Consumer Protection
Federal and State Agencies Face Challenges in Combating Predatory Lending Gao ID: GAO-04-280 January 30, 2004While there is no universally accepted definition, the term "predatory lending" is used to characterize a range of practices, including deception, fraud, or manipulation, that a mortgage broker or lender may use to make a loan with terms that are disadvantageous to the borrower. No comprehensive data are available on the extent of these practices, but they appear most likely to occur among subprime mortgages--those made to borrowers with impaired credit or limited incomes. GAO was asked to examine actions taken by federal agencies and states to combat predatory lending; the roles played by the secondary market and by consumer education, mortgage counseling, and loan disclosure requirements; and the impact of predatory lending on the elderly.
While only one federal law--the Home Ownership and Equity Protection Act--is specifically designed to combat predatory lending, federal agencies have taken actions, sometimes jointly, under various federal consumer protection laws. The Federal Trade Commission (FTC) has played the most prominent enforcement role, filing 19 complaints and reaching multimillion dollar settlements. The Departments of Justice and Housing and Urban Development have also entered into predatory lending-related settlements, using laws such as the Fair Housing Act and the Real Estate Settlement Procedures Act. Federal banking regulators, including the Federal Reserve Board, report little evidence of predatory lending by the institutions they supervise. However, the nonbank subsidiaries of financial and bank holding companies--financial institutions which account for a significant portion of subprime mortgages--are subject to less federal supervision. While FTC is the primary federal enforcer of consumer protection laws for these entities, it is a law enforcement agency that conducts targeted investigations. In contrast, the Board is well equipped to routinely monitor and examine these entities and, thus, potentially deter predatory lending activities, but has not done so because its authority in this regard is less clear. As of January 2004, 25 states, as well as several localities, had passed laws to address predatory lending, often by restricting the terms or provisions of certain high-cost loans; however, federal banking regulators have preempted some state laws for the institutions they supervise. Also, some states have strengthened their regulation and licensing of mortgage lenders and brokers. The secondary market--where mortgage loans and mortgage-backed securities are bought and sold--benefits borrowers by expanding credit, but may facilitate predatory lending by allowing unscrupulous lenders to quickly sell off loans with predatory terms. In part to avoid certain risks, secondary market participants perform varying degrees of "due diligence" to screen out loans with predatory terms, but may be unable to identify all such loans. GAO's review of literature and interviews with consumer and federal officials suggest that consumer education, mortgage counseling, and loan disclosure requirements are useful, but may be of limited effectiveness in reducing predatory lending. A variety of factors limit their effectiveness, including the complexity of mortgage transactions, difficulties in reaching target audiences, and counselors' inability to review loan documents. While there are no comprehensive data, federal, state, and consumer advocacy officials report that the elderly have disproportionately been victims of predatory lending. According to these officials and relevant studies, older consumers may be targeted by predatory lenders because, among other things, they are more likely to have substantial home equity and may have physical or cognitive impairments that make them more vulnerable to an unscrupulous mortgage lender or broker.
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Director: Team: Phone:GAO-04-280, Consumer Protection: Federal and State Agencies Face Challenges in Combating Predatory Lending
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Report to the Chairman and Ranking Minority Member, Special Committee
on Aging, U.S. Senate:
January 2004:
CONSUMER PROTECTION:
Federal and State Agencies Face Challenges in Combating Predatory
Lending:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-280]:
GAO Highlights:
Highlights of GAO-04-280, a report to the Chairman and Ranking
Minority Member, Special Committee on Aging, U.S. Senate
Why GAO Did This Study:
While there is no universally accepted definition, the term ’predatory
lending“ is used to characterize a range of practices, including
deception, fraud, or manipulation, that a mortgage broker or lender
may use to make a loan with terms that are disadvantageous to the
borrower. No comprehensive data are available on the extent of these
practices, but they appear most likely to occur among subprime
mortgages”those made to borrowers with impaired credit or limited
incomes. GAO was asked to examine actions taken by federal agencies
and states to combat predatory lending; the roles played by the
secondary market and by consumer education, mortgage counseling, and
loan disclosure requirements; and the impact of predatory lending on
the elderly.
What GAO Found:
While only one federal law”the Home Ownership and Equity Protection
Act”is specifically designed to combat predatory lending, federal
agencies have taken actions, sometimes jointly, under various federal
consumer protection laws. The Federal Trade Commission (FTC) has
played the most prominent enforcement role, filing 19 complaints and
reaching multimillion dollar settlements. The Departments of Justice
and Housing and Urban Development have also entered into predatory
lending-related settlements, using laws such as the Fair Housing Act
and the Real Estate Settlement Procedures Act. Federal banking
regulators, including the Federal Reserve Board, report little
evidence of predatory lending by the institutions they supervise.
However, the nonbank subsidiaries of financial and bank holding
companies”financial institutions which account for a significant
portion of subprime mortgages”are subject to less federal supervision.
While FTC is the primary federal enforcer of consumer protection laws
for these entities, it is a law enforcement agency that conducts
targeted investigations. In contrast, the Board is well equipped to
routinely monitor and examine these entities and, thus, potentially
deter predatory lending activities, but has not done so because its
authority in this regard is less clear.
As of January 2004, 25 states, as well as several localities, had
passed laws to address predatory lending, often by restricting the
terms or provisions of certain high-cost loans; however, federal
banking regulators have preempted some state laws for the institutions
they supervise. Also, some states have strengthened their regulation
and licensing of mortgage lenders and brokers.
The secondary market”where mortgage loans and mortgage-backed
securities are bought and sold”benefits borrowers by expanding credit,
but may facilitate predatory lending by allowing unscrupulous lenders
to quickly sell off loans with predatory terms. In part to avoid
certain risks, secondary market participants perform varying degrees
of ’due diligence“ to screen out loans with predatory terms, but may
be unable to identify all such loans.
GAO‘s review of literature and interviews with consumer and federal
officials suggest that consumer education, mortgage counseling, and
loan disclosure requirements are useful, but may be of limited
effectiveness in reducing predatory lending. A variety of factors
limit their effectiveness, including the complexity of mortgage
transactions, difficulties in reaching target audiences, and
counselors‘ inability to review loan documents.
While there are no comprehensive data, federal, state, and consumer
advocacy officials report that the elderly have disproportionately
been victims of predatory lending. According to these officials and
relevant studies, older consumers may be targeted by predatory lenders
because, among other things, they are more likely to have substantial
home equity and may have physical or cognitive impairments that make
them more vulnerable to an unscrupulous mortgage lender or broker.
What GAO Recommends:
GAO suggests that Congress consider providing the Federal Reserve
Board with the authority to routinely monitor and, as necessary,
examine nonbank mortgage lending subsidiaries of financial and bank
holding companies to ensure compliance with federal consumer
protection laws applicable to predatory lending. Congress should also
consider giving the Board specific authority to initiate enforcement
actions under those laws against these nonbank mortgage lending
subsidiaries.
www.gao.gov/cgi-bin/getrpt?GAO-04-280.
To view the full product, including the scope and methodology, click
on the link above. For more information, contact David G. Wood at
202-512-8678 or woodd@gao.gov.
[End of section]
Contents:
Transmittal Letter:
Executive Summary:
Purpose:
Background:
Results in Brief:
Principal Findings:
Matters for Congressional Consideration:
Agency Comments and Our Evaluation:
Chapter 1: Introduction:
The Nature and Attributes of Predatory Lending:
Emergence of Subprime Mortgage Market:
The Extent of Predatory Lending Is Unknown:
Emergence of Predatory Lending As Policy Issue:
Objectives, Scope, and Methodology:
Chapter 2: Federal Agencies Have Taken Steps to Address Predatory
Lending, but Face Challenges:
Federal Agencies Use a Variety of Laws to Address Predatory Lending
Practices:
Federal Agencies Have Taken Some Enforcement Actions, but Banking
Regulators Have Focused on Guidance and Regulatory Changes:
Jurisdictional Issues Related to Nonbank Subsidiaries Challenge Efforts
to Combat Predatory Lending:
Conclusions:
Matters for Congressional Consideration:
Agency Comments and Our Evaluation:
Chapter 3: States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted:
States and Localities Have Addressed Predatory Lending through
Legislation, Regulation, and Enforcement Actions:
Activities in North Carolina and Ohio Illustrate State Approaches to
Predatory Lending:
Regulators Have Determined That Federal Law Preempts Some State
Predatory Lending Laws, but Views on Preemption Differ:
Chapter 4: The Secondary Market May Play a Role in Both Facilitating
and Combating Predatory Lending:
The Development of a Secondary Market for Subprime Loans Can Benefit
Consumers:
The Secondary Market for Subprime Loans Can Facilitate Predatory
Lending:
Due Diligence Can Help Purchasers Avoid Predatory Loans, but Efforts
Vary among Secondary Market Participants:
Assignee Liability May Help Deter Predatory Lending but Can Also Have
Negative Unintended Consequences:
Chapter 5: The Usefulness of Consumer Education, Counseling, and
Disclosures in Deterring Predatory Lending May Be Limited:
Many Consumer Education and Mortgage Counseling Efforts Exist, but
Several Factors Limit Their Potential to Deter Predatory Lending:
Disclosures, Even If Improved, May Be of Limited Use in Deterring
Predatory Lending:
Chapter 6: Elderly Consumers May Be Targeted for Predatory Lending:
A Number of Factors Make Elderly Consumers Targets of Predatory
Lenders:
Some Education and Enforcement Efforts Focus on Elderly Consumers:
Appendixes:
Appendix I: FTC Enforcement Actions Related to Predatory Lending:
Appendix II: Comments from the Board of Governors of the Federal
Reserve System:
Appendix III: Comments from the Department of Justice:
Appendix IV: Comments from the Department of Housing and Urban
Development:
Appendix V: Comments from the National Credit Union Administration:
Appendix VI: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Table:
Table 1: Preemption Determinations Issued by OCC, OTS, and NCUA Related
to Predatory Mortgage Lending Laws:
Figures:
Figure 1: Federal Laws and Statutes Used to Address Lending Practices
Generally Considered to be Predatory:
Figure 2: Structure and Federal Oversight of Mortgage Lenders:
Figure 3: States and Localities That Have Enacted Predatory Lending
Laws:
Figure 4: Steps in the Securitization of Residential Mortgages:
Abbreviations:
CRA: Community Reinvestment Act:
DOJ: Department of Justice:
ECOA: Equal Credit Opportunity Act:
FDIC: Federal Deposit Insurance Corporation:
FHA: Federal Housing Administration:
FTC: Federal Trade Commission:
GAO: General Accounting Office:
GSE: government-sponsored enterprise:
HMDA: Home Mortgage Disclosure Act:
HOEPA: Home Ownership and Equity Protection Act:
HUD: Department of Housing and Urban Development:
NCUA: National Credit Union Administration:
OCC: Office of the Comptroller of the Currency:
OTS: Office of Thrift Supervision:
RESPA: Real Estate Settlement Procedures Act:
TILA: Truth in Lending Act:
Transmittal Letter
January 30, 2004:
The Honorable Larry E. Craig:
Chairman:
The Honorable John Breaux:
Ranking Minority Member:
Special Committee on Aging:
United States Senate:
This report responds to your request that we evaluate issues related to
predatory home mortgage lending. As you requested, this report reviews
(1) federal laws related to predatory lending and federal agencies'
efforts to enforce them, (2) actions taken by states to address
predatory lending, (3) the secondary market's role in facilitating or
inhibiting predatory lending, (4) how consumer education, mortgage
counseling, and loan disclosures may deter predatory lending, and (5)
the relationship between predatory lending activities and elderly
consumers. This report includes a Matter for Congressional
Consideration.
As agreed with your office, we plan no further distribution of this
report until 30 days from its issuance date unless you publicly release
its contents sooner. We will then send copies of this report to the
Chairman and Ranking Minority Member of the Senate Committee on
Banking, Housing, and Urban Affairs; the Chairman and Ranking Minority
Member of the House Committee on Financial Services; the Secretary of
the Department of Housing and Urban Development; the Secretary of the
Department of the Treasury; the Chairman of the Federal Trade
Commission; the Chairman of the Board of Governors of the Federal
Reserve System; the Chairman of the Federal Deposit Insurance
Corporation; the Comptroller of the Currency; the Director of the
Office of Thrift Supervision; the Chairman of the National Credit Union
Administration; and other interested parties. Copies will also be made
available to others upon request. In addition, this report will be
available at no charge on the GAO Web site at [Hyperlink, http://
www.gao.gov].
This report was prepared under the direction of Harry Medina, Assistant
Director. Please contact Mr. Medina at (415) 904-2000 or me at (202)
512-8678 if you or your staff have any questions about this report.
Major contributors to this report are listed in appendix VI.
Signed by:
David G. Wood:
Director, Financial Markets and Community Investment:
[End of section]
Executive Summary:
Purpose:
Each year, millions of American consumers take out mortgage loans
through mortgage brokers or lenders to purchase homes or refinance
existing mortgage loans. While the majority of these transactions are
legitimate and ultimately benefit borrowers, some have been found to be
"predatory"--that is, to contain terms and conditions that ultimately
harm borrowers. Loans with these features, often targeted at the
elderly, minorities, and low-income homeowners, can strip borrowers of
home equity built up over decades and cause them to lose their homes.
The Chair and Ranking Member of the Senate Special Committee on Aging
asked GAO to examine the efforts under way to combat predatory lending.
GAO reviewed (1) federal laws related to predatory lending and federal
agencies' efforts to enforce them, (2) actions taken by states to
address predatory lending, (3) the secondary market's role in
facilitating or inhibiting predatory lending, (4) how consumer
education, mortgage counseling, and loan disclosures may deter
predatory lending, and (5) the relationship between predatory lending
activities and elderly consumers. The scope of this work was limited to
home mortgage lending and did not include other forms of consumer
loans. To address these objectives, GAO reviewed data and interviewed
officials from federal, state, and local agencies and from industry and
consumer advocacy groups; examined federal, state, and local laws; and
reviewed relevant literature. At GAO's request, federal agencies
identified enforcement or other actions they have taken to address
predatory lending. GAO also obtained data from publicly available
databases; the data were analyzed and found to be sufficiently reliable
for this report. Chapter 1 provides the details of the scope and
methodology of this report. The work was conducted between January 2003
and January 2004 in accordance with generally accepted government
auditing standards.
Background:
While there is no uniformly accepted definition of predatory lending, a
number of practices are widely acknowledged to be predatory. These
include, among other things, charging excessive fees and interest
rates, lending without regard to borrowers' ability to repay,
refinancing borrowers' loans repeatedly over a short period of time
without any economic gain for the borrower, and committing outright
fraud or deception--for example, falsifying documents or intentionally
misinforming borrowers about the terms of a loan.[Footnote 1] These
types of practices offer lenders that originate predatory loans
potentially high returns even if borrowers default, since many of these
loans require excessive up-front fees. No comprehensive data are
available on the incidence of these practices, but banking regulators,
consumer advocates, and industry participants generally agree that
predatory loans are most likely to occur in the market for "subprime"
loans. The subprime market serves borrowers who have limited incomes or
poor or no credit histories, in contrast with the prime market, which
encompasses traditional lenders and borrowers with credit histories
that put them at low risk of default. Originators of subprime loans
most often are mortgage and consumer finance companies but can also be
banks, thrifts, and other institutions.
Serious data limitations make the extent of predatory lending difficult
to determine. However, there have been a number of major settlements
resulting from government enforcement actions or private party lawsuits
in the last 5 years that have accused lenders of abusive practices
affecting large numbers of borrowers. For example, in October 2002,
Household International, a large home mortgage lender, agreed to pay up
to $484 million to homeowners to settle states' allegations that it
used unfair and deceptive lending practices to make mortgage loans with
excessive interest and fees. In addition, the rate of foreclosures of
subprime loans has increased substantially since 1990, far exceeding
the rate of increase for subprime originations. Some consumer groups
and industry observers have attributed this development, at least in
part, to an increase in abusive lending, particularly of loans made
without regard to borrowers' ability to repay. Additionally, groups
such as legal services agencies have reported seeing an ever-greater
number of consumers, particularly the elderly and minorities, who are
in danger of losing their homes as a result of predatory lending
practices.
Results in Brief:
Federal agencies have addressed predatory lending under a variety of
federal laws, including the Home Ownership and Equity Protection Act
(HOEPA), which was an amendment to the Truth in Lending Act (TILA)
designed specifically to combat predatory lending, and other consumer
protection laws such as the Federal Trade Commission Act (FTC Act),
TILA generally, and the Real Estate Settlement Procedures Act (RESPA).
The Federal Trade Commission (FTC) has played a prominent role because
it is responsible for implementing and enforcing certain federal laws
among lending institutions that are not supervised by federal banking
regulators. As of December 2003, FTC reported that it had taken 19
enforcement actions against mortgage lenders and brokers for predatory
practices, including some actions that have resulted in multimillion
dollar settlements. The Department of Housing and Urban Development's
(HUD) enforcement activities related to abusive lending have focused on
criminal fraud in its Federal Housing Administration (FHA) loan
insurance program. The federal banking regulators--the Federal Deposit
Insurance Corporation (FDIC), Board of Governors of the Federal Reserve
System (the Board), Office of the Comptroller of the Currency (OCC),
Office of Thrift Supervision (OTS), and National Credit Union
Administration (NCUA)--report little evidence of predatory lending by
the depository institutions that they supervise. However, concerns
exist about nonbank mortgage lending companies that are owned by
financial or bank holding companies, which have been involved in
several notable enforcement actions involving allegations of abusive
lending practices. While FTC has clear authority to conduct
investigations and enforce consumer protection laws among these nonbank
mortgage lending companies, as a law enforcement agency its role is to
investigate possible violations rather than to act as a supervisory
agency with routine monitoring and examination responsibilities. The
Board may be better equipped to monitor and examine these subsidiaries'
compliance with federal consumer protection laws and thus to deter
predatory lending, but it does not have clear authority to do so.
According to a database that tracks state and local legislation, 25
states, 11 localities, and the District of Columbia have passed their
own laws addressing predatory lending.[Footnote 2] While these laws
vary, most of them restrict the terms or provisions of mortgage loans
originated within their jurisdictions. In addition, some states have
strengthened the regulation and licensing of mortgage lenders and
brokers, and state law enforcement agencies and banking regulators have
taken a number of enforcement actions under state consumer protection
and banking laws. Some federal regulators have asserted that federal
law preempts some state predatory lending laws for the institutions
they regulate, stating that federally chartered lending institutions
should be required to comply with a single uniform set of national
regulations. Many state officials and consumer advocates, however,
maintain that federal preemption interferes with the states' ability to
protect consumers.
The secondary market for mortgage loans--which allows lenders and
investors to sell and buy mortgages and mortgage-backed securities--
provides lenders with an additional source of liquidity and may benefit
borrowers by increasing access to credit and lowering interest rates.
But the secondary market may also inadvertently serve to facilitate
predatory lending, both by providing a source of funds for unscrupulous
originators to quickly sell off loans with predatory terms and by
reducing incentives for these originators to ensure that borrowers can
repay their loans. Secondary market participants may use varying
degrees of "due diligence"--a review and appraisal of legal and
financial information--to avoid purchasing loans with abusive terms.
