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August 2003 PDF>The Challenge to the Future of Subprime Residential Lending - The Challenge to the Future of Subprime Residential Lending
Channeling Mortgage Loan Officers and Businesses Away From Predatory Practices
By Jack B. Wolfe and Howard A. Lax
(The opinions expressed in this article are those of the authors and do not necessarily represent the opinions of the Greatland Corporation.)
The single most notorious factor inhibiting the growth and maturity of subprime mortgage lending is the use of fraudulent and unethical practices by some individuals and businesses to increase profits generated by mortgage loan originations. These practices are commonly referred to as “predatory lending practices.”[i] This paper outlines issues and problems associated with predatory lending practices, and proposes a comprehensive program to curb such practices without significantly reducing the terms or availability of subprime loan products.[ii]
The subprime mortgage lending industry and its borrowers enjoy the benefits of easy access to money that, a decade ago, were only available to conventional conforming borrowers (“prime” borrowers) through the Federal National Mortgage Association (Fannie Mae)[iii] and the Federal Home Loan Mortgage Corporation (Freddie Mac).[iv] The prime mortgage lending industry developed in the late 1970’s and 1980’s, spurred by deregulation of interest rates and other finance charges.[v] After the Alternative Mortgage Transaction Parity Act of 1982 (the Parity Act)[vi] was enacted and the opt-out period expired in 1985, a multitude of alternative mortgage loan products were developed.
Subprime loan products were first widely available during the past decade.[vii] These products disproportionately serve the lower income segment of society, a segment that is statistically underserved by mortgage lenders.[viii] Subprime loans fill the void of residential financing facilitated by adversity to credit risk instilled by federal depository institution regulators.[ix] The availability of residential credit to individuals with less than pristine credit histories, helped to lift homeownership levels to heights not seen previously.[x]
Subprime loans were intended as a means of financing homes for less credit worthy borrowers, consolidating debt, and providing temporary relief from cash flow problems caused by underemployment. Under utopian circumstances, all subprime borrowers would improve their credit standing through money management and a history of making timely mortgage payments and payments of other obligations.[xi] An improved credit history corresponds to a lower credit risk factor (corresponding to a higher credit score) that allows the subprime borrower to qualify for lower cost credit. By refinancing a high cost subprime loan into a lower cost prime loan, the borrower is able to use the difference in finance charges to increase savings, or to afford a better home.
In reality, easy access to subprime mortgage loans allows most borrowers to improve their living standards, and many graduate to prime loans. However, this is not the case for a minority of subprime borrowers. Some borrowers sink into higher and higher cost loans as these borrowers either (a) borrow money to support a standard of living beyond that which their income will support, and/or (b) convert unsecured credit to secured credit to forestall the day of reckoning for credit problems instead of facing these problems. The societal solution for this phenomenon is the same as the solution for excessive gambling, smoking or alcohol use. First, better financial education is needed at the public school level and in mass media.[xii] Second, disclosures should be distilled to the minimum level necessary to allow easy evaluation of the mortgage loan product. A poster in an office, or a post card containing these disclosures, is all that the average consumer can absorb and process when evaluating consumer products.
Another group of homeowners fall victim to a small number of loan officers, mortgage brokers and mortgage lenders who, through salesmanship and/or predatory practices, drive up the cost of credit.[xiii] Individual instances of predatory lending practices are well documented in congressional hearings and various publications.[xiv] Testimony at these hearings by “experts” representing consumer groups cite subprime lending in general as the evil force that must be further regulated to stop predatory lending practices. These experts assume that predatory lenders target low and moderate income individuals, especially those of minority races, because these classes of individuals are predisposed to falling prey to predatory loans.[xv] Part of the solution, according to these experts, is to ban alternative mortgage terms that appear in subprime loans.
The statistics of predatory loans mistakenly point to this conclusion. Statistical evidence obtained from loan data reported under the Home Mortgage Disclosure Act shows that low and moderate income borrowers, especially those of minority races, are historically underserved by mortgage lenders and, in particular, depository institutions. These classes of individuals are, perhaps, the last great frontier of business with little or no competition. Hence, small mortgage brokers and lenders who cannot compete against institutional lenders are drawn to this market.
