Orrick, Herrington & Sutcliffe in Washington and a former Deputy General Counsel at the CFPB, told Newsweek.

"A ruling that those rules are void, such that they never had any legal effect, could cause a lot of uncertainty about what lenders obligations are going forward certainly, and also whether loans that were were extended 5-10 years ago can be challenged as problematic for some reason," he added.

Adam Levitin, a law Professor at Georgetown University, has described the case's origins as accidental pointing out that CFSA's initial case was about the bureau's regulations of payday lending.

"It did so mainly on procedural grounds, but it also threw in an argument that the CFPB's funding structure—and therefore everything it has done with the funds—is unconstitutional," he wrote in a Financial Times piece.

The Fifth Circuit agreed. "Congress's decision to abdicate its appropriations power under the Constitution, i.e., to cede its power of the purse to the Bureau, violates the Constitution's structural separation of powers," it concluded.

The Solicitor General, on behalf of the CFPB in their petition to the Supreme Court in November, argued that Congress had authorized the agency to "use a specified amount of funds from a specified source for specified purposes."

Coleman questioned whether the unconstitutional argument would be persuasive to the Court.

"There is a very good chance that the Supreme Court overrules Fifth Circuit and upholds the constitutionality of the agency," he said. "If it were to agree that the agency's funding structure is unconstitutional, it may still take steps to craft a remedy that seeks to avoid adverse market implications, particularly in the mortgage market."

One option would be to give Congress the opportunity to put the CFPB on annual appropriations and ratify the rules that the Bureau has implemented.

"I think the industry's perspective, and certainly my personal perspective, is that one hopes that rational minds will come to the end of this process with an end result that doesn't punish innocent lenders who've been trying to follow the law for 12 years, or homeowners who were already struggling with very high rates on mortgages," he said.