Fannie Mae and Freddie Mac--which are relatively recent entrants in the
subprime market--have due diligence processes that are designed, in
part, to avoid purchasing loans that may have been harmful to
consumers. Other firms may use due diligence not necessarily to avoid
loans that may have harmed consumers but to avoid loans that are not in
compliance with applicable law or that present undue financial or
reputation risks. Some states have passed laws making secondary market
buyers liable for violations by loan originators, although such laws
may have the unintended consequence of reducing the availability of
legitimate credit to consumers.
A number of federal, state, nonprofit, and industry-sponsored
organizations offer consumer education initiatives designed to deter
predatory lending by, among other things, providing information about
predatory practices and working to improve consumers' overall financial
literacy. GAO's review of literature and interviews with consumer and
federal officials suggest that while tools such as consumer education,
mortgage counseling, and disclosures are useful, they may be of limited
effectiveness in reducing predatory lending. For instance, consumer
education is hampered by the complexity of mortgage transactions and
the difficulty of reaching the target audience. Similarly, unreceptive
consumers and counselors' lack of access to relevant loan documents can
hamper the effectiveness of mortgage counseling efforts, while the
sheer volume of mortgage originations each year makes providing
universal counseling difficult. And while efforts are under way to
improve the federally required disclosures associated with mortgage
loans, the complexity of mortgage transactions also hinders these
efforts, especially given the lack of financial sophistication among
many borrowers who are targeted by predatory lenders.
While there are no comprehensive data, government officials and
consumer advocacy organizations have reported that elderly consumers
have been disproportionately targeted and victimized by predatory
lenders. According to these officials and organizations, elderly
consumers appear to be favored targets for several reasons--for
example, because they may have substantial equity in their homes or
live on limited incomes that make them susceptible to offers for quick
access to cash. Further, some seniors have cognitive or physical
impairments such as poor eyesight, hearing, or mobility that may limit
their ability to access competitive sources of credit. Most consumer
financial education efforts seek to serve the general consumer
population, but a few education initiatives have focused specifically
on predatory lending and the elderly. Most legal assistance related to
predatory lending aims at assisting the general population of
consumers, although some is focused on elderly consumers in particular.
Principal Findings:
Federal Agencies Have Taken Enforcement and Other Actions to Address
Predatory Lending, but Face Challenges:
Federal agencies and regulators have used a number of federal laws to
combat predatory lending practices. Among the most frequently used
laws--HOEPA, the FTC Act, TILA, and RESPA--only HOEPA was specifically
designed to address predatory lending. Enacted in 1994, HOEPA places
restrictions on certain high-cost loans, including limits on prepayment
penalties and balloon payments and prohibitions against negative
amortization. However, HOEPA covers only loans that exceed certain rate
or fee triggers, and although comprehensive data are lacking, it
appears that HOEPA covers only a limited portion of all subprime loans.
The FTC Act, enacted in 1914 and amended on numerous occasions,
authorizes FTC to prohibit and take action against unfair or deceptive
acts or practices in or affecting commerce. TILA and RESPA are designed
in part to provide consumers with accurate information about the cost
of credit.
Other federal laws that have been used to address predatory lending
practices include criminal fraud statutes that prohibit certain types
of fraud sometimes used in abusive lending schemes, such as forgery and
false statements. Also, the Fair Housing Act and Equal Credit
Opportunity Act--which prohibit discrimination in housing-related
transactions and the extension of credit, respectively--have been used
in cases against abusive lenders that have targeted certain protected
groups.
Using these or other authorities, federal agencies have taken a number
of enforcement actions and other steps, such as issuing guidance and
revising regulations.
* Among federal agencies, FTC has a prominent role in combating
predatory lending because of its responsibilities in implementing and
enforcing certain federal laws among lending institutions that are not
depository institutions supervised by federal banking regulators. FTC
has reported that it has filed 19 complaints--17 since 1998--alleging
deceptive or other illegal practices by mortgage lenders or brokers and
that some actions have resulted in multimillion dollar settlements. For
example, in 2002 FTC settled a complaint against a lender charged with
engaging in systematic and widespread deceptive and abusive lending
practices. According to FTC staff, close to 1 million borrowers will
receive about $240 million in restitution under the settlement.
* DOJ, which is responsible for enforcing certain federal civil rights
laws, has filed an enforcement action on behalf of the FTC and
identified two additional enforcement actions it has taken that are
related to predatory mortgage lending practices. The statutes DOJ
enforces only address predatory lending practices when they are alleged
to be discriminatory.
* HUD has undertaken enforcement activities related to abusive lending
that primarily focus on reducing losses to the FHA insurance fund, most
notably violations of criminal fraud statutes and FHA regulations
through "property flipping" schemes, which in some cases can harm
borrowers by leaving them with mortgage loans that may far exceed the
value of their homes.[Footnote 3] HUD has also taken three enforcement
actions in abusive mortgage lending cases for violations of RESPA's
prohibitions on certain types of fees.
* Federal banking regulators have stated that their monitoring and
examination activities have uncovered little evidence of predatory
lending in federally regulated depository institutions. Four of the
five federal banking regulators reported taking no formal enforcement
actions involving predatory mortgage lending against the institutions
they regulate, while the fifth--OCC--reported that it has taken one
formal enforcement action against a bank engaged in abusive mortgage
lending. Regulators noted that they have taken informal enforcement
actions to address questionable practices raised during the examination
process and required their institutions to take corrective action.
* The banking regulators have also issued guidance to the institutions
they supervise on avoiding direct or indirect involvement in predatory
lending. In addition, the Board has made changes to its regulations
implementing HOEPA that, among other things, increase the number of
loans HOEPA covers. The Board also made changes to its regulations
implementing the Home Mortgage Disclosure Act that make it easier to
analyze potential patterns of predatory lending.
Federal agencies and banking regulators have coordinated their efforts
to address predatory lending on certain occasions through participation
in interagency working groups and through joint enforcement actions.
For example, FTC, DOJ, and HUD coordinated to take an enforcement
action against Delta Funding Corporation, with each agency
investigating and bringing actions for violations of the laws within
its jurisdiction.
Issues related to federal oversight and regulation of certain nonbank
mortgage lenders may challenge efforts to combat predatory lending.
Nonbank mortgage lending companies owned by financial or bank holding
companies (nonbank mortgage lending subsidiaries), such as finance and
mortgage companies, account for an estimated 24 percent of subprime
loan orginations, according to HUD, and some have been the target of
notable federal and state enforcement actions involving allegations of
abusive lending.[Footnote 4] FTC is the primary federal enforcer of
consumer protection laws for these nonbank subsidiaries, but it is a
law enforcement rather than supervisory agency. Thus, FTC's mission and
resource allocations are focused on conducting investigations in
response to consumer complaints and other information rather than on
routine monitoring and examination responsibilities. In contrast, the
Board conducts periodic examinations of financial and bank holding
companies and, under the Bank Holding Company Act, is authorized to
monitor and examine the subsidiaries of a bank holding company under
certain circumstances. However, this authority does not clearly extend
to routine examinations of nonbank subsidiaries of these holding
companies with regard to laws pertinent to predatory lending. In
addition, the Board does not have specific authority under pertinent
federal consumer protection laws to institute an enforcement action
against a nonbank subsidiary of a financial or bank holding company.
Granting the Board concurrent enforcement authority with the FTC for
these nonbank subsidiaries of holding companies could help deter some
predatory lending.
Many States Have Passed Laws Addressing Predatory Lending, but Federal
Agencies Have Preempted Some Statutes:
In response to concerns about the growth of predatory lending and the
limitations of existing laws, 25 states, the District of Columbia, and
11 localities have passed their own laws addressing predatory lending
practices, according to a database that tracks such laws. Most of these
laws regulate and restrict the terms and characteristics of high-cost
loans--that is, loans that exceed certain rate or fee thresholds. While
some state statutes follow the thresholds for covered loans established
in HOEPA, many set lower thresholds in order to cover more loans than
the federal statute. The statutes vary, but they generally cover a
variety of predatory practices, such as balloon payments and prepayment
penalties, and some include restrictions on such things as mandatory
arbitration clauses that can restrict borrowers' ability to obtain
legal redress through the courts.
Some states have also increased the regulation of and licensing
requirements for mortgage lenders and brokers, in part to address
concerns that some unscrupulous lenders and brokers have been
responsible for lending abuses and that these entities have not been
adequately regulated. For example, some states have increased the
educational requirements that lenders and brokers must meet in order to
obtain a license. In recent years, state law enforcement agencies and
banking regulators have also taken a number of actions against mortgage
lenders involving predatory lending. For example, an official from
Washington State's Department of Financial Institutions reported that
the department had taken several enforcement actions to address
predatory lending, including one that resulted in a lender being
ordered to return more than $700,000 to 120 Washington borrowers for
allegedly deceiving them and charging prohibited fees.
Three federal banking regulators--NCUA, OCC, and OTS--have issued
opinions stating that federal laws preempt some state predatory lending
laws for the institutions that they regulate. The regulators note that
such preemption creates a more uniform regulatory framework, relieves
lending institutions of the burden of complying with a hodgepodge of
state and federal laws, and avoids state laws that may restrict
legitimate lending activities. State officials and consumer advocates
that oppose preemption argue that federal laws do not effectively
protect consumers against predatory lending practices and that federal
regulators do not devote sufficient resources toward enforcement of
consumer protection laws for the institutions they oversee.
The Secondary Market May Benefit Consumers but Can Also Facilitate
Predatory Lending:
In 2002, an estimated 63 percent of subprime loans, worth $134 billion,
were securitized and sold on the secondary market.[Footnote 5] The
existence of a secondary market for subprime loans has benefited
consumers by increasing the sources of funds available to subprime
lenders, potentially lowering interest rates and origination costs for
subprime loans. However, the secondary market may also inadvertently
facilitate predatory lending by providing a source of funds for
unscrupulous originators, allowing them to quickly sell off loans with
predatory terms. Further, originators of subprime mortgage loans
generally make their profits from high origination fees, and the
existence of a secondary market may reduce the incentive for these
lenders to ensure that borrowers can repay.
Purchasers of mortgage loans undertake a process of due diligence
designed to avoid legal, financial, and reputational risk. Prior to the
sale, purchasers typically review electronic data containing
information on the loans, such as the loan amount, interest rate, and
credit score of the borrower. Purchasers also often physically review a
sample of individual loans, including such items as the loan
application and settlement forms. However, the degree of due diligence
purchasers undertake varies. Fannie Mae and Freddie Mac--which are
estimated to account for a relatively small portion of the secondary
market for subprime loans--told us that they undertake a series of
measures aimed at avoiding the purchase of loans with abusive
characteristics that may have harmed borrowers. In contrast, according
to some market participants, the due diligence of other secondary
market purchasers of residential mortgages may be more narrowly focused
on the creditworthiness of the loans and on their compliance with
federal, state, and local laws. However, even the most stringent
efforts cannot uncover some predatory loans. For example, due diligence
by secondary market purchasers may be unable to uncover fraud that
occurred during the loan underwriting or approval process, some
excessive or unwarranted fees, or loan flipping.
Under some state and local legislation, purchasers of mortgages or
mortgage-backed securities on the secondary market may be liable for
violations committed by the originating lenders--referred to as
"assignee liability" provisions. HOEPA contains such a provision for
loans above certain thresholds, as do the antipredatory lending laws in
at least eight states and the District of Columbia, according to a
database that tracks state predatory lending laws. Assignee liability
is intended to discourage secondary market participants from purchasing
loans that may have predatory features and to provide an additional
source of redress for victims of abusive lenders. However, according to
some secondary market participants, assignee liability can also
discourage legitimate lending activity. Secondary market purchasers
that are unwilling to assume the potential risks associated with
assignee liability provisions have stopped purchasing, or announced
their intention to stop purchasing, mortgages originated in areas
covered by such provisions. Credit rating agencies--whose decisions
influence securitizers' ability to sell the securities--have asserted
that assignee liability provisions can make it difficult for them to
measure the risk associated with pools of loans. Assignee liability
provisions of the Georgia Fair Lending Act were blamed for causing
several participants in the mortgage lending industry to withdraw from
the market, and the provisions were subsequently repealed.
The Usefulness of Consumer Education, Counseling, and Disclosures in
Deterring Predatory Lending May Be Limited:
In response to widespread concern about low levels of financial
literacy among consumers, federal agencies have conducted and funded
financial education for consumers as a means of improving consumers'
financial literacy and, in some cases, raising consumers' awareness of
predatory lending practices. For example, FDIC sponsors a financial
literacy program, MoneySmart, which is designed for low-and moderate-
income individuals with little banking experience. Other federal
agencies, including the Board, FTC, HUD, and OTS, engage in activities
such as distributing educational literature, working with community
groups, and providing institutions they regulate with guidance on
encouraging financial literacy. Federal agencies have also taken some
actions to coordinate their efforts to educate consumers about
predatory lending. For example, in October 2003, the Interagency Task
Force on Fair Lending, which consists of 10 federal agencies, published
a brochure that alerts consumers to the potential pitfalls of home
equity loans, particularly high-cost loans. A number of states,
nonprofits, and trade organizations also conduct consumer financial
education activities, which sometimes focus specifically on raising
awareness about predatory lending.
While representatives of the mortgage lending industry and consumer
groups have noted that financial education may make some consumers less
susceptible to abusive lending practices, GAO's review of literature
and interviews with consumer and federal officials suggest that
consumer education by itself has limits as a tool for deterring
predatory lending. First, mortgage loans are complex financial
transactions, and many different factors--including the interest rate,
fees, provisions of the loan, and situation of the borrower--determine
whether a loan is in a borrower's best interests. Even an excellent
campaign of consumer education is unlikely to provide less
sophisticated consumers with enough information to properly assess
whether a loan contains abusive terms. Second, predatory lenders and
brokers tend to use aggressive marketing tactics that are designed to
confuse consumers. Broad-based campaigns to make consumers aware of
predatory lending may not be sufficient to prevent many consumers--
particularly those who may be uneducated or unsophisticated in
financial matters--from succumbing to such tactics. Finally, the
consumers who are often the targets of predatory lenders are also some
of the hardest to reach with educational information.
Prepurchase mortgage counseling--which can offer a "third party" review
of a prospective mortgage loan--may help borrowers avoid predatory
loans, in part by alerting consumers to predatory loan terms and
practices. HUD supports a network of approximately 1,700 HUD-approved
counseling agencies across the country and in some cases provides
funding for their activities. While beneficial, the role of mortgage
counseling in preventing predatory lending is likely to be limited.
Borrowers do not always attend such counseling, and when they do,
counselors may not have access to all of the loan documents needed to
review the full final terms and provisions before closing. In addition,
counseling may be ineffective against lenders and brokers engaging in
fraudulent practices, such as falsifying applications or loan
documents, that cannot be detected during a prepurchase review of
mortgage loan documents.
Finally, disclosures made during the mortgage loan process, while
important, may be of limited usefulness in reducing the incidence of
predatory lending practices. TILA and RESPA have requirements covering
the content, form, and timing of the information that must be disclosed
to borrowers. However, industry and consumer advocacy groups have
publicly expressed dissatisfaction with the current disclosure system.
HUD issued proposed rules in July 2002 intended to streamline the
disclosure process and make disclosures more understandable and timely,
and debate over the proposed rules has been contentious. Although
improving loan disclosures would undoubtedly have benefits, once again
the inherent complexity of loan transactions may limit any impact on
the incidence of predatory lending practices. Moreover, even a
relatively clear and transparent system of disclosures may be of
limited use to borrowers who lack sophistication about financial
matters, are not highly educated, or suffer physical or mental
infirmities. Finally, as with mortgage counseling, revised disclosure
requirements would not necessarily help protect consumers against
lenders and brokers that engage in outright fraud or that mislead
borrowers about the terms of loans in the disclosure documents
themselves.
Predatory Lenders May Target Elderly Consumers:
Consistent observational and anecdotal evidence, along with some
limited data, indicates that, for a variety of reasons, elderly
homeowners are disproportionately the targets of predatory lending.
Abusive lenders tend to target homeowners who have substantial equity
in their homes, as many older homeowners do. In addition, some brokers
and lenders aggressively market home equity loans as a source of cash,
particularly for older homeowners who may have limited incomes but
require funds for major home repairs or medical expenses. Moreover,
diseases and physical impairments associated with aging--such as
declining vision, hearing, or mobility--can restrict elderly consumers'
ability to access financial information and compare credit terms. Some
older persons may also have diminished cognitive capacity, which can
impair their ability to comprehend and make informed judgments on
financial issues. Finally, several advocacy groups have noted that some
elderly people lack social and family support systems, potentially
increasing their susceptibility to unscrupulous lenders who may market
loans by making home visits or offering other personal contact.
Because the elderly may be more susceptible to predatory lending,
government agencies and consumer advocacy organizations have focused
some of their education efforts on this population. For example, the
Justice Department offers on its Web site the guide "Financial Crimes
Against the Elderly," which includes references to predatory lending.
The Department of Health and Human Services' Administration on Aging
provides grants to state and nonprofit agencies for programs aimed at
preventing elder abuse, including predatory lending practices targeting
older consumers. The AARP, which represents Americans age 50 and over,
sponsors a number of financial education efforts, including a
borrower's kit that contains tips for avoiding predatory lending.
Consumer protection and fair lending laws that have been used to
address predatory lending do not generally have provisions specific to
elderly persons, although the Equal Credit Opportunity Act does
prohibit unlawful discrimination on the basis of age in connection with
any aspect of a credit transaction. Federal and state enforcement
actions and private class-action lawsuits involving predatory lending
generally seek to provide redress to large groups of consumers. Little
comprehensive data exist on the age of consumers involved in these
actions, but a few cases have involved allegations of predatory lending
targeting elderly borrowers. For example, FTC, six states, AARP, and
private plaintiffs settled a case with First Alliance Mortgage Company
in March 2002 for more than $60 million. An estimated 28 percent of the
8,712 borrowers represented in the class-action suit were elderly. The
company was accused of using misrepresentation and unfair and deceptive
practices to lure senior citizens and those with poor credit histories
into entering into abusive loans. In addition, some nonprofit groups--
such as the AARP Foundation Litigation, the National Consumer Law
Center, and South Brooklyn Legal Services' Foreclosure Prevention
Project--provide legal services that focus, in part, on helping elderly
victims of predatory lending.
Matters for Congressional Consideration:
To enable greater oversight of and potentially deter predatory lending
from occurring at certain nonbank lenders, Congress should consider
making appropriate statutory changes to grant the Board of Governors of
the Federal Reserve System the authority to routinely monitor and, as
necessary, examine the nonbank mortgage lending subsidiaries of
financial and bank holding companies for compliance with federal
consumer protection laws applicable to predatory lending practices.
Also, Congress should consider giving the Board specific authority to
initiate enforcement actions under those laws against these nonbank
mortgage lending subsidiaries.
Agency Comments and Our Evaluation:
GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and
comment. The agencies provided technical comments that have been
incorporated where appropriate. In addition, the Board, DOJ, FDIC, FTC,
HUD, and NCUA provided general comments, which are discussed in greater
detail at the end of chapter 2. The written comments of the Board, DOJ,
HUD, and NCUA are printed in appendixes II through V.