Studies of lending patterns do not investigate the role of the loan officer in setting loan terms. In large part, it is loan officers who control the terms of loans offered to consumers, and loan officers that engage in predatory lending practices. Subprime loans are not an environmentally hazardous substance. Loans do not harm borrowers — loan officers harm borrowers. Loan officers have the ability to hurt borrowers by recommending inappropriate financial terms. Legislation to curb abusive lending practices should regulate loan officer conduct, and not the terms of loans.[xvi] Legislation should impose a code of ethics,[xvii] and not limit alternative mortgage loan products. Legislatures and city councils do not understand this concept.[xviii]
There appears to be significant lethargy among rank and file loan officers and small lenders to address
the issues feeding the perception that mortgage loans are hazardous to public health. Many mortgage broker/lender business owners are content to employ a pure commission compensation system to attract producing loans officers, regardless of marketing tactics utilized by the loan officers. These business owners avoid looking into the actual loan origination process for each loan. Hiring loan officers on an “eat what you kill,” and “sink or swim” basis avoids the need for comprehensive employee training and subjective evaluation of employees. Benign neglect management policies save money, but they bring out the worst practices in some loan officers.[xix]
Brokers and lenders compete for the services of productive loan officers. No business owner wants to “rock the boat” knowing that a good loan officer can walk down the street to the next net branch office. As a result of these competitive pressures, loan managers cannot or do not police loan officers effectively. When a loan officer is caught, he or she moves on to another broker or lender office. No effort is made to report the loan officer’s behavior to state regulators, since the sins of the employee are the vicarious liability of the employer.[xx] Similarly, no effort is made to thoroughly investigate a new loan officer who appears to be producing significant profits from the first day on the job. Even when the loan officer is subject to a non-compete clause, the prior employer will rarely spend the time and money to sue a loan officer who is not collectable.
For the good of the industry and the public, this behavior must change. Loan officers and their employers must be accountable for each other’s actions. The time has come to address this issue on a comprehensive basis, and not through knee jerk legislation that does more harm than good. Legislation and regulation advocated by some consumer groups[xxi] to require beneficial aspects of loan terms creates uncertainty in the enforceability of loans that chills the secondary mortgage market and the market for securities backed by these loans.[xxii] Furthermore, new laws never deter lenders that break existing laws. These laws deter subprime lending by legitimate lenders, leaving lenders who are already breaking the law to move into the void left by the withdrawal of legitimate loan programs.
The Federal Reserve Board recognizes that a comprehensive program of regulation of the industry and education for consumers is essential to subdue instances of predatory lending practices:
With this issue gaining national attention, intensive efforts at local and federal levels have been undertaken to identify the unacceptable practices of predatory lenders and consider actions to thwart their activities. The consensus among the groups that are grappling with the problem is that several strategies must be deployed to address this issue. Clearly, effective regulatory and legal mechanisms must be in place to establish acceptable lending practices and provide for consequences when those standards are violated. Of equal, if not greater, importance is the need for intensive consumer education programs to empower homeowners to understand their rights, know their options, and pursue alternative sources for financing.[xxiii]
The path to improving the performance as well as the image of the mortgage banking industry requires a five-prong approach. First, loan officers must be educated to avoid learning bad behaviors. The mortgage banking industry must reverse the perception and reality that a person may be a used car salesman one day, and a mortgage loan officer the next day. New loan officers should demonstrate a minimal level of education and training, and employers must sponsor continuing lending education. Sufficient low cost programs exist from the Mortgage Bankers Association of America and other private resources to offer training to all loan officers.
Second, loan officers should be registered and complaints concerning specific loan officers should be tracked. Loan officers should not be permitted to run from their illegal acts by switching jobs. Loan officers who continue to break ethical and legal rules must seek employment in another field. New legislation is needed to provide a strong foundation to achieve this goal. In some states, moderate increases in user (licensing) fees will be needed to pay for increased licensing and examination personnel at state regulatory agencies.
Third, consumers must be better prepared to shop for and acquire financial services. Consumers (and most attorneys for that matter) do not understand the complex overlay of federal and state laws and regulations governing mortgage lending. No fee or finance charge disclosures, and no explanation of the mortgage loan origination process, are provided to a consumer until after they apply for a loan. Once the application is completed, disclosure upon disclosure is heaped on each loan applicant until it becomes impossible to read or to absorb the information provided to the consumer. At this point, the disclosures stop and the terms that will be offered to the borrower ebb and flow with the currents of various financial markets. Nobody knows where this roulette wheel will stop until the borrower walks into the closing. The consumer has no way of knowing whether the ultimate loan will track any of the disclosures provided at the time of application.
Congress attempted to provide a level playing field when the Truth-in-Lending Act (TILA) was passed, and lenders were required to provide an Annual Percentage Rate disclosure, finance charge disclosure, and other disclosures. In theory, and initially in practice, these disclosures helped consumers to shop for the best credit products for their financial needs. The subsequent proliferation of loan products and closing cost options reduced the effectiveness of these disclosures. The effectiveness of TILA disclosures was further minimized by the proliferation of state and federal disclosures that distract the consumer, or at least compete for the consumer’s attention. Congress and the states should decide which information is of paramount importance, fit this on one page, and enlarge the text to the point that this information attracts the consumer’s attention and allows the consumer to focus on and absorb this information before exploring additional information. Consumers should be allowed a three-day deliberation period before applying for a loan in which basic loan terms are frozen to allow the consumer to shop effectively for credit. In 1998, the Federal Reserve Board and HUD proposed changes to TILA and RESPA[xxiv], but these changes are not enough to reverse the sea of confusion generated by disclosures mandated by other state and federal laws. New legislation should require minimal disclosures for shoppers, and prevent a lender from switching terms while the consumer compares prices. Hopefully, the phrase “you should have locked in” will become a faint memory to consumers.