The Board commented that, while the existing structure has not been a
barrier to Federal Reserve oversight, the approach recommended in our
Matter for Congressional Consideration would likely be beneficial by
catching some abusive practices that might not be caught otherwise. The
Board also noted that the approach would pose tradeoffs, such as
different supervisory schemes being applied to nonbank mortgage lenders
based on whether or not they are part of a holding company, and
additional costs. Because nonbank mortgage lenders that are part of a
financial or bank holding company currently can be examined by the
Board in some circumstances, they are already subject to a different
supervisory scheme than other such lenders. We agree that the costs to
the lenders and the Board would increase to the extent the Board
exercised any additional authority to monitor and examine nonbank
lenders, and believe that Congress should consider both the potential
costs and benefits of clarifying the Board's authorities.
The FTC expressed concern that our report could give the impression
that we are suggesting that Congress consider giving the Board sole
jurisdiction--rather than concurrent jurisdiction with FTC--over
nonbank subsidiaries of holding companies. Our report did not intend to
suggest that the Congress make any change that would necessarily affect
FTC's existing authority for these entities, and we modified the report
to clarify this point.
DOJ commented that the report will be helpful in assessing the
department's role in the federal government's efforts to develop
strategies to combat predatory lending. DOJ disagreed with our
inclusion in the report of "property or loan flips," which it said was
a traditional fraud scheme but not a type of predatory lending. As we
noted in our report, there is no precise definition of predatory
lending. We incorporated a discussion of property flipping--quick
resales of recently sold FHA properties--because HUD officials
characterize some of these schemes as involving predatory practices
that can harm borrowers. We included loan flipping--the rapid and
repeated refinancing of a loan without benefit to the borrower--in our
report because this is widely characterized in the literature and by
federal, state, and nonprofit agency officials as a predatory lending
practice.
FDIC noted that our Matter for Congressional Consideration focuses on
nonbank subsidiaries of holding companies even though these entities
comprise, according to HUD, only about 20 percent of all subprime
lenders. We recognize that our Matter does not address all subprime
lenders or other institutions that may be engaging in predatory
lending, but believe it represents a potential step in addressing
predatory lending among a significant segment of mortgage lenders. NCUA
said that the report provides a useful discussion of the issues and the
agency concurs with our Matter for Congressional Consideration. HUD, in
its comment letter, described a variety of actions it has taken that it
characterized as combating predatory lending, particularly with regard
to FHA-insured loans.
[End of section]
Chapter 1: Introduction:
In recent years, abuses in home mortgage lending--commonly referred to
as "predatory lending"--have increasingly garnered the attention and
concern of policymakers, consumer advocates, and participants in the
mortgage lending industry.[Footnote 6] Once relatively rare, government
enforcement actions and private party lawsuits against institutions
accused of abusive home mortgage lending have increased dramatically in
the last 10 years. In 2002 alone, there were dozens of settlements
resulting from accusations of abusive lending. In the largest of these,
a major national mortgage lender agreed to pay up to $484 million to
tens of thousands of affected consumers.
The Nature and Attributes of Predatory Lending:
Predatory lending is an umbrella term that is generally used to
describe cases in which a broker or originating lender takes unfair
advantage of a borrower, often through deception, fraud, or
manipulation, to make a loan that contains terms that are
disadvantageous to the borrower. While there is no universally accepted
definition, predatory lending is associated with the following loan
characteristics and lending practices:
* Excessive fees. Abusive loans may include fees that greatly exceed
the amounts justified by the costs of the services provided and the
credit and interest rate risks involved. Lenders may add these fees to
the loan amounts rather than requiring payment up front, so the
borrowers may not know the exact amount of the fees they are paying.
* Excessive interest rates. Mortgage interest rates can legitimately
vary based on the characteristics of borrowers (such as
creditworthiness) and of the loans themselves. However, in some cases,
lenders may charge interest rates that far exceed what would be
justified by any risk-based pricing calculation, or lenders may "steer"
a borrower with an excellent credit record to a higher-rate loan
intended for borrowers with poor credit histories.
* Single-premium credit insurance. Credit insurance is a loan product
that repays the lender should the borrower die or become disabled. In
the case of single-premium credit insurance, the full premium is paid
all at once--by being added to the amount financed in the loan--rather
than on a monthly basis. Because adding the full premium to the amount
of the loan unnecessarily raises the amount of interest borrowers pay,
single-premium credit insurance is generally considered inherently
abusive.
* Lending without regard to ability to repay. Loans may be made without
regard to a borrower's ability to repay the loan. In these cases, the
loan is approved based on the value of the asset (the home) that is
used as collateral. In particularly egregious cases, monthly loan
payments have equaled or exceeded the borrower's total monthly income.
Such lending can quickly lead to foreclosure of the property.
* Loan flipping. Mortgage originators may refinance borrowers' loans
repeatedly in a short period of time without any economic gain for the
borrower. With each successive refinancing, these originators charge
high fees that "strip" borrowers' equity in their homes.
* Fraud and deception. Predatory lenders may perpetrate outright fraud
through actions such as inflating property appraisals and doctoring
loan applications and settlement documents. Lenders may also deceive
borrowers by using "bait and switch" tactics that mislead borrowers
about the terms of their loan. Unscrupulous lenders may fail to
disclose items as required by law or in other ways may take advantage
of borrowers' lack of financial sophistication.
* Prepayment penalties. Penalties for prepaying a loan are not
necessarily abusive, but predatory lenders may use them to trap
borrowers in high-cost loans.
* Balloon payments. Loans with balloon payments are structured so that
monthly payments are lower but one large payment (the balloon payment)
is due when the loan matures. Predatory loans may contain a balloon
payment that the borrower is unlikely to be able to afford, resulting
in foreclosure or refinancing with additional high costs and fees.
Sometimes, lenders market a low monthly payment without adequate
disclosure of the balloon payment.
Predatory lending is difficult to define partly because certain loan
attributes may or may not be abusive, depending on the overall context
of the loan and the borrower. For example, although prepayment
penalties can be abusive in the context of some loans, in the context
of other loans they can benefit borrowers by reducing the overall cost
of loans by reducing the lender's prepayment risk.
According to federal and industry officials, most predatory mortgage
lending involves home equity loans or loan refinancings rather than
loans for home purchases. Homeowners may be lured into entering
refinance loans through aggressive solicitations by mortgage brokers or
lenders that promise "savings" from debt consolidation or the ability
to "cash out" a portion of a borrower's home equity. Predatory lending
schemes may also involve home improvement contractors that work in
conjunction with a lender. The contractor may offer to arrange
financing for necessary repairs or improvements, and then perform
shoddy work or fail to complete the job, while leaving the borrower
holding a high-cost loan. Abuses in loan servicing have also
increasingly become a concern. Abusive mortgage lenders or servicing
agents may charge improper late fees, require unjustified homeowner's
insurance, or not properly credit payments. In November 2003, the
Federal Trade Commission (FTC) and the Department of Housing and Urban
Development (HUD) reached a settlement with a large national mortgage
servicer, Fairbanks Capital, after the company was accused of unfair,
deceptive, and illegal practices in the servicing of mortgage loans.
The settlement will provide $40 million to reimburse consumers.
Originating lenders or brokers that engage in abusive practices can
make high profits through the excessive points and fees that they
charge, particularly when borrowers make their payments regularly. Even
when a loan enters foreclosure, the originator of a predatory loan may
still make a profit due to the high up-front fees it has already
collected. Moreover, a lender that sells a loan in the secondary market
shortly after origination no longer necessarily faces financial risk
from foreclosure.[Footnote 7] Similarly, a mortgage broker that
collects fees up front is not affected by foreclosure of the loan.
According to HUD and community groups, predatory lending not only harms
individual borrowers but also can weaken communities and neighborhoods
by causing widespread foreclosures, which reduce property values.
Predatory lending also serves to harm the reputation of honest and
legitimate lenders, casting them in the same suspicious light as those
making unfair loans and thus increasing their reluctance to extend
credit to the traditionally underserved communities that are often
targeted by abusive lenders.
Emergence of Subprime Mortgage Market:
The market for mortgage loans has evolved considerably over the past 20
years. Among the changes has been the emergence of a market for
subprime mortgage loans. Most mortgage lending takes place in what is
known as the prime market, which encompasses traditional lenders and
borrowers with credit histories that put them at low risk of default.
In contrast, the subprime market serves borrowers who have poor or no
credit histories or limited incomes, and thus cannot meet the credit
standards for obtaining loans in the prime market.[Footnote 8] It is
widely accepted that the overwhelming majority of predatory lending
occurs in the subprime market, which has grown dramatically in recent
years. Subprime mortgage originations grew from $34 billion in 1994 to
more than $213 billion in 2002 and in 2002 represented 8.6 percent of
all mortgage originations, according to data reported by the trade
publication Inside B&C Lending. Several factors account for the growth
of the subprime market, including changes in tax law that increased the
tax advantages of home equity loans, rapidly increasing home prices
that have provided many consumers with substantial home equity, entry
into the subprime market by companies that had previously made only
prime loans, and the expansion of credit scoring and automated
underwriting, which has made it easier for lenders to price the risks
associated with making loans to credit-impaired borrowers.
Originating lenders charge higher interest rates and fees for subprime
loans than they do for prime loans to compensate for increased risks
and for higher servicing and origination costs. In many cases,
increased risks and costs justify the additional cost of the loan to
the borrower, but in some cases they may not. Because subprime loans
involve a greater variety and complexity of risks, they are not the
uniformly priced commodities that prime loans generally are. This lack
of uniformity makes comparing the costs of subprime loans difficult,
which can increase borrowers' vulnerability to abuse.
However, subprime lending is not inherently abusive, and certainly all
subprime loans are not predatory. Although some advocacy groups claim
that subprime lending involves abusive practices in a majority of
cases, most analysts believe that only a relatively small portion of
subprime loans contain features that may be considered abusive. In
addition, according to officials at HUD and the Department of the
Treasury, the emergence of a subprime mortgage market has enabled a
whole class of credit-impaired borrowers to buy homes or access the
equity in their homes. At the same time, however, federal officials and
consumer advocates have expressed concerns that the overall growth in
subprime lending and home equity lending in general has been
accompanied by a corresponding increase in predatory lending. For
example, lenders and brokers may use aggressive sales and marketing
tactics to convince consumers who need cash to enter into a home equity
loan with highly disadvantageous terms.
Originators of subprime loans are most often mortgage and consumer
finance companies, but can also be banks, thrifts, and other
institutions. Some originators focus primarily on making subprime
loans, while others offer a variety of prime and subprime loans.
According to HUD, 178 lenders concentrated primarily on subprime
mortgage lending in 2001. Fifty-nine percent of these lenders were
independent mortgage companies (mortgage bankers and finance
companies), 20 percent were nonbank subsidiaries of financial or bank
holding companies, and the remainder were other types of financial
institutions. Only 10 percent were federally regulated banks and
thrifts.[Footnote 9]
About half of all mortgage loans are made through mortgage brokers that
serve as intermediaries between the borrower and the originating
lender. According to government and industry officials, while the great
majority of mortgage brokers are honest, some play a significant role
in perpetrating predatory lending. A broker can be paid for his
services from up-front fees directly charged to the borrower and/or
through fees paid indirectly by the borrower through the lender in what
is referred to as a "yield spread premium."[Footnote 10] Some consumer
advocates argue that compensating brokers this way gives brokers an
incentive to push loans with higher interest rates and fees. Brokers
respond that yield spread premiums in fact allow them to reduce the
direct up-front fees they charge consumers.
The Extent of Predatory Lending Is Unknown:
Currently no comprehensive and reliable data are available on the
extent of predatory lending nationwide, for several reasons. First, the
lack of a standard definition of what constitutes predatory lending
makes it inherently difficult to measure. Second, any comprehensive
data collection on predatory lending would require access to a
representative sample of loans and to information that can only be
extracted manually from the physical loan files. Given that such
records are not only widely dispersed but also generally proprietary,
to date comprehensive data have not been collected.[Footnote 11]
Nevertheless, policymakers, advocates, and some lending industry
representatives have expressed concerns in recent years that predatory
lending is a significant problem. Although the extent of predatory
lending cannot be easily quantified, several indicators suggest that it
may be prevalent. Primary among these indicators are legal settlements,
foreclosure patterns, and anecdotal evidence.
In the past 5 years, there have been a number of major settlements
resulting from government enforcement actions and private party
lawsuits accusing lenders of abusive lending practices affecting large
numbers of borrowers. Among the largest of these settlements have been
the following:
* In October 2002, the lender Household International agreed to pay up
to $484 million to homeowners across the nation to settle allegations
by states that it used unfair and deceptive lending practices to make
mortgage loans with excessive interest and charges.
* In September 2002, Citigroup agreed to pay up to $240 million to
resolve charges by FTC and private parties that Associates First
Capital Corporation and Associates Corporation of North America (The
Associates) engaged in systematic and widespread deceptive and abusive
lending practices.[Footnote 12] According to FTC staff, under the
settlement close to 1 million borrowers will receive compensation for
loans that misrepresented insurance products and that contained other
abusive terms.
* In response to allegations of deceptive marketing and abusive
lending, First Alliance Mortgage Company entered into a settlement in
March 2002 with FTC, six states, and private parties to compensate
nearly 18,000 borrowers more than $60 million dollars.
Further, between January 1998 and September 1999, the foreclosure rate
for subprime loans was more than 10 times the foreclosure rate for
prime loans.[Footnote 13] While it would be expected that loans made to
less creditworthy borrowers would result in some increased rate of
foreclosure, the magnitude of this difference has led many analysts to
suggest that it is at least partly the result of abusive lending,
particularly of loans made without regard to the borrower's ability to
repay. Moreover, the rate of foreclosures of subprime mortgage loans
has increased substantially since 1990, far exceeding the rate of
increase for subprime originations. A study conducted for HUD noted
that while the increased rate in subprime foreclosures could be the
result of abusive lending, it could also be the result of other
factors, such as an increase in subprime loans that are made to the
least creditworthy borrowers.[Footnote 14]
In the early 1990s, anecdotal evidence began to emerge suggesting that
predatory lending was on the rise. Legal services agencies throughout
the country reported an increase in clients who were facing foreclosure
as a result of mortgage loans that included abusive terms and
conditions. These agencies noted that for the first time they were
seeing large numbers of consumers, particularly elderly and minority
borrowers, who were facing the loss of homes they had lived in for many
years because of a high-cost refinancing. Similar observations were
also reported extensively at forums on predatory lending sponsored by
HUD and the Department of the Treasury in five cities during 2000, at
hearings held in four cities during 2000 by the Board of Governors of
the Federal Reserve System (the Board), and at congressional hearings
on the issue in 1998, 2001, 2002, and 2003.[Footnote 15]
Federal officials and consumer advocates maintain that predatory
lenders often target certain populations, including the elderly and
some low-income and minority communities. Some advocates say that in
many cases, predatory lenders target communities that are underserved
by legitimate institutions, such as banks and thrifts, leaving
borrowers with limited credit options. According to government
officials and legal aid organizations, predatory lending appears to be
more prevalent in urban areas than in rural areas, possibly because of
the concentration of certain target groups in urban areas and because
the aggressive marketing tactics of many predatory lenders may be more
efficient in denser neighborhoods.[Footnote 16]
Emergence of Predatory Lending As Policy Issue:
The federal government began addressing predatory home mortgage lending
as a significant policy issue in the early 1990s. In 1994, the Congress
passed the Home Ownership and Equity Protection Act (HOEPA), an
amendment to the Truth in Lending Act that set certain restrictions on
"high-cost" loans in order to protect consumers.[Footnote 17] In 1998,
as part of an overall review of the statutory requirements for mortgage
loans, HUD and the Board released a report recommending that additional
actions be taken to protect consumers from abusive lending
practices.[Footnote 18] HUD and the Department of the Treasury formed a
task force in 2000 that produced the report Curbing Predatory Home
Mortgage Lending, which made several dozen recommendations for
addressing predatory lending.[Footnote 19], [Footnote 20]
As discussed in chapters 2 and 3, a variety of federal, state, and
local laws have been used to take civil and criminal enforcement
actions against institutions and individuals accused of abusive lending
practices. Various federal agencies have responsibilities for enforcing
laws related to predatory lending. In addition, some state or local
enforcement authorities--including attorneys general, banking
regulators, and district attorneys--have used state and local laws
related to consumer protection and banking to address predatory lending
practices. In addition, many private attorneys and advocacy groups have
pursued private legal actions, including class actions, on behalf of
borrowers who claim to have been victimized by abusive lending.
Objectives, Scope, and Methodology:
Our objectives were to describe (1) federal laws related to predatory
lending and federal agencies' efforts to enforce them; (2) the actions
taken by the states in addressing predatory lending; (3) the secondary
market's role in facilitating or inhibiting predatory lending; (4) how
consumer education, mortgage counseling, and loan disclosures may deter
predatory lending; and (5) the relationship between predatory lending
activities and elderly consumers. The scope of this work was limited to
home mortgage lending and did not include other forms of consumer
loans.
To identify federal laws and enforcement activities related to
predatory lending, we interviewed officials and reviewed documents from
HUD, the Department of Justice (DOJ), the Department of the Treasury,
the Federal Deposit Insurance Corporation (FDIC), FTC, the Board, the
National Credit Union Administration (NCUA), the Office of the
Comptroller of the Currency (OCC), and the Office of Thrift Supervision
(OTS). We asked each agency to provide us with the enforcement actions
they have taken that--in their assessment--were related to predatory
home mortgage lending. We compiled and reviewed data on these
enforcement actions and other steps these agencies have taken to
address abusive lending practices. We also reviewed and analyzed
federal laws that have been used to combat these practices.
To identify actions taken by states and localities, we reviewed and
analyzed a publicly available database maintained by the law firm of
Butera & Andrews that tracks state and municipal antipredatory lending
legislation. We reviewed information related to this database and
conducted interviews with the person who maintains it. In order to
identify gaps in the completeness or accuracy of data, we compared data
elements from this database and from three similar databases maintained
by Lotstein Buckman, the National Conference of State Legislatures, and
the Mortgage Bankers Association of America. We determined that the
data were sufficiently reliable for use in this report. We also
interviewed officials representing a wide range of state and local
government agencies, lending institutions, and advocacy groups in a
number of states and municipalities. In order to illustrate approaches
taken in certain states with regard to predatory lending, we collected
and analyzed additional information from two states, North Carolina and
Ohio. We chose these states to illustrate the differing characteristics
of two states' approaches to addressing predatory lending--particularly
with regard to legislation restricting high-cost loans and tightening
regulation of mortgage lenders and brokers. We also conducted meetings
with the Conference of State Bank Supervisors and the National
Association of Attorneys General that included representatives from
several states. Additionally, we conducted interviews with OCC, OTS,
and NCUA to understand their policies and processes on federal
preemption of state antipredatory lending laws.
To describe the secondary market's role, we interviewed officials and
reviewed documents from the Bond Market Association, the Securities
Industry Association, Fannie Mae, Freddie Mac, a due diligence
contractor, and two credit rating agencies. We also spoke with
officials representing federal and state agencies, and with
representatives of the lending industry and consumer groups. In
addition, we reviewed and analyzed several local and state laws
containing assignee liability provisions.