Fourth, state regulatory agencies (especially Michigan’s Office of Financial and Insurance Services) must increase the number and quality of examiners to enforce existing laws. Regulatory review examiners currently follow a checklist that they do not fully understand, and an examination regimen that they cannot reasonably complete in under a week. Examiners need to understand how the mortgage banking industry works, and where to look for the closets that may hold skeletons. In addition, annual licensing reports need to be improved to remind licensees of their obligations under current laws.
For example, the current number of Michigan banking examiners available to police mortgage lenders assures loan officers that a full examination of their activities will occur no sooner than six months after a complaint is filed, and no more often than every two or three decades if no complaints are filed. A loan officer who suspects that he or she has been “caught” can work for a new mortgage lender with little or no fear of prosecution or civil liability for past acts. In Michigan, sufficient user fees are collected to increase personnel to enforce the current laws, but statewide budget concerns restrict state regulatory agencies from hiring additional personnel. Predatory lending will wane as soon as laws that prohibit lending fraud are enforced.
In addition, there are too few licensing examiners in Michigan to register loan officers, let alone license mortgage brokers and lenders. Few, if any, of the states other than Michigan have a minimum license examination period of ninety to 150 days. Many states set a maximum examination period of thirty to sixty days. If Michigan will add a loan officer registration provision to its licensing acts, additional user fees must be collected to review registrations and to improve responsiveness of licensing examiners.
Fifth, Congress must act to create a unified secondary market for subprime loans that is as strong and robust as the market for conventional conforming loans. At present, the subprime lending market is fractured and characterized by diversity in underwriting standards and loan pricing when compared to the uniformity of the secondary market for conforming loans (Fannie Mae and Freddie Mac).[xxv] Uniform underwriting standards published by subprime GSE, and uniform subprime desktop underwriting tools, will eliminate the “wild west” nature of subprime lending and allow the subprime loan industry to evolve to offer relatively uniform rates and loan terms for subprime loans.
Finally, we must recognize that the Michigan legislature has mandated financial counseling for consumers. Other states are considering this path. HUD, state legislatures, city councils, and many others believe that home ownership counseling can greatly benefit borrowers, reduce predatory lending, and reduce mortgage defaults. The problem with this belief is that, despite a dozen studies of these issues, there is no good objective evidence that home ownership counseling achieves these goals to any significant degree, or that the cost of these programs to the government and to borrowers is worth the benefits of these programs. A review of home ownership counseling studies undertaken by HUD and others prepared by Alan Mallach for the Federal Reserve Bank of Philadelphia concludes that these studies do not show that any statistically significant benefits are derived from home ownership counseling.[xxvi] We need a better education program, for all consumers, to reflect the entire range of money management, including responsible saving, investing and borrowing. This program should begin in the public schools as a mandatory part of the high school curriculum. Refresher courses and advanced education should be offered through community education programs. Only when the consumer understands the complexities of financial transactions can the consumer achieve financial freedom. <
Jack B. Wolfe is the CEO of World Wide Financial Services, Inc. doing business as LoanGiant.com. LoanGiant.com is a full service retail mortgage banking company offering residential mortgage loans, and has been in business since 1990. LoanGiant.com closes $100 million of conforming and non-conforming residential loans each month.
Howard A. Lax is a corporate law attorney with Lipson, Neilson, Cole, Seltzer & Garin, P.C. Mr. Lax specializes in financial institutions consumer compliance and regulatory affairs, and real property law, and has served as legal counsel for banks, mortgage brokers and lenders since 1985.
[i]The Federal Reserve Board has tried to define and circumscribe “predatory lending” for several years. A letter dated April 28, 2000, from Edward M. Gramlich, Member of the Board, Federal Reserve, to The Honorable Phil Gramm Chairman, United States Senate Committee on Banking, Housing, and Urban Affairs (http://www.senate.gov/~banking/docs/reports/predlend/fed.htm), described the difficulties in defining a predatory loan because “predatory lending” is a amorphous collection of practices, and not a defined loan product.
“As described in the 1998 report, abusive practices in home equity lending take many forms, but principally fall within two categories. The first category includes the use of blatantly fraudulent or deceptive techniques that may also involve other unlawful acts. These practices occur even though they are prohibited under existing law. For example, loan applicants’ income and ability to make scheduled loan payments may be falsified, signatures may be forged or obtained on blank documents, or borrowers may be charged fees that are not tied to any service rendered.
A second category of abuses described in the report involves various techniques used to manipulate borrowers into accepting high rates or unaffordable terms, even though they may qualify for lower-cost alternatives. The loan documentation might appear to be proper and legally enforceable, but the broker or creditor may pressure consumers to enter transactions that they do not fully understand. Homeowners are charged high up-front fees that are added to the loan amount. In some cases, if there is sufficient equity in the property, the loan may be made without consideration of the borrowers' ability to repay. In other cases, a consumer may not understand that a loan with affordable monthly payments will not amortize the principal or that there will be a balloon payment that the consumer must refinance at additional cost.”
The preamble of the Federal Reserve Board's revision to Section 32 of Regulation Z, 12 CFR 226.32 (66 FR 65604, 12/21/2001), describes the phenomena of “predatory lending”:
“Since the mid-1990s, the subprime mortgage market has grown substantially, providing access to credit to borrowers with less-than-perfect credit histories and to other borrowers who are not served by prime lenders. With this increase in subprime lending there has also been an increase in reports of ‘predatory lending.’ The term ‘predatory lending’ encompasses a variety of practices. In general, the term is used to refer to abusive lending practices involving fraud, deception, or unfairness. Some abusive practices are clearly unlawful, but others involve loan terms that are legitimate in many instances and abusive in others, and thus are difficult to regulate. Loan terms that may benefit some borrowers, such as balloon payments, may harm other borrowers, particularly if they are not fully aware of the consequences. The reports of predatory lending have generally included one or more of the following: (1) Making unaffordable loans based on the borrower’s home equity without regard to the borrower’s ability to repay the obligation; (2) inducing a borrower to refinance a loan repeatedly, even though the refinancing may not be in the borrower’s interest, and charging high points and fees each time the loan is refinanced, which decreases the consumer’s equity in the home; and (3) engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower-for example, ‘packing’ loans’ with credit insurance without a consumer’s consent.”
Several commenters define “predatory lending” in terms of specific practices, akin to biblical plagues. In “Predatory Lending In NewJersey: TheRisingThreat To Low-IncomeHomeowners,” by Ken Zimmerman, Elvin Wyly, and Hilary Botein, (New Jersey Institute for Social Justice, February 2002), published at http://www.njisj.org/reports/predatory_lending.pdf, the authors write:
Predatory lending refers to a wide array of practices that disproportionately affect low-income, elderly, and minority homeowners and result in unjustified increased payments, inability to refinance loans, and, in too many cases, equity stripping and foreclosure…Three features, alone or in combination, define predatory practices: (1) targeted marketing to households on the basis of borrowers’ race, ethnicity, gender, or age or other personal characteristics unrelated to creditworthiness; (2) unreasonable and unjustifiable loan terms; and (3) outright fraudulent behavior that maximizes the destructive financial impact on consumers of the targeted marketing and lending provisions.Among predatory lending practices, the most harmful include:
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Lending based on the value of the home without regard to a borrower’s ability to pay;
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Excessive interest rates and fees that are not justified by the borrower’s credit profile;
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Multiple and repeated refinancings that cause the borrower to pay significant transaction costs and reduce equity without a corresponding benefit (frequently referred to as “flipping”);
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The imposition of prepayment fees that provide no benefit to borrowers but penalize them by precluding them from refinancing a high-cost loan at lower rates;
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The practice of having borrowers finance the purchase of credit insurance (“single premium credit insurance”), immediately reducing the homeowner’s equity without any corresponding benefit; and
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Mandatory arbitration clauses and other obstacles that prevent borrowers from obtaining meaningful legal redress.
The statement of William J. Brennan, Jr., Director of the Home Defense Program of the Atlanta Legal Aid Society, to the U.S. Senate Special Committee on Aging (March 16, 1998) describes thirty predatory lending practices.
[ii] In the Spring of 2001, federal banking regulators issued an “Expanded Guidance for Subprime Lending Programs” (http://www.federalreserve.gov/boarddocs/srletters/2001/sr0104a1.pdf) that defines a “subprime loan:”
“The term ‘subprime’ refers to the credit characteristics of individual borrowers. Subprime borrowers typically have weakened credit histories that include payment delinquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories. Subprime loans are loans to borrowers displaying one or more of these characteristics at the time of origination or purchase. Such loans have a higher risk of default than loans to prime borrowers. Generally, subprime borrowers will display a range of credit risk characteristics that may include one or more of the following:
· Two or more 30-day delinquencies in the last 12 months, or one or more 60-day delinquencies in the last 24 months;· Judgment, foreclosure, repossession, or charge-off in the prior 24 months;· Bankruptcy in the last 5 years;· Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of 660 or below (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood; and/or· Debt service-to-income ratio of 50% or greater, or otherwise limited ability to cover family living expenses after deducting total monthly debt-service requirements from monthly income.”