To describe the role of consumer education, mortgage counseling, and
disclosures in deterring predatory lending, we interviewed officials
from entities that engage in consumer financial education, including
several federal and state agencies, industry trade groups, and local
nonprofit organizations such as the Long Island Housing Partnership,
the Greater Cincinnati Mortgage Counseling Service, and the Foreclosure
Prevention Project of South Brooklyn Legal Services. We also reviewed
and analyzed the materials these entities produce. Additionally, we
conducted a literature review of studies that have evaluated the
effectiveness of consumer education and homeownership counseling.
To describe the impact on older consumers, we conducted a literature
review on predatory lending and the elderly and examined studies on
financial exploitation of the elderly. We also examined certain
enforcement activities and private party lawsuits in which elderly
consumers may have been targeted by abusive lenders. We interviewed
federal and state agencies that have addressed issues of financial
abuse of the elderly, including the Department of Health and Human
Services' Administration on Aging and the National Institute on Aging,
as well as nonprofit groups that have addressed this issue, including
AARP (formerly known as the American Association of Retired Persons).
In addressing all of the objectives, we met with a wide range of
organizations that represent consumers, among them the National
Community Reinvestment Coalition, the Coalition for Responsible
Lending, the National Consumer Law Center, the Association of Community
Organizations for Reform Now, and AARP. We also met with organizations
representing various aspects of the mortgage lending industry, among
them the American Financial Services Association, the Consumer Mortgage
Coalition, the Coalition for Fair and Affordable Lending, America's
Community Bankers, the National Association of Mortgage Brokers, the
Mortgage Bankers Association of America, and the National Home Equity
Mortgage Association.
We provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and
comment. The agencies provided technical comments that have been
incorporated, as appropriate, as well as general comments that are
discussed at the end of chapter 2. The written comments of the Board,
DOJ, HUD, and NCUA are printed in appendixes II through V. We conducted
our work between January 2003 and January 2004 in accordance with
generally accepted government auditing standards in Atlanta, Boston,
New York, San Francisco, and Washington, D.C.
[End of section]
Chapter 2: Federal Agencies Have Taken Steps to Address Predatory
Lending, but Face Challenges:
While HOEPA is the only federal law specifically designed to combat
predatory mortgage lending, federal agencies, including federal banking
regulators, have used a number of federal consumer protection and
disclosure statutes to take actions against lenders that have allegedly
engaged in abusive or predatory lending.[Footnote 21] These statutes
have enabled agencies to file complaints on behalf of consumers over
issues such as excessive interest rates and fees, deceptive lending
practices, and fraud. FTC, DOJ, HUD, and federal banking regulators
have taken steps to address predatory lending practices through
enforcement and civil actions, guidance, and regulatory changes. In
some cases, agencies have coordinated their efforts through joint
enforcement actions and participation in interagency working groups or
task forces. However, questions of jurisdiction regarding certain
nonbank mortgage lenders may challenge efforts to combat predatory
lending. While the Board has authority to examine many such nonbank
mortgage lenders under certain circumstances, it lacks clear authority
to enforce federal consumer protection laws against them.
Federal Agencies Use a Variety of Laws to Address Predatory Lending
Practices:
As shown in figure 1, Congress has passed numerous laws that can be
used to protect consumers against abusive lending practices. Federal
agencies have applied provisions of these laws to seek redress for
consumers who have been victims of predatory lending. Among the most
frequently used laws are TILA, HOEPA, the Real Estate Settlement
Procedures Act (RESPA), and the FTC Act.[Footnote 22] Congress has also
given certain federal agencies responsibility for writing regulations
that implement these laws. For example, the Board writes Regulation Z,
which implements TILA and HOEPA, and HUD writes Regulation X, which
implements RESPA. Also, in some cases, DOJ has brought actions under
criminal fraud statutes based on conduct that can constitute predatory
lending.
Figure 1: Federal Laws and Statutes Used to Address Lending Practices
Generally Considered to be Predatory:
[See PDF for image]
[A] HOEPA covers only a limited portion of all subprime loans.
[End of figure]
TILA, which became law in 1968, was designed to provide consumers with
accurate information about the cost of credit. Among other things, the
act requires lenders to disclose information about the terms of loans-
-including the amount being financed, the total finance charge, and
information on the annual percentage rate--that can help borrowers
understand the overall costs of their loans. TILA also provides
borrowers with the right to cancel certain loans secured by a principal
residence within 3 days of closing or 3 days of the time at which the
final disclosure is made, whichever is later.[Footnote 23]
In 1994, Congress enacted the HOEPA amendments to TILA in response to
concerns about predatory lending. HOEPA covers certain types of loans
made to refinance existing mortgages, as well as home equity loans,
that satisfy specific criteria.[Footnote 24] HOEPA covers only a
limited portion of all subprime loans, although there is no
comprehensive data on precisely what that portion is.[Footnote 25] The
law is designed to limit predatory practices for these so-called "high-
cost" HOEPA loans in several ways. First, it places restrictions on
loans that exceed certain rate or fee thresholds, which the Board can
adjust within certain limits prescribed in the law. For these loans,
the law restricts prepayment penalties, prohibits balloon payments for
loans with terms of less than 5 years, prohibits negative amortization,
and contains certain other restrictions on loan terms or
payments.[Footnote 26] Second, HOEPA prohibits lenders from routinely
making loans without regard to the borrower's ability to repay. Third,
the law requires lenders to include disclosures in addition to those
required by TILA for consumer credit transactions to help borrowers
understand the terms of the high-cost loan and the implications of
failing to make required payments. Each federal banking regulator is
charged with enforcing TILA and HOEPA with respect to the depository
institutions it regulates, and FTC is primarily responsible for
enforcing the statutes for most other financial institutions, including
independent mortgage lenders and nonbank subsidiaries of holding
companies. In enforcing TILA and HOEPA, FTC has required violators to
compensate borrowers for statutory violations. Under certain
circumstances, HOEPA provides for damages in addition to the actual
damages a person sustains as a result of a creditor's violation of the
act.[Footnote 27]
RESPA, passed in 1974, seeks to protect consumers from unnecessarily
high charges in the settlement of residential mortgages by requiring
lenders to disclose details of the costs of settling a loan and by
prohibiting certain other costs.[Footnote 28] Among its provisions is a
prohibition against kickbacks--payments made in exchange for referring
a settlement service, such as lender payments to real estate agents for
the referral of business. RESPA also prohibits unearned fees such as
adding an additional charge to a third party fee when no or nominal
services are performed. These practices can unjustly increase the costs
of loans and the settlement process. HUD enforces RESPA, working
closely with federal banking regulators and other federal agencies such
as the FTC and the Department of Justice. HUD often brings joint
enforcement actions with these agencies, using RESPA and the statutes
enforced by the other federal agencies. In addition, the banking
regulators may prohibit violations of RESPA in their own regulations.
The FTC Act, enacted in 1914 and amended on numerous occasions,
provides the FTC with the authority to prohibit and take action against
unfair or deceptive acts or practices in or affecting commerce. FTC has
used the act to address predatory lending abuses when borrowers have
been misled or deceived about their loan terms.[Footnote 29]
Various criminal fraud statutes prohibit certain types of fraud
sometimes used in abusive lending schemes, including forgery and false
statements. DOJ and HUD have used these statutes to fight fraudulent
schemes that have resulted in borrowers purchasing homes worth
substantially less than their mortgage amounts or borrowers being
unfairly stripped of the equity in their homes. HUD officials have
described some of these fraudulent activities as constituting predatory
lending.
The following other federal laws have been used to a lesser extent to
address abusive lending:
* The Fair Housing Act prohibits discrimination based on race, sex, and
other factors in housing-related transactions, and the Equal Credit
Opportunity Act (ECOA) prohibits discrimination against borrowers in
the extension of credit. Federal agencies have used both laws in cases
against lenders that have allegedly targeted certain protected groups
with abusive loans.
* The Home Mortgage Disclosure Act (HMDA) requires lenders to make
publicly available certain data about mortgage loans. Federal agencies
have used the data provided by HMDA to help identify possible
discriminatory lending patterns, including those that involve abusive
lending practices.
* The Community Reinvestment Act (CRA) requires that banking regulators
consider a depository institution's efforts to meet the credit needs of
its community--including low-and moderate-income neighborhoods--in
examinations and when it applies for permission to take certain actions
such as a merger or acquisition. An institution's fair lending record
is taken into account in assessing CRA performance. CRA regulations
state that abusive lending practices that violate certain federal laws
will adversely affect an institution's CRA performance.[Footnote 30]
* Also, federal banking regulators may rely on their supervisory and
enforcement authorities under the laws they administer, as well as on
the Federal Deposit Insurance Act, to enforce these consumer
protections laws and ensure that an institution's conduct with respect
to compliance with consumer protection laws does not affect its safety
and soundness or that of an affiliated institution.
* Finally, FTC and the banking regulators can also use the Fair Debt
Collection Practices Act and Fair Credit Reporting Act in enforcement
actions related to predatory lending that involve violations of credit
reporting and loan servicing provisions.
Although a number of federal laws have been used to protect borrowers
from abusive lending or to provide them redress, not all potentially
abusive practices are illegal under federal law. Enforcement officials
and consumer advocates have stated that some lenders make loans that
include abusive features but are designed to remain below the
thresholds that would subject them to the restrictions of HOEPA. For
loans not covered under HOEPA, certain lending practices many consider
to be abusive are not, depending on the circumstances, necessarily a
violation of any federal law. For example, it is not necessarily
illegal to charge a borrower interest rates or fees that exceed what is
justified by the actual risk of the mortgage loan. Nor is it per se
illegal under federal law to "steer" a borrower with good credit who
qualifies for a prime loan into a higher cost subprime loan.[Footnote
31] Finally, with the exception of loans covered under HOEPA, there are
no federal statutes that expressly prohibit making a loan that a
borrower will likely be unable to repay.[Footnote 32]
Federal Agencies Have Taken Some Enforcement Actions, but Banking
Regulators Have Focused on Guidance and Regulatory Changes:
FTC, DOJ, and HUD have taken enforcement actions to address violations
related to abusive lending.[Footnote 33] As of December 2003, FTC
reported that the agency had taken 19 actions against mortgage lenders
and brokers for predatory practices. DOJ has addressed predatory
lending that is alleged to be discriminatory by enforcing fair lending
laws in a limited number of cases. HUD's efforts have generally focused
on reducing losses to the Federal Housing Administration (FHA)
insurance fund, including implementing a number of initiatives to
monitor lenders for violations of FHA guidelines.[Footnote 34] HUD
reported having taken a small number of actions to enforce RESPA and
the Fair Housing Act in cases involving predatory lending.
Federal banking regulators stated that their monitoring and examination
activities have revealed little evidence of predatory lending practices
by federally regulated depository institutions. Accordingly, most
banking regulators reported that they have taken no formal enforcement
actions related to predatory mortgage lending abuses by the
institutions they supervise. Regulators have addressed predatory
lending primarily by issuing guidance to their institutions on guarding
against direct or indirect involvement in predatory lending practices
and by making certain changes to HOEPA and HMDA regulations. In
addition, several federal agencies have coordinated certain efforts to
pursue enforcement actions related to predatory lending and have shared
information on their efforts to address fair lending and predatory
lending.
FTC Has Played the Predominant Federal Role in Enforcement Actions
Related to Predatory Lending:
FTC is responsible for implementing and enforcing certain federal laws
among lending institutions that are not supervised by federal banking
regulators. FTC reported that between 1983 and 2003, it filed 19
complaints alleging deceptive or other illegal practices by mortgage
lenders and brokers, 17 of them filed since 1998.[Footnote 35] For a
list of these FTC enforcement actions, see appendix I. As of December
2003, FTC had reached settlements in all but one of the cases. In most
of these settlements, companies have agreed to provide monetary redress
to consumers and to halt certain practices in the future. In some
cases, the settlements also imposed monetary penalties that the
companies have paid to the government. Among the recent enforcement
actions related to predatory lending that the FTC identified are the
following:
* The Associates. In 2002, FTC settled a complaint against Associates
First Capital Corporation and Associates Corporation of North America
(collectively, The Associates), as well as their successor, Citigroup.
The complaint alleged that the lender violated the FTC Act and other
laws by, among other things, deceiving customers into refinancing debts
into home loans with high interest rates and fees and purchasing high-
cost credit insurance. The settlement, along with a related settlement
with private parties, provides for up to $240 million in restitution to
borrowers.[Footnote 36]
* First Alliance. In 2002, FTC, along with several states and private
plaintiffs, settled a complaint against First Alliance Mortgage Company
alleging that it violated federal and state laws by misleading
consumers about loan origination and other fees, interest rate
increases, and monthly payment amounts on adjustable rate mortgage
loans. The company agreed to compensate nearly 18,000 borrowers more
than $60 million in consumer redress and to refrain from making
misrepresentations about future offers of credit.
* Fleet Finance and Home Equity U.S.A. In 1999, Fleet Finance, Inc.,
and Home Equity U.S.A., Inc., settled an FTC complaint alleging
violations of the FTC Act, TILA, and related regulations. These
violations included failing to provide required disclosures about home
equity loan costs and terms and failing to alert borrowers to their
right to cancel their credit transactions. To settle, the company
agreed to pay up to $1.3 million in redress and administrative costs
and to refrain from violating TILA in the future.
* Operation Home Inequity. In 1999, FTC conducted "Operation Home
Inequity," a law enforcement and consumer education campaign that
sought to curb abusive practices in the subprime mortgage lending
market. FTC reached settlements with seven subprime mortgage lenders
that had been accused of violating a number of consumer protections
laws, including the FTC Act, TILA, and HOEPA. Six companies were
required to pay $572,000 in consumer redress, and all lenders were
required to adhere to future lending restrictions. FTC staff told us
that the operation was intended in large part to increase consumers'
awareness of predatory lending and to provide a deterrent effect by
warning lenders that FTC is able and willing to take action against
them.
FTC staff expressed their belief that the agency's enforcement actions
over the years have been successful in deterring other lenders from
engaging in abusive practices. However, in a congressional hearing in
2000 FTC had requested statutory changes that would improve its ability
to enforce HOEPA. For example, FTC recommended that Congress expand
HOEPA to prohibit the financing of lump-sum credit insurance premiums
in loans covered by HOEPA and to give FTC the power to impose civil
penalties for HOEPA violations.[Footnote 37]
DOJ Has Enforced Fair Lending Laws in Connection with Predatory
Lending:
DOJ's Housing and Civil Enforcement Section is responsible for
enforcing certain federal civil rights laws, including the Fair Housing
Act and ECOA. DOJ identified two enforcement actions it has taken
related to predatory mortgage lending practices that it alleged were
discriminatory.[Footnote 38]
* Delta Funding. In 2000, DOJ, in cooperation with FTC and HUD, brought
charges against Delta Funding Corporation, accusing the consumer
finance company of violations of the Fair Housing Act, HOEPA, ECOA,
RESPA, and related federal regulations.[Footnote 39] Delta allegedly
approved and funded loans that carried substantially higher broker fees
for African American females than for similarly situated white males.
Delta was also accused of violating certain consumer protection laws by
paying kickbacks and unearned fees to brokers to induce them to refer
loan applicants to Delta and by systematically making HOEPA loans
without regard to borrowers' ability to repay. The settlement placed
restrictions on the company's future lending operations and victims
were compensated from previously established monetary relief
funds.[Footnote 40]
* Long Beach Mortgage. In 1996 DOJ settled a complaint alleging
violations of the Fair Housing Act and ECOA against Long Beach Mortgage
Company.[Footnote 41] According to the complaint, the company's loan
officers and brokers charged African American, Hispanic, female, and
older borrowers higher loan rates than it charged other similarly
situated borrowers. The company agreed to set up a $3 million fund to
reimburse 1,200 consumers who had received Long Beach loans.[Footnote
42]
Representatives from both FTC and DOJ have stated that their
enforcement actions can be very resource intensive and can involve
years of discovery and litigation. For example, FTC filed a complaint
against Capitol City Mortgage Corporation in 1998 that is still in
litigation more than 5 years later. FTC staff told us that because
cases involving predatory lending can be so resource intensive, the
agencies try to focus their limited resources on the cases that will
have the most impact, such as those that may result in large
settlements to consumers or that will have some deterrent value by
gaining national exposure. Similarly, DOJ officials select certain
discrimination cases, including those mentioned above, in part because
of their broad impact.
HUD's Enforcement Activities Focus on FHA Loans:
HUD's enforcement and regulatory activity with regard to abusive
mortgage lending comes primarily through its management of the FHA
single-family mortgage insurance programs, its rule-making and
enforcement authority under RESPA, and its enforcement of the Fair
Housing Act.
Most of HUD's enforcement activities related to abusive lending have
focused on reducing losses to the FHA insurance fund. Investigators
from HUD's Office of the Inspector General have worked with
investigators from U.S. Attorneys' Offices and the FBI in a joint law
enforcement effort to target fraud in the FHA mortgage insurance
program, which can result in defaults and thus in losses to the
insurance fund.[Footnote 43] The fraudulent activities sometimes
involve property flipping schemes, which can harm borrowers by leaving
them with mortgage loans that may far exceed the value of their
homes.[Footnote 44] Under certain circumstances, such activity can
involve predatory lending practices. To address these crimes,
investigators have presented evidence of false statements and other
criminal fraud and deception. In addition, representatives from HUD
told us that they have processes in place to ensure that lenders adhere
to agency guidelines and make loans that satisfy FHA requirements. The
Office of Lender Activities and Program Compliance approves,
recertifies, and monitors FHA lenders and works with them to ensure
compliance. If necessary, the office refers violating lenders to HUD's
Mortgagee Review Board, which has the authority to take administrative
actions such as withdrawing approval for a lender to make FHA-insured
loans. HUD officials told us that the board has taken many
administrative actions to address violations that could be indicative
of predatory lending, such as charging excessive and unallowable fees,
inflating appraisals, and falsifying documents showing income or
employment. In an effort to address abusive property flipping schemes
involving homes secured by FHA-insured loans, HUD issued a final rule
in May 2003 that prohibits FHA insurance on properties resold less than
90 days after their previous sale.
HUD officials say that programs they have in place to improve the
monitoring of FHA lenders also serve to deter predatory lending. For
example, HUD's Credit Watch Program routinely identifies those lenders
with the highest early default and insurance claim rates and
temporarily suspends the FHA loan origination approval agreements of
the riskiest lenders, helping to ensure that lenders are not making
loans that borrowers cannot repay. Also, the Neighborhood Watch program
provides information to FHA participants about lenders and appraisers
whose loans have high default and FHA insurance claim rates. HUD told
us that it has also taken a series of actions to better ensure the
integrity of appraisals used to finance FHA insured loans. As of
December 2003, HUD was in the final stages of issuing a rule that would
hold lenders accountable for appraisals associated with loans they
make.
HUD's Office of RESPA and Interstate Land Sales is responsible for
handling complaints, conducting investigations, and taking enforcement
actions related to RESPA. HUD has taken several enforcement actions
related to RESPA's prohibition of kickbacks and referral fees, three of
which related directly to abusive mortgage lending, as of December
2003.[Footnote 45] Also, as discussed above, in November 2003 HUD and
FTC jointly filed a case against and reached settlement with a mortgage
loan servicing company charged with violations of the FTC Act, RESPA,
and other laws.[Footnote 46] HUD has also recently hired additional
staff to enhance its RESPA enforcement efforts. Finally, in 2002, HUD
issued a proposed rule designed to change the regulatory requirements
of RESPA to simplify and potentially lower the costs of the home
mortgage settlement process. According to HUD, as of December 2003, the
final rule had been submitted to the Office of Management and Budget
and was being reviewed.
HUD's Office of Fair Housing and Equal Opportunity is responsible for
enforcing the Fair Housing Act. HUD identified one action--a letter of
reprimand to a financial institution--related to enforcement of this
act in a case involving predatory lending.
Federal Banking Regulators Have Issued Guidance and Made Regulatory
Changes:
According to federal banking regulators and state enforcement
authorities, federally regulated depository institutions--banks,
thrifts, and credit unions--have not typically engaged in predatory
lending practices. Federal banking regulators have systems in place to
track customer complaints and reported that they have received few
complaints related to predatory lending by the institutions they
supervise. The regulators conduct routine examinations of these
institutions and have the authority, in cases of suspected predatory
lending, to enforce a variety of fair lending and consumer protection
laws. Banking regulators noted that the examination process, which
involves routine on-site reviews of lenders' activities, serves as a
powerful deterrent to predatory lending by the institutions they
examine.
Officials of OTS, FDIC, the Board, and NCUA said that they had taken no
formal enforcement actions related to predatory mortgage lending
against the institutions they regulate.[Footnote 47] Officials at OCC
said they have taken one formal enforcement action related to predatory
mortgage lending to address fee packing, equity stripping, and making
loans without regard to a borrower's ability to pay. In November 2003,
the agency announced an enforcement action against Loan Star Capital
Bank seeking to reimburse 30 or more borrowers for more than $100,000
in abusive fees and closing costs that violated the FTC Act, HOEPA,
TILA, and RESPA.[Footnote 48] The bank also was required to conduct a
comprehensive review of its entire mortgage portfolio and to provide
restitution to any additional borrowers who may have been harmed.
While most federal banking regulators stated that they have taken no
formal enforcement actions, representatives from some said they had
taken informal enforcement actions to address some questionable
practices among their institutions. For example, OTS has examined
institutions that may have charged inappropriate fees or violated HOEPA
and resolved the problems by requiring corrective action as part of the
examination process. In addition, most of the banking regulators have
taken formal enforcement actions, including issuing cease-and-desist
orders, in response to activities that violated fair lending and
consumer protection laws but were not necessarily deemed to constitute
"predatory lending.":
Guidance:
Federal banking regulators have issued guidance to their institutions
about both predatory lending and subprime lending in general. In
February 2003, OCC issued two advisory letters related to predatory
lending to the national banks and the operating subsidiaries it
supervises. One letter provided specific guidelines for guarding
against predatory lending practices during loan originations, and the
other alerted institutions to the risk of indirectly engaging in
predatory lending through brokered or purchased loans.[Footnote 49] The
advisory letters described loan attributes that are often considered
predatory and established standards for policies and procedures for
monitoring loan transactions to avoid making, brokering, or purchasing
loans with such attributes. For example, the first letter stated that
banks should establish underwriting policies and procedures to
determine that borrowers have the capacity to repay their loans. The
advisory letter also stated OCC's position that predatory lending will
also affect a national bank's CRA rating. The advisories have also
clarified ways in which predatory practices can create legal, safety
and soundness, and reputation risks for national banks. For example,
they laid out ways in which the origination or purchase of predatory
loans may constitute violations of TILA, RESPA, HOEPA, the FTC Act, and
fair lending laws. In addition, in January 2004, OCC issued a rule
adopting antipredatory lending standards that expressly prohibit
national banks from making loans without regard to the borrower's
ability to repay and from engaging in unfair and deceptive practices
under the FTC Act.[Footnote 50]
In 1999 and 2001, the Board, FDIC, OCC, and OTS issued joint guidance
to their institutions on subprime lending in general.[Footnote 51] The
guidance highlighted the additional risks inherent in subprime lending
and noted that institutions engaging in such lending need to be aware
of the potential for predatory practices and be particularly careful to
avoid violating fair lending and consumer protection laws and
regulations. The NCUA issued similar guidance to insured credit unions
in 1999.[Footnote 52] Federal banking regulators have also previously
issued guidance about abusive lending practices, unfair or deceptive
acts or practices, and other issues related to predatory
lending.[Footnote 53]
Regulatory Changes:
The Board is responsible for issuing regulations that implement HOEPA
and HMDA, two laws that play a role in addressing predatory lending. In
December 2001, in response to concerns that HOEPA may not be adequately
protecting consumers from abusive lending practices, the Board amended
Regulation Z, which implements HOEPA, to:
* lower the interest rate "trigger" that determines whether loans are
covered under HOEPA in order to bring more loans under the protection
of the law,[Footnote 54]
* require that fees paid for credit insurance and similar debt
protection products be included when determining whether loans are
subject to HOEPA,
* prohibit creditors that make HOEPA loans from refinancing the loan
within one year of origination with another HOEPA loan, unless the
refinancing is in the borrower's interest, and:
* clarify the prohibition against engaging in a "pattern or practice"
of lending without regard to borrowers' ability to repay.[Footnote 55]
In February 2002, the Board also made changes to Regulation C, which
implements HMDA. The changes, which went into effect in January 2004,
require lenders to provide additional data that may facilitate analyses
of lending patterns that may be predatory. For example:
* if the costs to the borrower of financing a loan exceed a certain
threshold determined by the Board, the lender must report the cost of
the loan;[Footnote 56]
* if an application or loan involves a manufactured home, the lender is
required to identify that fact, in part to help identify predatory
practices involving these types of homes; and:
* if a loan is subject to HOEPA, the lender is required to identify
that fact in order to give policymakers more specific information about
the number and characteristics of HOEPA loans.[Footnote 57]
Because HOEPA expressly grants the Board broad authority to issue rules
to regulate unfair or deceptive acts and practices, some consumer
advocacy organizations have argued that the Board should use its
authority to do more to curb predatory lending.[Footnote 58] For
example, some consumer groups have called on the Board to use its rule-
making authority to prohibit the financing of single-premium credit
insurance--a product that is believed by many to be inherently
predatory.[Footnote 59] Under the McCarran Ferguson Act,[Footnote 60]
unless a federal statute is specifically related to the business of
insurance, the federal law may not be construed to invalidate, impair,
or supercede any state law enacted to regulate the business of
insurance. Board officials say it is not clear the extent to which
rules issued by the Board under HOEPA seeking to regulate the sale of
single-premium credit insurance would be consistent with that standard.
The Board has previously recommended that it would be more appropriate
for Congress to address this issue through changes in law. Some
consumer groups also have argued that the Board should increase the
loan data reporting requirements of HMDA to help detect abusive
lending. The Board has added certain loan pricing and other items to
the HMDA reporting requirements, effective in January 2004, but did not
add other data reporting requirements, such as the credit score of the
applicant. Board officials said this is based on the belief that the
need for additional loan data to ensure fair lending must be weighed
against the costs and burdens to the lender of gathering and reporting
the additional information.
Agencies Have Coordinated on Enforcement Actions and Participated in
Interagency Groups:
Federal agencies have worked together to investigate and pursue some
cases involving predatory lending. For example, FTC, DOJ, and HUD
coordinated to take enforcement action against Delta Funding
Corporation, with each agency investigating and bringing actions for
violations of the laws under its jurisdiction. DOJ conducted its
enforcement action against Long Beach Mortgage Company in coordination
with OTS, which investigated the initial complaint in 1993 when the
company was a thrift. Federal agencies have also coordinated with state
authorities and private entities in enforcement actions. For example,
in 2002, FTC joined six states, AARP, and private attorneys to settle a
complaint against First Alliance Mortgage Company alleging that the
company used deception and manipulation in its lending practices.
Federal regulators have also coordinated their efforts to address fair
lending and predatory lending through working groups. For example:
* In the fall of 1999 the Interagency Fair Lending Task Force, which
coordinates federal efforts to address discriminatory lending,
established a working group to examine the laws related to predatory
lending and determine how enforcement and consumer education could be
strengthened.[Footnote 61] Because of differing views on how to define
and combat predatory lending, the group was unable to agree on a
federal interagency policy statement related to predatory lending in
2001. The Task Force then continued its efforts related to consumer
education and published a brochure in 2003 to educate consumers about
predatory lending practices.
* The five banking regulators have conducted additional coordination
activities through the Federal Financial Institutions Examination
Council's Task Force on Consumer Compliance.[Footnote 62] The task
force coordinates policies and procedures for ensuring compliance with
fair lending laws and the Community Reinvestment Act, both of which
have been identified as tools that can be used to address predatory
lending. The council publishes a document that responds to frequently
asked questions about community reinvestment, including how examiners
should consider illegal credit practices, which may be abusive, in
determining an institution's Community Reinvestment Act rating.
* In 2000, HUD and the Department of the Treasury created the National
Task Force on Predatory Lending, which convened forums around the
country to examine the issue and released a report later in the
year.[Footnote 63] The report made specific recommendations to
Congress, federal agencies, and other stakeholders that were aimed at
(1) improving consumer literacy and disclosure, (2) reducing harmful
sales practices, (3) reducing abusive or deceptive loan terms and
conditions, and (4) changing structural aspects of the lending market.
Some of the recommendations made in the HUD-Treasury task force report
have been implemented. For example, as recommended in the report, the
Board has adopted changes to HOEPA regulations that have increased the
number of loans covered and added additional restrictions. In addition,
as the report recommended, FTC and some states have devoted more
resources in the past few years to actively pursuing high-profile
enforcement cases. As discussed in chapter 5, federal and state
agencies have also worked to improve one of the areas highlighted in
the report: public awareness about predatory lending issues. Other
recommendations made in the report have not been implemented, however.
For example, Congress has not enacted legislation to expand penalties
for violations of TILA, HOEPA, and RESPA or to increase the damages
available to borrowers harmed by such violations. HUD and the
Department of the Treasury told us that they have not formally tracked
the status of the recommendations made in the report, although HUD
officials said they are informally monitoring the recommendations in
the report that relate to their agency. Officials at both agencies also
noted that the report and its recommendations were the product of a
previous administration and may or may not reflect the views of the
current administration.
In addition to participating in interagency groups, agencies share
information related to fair lending violations under statutory
requirements and formal agreements. For example, since 1992 HUD and the
banking regulators have had a memorandum of understanding stating that
HUD will refer allegations of fair lending violations to banking
regulators and a 1994 executive order requires that executive branch
agencies notify HUD of complaints and violations of the Fair Housing
Act. In addition, whenever the banking regulatory agencies or HUD have
reason to believe that an institution has engaged in a "pattern or
practice" of illegal discrimination, they are required to refer these
cases to DOJ for possible civil action.
Jurisdictional Issues Related to Nonbank Subsidiaries Challenge Efforts
to Combat Predatory Lending:
Jurisdictional issues related to the regulation of certain nonbank
mortgage lenders may challenge efforts to combat predatory lending.
Many federally and state-chartered banks and thrifts, as well as their
subsidiaries, are part of larger financial holding companies or bank
holding companies.[Footnote 64] These holding companies may also
include nonbank financial companies, such as finance and mortgage
companies, that are subsidiaries of the holding companies themselves.
These holding company subsidiaries are frequently referred to as
affiliates of the banks and thrifts because of their common ownership
by the holding company. As shown in figure 2, the federal regulators of
federally and state-chartered banks and thrifts also regulate the
subsidiaries of those institutions. For example, as the primary
regulator for national banks, OCC also examines operating subsidiaries
of those banks. On the other hand, federal regulators generally do not
perform routine examinations of independent mortgage lenders and
affiliated nonbank subsidiaries of financial and bank holding companies
engaged in mortgage lending.
Figure 2: Structure and Federal Oversight of Mortgage Lenders:
[See PDF for image]
Note: The primary federal agency for enforcement of the various federal
laws used to combat abusive or predatory lending activities is shown in
parentheses.
[A] FTC is responsible for enforcing federal laws for lenders that are
not depository institutions but it is not a supervisory agency and does
not conduct routine examinations.
[End of figure]
Some disagreement exists between states and some federal banking
regulators over states' authority to regulate and supervise the
operating subsidiaries of federally chartered depository institutions.
For example, OCC issued an advisory letter in 2002 noting that federal
law provides the agency with exclusive authority to supervise and
examine operating subsidiaries of national banks and that the states
have no authority to regulate or supervise these subsidiaries.[Footnote
65] Some representatives of state banking regulators expressed concerns
to us about this because of the subsidiaries' potential involvement in
predatory lending practices. OCC has stated that the subsidiaries of
the institutions it regulates do not play a large role in subprime
lending and that little evidence exists to show that these subsidiaries
are involved in predatory lending. But some state enforcement
authorities and consumer advocates argue otherwise, citing some
allegations of abuses at national bank subsidiaries. However, several
state attorneys general have written that predatory lending abuses are
"largely confined" to the subprime lending market and to non-depository
institutions, not banks or direct bank subsidiaries.[Footnote 66] OCC
officials stated that the agency has strong monitoring and enforcement
systems in place and can and will respond vigorously to any abuses
among institutions it supervises.[Footnote 67] For example, OCC
officials pointed to an enforcement action taken in November 2003 that
required restitution of more than $100,000 to be paid to 30 or more
borrowers for fees and interest charged in a series of abusive loans
involving small "tax-lien loans.":
A second issue relates to the monitoring and supervision of certain
nonbank subsidiaries of holding companies. As noted previously, many
federally and state-chartered banks and thrifts, as well as their
subsidiaries, are part of larger financial or bank holding
companies.[Footnote 68] These holding companies may also include
nonbank subsidiaries, such as finance and mortgage companies, that are
affiliates but not subsidiaries of the federally regulated bank or
thrift. Although these affiliates engage in financial activities that
may be subject to federal consumer protection and fair lending laws,
unlike depository institutions they are not subject to routine
supervisory examinations for compliance with those laws. While the
Board has jurisdiction over these entities for purposes of the Bank
Holding Company Act, it lacks authority to ensure and enforce their
compliance with federal consumer protection and fair lending laws in
the same way that the federal regulators monitor their depository
institutions.
One reason for the concern about these entities is that nonbank
subsidiaries of holding companies conduct a significant amount of
subprime mortgage lending. Of the total subprime loan originations made
by the top 25 subprime lenders in the first 6 months of 2003, 24
percent were originated by nonbank subsidiaries of holding companies.
In addition, of the 178 lenders on HUD's 2001 subprime lender list, 20
percent were nonbank subsidiaries of holding companies. These types of
subsidiaries have also been targets of some of the most notable federal
and state enforcement actions involving abusive lending. For example,
The Associates and Fleet Finance, which were both nonbank subsidiaries
of bank holding companies, were defendants in two of the three largest
cases involving subprime lending that FTC has brought.[Footnote 69]
The Associates case illustrates an important aspect of the current
federal regulatory oversight structure pertinent to predatory lending.
The Board has authority under the Bank Holding Company Act to condition
its approval of holding company acquisitions. The Board used this
authority in connection with Citigroup's acquisition of European
American Bank because of concerns about the subprime lending activities
of The Associates, which Citigroup had acquired and merged into its
CitiFinancial subsidiary. As a condition of approving the acquisition
of European American Bank, the Board directed that an examination of
certain subprime lending subsidiaries of Citigroup be carried out to
determine whether Citigroup was effectively implementing policies and
procedures designed to ensure compliance with fair lending laws and
prevent abusive lending practices. However, the Board does not have
clear authority to conduct the same type of monitoring outside of the
Bank Holding Company Act approval process. Although the Board has the
authority to monitor and perform routine inspections or examinations of
a bank holding company, this authority apparently does not extend to
routine examinations of nonbank subsidiaries of bank holding companies
with regard to compliance with consumer protection laws. The Bank
Holding Company Act, as amended by the Gramm-Leach-Bliley Act,
authorizes the Board to examine a nonbank subsidiary for specific
purposes, including "to monitor compliance with the provisions of (the
Bank Holding Company Act) or any other Federal law that the Board has
specific jurisdiction to enforce against such company or subsidiary."
Federal consumer protection laws do not give the Board specific
enforcement jurisdiction over nonbank subsidiaries.
For this reason, FTC is the primary federal agency monitoring nonbank
subsidiaries' compliance with consumer protection laws. FTC is the
primary federal enforcer of consumer protection laws for these nonbank
subsidiaries, but it is a law enforcement rather than supervisory
agency. Thus, FTC's mission and resource allocations are focused on
conducting investigations in response to consumer complaints and other
information rather than on routine monitoring and examination
responsibilities. Moreover, as discussed elsewhere in this report,
states vary widely in the extent to which they regulate practices that
can constitute predatory lending.
The HUD-Treasury report on predatory lending argued that the Board
should take more responsibility for monitoring nonbank subsidiaries of
bank holding companies, in part to ensure that consumer protection laws
are adequately enforced for these institutions. Similarly, in 1999, GAO
recommended that the Board monitor the lending activities of nonbank
mortgage lending subsidiaries of bank holding companies and consider
examining these entities if patterns in lending performance, growth, or
operating relationships with other holding company entities indicated
the need to do so.[Footnote 70] In its written response to GAO's
recommendation, the Board said that while it has the general legal
authority to examine these entities, it has neither the clear
enforcement jurisdiction nor the legal responsibility for engaging in
such activities, as Congress has directly charged FTC with primary
responsibility over enforcement with regard to these entities.
Among federal agencies, the Board is uniquely situated to monitor the
activities of the nonbank mortgage lending subsidiaries of financial
and bank holding companies by virtue of its role as the regulator of
holding companies and its corresponding access to data (such as
internal operating procedures, loan level data, and current involvement
in subprime lending) that are not readily available to the public. In
addition, the Board has extensive experience monitoring and analyzing
HMDA data. The recent changes in HMDA reporting requirements will
increase the Board's ability to effectively monitor nonbank mortgage
lending subsidiaries of holding companies for lending abuses.
In contrast to the specific limits on the Board's examination
authority, its authority to enforce the federal consumer protection
laws against nonbank subsidiaries is somewhat less clear. The laws
themselves specify the institutions subject to enforcement by the
Board, but those institutions generally do not include nonbank
subsidiaries. The Board has concluded that it must defer enforcement
action at least where, as here, a statute specifically prescribes its
enforcement jurisdiction to cover only certain entities and
specifically grants enforcement authority for other entities to another
agency.
Conclusions:
Under a number of laws, federal agencies have taken action to protect
consumers from abusive lending practices. While FTC has taken a number
of significant enforcement actions to battle abuses in the industry,
its resources are finite and, as a law enforcement agency, it does not
routinely monitor or examine lenders, including the mortgage lending
subsidiaries of financial and bank holding companies.