A year later, Federal banking regulators published a notice [67 FR 46250 (7/12/02), which was later withdrawn] that would have required depository institutions to provide information to regulators concerning subprime loans. The notice defined a subprime loan in the same manner as the earlier guidance. The notice stated that the above list is illustrative rather than exhaustive, and does not define specific parameters for all subprime borrowers.
[iii] To meet the need for consistent sources of money for home financing, the federal agency known as Fannie Mae was abolished effective September 1, 1968, by Title VIII of the Housing and Urban Development Act of 1968 (82 Stat. 536), August 1, 1968. In its place, Congress created (a) the current Federal National Mortgage Association to be responsible for managing secondary mortgage market operations, (b) the Government National Mortgage Association, which was given the authority to issue securities backed by FHA/VA loans, and (c) HUD, a federal agency responsible for the federally aided housing programs and management, and for liquidating the functions of the former Fannie Mae. See http://www.archives.gov/research_room/federal_records_guide/federal_national_mortgage_association_rg294.html for a complete history of this entity.
[iv]Congress chartered the Federal Home Loan Mortgage Corporation in 1970 to purchase conventional loans. Both Freddie Mac and Fannie Mae have the same goals to increase the liquidity of the mortgage market and make home ownership more widely available. Fannie Mae and Freddie Mac are referred to collectively as Government Sponsored Enterprises (GSEs).
[v] Section 501 of the Depository Institution Deregulation and Monetary Control Act of 1980 preempted state limits on the amount of any finance charge (including interest) imposed for a federally related first lien residential mortgage loan. This section of the Act is codified at 15 U.S.C. §1735f-7a.
[vi] 12 USC §3801 et. seq.
[vii] The secondary market for non-conforming and subprime loans appeared after 1986 changes in tax rules and 1987 changes to the tax code made Real Estate Mortgage Investment Conduits (REMICS) possible. Early securitizations or pools of mortgage backed loans involved ARM loans that were not considered “conforming” by the GSE’s. By 1994, subprime loans represented 5% of all originations. This increased to 12% by 1996, and 15% in 1997 ($125 billion in 1997), outpacing the overall growth in mortgage loan originations. The rise of the secondary market for subprime loans is described in further detail in “The Nonagency Mortgage Market: Background and Overview,” by Eric Bruskin, Ph.D., Anthony B. Sanders, Ph.D., Galbreath Distinguished Scholar and Professor of Finance, The Ohio State University, and David Sykes, Ph.D., Consultant, April, 1999, published at http://fisher.osu.edu/~sanders_12/ch1c.pdf. See also Prepared Statement of the Federal Trade Commission by Jodie Bernstein, Director, Bureau of Consumer Protection before the SENATE SPECIAL COMMITTEE ON AGING, On Home Equity Lending Abuses in the Subprime Mortgage Industry, March 16, 1998, at http://www.ftc.gov/os/1998/03/grass5.htm.
[viii] Studies from the early 1960’s show that lower income groups historically hold a larger share of aggregate home ownership equity than most other forms of wealth. Contrary to the trend in upper income levels, mortgage debt was comparatively infrequent in the lower income groups, with 40 per cent of the population with low incomes owning homes but only 10 per cent owing mortgage debt. As a result, the 30 per cent of the population with the lowest incomes owed 5 per cent of total mortgage debt. See “Survey of Financial Characteristics of Consumers,” by Dorothy S. Projector and Gertrude S. Weiss, published at http://www.federalreserve.gov//pubs/oss/oss2/6263/sfcc62book.pdf.
[ix] “By providing loans to borrowers who do not meet the credit standards for borrowers in the prime market, subprime lending provides an important service, enabling such borrowers to buy new homes, improve their homes, or access the equity in their homes for other purposes.” [HUD and U.S. Department of Treasury Joint Report on Recommendations to Curb Predatory Lending (June 20, 2000) at http://www.hud.gov/library/bookshelf18/pressrel/treasrpt.pdf.] On the other hand, federal banking regulators discourage subprime lending by increasing the level of scrutiny and caution that must be exercised by depository institutions that offer subprime loans. See FRB Supervision and Regulation Letters SR 01-4 (GEN) dated January 31, 2001 http://www.federalreserve.gov/boarddocs/srletters/2001/sr0104.htm and SR 99-6 dated March 5, 1999 http://www.federalreserve.gov/boarddocs/srletters/1999/sr9906.htm. In a joint “Expanded Guidance for Subprime Lending Programs” attached to SR 01-4 (GEN), the OCC, FRB, FDIC and OTS proposed greater (and more expensive) safeguards for subprime lending programs:
This expanded guidance applies specifically to those institutions that have subprime lending programs with an aggregate credit exposure greater than or equal to 25% of tier 1 capital. Aggregate exposure includes principal outstanding and committed, accrued and unpaid interest, and any retained residual assets relating to securitized subprime loans. The Agencies may also apply these guidelines to certain smaller subprime portfolios, such as those experiencing rapid growth or adverse performance trends, those administered by inexperienced management, and those with inadequate or weak controls.