Congress provided banking regulators with the authority to ensure
compliance with consumer protection laws by the institutions they
regulate, in part because it recognized the efficiencies of having
banking regulators monitor for compliance with these laws while
examining their institutions for safety and soundness. The Board is in
a position to help ensure compliance with federal consumer protection
laws by certain subsidiaries of financial and bank holding companies if
it were clearly authorized to do so. While concerns about predatory
lending extend well beyond the activities of the nonbank subsidiaries
of holding companies, these entities represent a significant portion of
the subprime mortgage market. Monitoring the mortgage lending
activities of the nonbank subsidiaries would help the Board determine
when it would be beneficial to conduct examinations of specific nonbank
subsidiaries. The Board could then refer its findings to DOJ, HUD, or
FTC or take its own enforcement action if a problem exists. Granting
the Board concurrent enforcement authority--with the FTC--for these
nonbank subsidiaries of holding companies would not diminish FTC's
authority under federal laws used to combat predatory lending.
The significant amount of subprime lending among holding company
subsidiaries, combined with recent large settlements in cases involving
allegations against such subsidiaries, suggests a need for additional
scrutiny and monitoring of these entities. The Board is in an optimal
position to play a larger role in such monitoring but does not have
clear legal authority and responsibility to do so for these entities
with regard to monitoring compliance of consumer protection laws.
Matters for Congressional Consideration:
To enable greater oversight of and potentially deter predatory lending
from occurring at certain nonbank lenders, Congress should consider
making appropriate statutory changes to grant the Board of Governors of
the Federal Reserve System the authority to routinely monitor and, as
necessary, examine the nonbank mortgage lending subsidiaries of
financial and bank holding companies for compliance with federal
consumer protection laws applicable to predatory lending practices.
Also, Congress should consider giving the Board specific authority to
initiate enforcement actions under those laws against these nonbank
mortgage lending subsidiaries.
Agency Comments and Our Evaluation:
GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
NCUA, OCC, OTS, and the Department of the Treasury for review and
comment. The agencies provided technical comments that have been
incorporated, as appropriate. In addition, the Board, DOJ, FDIC, FTC,
HUD, and NCUA provided general comments, which are discussed below. The
written comments of the Board, DOJ, HUD, and NCUA are printed in
appendixes II through V.
The Board commented that, while the existing structure has not been a
barrier to Federal Reserve oversight, the approach recommended in our
Matter for Congressional Consideration would likely be beneficial by
catching some abusive practices that might not be caught otherwise. The
Board also noted that the approach would pose tradeoffs, such as
different supervisory schemes being applied to nonbank mortgage lenders
based on whether or not they are part of a holding company. Because
nonbank mortgage lenders that are part of a financial or bank holding
company are already subject to being examined by the Board in some
circumstances, they are already subject to a different supervisory
scheme than other such lenders. For example, in its comments the Board
noted that it may on occasion direct an examination of a nonbank
lending subsidiary of a holding company when necessary in the context
of applications that raise serious fair lending or compliance issues.
Accordingly, we do not believe that clarifying jurisdiction as
contemplated in the Matter would result in a significant departure from
the current supervisory scheme for nonbank mortgage lenders. The Board
also noted that that there could be some additional cost to the nonbank
mortgage lending subsidiaries of financial or bank holding companies,
as well as to the Board, if the Board were to exercise additional
authority. We agree and believe that Congress should consider both the
potential costs as well as the benefits of clarifying the Board's
authorities.
The FTC expressed concern that our report could give the impression
that we are suggesting that Congress consider giving the Board sole
jurisdiction--rather than concurrent jurisdiction with FTC--over
nonbank subsidiaries of holding companies. Our report did not intend to
suggest that the Congress make any change that would necessarily affect
FTC's existing authority for these entities and we modified our report
to clarify this point. To illustrate the difference in regulatory and
enforcement approaches, our draft report contrasted the Board's routine
examination authority with the FTC's role as a law enforcement agency.
In its comments, FTC noted that it uses a number of tools to monitor
nonbank mortgage lenders, of which consumer complaints is only one. The
agency also commented that a key difference between the FTC and the
Board is that the Board has access to routine information to aid in its
oversight as part of the supervisory process. Our report did not intend
to suggest that the FTC's actions are based solely on consumer
complaints, and we revised the report to avoid this impression.
DOJ commented that the report will be helpful in assessing the
department's role in the federal government's efforts to develop
strategies to combat predatory lending. DOJ disagreed with our
inclusion in the report of "property or loan flips," which it
characterized as a traditional fraud scheme rather than an example of
predatory lending. As our report states, there is no precise definition
of predatory lending. We included a discussion of efforts to combat
"property flipping" because HUD officials told us that these schemes
sometimes involve predatory practices that can harm borrowers. As we
note in the report, while HUD categorizes property flipping as a
predatory lending practice, not all federal agencies concur with this
categorization. Distinct from property flipping is "loan flipping"--the
rapid and repeated refinancing of a loan without benefit to the
borrower. This practice is widely noted in literature and by federal,
state, industry, and nonprofit officials as constituting predatory
lending.
FDIC noted that our Matter for Congressional Consideration focuses on
nonbank subsidiaries of financial and bank holding companies even
though these entities comprise, according to HUD, only about 20 percent
of all subprime lenders. We acknowledge that our Matter does not
address all subprime lenders or institutions that may be engaging in
predatory lending, but believe it represents a step in addressing
predatory lending among a significant category of mortgage lenders.
NCUA said that the report provides a useful discussion of the issues
and that the agency concurs with our Matter for Congressional
Consideration. HUD, in its comment letter, described a variety of
actions it has taken that it characterized as combating predatory
lending, particularly with regard to FHA-insured loans.
[End of section]
Chapter 3: States Have Enacted and Enforced Laws to Address Predatory
Lending, but Some Laws Have Been Preempted:
In part because of concerns about the growth of predatory lending and
the limitations of existing state and federal laws, 25 states, the
District of Columbia, and 11 localities had passed their own laws
addressing predatory lending practices as of January 9, 2004.[Footnote
71] Most of the state laws restrict the terms or provisions of certain
high-cost loans, while others apply to a broader range of loans. In
addition, some states have taken measures to strengthen the regulation
and licensing of mortgage lenders and brokers, and some have used
existing state consumer protection and banking laws to take enforcement
actions related to abusive lending. However, regulators of federally
chartered financial institutions have issued opinions stating that
federal laws may preempt some state predatory lending laws and that
nationally chartered lending institutions should have to comply only
with a single uniform set of national standards. Many state officials
and consumer advocates have opposed federal preemption of state
predatory lending laws on the grounds that it interferes with the
states' ability to protect consumers.
States and Localities Have Addressed Predatory Lending through
Legislation, Regulation, and Enforcement Actions:
Since 1999, many states and localities have passed laws designed to
address abusive mortgage lending by restricting the terms or provisions
of certain loans. In addition, states have increased the registration
or licensing requirements of mortgage brokers and mortgage lenders and
have undertaken enforcement activities under existing consumer
protection laws and regulations to combat abusive lending.
A Growing Number of States and Localities Have Passed Laws to Address
Abusive Lending:
According to the database of state laws, as of January 9, 2004, 25
states and the District of Columbia had passed laws that were
specifically designed to address abusive lending practices.[Footnote
72] (See fig. 3.) These laws were motivated, at least in part, by
growing evidence of abusive lending and by concerns that existing laws
were not sufficient to protect consumers against abusive lending
practices.
Figure 3: States and Localities That Have Enacted Predatory Lending
Laws:
[See PDF for image]
[End of figure]
Based on our review of the database of state laws, the predatory
lending statutes in 20 of the 25 states regulate and restrict the terms
and characteristics of certain kinds of "high-cost" or "covered"
mortgage loans that exceed certain interest rate or fee
triggers.[Footnote 73] Some state laws, such as those in Florida, Ohio,
and Pennsylvania, use triggers that are identical to those in the
federal HOEPA statute but add provisions or requirements, such as
restrictions on refinancing a loan under certain conditions.[Footnote
74] Other state laws, such as those of Georgia, New Jersey and North
Carolina, use triggers that are lower than those in HOEPA and therefore
cover more loans than the federal legislation.[Footnote 75] Some states
design their triggers to vary depending on the amount of the loan. For
example, in New Mexico and North Carolina, covered loans greater than
$20,000 are considered high cost if the points and fees on the loan
exceed 5 percent of the total loan amount (North Carolina) or equal or
exceed it (New Mexico). In these states, loans for less than $20,000
are considered high cost if the points and fees exceed either 8 percent
of the total or $1,000.[Footnote 76] In the remaining 5 states, the
predatory lending laws apply to most mortgage loans; there is no
designation of loans as high cost. For example, West Virginia's law in
effect generally prohibits lenders from charging prepayment penalties
on any loans and restricts points and fees to either 5 or 6 percent,
depending on whether the loan includes a yield spread premium.[Footnote
77] Michigan's law prohibits the financing of single-premium credit
insurance into loans.[Footnote 78]
According to the database, common provisions in state laws are designed
to address the following:
* Lending without regard to the ability to repay. Restrictions on the
making of loans without regard to the borrower's ability to repay the
loan, sometimes referred to as asset-based lending.
* Prepayment penalties. Limitations on the amount of a prepayment
penalty, terms under which a penalty can be assessed, or both.
* Balloon payments. Prohibitions on loans with balloon payments or
restrictions on their timing.
* Negative amortization. Prohibitions on loans where regularly
scheduled payments do not cover the interest due.
* Loan flipping. Restrictions or prohibitions on the repeated
refinancing of certain loans within a short period of time if the
refinancing will not benefit the borrower.
* Credit counseling. Requirements that borrowers either receive or are
notified of the availability of loan counseling.
* Arbitration clauses. Restrictions on mandatory arbitration clauses,
which limit a borrower's right to seek redress in court. Some laws
prohibit mandatory arbitration clauses altogether, while others require
compliance with certain standards, such as those set by a nationally
recognized arbitration organization.
* Assignee liability. Provisions that expressly hold purchasers or
securitizers of loans liable for violations of the law committed by the
originator, under certain conditions. (See ch. 4 for more information
on assignee liability.):
In addition, according to the database we reviewed, 11 cities and
counties have passed laws of their own designed to address predatory
lending since 2000.[Footnote 79] Some local laws are similar to state
laws in that they define high-cost loans and restrict their provisions,
such as in Los Angeles, California. Other localities, such as Oakland,
California, have passed resolutions prohibiting lenders that engage in
predatory lending practices from doing business with the locality.
Some States Have Increased the Regulation of Lenders and Brokers and
Undertaken Enforcement Activities to Combat Predatory Lending:
In general, states have regulated mortgage lenders and brokers,
although to varying degrees. Some state officials told us that because
of concerns that unscrupulous mortgage lenders and brokers were not
adequately regulated and were responsible for lending abuses, some
states have increased their regulation or licensing requirements of
lenders and brokers. As part of their licensing requirements, states
sometimes require that these companies establish a bond to help
compensate victims of predatory lenders or brokers that go out of
business, and some states also require that individuals working for or
as mortgage lenders and brokers meet certain educational requirements.
Some states have also reorganized their agencies' operations to better
address abuses by lenders and brokers. For example, an official with
the Kansas Office of the State Banking Commissioner told us that in
1999 the Kansas legislature created the Division of Consumer and
Mortgage Lending, which provides additional staff for examination and
enforcement activities. Similarly, an official from the Idaho
Department of Finance told us that the state created the Consumer
Finance Bureau in 2000 to oversee and conduct routine examinations of
mortgage brokers and mortgage lenders.
State law enforcement agencies and banking regulators have also taken a
number of actions in recent years to enforce existing state consumer
protection and banking laws in cases involving predatory lending. For
example, an official from the Washington Department of Financial
Institutions reported that it has taken several enforcement actions in
recent years to address predatory lending. In one such action, a
California mortgage company that allegedly deceived borrowers and made
prohibited charges was ordered to return more than $700,000 to 120
Washington State borrowers. According to officials of the Conference of
State Bank Supervisors, states reported that in addressing predatory
lending they have usually relied on general state consumer protection
laws in areas such as fair lending, licensing, and unfair and deceptive
practices. In some states, consumer protection statutes do not apply to
financial institutions, so state banking regulators, rather than the
attorneys general, typically initiate enforcement activities. Because
allegations of predatory practices often involve lending activities in
multiple states, states have sometimes cooperated in investigating
alleged abuses and negotiating settlements. For example, in 2002 a
settlement of up to $484 million with Household Finance Corporation
resulted from a joint investigation begun by the attorneys general and
financial regulatory agencies of 19 states and the District of
Columbia. State agencies have also conducted investigations in
conjunction with the federal government.
Activities in North Carolina and Ohio Illustrate State Approaches to
Predatory Lending:
States have varied in their approaches to addressing predatory lending
issues. We reviewed legislative and enforcement activities related to
predatory lending in two states, North Carolina and Ohio, to illustrate
two different approaches.
Impact of North Carolina's Laws on High-Cost Loans and Licensing of
Brokers and Originators Remains Uncertain:
North Carolina has enacted two separate laws to address concerns about
predatory lending. In 1999, the legislature passed a law that attempted
to curb predatory lending by prohibiting specific lending practices and
restricting the terms of high-cost loans.[Footnote 80] In 2001, North
Carolina supplemented its predatory lending law by adopting legislation
that required the licensing of mortgage professionals (mortgage
lenders, brokers, and loan officers), defined a number of prohibited
activities related to the making of residential mortgages, and enhanced
the enforcement powers of the banking commissioner.[Footnote 81]
According to the North Carolina Commissioner of Banks, the North
Carolina laws applicable to predatory lending were the product of a
consensus of banks, mortgage bankers and brokers, nonprofit
organizations, and other stakeholders and were intended to address
lending abuses that were not prohibited by federal statutes and
regulations. Among other things, the 1999 legislation, known as the
North Carolina Anti-Predatory Lending Law, imposes limitations specific
to both "high-cost" loans and other "consumer home loans."[Footnote 82]
North Carolina's predatory lending law did not restrict initial
interest rates but instead focused on prohibiting specific lending
practices and restricting the terms of high-cost loans. In conjunction
with other North Carolina laws, the 1999 legislation contains four key
features. First, it bans prepayment penalties for all home loans with a
principal amount of $150,000 or less. Second, it prohibits loan
flipping--refinancings of consumer home loans that do not provide a
reasonable, net tangible benefit to the borrower. Third, it prohibits
the financing of single-premium credit life insurance. Finally, it sets
a number of restrictions on high-cost loans, including making loans
without regard to borrowers' ability to repay; financing points, fees,
and any other charges payable to third parties; or setting up loans
with balloon payments. Further, the law prohibits home improvement
contract loans under which the proceeds go directly to the contractor,
and requires that borrowers receive financial counseling prior to
closing.
Although the North Carolina predatory lending law governs the practices
of lenders and mortgage brokers, some groups questioned whether it
provided for effective enforcement. Specifically, concerns were focused
on the lack of state licensing and oversight of all segments of the
mortgage lending profession, including mortgage brokers and bankers.
Additionally, some critics asserted that the statute provided the state
banking commissioner with limited and uncertain authority to enforce
the predatory lending provisions. As a result, even before the
predatory lending legislation passed, stakeholders worked on a measure
to fill the gaps left by the state's predatory lending law.
North Carolina's second statute, the Mortgage Lending Act, was signed
into law on August 29, 2001. Prior to the act, some mortgage banking
firms and all mortgage brokerages domiciled in the state had been
required to register with the state's banking regulator, but individual
loan originators were not. The Mortgage Lending Act imposed licensing
requirements on all mortgage bankers and brokers, including individuals
who originate loans, and added continuing education and testing
requirements for mortgage loan officers. The provisions of the act mean
that individuals as well as firms are now subject to regulatory
discipline. According to the North Carolina Commissioner of Banks, the
act has been effective in reducing the number of abusive brokers and
individual loan originators. The commissioner noted that a large number
of applications for licenses have been denied because the applicants
did not meet basic requirements or did not pass the required background
check.
Studies on the impact of North Carolina's Anti-Predatory Lending Law
have offered conflicting conclusions. For example, one study found an
overall decline in subprime mortgages and concluded that any reductions
in predatory lending had been attained at the expense of many
legitimate loans.[Footnote 83] Some have pointed to this evidence as
suggesting that the law has reduced legitimate credit to those who most
need it. Another study found a reduction in subprime originations but
attributed the decline to a reduction in loans with abusive or
predatory terms.[Footnote 84] Consumer advocates and state officials
have cited this study as evidence that the law has worked as intended.
Our review of the five studies available on the impact of the North
Carolina predatory lending law suggested that data limitations and the
lack of an accepted definition of predatory lending make determining
the law's impact difficult. For example, information about borrowers'
risk profiles, the pricing and production costs of the loans, and the
lenders' and borrowers' behaviors was not available to the study
researchers. In addition, the extent to which any potential reductions
in predatory loans can be attributed to the Mortgage Lending Act as
opposed to the Anti-Predatory Lending Law is unclear. Additional
experience with the North Carolina laws may be needed in order to
properly assess them.
Ohio Has Preempted Local Laws and Taken Action to Regulate Mortgage
Brokers:
In February 2002, the Ohio legislature enacted a law with the purpose
of bringing Ohio law into conformance with HOEPA.[Footnote 85] Among
other things, the legislation preempted certain local predatory lending
ordinances. The law was passed in response to an ordinance enacted in
the city of Dayton, which was designed to fight predatory lending by
regulating mortgage loans originated in that city. Proponents of the
state law argued that regulating lenders is a state rather than
municipal function and that lending rules should be uniform throughout
the state. Some advocates argued that the state law prevents cities
from protecting their citizens from abusive lending practices.
The Ohio law imposes certain restrictions on high-cost loans as defined
by HOEPA. These include additional restrictions on credit life or
disability insurance beyond those imposed by HOEPA. The law also
prohibits the replacement or consolidation of a zero-interest rate or
other low-rate loan made by a governmental or nonprofit lender with a
high-cost loan within the first 10 years of the low-rate loan unless
the current holder of the loan consents in writing to the
refinancing.[Footnote 86] Because the purpose of this law was to bring
Ohio's law into conformance with HOEPA, the law applies only to loans
that qualify as mortgage loans subject to HOEPA. Thus, like predatory
lending laws in some other states, the Ohio law applies to relatively
few loans.
In May 2002, the Ohio legislature passed another piece of legislation,
designed in part to address abusive lending--the Ohio Mortgage Broker
Act--that imposed requirements on the state's mortgage brokers and loan
officers.[Footnote 87] Among other things, this law required state
examination, education, and licensing of loan officers, and prohibited
brokers from engaging in certain deceptive or fraudulent practices. It
also required that mortgage brokers and loan officers receive
continuing education and take prelicensing competency tests.
In the act adopting HOEPA standards, the Ohio legislature also
established a Predatory Lending Study Committee, which was charged with
investigating the impact of predatory lending practices on the citizens
and communities of Ohio.[Footnote 88] The study committee consisted of
15 members, including representatives from state agencies, consumer
groups, and the lending industry. The act required the committee to
submit a report to the governor and legislators by the end of June
2003. The committee reached consensus on two major issues. First, it
recommended that all appraisers in the state be licensed and subject to
criminal background checks, and second, it recommended increased
enforcement of the Ohio Mortgage Broker Act. The Division of Financial
Institutions, which is responsible for enforcing the Ohio Mortgage
Broker Act, has hired additional staff to ensure compliance with the
law. The report and recommendations have been forwarded to the governor
and the committee suggested that the Ohio General Assembly consider all
recommendations.
Other local ordinances have been passed in Ohio to address predatory
lending. One of these ordinances, passed in November 2002 by the Toledo
City Council to regulate mortgage lending practices, was challenged,
and its enforcement stayed, because of the state HOEPA law passed in
February 2002.[Footnote 89] One provision of that ordinance prohibited
making an abusive loan by "taking advantage of a borrower's physical or
mental infirmities, ignorance or inability to understand the terms of
the loan." This provision drew criticism from the mortgage industry,
which said the language was vague and difficult to comply with. For
example, one secondary market participant noted that it would be nearly
impossible to assess borrowers' mental capabilities for loans they did
not originate in the first place. Violating the law was made a criminal
offense, and convicted offenders could not receive city contracts or
conduct other business with the city.
Regulators Have Determined That Federal Law Preempts Some State
Predatory Lending Laws, but Views on Preemption Differ:
Significant debate has taken place as to the advantages and
disadvantages of state and local predatory lending laws. In several
cases, regulators of federally supervised financial institutions have
determined that federal laws preempt state predatory lending laws for
the institutions they regulate. In making these determinations, two
regulators--OCC and OTS--have cited federal law that provides for
uniform regulation of federally chartered institutions and have noted
the potential harm that state predatory lending laws can have on
legitimate lending. Representatives of the lending industry and some
researchers agree with the federal banking regulators, arguing that
restrictive state predatory lending laws may ultimately hurt many
borrowers by reducing the supply of lenders willing to make subprime
loans, creating undue legal risks for legitimate lenders, and
increasing the costs of underwriting mortgage loans. Moreover, industry
representatives have said that most predatory lending practices are
already illegal under federal and state civil and criminal laws and
that these laws should simply be more stringently enforced. In
contrast, many state officials and consumer advocates are opposed to
federal preemption of state predatory lending laws. They maintain that
federal laws related to predatory lending are insufficient, and thus
preemption interferes with their ability to protect consumers in their
states, particularly from any potential abuses by the subsidiaries of
federally chartered institutions.
OCC, OTS, and NCUA Have Determined That Federal Law Preempts Some State
Predatory Lending Laws:
Because both the federal and state governments have roles in chartering
and regulating financial institutions, questions can arise as to
whether a federal statute preempts particular state laws.[Footnote 90]
Affected parties may seek guidance from federal agencies requesting
their views on whether a particular federal statute preempts a
particular state law; in these instances, the agency may issue an
advisory opinion or order on the issue. Because the courts are
ultimately responsible for resolving conflicts between federal and
state laws, these advisory opinions and orders are subject to court
challenge and review. As of November 2003, one or more federal
regulators had determined that federal laws preempted the predatory
mortgage lending laws of the District of Columbia and five states--
Georgia, New Jersey, New Mexico, New York, and North Carolina. (See
table 1.):
Table 1: Preemption Determinations Issued by OCC, OTS, and NCUA Related
to Predatory Mortgage Lending Laws:
OCC: Georgia (2003); OTS: Georgia (2003); NCUA: Georgia (2002).
OTS: New York (2003); NCUA: New York (2000).
OTS: New Mexico (2003); NCUA: North Carolina (2002).
OTS: New Jersey (2003); NCUA: District of Columbia (2003).
Source: GAO.
[End of table]
Preemption of state law is rooted in the U.S. Constitution's Supremacy
Clause, which provides for the supremacy of federal law. Over the
years, the courts have developed a substantial body of precedent that
has guided the analysis of whether any particular federal law or
regulation overrides or preempts state law. The courts' analysis of
whether federal law preempts state law has fundamentally centered on
whether Congress intended for the federal law or regulation to override
state law, either from the face of the statute itself (express
preemption) or from the structure and purpose of the statute (implied
preemption.) In their preemption opinions, OCC, OTS, and NCUA have
cited a variety of legislation and legal precedents. Since 1996, OTS
has had regulations in place that describe its preemption of state
lending laws.[Footnote 91] In January 2004, OCC issued a rule amending
its regulations in a similar manner, clarifying what types of state
laws federal law preempts in the context of national bank
lending.[Footnote 92] OCC stated that it issued the rule in response to
the number and significance of the questions that have arisen with
respect to the preemption of state laws and to reduce uncertainty for
national banks that operate in multiple states. In its rulemaking, OCC
stated that it was seeking to provide more comprehensive standards
regarding the applicability of state laws to lending, deposit taking,
and other authorized activities of national banks. The regulations list
examples of the types of state statutes that are preempted (such as
laws regulating credit terms, interest rates, and disclosure
requirements) and examples of the types of state laws that would not be
preempted (such as laws pertaining to zoning, debt collection, and
taxation). When OCC first proposed these rules, one news article stated
that it "triggered a flood of letters and strong reactions from all
corners of the predatory lending debate." States and consumer groups
were critical of the proposal. In contrast, the Mortgage Bankers
Association of America and some large national banking companies wrote
comment letters in support of OCC's proposed rules.
Views Differ on the Implications of Federal Preemption of State
Predatory Lending Laws:
Federal banking regulators point out that preemption of states'
antipredatory lending laws applies only to institutions chartered by
the agency issuing the preemption order. For example, OTS's preemption
opinion served to preempt New Jersey's predatory lending statute for
federally chartered thrifts but did not affect the statute's
applicability to independent mortgage companies, national banks, and
state-chartered banks and thrifts. In preempting the New Jersey Home
Ownership Security Act of 2002, OTS's Chief Counsel noted that
requiring federally chartered thrifts to comply with a hodgepodge of
conflicting and overlapping state lending requirements would undermine
Congress's intent that federal savings institutions operate under a
single set of uniform laws and regulations that would facilitate
efficiency and effectiveness.[Footnote 93] Federal banking regulators
have said that they have found little to no evidence of predatory
lending by the institutions they regulate, pointing out that federally
supervised institutions are highly regulated and subject to
comprehensive supervision.[Footnote 94] They have also noted that they
have issued guidance and taken numerous other steps to ensure that
their institutions do not engage in predatory lending. Further, OCC has
stated that state predatory lending laws, rather than reducing
predatory lending among federally supervised institutions, can actually
restrict and inhibit legitimate lending activity. The lending industry
has generally supported preemption. For example, the Mortgage Bankers
Association of America has argued that uniformity in lending
regulations is central to an efficient and effective credit market.
In contrast, many state officials and consumer advocates have opposed
federal preemption of state predatory lending laws, for several
reasons. First, they contend that state predatory lending laws are
necessary to address gaps in relevant federal consumer protection laws.
For example, one state official said that the predatory lending
legislation adopted by his state was more focused and effective than
the provisions of the Federal Trade Commission Act. In addition,
opponents of preemption claim that federal regulators may not devote
the necessary resources or have the willingness to enforce federal
consumer protection laws relevant to predatory lending by federally
chartered institutions and their subsidiaries. In response to OCC's and
OTS's statements that there is no evidence of predatory lending among
subsidiaries of federally regulated depository institutions, opponents
of preemption noted that there are several cases in which allegations
of abusive lending practices involving some of these subsidiaries have
been raised.[Footnote 95]
[End of section]
Chapter 4: The Secondary Market May Play a Role in Both Facilitating
and Combating Predatory Lending:
By providing lenders with an additional source of liquidity, the
secondary market can benefit borrowers by increasing the availability
of credit and, in general, lowering interest rates. While a secondary
market for prime mortgage loans has existed for decades, a relatively
recent secondary market for subprime loans now offers these potential
benefits to subprime borrowers as well. However, the secondary market
may also serve to facilitate predatory lending, as it can provide a
source of funds for unscrupulous originators that quickly sell off
loans with predatory terms. Secondary market participants may use
varying degrees of due diligence to avoid purchasing loans with abusive
terms. In addition, some states have enacted legislation with assignee
liability--potentially holding purchasers liable for violations of
abusive lending laws that occurred in the loan origination. However,
extending liability to secondary market purchasers may cause lenders
and other secondary market participants, such as credit rating
agencies, to withdraw from the market, as occurred in Georgia.
The Development of a Secondary Market for Subprime Loans Can Benefit
Consumers:
Originators of mortgage loans--which can include banks, other
depository institutions, and mortgage lenders that are not depository
institutions--may keep the loans or sell them in the secondary market.
Secondary market purchasers may then hold the loans in their own
portfolio or may pool together a group of loans and issue a mortgage-
backed security that is backed by a pool of such loans. The
securitization of mortgage loans became common during the 1980s and, by
the 1990s, had become a major source of funding in the prime mortgage
market. According to the Office of Federal Housing Enterprise
Oversight, by the end of 2002 more than 58 percent of outstanding U.S.
single-family residential mortgage debt was financed through
securitization. Two government-sponsored enterprises--Fannie Mae and
Freddie Mac--represented nearly 40 percent of the amount
securitized.[Footnote 96]
The securitization of subprime mortgage loans did not become common
until the mid-1990s. The development of a secondary market for these
loans has been an important factor in the growth of subprime lending,
expanding subprime lenders' access to funds and thus increasing the
availability of subprime credit. The trade journal Inside B&C Lending
estimated that in 2002 approximately 63 percent of new subprime
mortgages, representing $134 billion, were securitized. The originators
of subprime loans are often nonbank mortgage and finance companies. As
secondary market participants--such as the Wall Street investment firms
that have been the major underwriters for subprime securities--have
grown more willing to purchase these instruments, subprime originators
have gained access to an important source of liquidity that has allowed
them to make more subprime loans.
As shown in figure 4, the process of securitization starts with
borrowers obtaining mortgages either directly from a lender or through
a broker. The lender then creates a pool--a separate legal entity that
purchases the mortgages and issues securities based on them. The lender
hires a credit rating agency, which has no direct financial interest in
the deal, to confirm the value of the securities based on the expected
return and risks of the underlying mortgages. At the same time, the
lender hires an underwriter to sell the securities to investors. The
value of the securities is based exclusively on the mortgages
themselves and is separate from the financial condition of the original
lender. Finally, a servicer is hired to collect mortgage payments from
the borrowers and disburse interest and principal payments to the
investors. The process described above is for securitizations performed
via private conduits--that is, without the participation of government-
sponsored enterprises.
Figure 4: Steps in the Securitization of Residential Mortgages:
[See PDF for image]
Note: This chart represents the process for fully private
securitizations and not for government-sponsored enterprises.
[End of figure]
Freddie Mac and Fannie Mae are relatively recent entrants into the
subprime market; Freddie Mac began purchasing subprime loans in 1997
and Fannie Mae in 1999. Both companies have moved slowly and have
limited their purchases to the segment of the subprime market with the
most creditworthy of subprime loans. At present, the companies are
believed to represent a relatively small portion of the overall
secondary market for subprime loans. The exact portion they represent
is not clear, but a study conducted for HUD estimated that the
companies purchased about 14 percent of the subprime loans originated
in 2002.[Footnote 97] Both Fannie Mae and Freddie Mac have stated
publicly that they plan on expanding their role in the subprime market
in the future. In part, this may be a result of the affordable housing
goals that HUD set for the GSEs in October 2000, which increased the
goals for loans made to low-and moderate-income borrowers.[Footnote 98]
HUD recommended that the GSEs consider enhancing their roles in the
subprime market--which often serves low-and moderate-income borrowers-
-to help standardize mortgage terms in that market and potentially
reduce interest rates for subprime borrowers. While the GSEs are
currently believed to represent a small portion of the secondary market
for subprime lending, some market observers believe their share will
grow.
The growth of the secondary market for subprime loans has potentially
benefited some consumers. By providing subprime lenders with a new
source of liquidity, these lenders face lower funding costs and reduced
interest rate risk, in part because the supply of lenders willing to
make loans to borrowers with impaired credit has increased. Many
analysts say that, as a result, mortgage loans are now available to a
whole new population of consumers and interest rates on subprime loans
made by reputable lenders have fallen. In addition, increased
securitization of subprime lending may lead to more uniform
underwriting of subprime loans, which could further reduce origination
costs and interest rates to consumers.
The Secondary Market for Subprime Loans Can Facilitate Predatory
Lending:
While the development of a secondary market for subprime loans may have
benefits for borrowers, it can also provide a source of funds for
unscrupulous originators that quickly sell off loans with predatory
terms. The secondary market can complicate efforts to eliminate
predatory lending by separating ownership of a loan from its
originator. This separation can undermine incentives to reduce risk in
lending and create incentives that may increase the attractiveness of
making loans with predatory terms. As noted earlier, some originators
of subprime mortgage loans make their profits from high origination
fees. The existence of a market that allows originating lenders to
quickly resell subprime loans may reduce the incentive these lenders
have to ensure that borrowers can repay. Further, lenders often market
their products through brokers that do not bear the risks associated
with default, as brokers are compensated in up-front fees for the loans
they help originate. Some lenders and state officials told us that
unscrupulous brokers sometimes deceive originating lenders regarding
borrowers' ability to repay. Even if deceived, lenders who originate
the loans and then sell them in the secondary market ultimately may not
bear the risk of a loan default. Taken together, these circumstances
can undermine efforts to combat predatory lending practices.
Market forces provide some incentives to deter secondary market
purchasers from purchasing predatory loans because these loans create
both credit and reputation risk.[Footnote 99] However, predatory loans
do not in all cases create unusual financial risks or losses for
secondary market purchasers. For example, in most states loan
purchasers are generally not liable for damages that may have resulted
from the origination of abusive loans that they purchased, mitigating
much of the legal risk of buying loans that may have violated laws
addressing predatory lending. Moreover, loans with predatory features
may carry very high interest rates and have barriers to prepayment,
which may more than compensate for the increased credit risks
associated with subprime loans.
However, investors' insistence on the use of credit enhancements in the
securitization process may offset or mitigate the incentives to engage
in predatory lending of originators who sell loans to the secondary
market. Credit enhancements, which refer to a variety of approaches
used to reduce the credit risk of an obligation, are common in
securitization transactions, in part because of concerns that
originators may try to pass on lower-quality loans. Because the price
investors will pay for securities is based on risk as well as return,
sellers use the enhancements to lower the risk and thus raise the price
of securities. For example, the securities may be overcollateralized by
ensuring that the value of the collateral backing the securities--in
the case of mortgage backed securities, the face value of the loans--
exceeds the value of the securities being offered for sale. The
difference provides a "cushion" or reserve against possible credit
losses and permits a higher loss rate on the total mortgage pool
without endangering payments to the owners of the securities.
Securitizers can also include recourse provisions in their loan
purchases that require sellers to take back loans in the event of
borrower default. As a result of these factors, the degree to which
originators of loans sold in the secondary market--including loans with
abusive terms--are insulated from credit risks associated with those
loans varies, and the profits from selling the loans may vary with the
costs of credit enhancement.
Due Diligence Can Help Purchasers Avoid Predatory Loans, but Efforts
Vary among Secondary Market Participants:
Secondary market purchasers of residential mortgage loans undertake a
process of due diligence designed to minimize legal, financial, and
reputation risk associated with the purchase of those loans. Due
diligence can play an important role in avoiding the purchase of
abusive loans, but cannot necessarily identify all potentially abusive
loans. Officials of Fannie Mae and Freddie Mac--which, as noted
previously, are relatively recent entrants in the subprime market--are
also concerned about risks but say that their due diligence processes
are also designed to avoid purchasing loans that may have been harmful
to consumers. Other firms' due diligence is not necessarily
specifically intended to avoid loans that may have harmed consumers but
rather to avoid purchasing loans that are not in compliance with
applicable law or that present undue financial or reputation
risks.[Footnote 100]
Due Diligence May Deter the Purchase of Some Predatory Loans but Has
Limitations:
Loans purchased in the secondary market are usually not purchased
individually but rather as a pool of many loans. Purchasers or
securitizers of residential mortgage loans try to ensure that the loans
in a particular pool are creditworthy and in compliance with law.
Purchasers perform a general background and financial review of the
institutions from which they purchase loans. In addition, secondary
market purchasers of loans nearly always conduct due diligence, or a
review and appraisal of confidential legal and financial information
related to the loans themselves. Before or after the sale, purchasers
may review electronic data containing information on the loans, such as
the loan amount, interest rate, and borrower's credit score. Purchasers
also may physically review a sample of individual loans, including
items such as the loan applications and settlement forms.
Some industry representatives and federal agencies say that appropriate
due diligence can play an important role in deterring predatory
lending. Participants in the secondary market have an interest in not
purchasing loans that may be considered predatory because such loans
can create unwarranted legal, financial, and reputation risk. For
example, if such loans violate relevant municipal, state, or federal
laws, purchasing them could, in some cases, expose the buyers to legal
risks such as lawsuits, fines, and penalties. Moreover, predatory loans
may be more likely to go into default, increasing financial risk
without a commensurate increase in expected returns. In addition, many
industry officials told us that reputation risk is a major reason why
they want to avoid purchasing predatory loans. Firms involved in the
securitization process do not want to be associated with predatory
lending activity that could affect their relationships with other
firms, community groups, and government agencies.
Due diligence reviews for residential mortgage loans are designed to
determine the financial characteristics of the loans and to ensure
compliance with applicable federal, state, and municipal laws,
including those designed to prohibit predatory lending. The reviews
also can be designed to detect loans that have potentially abusive
terms but are not necessarily violating any law. For example, an
electronic review of loan data can flag characteristics such as
interest rates that appear excessive but are nonetheless legal. A loan-
level file review, in which a purchaser reviews the physical loan
origination documents, offers access to more information and can
highlight items such as points and fees and the borrower's capacity to
repay. While nearly all purchasers of loans use due diligence to check
for legal compliance, purchasers set their own guidelines for what
other loan characteristics meet their standards.
While due diligence in the secondary market is important, the role that
it can play in deterring predatory lending by performing due diligence
is limited. For one thing, more than one-third of all new subprime
loans are not securitized in the first place but are held in the
portfolio of the originating lender and thus do not face securitizers'
due diligence reviews. In addition, even the most thorough due
diligence will not necessarily catch all abusive loans or abusive
lending practices. For example:
* Due diligence may not detect fraud in the underwriting or approving
of a mortgage. For instance, if a mortgage broker includes false
information in a loan application to ensure that a borrower meets an
originator's income requirements, the process of due diligence may not
detect it.[Footnote 101]
* The data tapes used for loan reviews do not include point and fee
information.[Footnote 102] Thus, securitizers typically cannot detect
excessive or unwarranted fees prior to purchasing a loan without a
loan-level review.
* Loan flipping (repeated refinancings) can be difficult to detect
because loan files do not necessarily include information on previous
refinancings.
Fannie Mae and Freddie Mac Appear to Perform Extensive Due Diligence to
Avoid Buying Loans with Abusive Terms:
Fannie Mae and Freddie Mac have relatively strict criteria for the
loans they purchase, particularly subprime loans. As noted, both
companies limit their purchases to the most creditworthy subprime
loans. In April 2000, Fannie Mae issued guidelines to sellers of
subprime loans that set criteria designed to help the GSE avoid
purchasing loans with abusive features. For example, the guidelines
state that Fannie Mae's approved lenders may not "steer" a borrower who
qualifies for a standard loan to a higher cost product, may not make
loans without regard to the borrower's ability to repay, and may not in
most instances charge more than 5 percent of the loan amount in points
and fees. Freddie Mac issued similar guidelines to its sellers and
servicers in December 2000. Further, both companies, like other
secondary market purchasers, rely on a system of representations and
warranties, under which sellers contractually agree to buy back loans
they sell that turn out not to meet the terms of the contract.