This guidance is meant to intensify examination scrutiny of institutions that systematically target the subprime market through programs that employ tailored marketing, underwriting standards, and risk selection. In accordance with previously issued guidance, such lending should be conducted in a segregated program, portfolio, and/or portfolio segment. The term “program”refers to the process of acquiring on a regular or targeted basis, either through origination or purchase, subprime loans to be held in the institution’s own portfolio or accumulated and packaged for sale. The average credit risk profile of such programs or portfolios will likely display significantly higher delinquency and/or loss rates than prime portfolios.” http://www.federalreserve.gov/boarddocs/srletters/2001/sr0104a1.pdf, Page 2.
[x] Census Bureau data released on January 27, 2003 shows that there are more homeowners in America than at any time in history. The 2002 annual homeownership rate was 67.9 percent, up 0.1 percent from the previous record posted in 2001. And, in the fourth quarter of 2002, a new all-time national homeownership record was set at 68.3 percent, up 0.3 percent from both the third quarter of 2002 and the fourth quarter of 2001. Homeownership also increased for minorities to a record high of 49.9 percent in 2002, an increase of 0.8 percent over 2001 and about 7 percent more than in 1990. See the HUD press release at http://www.hud.gov/news/releasedocs/homeowninc.cfm. This compares to a 9 percent increase in home ownership for black Americans from 1950 to 1980 and a 1 percent decrease from 1980 to 1990. See “Historical Census of Housing Tables Ownership Rates” published by the US Census Bureau at http://landview.census.gov/hhes/www/housing/census/historic/ownrate.html.
[xi] “Educating individuals about the fundamentals of budgeting and saving serves as the foundation for building wealth. To that end, compelling evidence that financial education matters was revealed in a recent article in the Journal of Public Economics, which found that high-school students who received instruction on financial decision making--including budgeting, credit management, and saving and investing--had significantly higher levels of wealth in adulthood than others.” Remarks by Federal Reserve Board Governor Edward M. Gramlich at the Home Ownership Summit of the Local Initiatives Support Corporation (LISC), Washington, D.C., November 8, 2001, titled “Promoting and Sustaining Home Ownership.”
[xii] See, for example, the “Don’t Borrow Trouble” campaign (http://www.dontborrowtrouble.com/) and the “Credit Smart” education program (http://www.freddiemac.com/creditsmart/) sponsored by Freddie Mac. During the 1990’s HUD spent an average of $12 million per year funding home ownership counseling programs. This amount is totally inadequate to provide societal education, and the Freddie Mac program. Truly effective foreclosure intervention requires direct financial assistance to the homeowner, but the cost is prohibitive. Northwest Area Foundation’s Mortgage Foreclosure Prevention Collaborative undertook one such program in 1995. The average loan provided each family receiving financial assistance under the program was $2100. “A level of assistance of this sort is beyond the reach of all but a handful of programs; moreover, it is still unknown whether short-term financial assistance actually stabilizes the home owner’s situation on a long-term basis or merely puts off the day of reckoning.” “HOME OWNERSHIP EDUCATION AND COUNSELING; Issues in Research and Definition,” Prepared by Alan Mallach, AICP for the Federal Reserve Bank of Philadelphia, published at http://www.phil.frb.org/cca/capubs/homeowner.pdf.
[xiii] Many examples of predatory practices are discussed in “A Tale of Three Markets: The Law and Economics of Predatory Lending, “ by Kathleen C. Engel and Patricia A. McCoy, 80 Texas Law Review 1255 (No. 6, May 2002).
[xiv] See statements from the Senate Special Committee on Aging hearing on March 16, 1998 entitled, “Equity Predators: Stripping, Flipping and Packing Their Way to Profits,” published at http://aging.senate.gov/oas/hr14su.htm; “Predatory Lending In New Jersey: The Rising Threat To Low-Income Homeowners,” By Ken Zimmerman, Elvin Wyly, and Hilary Botein, February 2002, published at http://www.njisj.org/reports/predatory_lending.html. Some studies suggest that as many as one third of all subprime loans are “predatory loans,” but these studies include in this number any loan with a high interest rate on the assumption that any high interest rate loan is a predatory loan. See “Inequities in California’s Subprime Mortgage Market” prepared for the California Reinvestment Committee by Associate Director Kevin Stein and Research Associate Margaret Libby, November 2001 at http://www.calreinvest.org/PredatoryLending/StudyOnWeb7.24.01.html.
[xv] See, for example, the study by ACORN showing that a third of all subprime loans in the Detroit metropolitan area are made to African Americans at http://www.acorn.org/acorn10/predatorylending/plreports/SU2002/detroit.htm.
[xvi] Cracks are appearing in state predatory lending initiatives. The OTS General Counsel issued an opinion on January 21, 2003, http://www.ots.treas.gov/docs/56301.pdf that Georgia’s Fair Lending Act is not applicable to federal savings associations. The Georgia opinion was followed by an opinion issued on January 30, 2003, (http://www.ots.treas.gov/docs/77304.html) stating that most of New York’s predatory lending law is preempted. OTS regulations and the Home Owners Loan Act (HOLA) “preempt the field” of all state laws and regulations impinging upon the terms of credit, including loan-related fees, disclosures, advertising, processing, origination, refinancing, servicing, sale, purchase, investment, and participation in mortgages. The prohibition on mandatory arbitration clauses and the "multifaceted compliance scheme" established by the New York law are not preempted.
[xvii] See, for example, Wisconsin ethics regulations for loan officers at Wisconsin Administrative Code DFI-BKG Chapter 43.
[xviii] A good example is the proposed ordinance introduced in the Detroit City Council shortly after passage of the Georgia Fair Lending Act. Mortgage lenders pointed out various problems in the ordinance that would prevent them from continuing many loan programs for City of Detroit properties. The City’s law department objected to the ordinance on the basis that it was unconstitutional, and in conflict with federal laws. The City Council ignored the lenders’ and the City Law Department’s advice. As a result, the Michigan legislature enacted HB to preempt all local ordinances regulating mortgage lending.
[xix] Keeping capital to a minimum may frustrate potential claimants seeking to hold a business liable for the acts of loan officers. However, most state licensing regulators do not permit owners a second chance if their business goes bankrupt. Some of the owners involved in large mortgage lender bankruptcies have been able to sneak around the licensing system by becoming net branch managers for other lenders.
[xx] See, for example, Meyer v. Holley, ___ U.S. ____ (No. 01-1120, January 22, 2003), in which the Supreme Court recognized that an employer real estate broker could be held vicariously liable for the criminal acts of the real estate salespersons under the Fair Housing Act, but the broker could not be held personally liable for the acts of the salespersons.
[xxi] Some proponents of these laws have the ulterior motive of deciding which borrowers deserve credit, and that anyone with unsecured credit should never convert it to secured credit. These proponents think that lenders leaving a market prove they are predatory lenders. This is not true. The lenders withdrawing from the markets that are subject to these laws include the most respected and largest subprime lenders in the marketplace.
[xxii] “The Unintended Consequences: Real-world Experiences, Effects on Credit Availability, Reaction by the Secondary Market, Legislative Solutions,” Georgia Bankers Association, Georgia Credit Union Affiliates, and the Community Bankers Association of Georgia (January, 2003). See also the Dow Jones Business News story, “Predatory Lending Laws May Hit Home in Mortgage Market” dated December 24, 2002, By Christine Richard and Agnes T. Crane:
“While Fitch Ratings recognizes the intent of legislators to protect the consumer from predatory lenders, the ambiguities in the statutes may negatively impact mortgage markets and their participants,” Steve Grundleger, manager director at Fitch Ratings said in a statement issued Tuesday….
Standard & Poors, also in a written statement Tuesday, said the law “has caused confusion among investors and issuers (of mortgage backed securities).” The rating agency noted that “many lenders have restricted, or ceased entirely, lending operations in Georgia.”
Freddie Mac stopped buying loans considered to be high cost from Georgia when the legislation was enacted, according to Doug Robinson, a spokesman for the agency. Prior to that, the agency adhered to federal anti-predatory lending guidelines.
On January 16, 2003, Standard & Poors announced that it stopped rating securities backed by Georgia loans that are subject to the Georgia Fair Lending Act. This announcement was followed by similar announcements by Moody’s Investors Service and Fitch Ratings. Countrywide Home Loans, Inc., Household Mortgage, and other large wholesale lenders have stopped accepting applications to make or buy Georgia loans subject to this law. Ultimately, the Georgia legislature revised its Fair Lending Act to address some of these investors’ concerns. Similarly, New York City suspended implementation of its proposed anti-predatory lending rules because the various rating agencies would not provide ratings for mortgage backed security pools containing loans subject to these rules.
[xxiii] Capital Connections, Vol. 3, No. 1 (Winter 2001) at http://www.federalreserve.gov/dcca/newsletter/2001/winter01/homeown.htm.
[xxiv] See the 1998 Report to Congress at http://www.federalreserve.gov//boarddocs/rptcongress/tila.pdf. In testimony before the Subcommittee on Financial Institutions and Regulatory Relief and the Subcommittee on Housing Opportunity and Community Development of the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, on July 17, 1998, FRB Governor Gramlich opened his remarks with the following statement:
“Despite a number of Congressional actions designed to give mortgage borrowers greater information and protection, today's mortgage lending process can still be characterized as confusing, costly, and far less than optimal.”
Governor Gramlich presented identical testimony before the Subcommittee on Financial Institutions and Consumer Credit and the Subcommittee on Housing and Community Opportunity of the Committee on Banking and Financial Services, U.S. House of Representatives, on July 22, 1998. Changes in disclosure laws during the ensuing years did not resolve this problem, and may have contributed to the rise of predatory lending practices. Assistant Secretary Bair, in her speech at the Women in Housing and Finance Fall Symposium, (http://www.treasury.gov/press/releases/po772.htm) stated:
“Predatory lending is difficult to define. Hearings chaired by your feature speaker, Senator Sarbanes, last summer highlighted some of the more egregious cases. These hearings also underscored, however, the importance of distinguishing predatory lending from legitimate subprime lending.
Subprime lending serves an important function in providing credit to borrowers with impaired credit histories. Subprime lending has expanded credit availability to those low- and moderate-income individuals with the ability to repay, but who suffer from poor credit histories. Predatory lending simply preys on these people.
Contributing to the problem of predatory lending is the fact that the mortgage process is too complicated. Anyone who has taken out a mortgage knows that the process is flawed. The disclosures are complicated and difficult to comprehend quickly, even for people with legal or financial backgrounds.
Borrowers who do not understand the terms of their loans can be easily exploited. Some of this can be addressed through more effective borrower education. But part of the problem is also that the disclosures we are providing are complex and very difficult to understand.”
Ms. Bair suggested immediate steps to reduce exploitation of consumers through increased financial literacy and government education programs, enhanced enforcement efforts by the Justice Department and the FTC, and development of “best practices” standards by the mortgage banking industry. The Federal Reserve finalized changes to Section 32 of Regulation Z and HMDA reporting requirements in December. However, Ms. Bair recognized that there is no “panacea” for the complexity of the disclosures and the confusion experienced by borrowers. Ms. Bair recognized that prior efforts failed to reach a consensus to revise and modernize consumer lending disclosures, to make them consumer friendly.
[xxv] HUD frequently claims that a majority of subprime borrowers qualify for FHA or conventional financing. One of the contributing factors of this phenomenon is the “safe” underwriting of a borrower in a lower rather than higher credit level. The borrower is assured of obtaining a loan if their credit rating is higher than average for the loan credit level of the loan product.
[xxvi] HOME OWNERSHIP EDUCATION AND COUNSELING: Issues in Research and Definition-Prepared by Alan Mallach, AICP For the Federal Reserve Bank of Philadelphia:
“...there appears to be a growing consensus on the content and modalities of home-ownership education and counseling, at least within the nonprofit counseling and CDC industries. This is driven by two honorable, even admirable premises: first, that the expansion of home-ownership opportunities to previously underserved populations is a desirable national goal, and second, that the provision of education and counseling is a material, even essential condition of achieving that goal. Without necessarily challenging either proposition, we should add a note of caution. As the first part of this paper illustrates, we have little idea of whether HEC [home-ownership education and counseling] is effective and – to the extent that it may be – which features or dimensions have which effect on either the home buyer’s tenure decision or the homeowner’s default decision. Moreover, seen in the expansive terms of the nonprofit counseling industry, HEC is a potentially obtrusive engagement in the lives of prospective home buyers and home owners. A system that imposes itself to the extent that HEC does on the lives of its beneficiaries should be able to show in compelling fashion that the benefits it provides are commensurate with the level of intrusion and the time and energy devoted by both counselors and participants.
Finally, we have yet to establish a clear link between home-ownership education and counseling and loan performance and, by extension, the stability of the home ownership opportunities being created, and by further extension, the stability of the neighborhoods in which home ownership is being promoted. While it is clear that there are success stories in many parts of the country of which many individuals and organizations can justifiably be proud, we need to know more about what has led to their success – and indeed how to define success–before we can be confident that we are on the right track.” http://www.phil.frb.org/cca/capubs/homeowner.pdf.