Fannie Mae and Freddie Mac officials told us that they undertake a
series of measures aimed at avoiding the purchase of loans with
predatory characteristics. Approved sellers and servicers undergo a
background check and operational review and assessment that seeks, in
part, to determine whether lenders are able to comply with their
guidelines. Fannie Mae and Freddie Mac also require that special steps,
such as additional due diligence measures, be taken in purchasing
subprime loans. For example, Fannie Mae requires that subprime loans be
originated using the company's automated desktop underwriting system,
which helps ensure that borrowers are not being steered to a more
expensive loan than they qualify for.[Footnote 103] Fannie Mae
officials say that the automated desktop underwriting system also
facilitates traditional lenders that serve subprime borrowers.
In addition, both companies said that they undertake extensive and
costly due diligence that goes well beyond simple legal compliance and
is aimed at avoiding loans that may potentially be considered abusive
or detrimental to the borrower. Both companies use an outside
contractor to conduct their loan-level due diligence reviews on
subprime loans. The contractor has a standard "script" that reviews a
large number of data elements related to legal compliance and
creditworthiness. However, the contractor told us that Fannie Mae and
Freddie Mac add elements to the script to make the review more
stringent with regard to identifying potentially abusive practices. For
example, Freddie Mac requires the contractor to check whether the
lender has gathered evidence of a borrower's income information
directly or relied on self-verification, which can raise uncertainty
about a borrower's capacity to repay. In addition, the contractor told
us that Fannie Mae and Freddie Mac are more likely than other firms to
reject or require a repurchase if evidence exists that the loan may
involve a predatory practice--even if the loan is otherwise legally
compliant.
Other Purchasers Vary in the Extent of Their Due Diligence:
According to industry representatives, all purchasers of mortgage loans
undertake a process of due diligence, but the process can vary in its
degree of stringency and comprehensiveness. For example, while most
firms typically pull a sample of loans for a loan-level file review,
companies may review anywhere between a few percent and 100 percent of
the loans. In addition, companies vary in terms of the data elements
they choose to review. Some firms review prior loans made to the
borrower in an effort to detect loan flipping, while others do not.
Further, some companies may be more willing than others to purchase
loans that are considered questionable in terms of legal compliance,
creditworthiness, or other factors.
As noted earlier, loans that have harmed consumers and that may be
deemed "predatory" by some observers are not necessarily against the
law, nor do they necessarily increase the risk of the loan.[Footnote
104] Industry officials told us that while securities firms are
concerned with the reputation risk that may come with purchasing
abusive loans, the primary function of their due diligence is to ensure
compliance with the law and to protect investors by ensuring that loans
are creditworthy.[Footnote 105]
Assignee Liability May Help Deter Predatory Lending but Can Also Have
Negative Unintended Consequences:
Some states have enacted predatory lending laws that have assignee
liability provisions under which purchasers of secondary market loans
may be liable for violations committed by the originators or subject to
a defense by the borrower against collecting the loan. Assignee
liability is intended to discourage secondary market participants from
purchasing loans that may have predatory features and to provide an
additional source of redress for victims of abusive lenders. However,
depending on the specific nature of the provision, assignee liability
may also have unintended consequences, including reducing access to or
increasing the cost of secondary market capital for legitimate loans.
For example, assignee liability provisions of a predatory lending law
in Georgia have been blamed for causing several participants in the
mortgage lending industry to withdraw from the market, and the
provisions were subsequently repealed.
Several States Hold Secondary Purchasers Liable for Predatory Lending
Violations:
Antipredatory lending laws in several states have included some form of
assignee liability. Typically, with assignee liability, little or no
distinction is made between the broker or lender originating a loan
that violates predatory lending provisions and the person who purchases
or securitizes the loans. Under these provisions, secondary market
participants that acquire loans may be liable for violations of the law
committed by the original lenders or brokers whether or not the
purchasers were aware of the violations at the time they bought the
loans. Further, borrowers can assert the same defenses to foreclosure
against both originating lenders and entities in the secondary market
that hold the loans (the assignees). Depending on the specific
provisions of the law, assignees may have to pay monetary damages to
aggrieved borrowers.
As of December 2003, at least nine states and the District of Columbia
had enacted predatory lending laws that expressly included assignee
liability provisions, though the nature of these provisions varies
greatly, according to the database of state and local legislation we
reviewed. Other states have passed predatory lending laws that do not
explicitly provide for assignee liability, but debate has occurred in
some of these states about whether assignee liability can be asserted
anyway under existing laws or legal principles. The federal HOEPA
statute includes an assignee liability provision, but, as noted in
chapter 2, only a limited number of subprime loans are covered under
HOEPA.
Assignee liability can take a variety of forms. For example, an
assignee can be held liable only in defensive claims (defense to
foreclosure actions and to claims regarding monies owed on a loan) or
can also be assessed for damages directly, including punitive
damages.[Footnote 106] Similarly, some laws include "safe harbor
provisions," under which assignee liability may not arise if the
assignee has taken certain measures to avoid obtaining a high-cost
loan. For example, under New Jersey law, no assignee liability arises
if the assignee demonstrates, by a preponderance of evidence, that a
person exercising reasonable due diligence could not determine that the
mortgage was a high-cost home loan.[Footnote 107] However, many
secondary market participants told us that the value of these safe
harbor provisions is limited, in part because of difficulties in
demonstrating compliance with safe harbor standards. For example, some
secondary market participants say that the New Jersey law does not
adequately define what constitutes "reasonable" due diligence.
Assignee Liability May Help Combat Predatory Lending but May Also
Hinder Legitimate Lending:
The issue of whether to include assignee liability provisions in state
and local predatory lending laws has been highly controversial, because
such provisions can potentially both confer benefits and cause
problems. Assignee liability has two possible primary benefits. First,
holding purchasers and securitizers of loans liable for abusive lending
violations provides them with an incentive not to purchase predatory
loans in the first place. If secondary market participants took greater
action--through policy decisions or stricter due diligence--to avoid
purchasing potentially abusive loans, originators of predatory loans
would likely see a steep decline in their access to secondary market
capital. Second, under some forms of assignee liability, consumers who
have been victimized by such lenders may have an additional source of
redress. In some cases, originators of abusive loans that have been
sold in the secondary market are insolvent or cannot be located,
leaving victims dependent on assignees for relief from foreclosure or
other redress.
However, assignee liability provisions may also have the serious if
unintended consequence of discouraging legitimate secondary market
activity. Secondary market participants say that because they do not
originate the loans they purchase, even the most stringent due
diligence process cannot ensure that all loans comply with applicable
law. In addition, some secondary market participants state that
assignee liability provisions require them to make subjective
determinations about whether the loans are in compliance with law, and
this ambiguity can create legal and financial risk. These factors,
industry participants say, can actually end up harming consumers by
raising the costs of ensuring compliance with the law and thus
increasing the cost of loans to borrowers. Further, if secondary market
participants are not willing to risk having to assume liability for
violations committed by originators, they may pull out of the market
altogether, reducing the availability and increasing the costs of
legitimate subprime credit. Finally, if states' predatory lending laws
have different terms and provisions regarding assignee
responsibilities, the secondary market as a whole could become less
efficient and liquid, further increasing rates on legitimate subprime
mortgages.
Credit rating agencies have been among the secondary market players
that have expressed concern about assignee liability provisions in
state predatory lending laws. When a residential mortgage-backed
security is created from a pool of loans, an independent credit rating
agency examines the security's underlying loans and assigns it with a
credit rating, which represents an opinion of its general
creditworthiness. Credit rating agencies need to monetize (measure) the
risk associated with the loans underlying a security in order to assign
a credit rating. Because assignee liability can create additional legal
and financial risks, the major credit rating agencies typically review
new predatory lending legislation to assess whether they will be able
to measure that risk adequately to rate securities backed by loans
covered under the law.
We talked with representatives of two major credit rating agencies,
firms that issue mortgage-backed securities, and the GSEs Fannie Mae
and Freddie Mac to better understand how specific assignee liability
provisions might affect their ability to conduct secondary market
transactions. In general, the representatives told us that the most
problematic assignee liability provisions for secondary market
participants are those with two characteristics:
* Ambiguous language. Credit rating agencies and other secondary market
players seek clear and objective descriptions of the loans covered by
the statutes and the specific actions or omissions that constitute a
violation. For example, some participants cited concerns about an
ordinance enacted in Toledo, Ohio, that prohibited taking advantage of
a borrower's "physical or mental infirmities" but did not define what
constituted such infirmities.[Footnote 108] Secondary market
participants noted that without objective criteria, there is no way to
ensure that an originator has complied adequately with the law.
* Punitive Damages. Under some assignee liability provisions, the
potential damages a borrower can receive are restricted to the value of
the loan, while other provisions allow for punitive damages, which are
not necessarily capped. Secondary market participants say that the
potential for punitive damages can make it very difficult to quantify
the risk associated with a security.
Georgia's Statute Illustrates Possible Effects of Assignee Liability
Provisions:
According to officials of industry and consumer advocacy organizations,
the Georgia Fair Lending Act, which became effective on October 1,
2002, was one of the strictest antipredatory lending laws in the
nation.[Footnote 109] It banned single-premium credit insurance and set
restrictions on late fees for all mortgage loans originated in the
state and, for a special category of "covered loans," prohibited
refinancing within 5 years after consummation of an existing home loan
unless the new loan provided a "tangible net benefit" to the borrower.
The act also created a category of "high-cost loans" that were subject
to certain restrictions, including limitations on prepayment penalties,
prohibitions on balloon payments, and prohibitions on loans that were
made without regard to the borrower's ability to repay.
The act also included fairly strict assignee liability. Secondary
market participants that purchased high-cost loans were liable for
violations of the law committed by the originator of the loans they
purchased, while purchasers of covered loans were subject to borrower
defenses and counterclaims based on violations of the act. The act also
expressly made mortgage brokers and loan servicers liable for
violations. Remedies available to borrowers included actual damages,
rescission of high-cost loans, attorney fees, and punitive damages.
Most of the violations were civil offenses, but knowing violations
constituted criminal offenses.
Shortly after the Georgia Fair Lending Act took effect, several
mortgage lenders announced that they would stop doing business in the
state due to the increased risk they would incur. In addition, several
secondary market participants stated their intention to cease doing
business in Georgia. In January 2003, the credit rating agency Standard
& Poor's announced it would stop rating mortgage-backed securities in
Georgia because of the uncertainty surrounding potential liability
under the act. Standard & Poor's decision extended to securitizations
of virtually all loans in the state, not just those of covered or high-
cost loans. The company said that because the act did not provide an
unambiguous definition of which loans were covered (and therefore
subject to assignee liability), it could not adequately assess the
potential risk to securitizers. In addition, the company said that it
was concerned about an antiflipping provision that did not adequately
define what constituted the "net tangible benefit" to borrowers that
certain refinancings had to provide. The two other major credit rating
agencies, Moody's and Fitch, also said that the law would limit their
ability to rate mortgage-backed securities in Georgia.
In response to these events, the Georgia legislature amended the
Georgia Fair Lending Act on March 7, 2003. The amendments eliminated
the category of "covered home loans" and the restrictions that had
existed for that category of loans. In addition, the amendments greatly
reduced the scope of assignee liability under the law, restricting such
liability to "high-cost" loans, and then only when the assignee is
unable to show that it has exercised reasonable due diligence to avoid
purchasing them. In addition, the amendments capped the amount of
damages an assignee can face and prohibited assignee liability in
class-action lawsuits. Once these amendments were passed, credit rating
agencies announced that they would once again rate securities backed by
mortgage loans originated in Georgia, and lenders said they would
continue to do business in the state. Advocates of the original Georgia
law argued that the legislature overreacted to actions by some members
of the lending industry, and many activists said that Standard & Poor's
and others had engaged in an orchestrated effort to roll back the
Georgia Fair Lending Act. Industry representatives said that the
response by lenders and others was a reasonable response to a statute
that created unacceptable risks of legal liability for lenders and
assignees.
Policymakers and industry representatives have frequently cited the
events in Georgia as a lesson in what can happen when secondary market
participants are held liable for violations by the original lender.
Industry representatives assert that assignee liability creates undue
risks to the secondary market, or makes assessing risks difficult, and
ultimately reduces borrowers' access to credit. In the case of Georgia,
however, it is unclear whether the problem was assignee liability
itself or the scope and characteristics of the specific assignee
liability provisions contained in the original law. Georgia's original
law created concern in large part because of perceived ambiguities in
defining which loans were subject to assignee liability and because
assignees' liability was subject to unlimited punitive damages. Not all
states with antipredatory lending statutes that include assignee
liability provisions have had lenders and credit agencies threaten to
withdraw from the market to the same extent, largely because these laws
generally cap an assignee's liability, create a safe harbor, or contain
less ambiguous language. The challenge to states that choose to impose
assignee liability is to craft provisions that may serve their purpose
of deterring predatory lending and providing redress to affected
borrowers without creating an undue adverse effect on the legitimate
lending market.
[End of section]
Chapter 5: The Usefulness of Consumer Education, Counseling, and
Disclosures in Deterring Predatory Lending May Be Limited:
A number of federal, state, nonprofit, and industry-sponsored
organizations offer consumer education initiatives designed to deter
predatory lending by, among other things, providing information about
predatory practices and working to improve consumers' overall financial
literacy. While consumer education efforts have been shown to have some
success in increasing consumers' financial literacy, the ability of
these efforts to deter predatory lending practices may be limited by
several factors, including the complexity of mortgage transactions and
the difficulty of reaching the target audience. Similarly, unreceptive
consumers and counselors' lack of access to relevant loan documents can
hamper the effectiveness of mortgage counseling efforts, while the
sheer volume of mortgage originations each year makes universal
counseling difficult. While efforts are under way to improve the
federally required disclosures associated with mortgage loans, their
potential success in deterring predatory lending is likewise hindered
by the complexity of mortgage transactions and by the lack of financial
sophistication among many borrowers who are the targets of predatory
lenders.
Many Consumer Education and Mortgage Counseling Efforts Exist, but
Several Factors Limit Their Potential to Deter Predatory Lending:
In response to widespread concern about low levels of financial
literacy among consumers, federal agencies such as FDIC, HUD, and OTS
have conducted and funded initiatives designed in part to raise
consumers' awareness of predatory lending practices. In addition, a
number of states, nonprofits, and trade organizations have undertaken
consumer education initiatives. Prepurchase mortgage counseling--which
can include a third party review of a prospective mortgage loan--may
also help borrowers avoid predatory loans, in part by alerting them to
the characteristics of predatory loans. In some circumstances, such
counseling is required. However, a variety of factors limit the
potential of these tools to deter predatory lending practices.
Some Federal Agencies Have Initiatives to Promote Awareness of
Predatory Lending:
A number of federal agencies and industry trade groups have advocated
financial education for consumers as a means of improving consumers'
financial literacy and addressing predatory lending. The Department of
the Treasury, as well as consumer and industry groups, have identified
the lack of financial literacy in the United States as a serious,
widespread problem.[Footnote 110] Studies have shown that many
Americans lack a basic knowledge and understanding of how to manage
money, use debt responsibly, and make wise financial
decisions.[Footnote 111] As a result, some federal agencies have
conducted or funded programs and initiatives that serve to educate and
inform consumers about personal financial matters. For example:
* FDIC sponsors MoneySmart, a financial literacy program for adults
with little or no banking experience and low to moderate incomes. FDIC
officials told us that the program, in effect, serves as one line of
defense against predatory lending. The MoneySmart curriculum addresses
such topics as bank services, credit, budgeting, saving, credit cards,
loans, and homeownership. MoneySmart is offered free to banks and
others interested in sponsoring financial education workshops.
* The Federal Reserve System's Community Affairs Offices issue media
releases and distribute consumer education publications to financial
institutions, community organizations, and to consumers directly. These
offices also have hosted conferences and forums on financial education
and predatory lending and have conducted direct outreach to communities
targeted by predatory lenders.
* OTS and NCUA have worked with community groups on financial literacy
issues and have disseminated financial education materials, including
literature on predatory lending issues, to their respective regulated
institutions.
* HUD has developed and distributed a brochure titled Don't Be a Victim
of Loan Fraud: Protect Yourself from Predatory Lenders, which seeks to
educate consumers who may be vulnerable to predatory lending,
especially the elderly, minorities, and low-income homeowners.
* Federal banking regulators give positive consideration in Community
Reinvestment Act performance reviews to institutions for providing
financial education to consumers in low-and moderate-income
communities.
* OCC issued an advisory letter in 2001 providing detailed guidance for
national banks, encouraging them to participate in financial literacy
initiatives and specifying a range of activities that banks can provide
to enhance their customers' financial skills, including support for
educational campaigns that help borrowers avoid abusive lending
situations.[Footnote 112]
* FTC and DOJ disseminate information designed to raise consumers'
awareness of predatory lending practices, particularly those involving
fraudulent acts. Brochures and other consumer materials are distributed
on the agencies' Web sites, as well as through conferences and
seminars, local consumer protection agencies, consumer credit
counselors, state offices, and schools. FTC has also supported public
service announcements on radio and television, including Spanish-
speaking media.
Some of these initiatives are general financial education programs that
do not specifically address predatory home mortgage lending, some
address predatory lending practices as one of a number of topics, and a
few focus specifically on predatory lending. Some of these initiatives
are directed to a general audience of consumers, while others are
directed toward low-income or other communities that are often the
targets of predatory lenders. A number of different media have been
used to deliver the messages, including print and online materials,
speeches and spot announcements, and materials for the hearing-and
visually impaired. In some cases, consumer financial education
materials have been produced in a variety of languages, including
Arabic, Chinese, Korean, and Spanish. Federal agencies' consumer
education campaigns typically take place in partnership with other
entities, including community and nonprofit groups and state and local
agencies.
Federal agencies have taken some actions to coordinate their efforts
related to educating consumers about predatory lending. For example, in
October 2003, the Interagency Task Force on Fair Lending, which
consists of 10 federal agencies, published a brochure that alerts
consumers to potential pitfalls of home equity loans, particularly
high-cost loans. The brochure Putting Your Home on the Loan Line is
Risky Business describes common predatory lending practices and makes
recommendations to help borrowers avoid them.
State Agencies, Nonprofits, and Industry Organizations Have Also
Initiated Consumer Education Efforts:
Some state agencies have also sponsored consumer education initiatives
that address predatory lending. For example, the Connecticut Department
of Banking offers an educational program in both English and Spanish
that partners with neighborhood assistance groups and others to promote
financial literacy and educate consumers on the state's antipredatory
lending statute. The Massachusetts Division of Banks maintains a toll-
free mortgage hotline to assist homeowners about potentially unethical
and unlawful lending practices. The hotline helps consumers determine
whether loan terms may be predatory and directs them to other sources
of information and assistance. The New York State Banking Department
distributes educational materials, including a video, that describe
predatory lending practices. The department has also conducted
educational outreach programs to community groups on the issue.
Nonprofits provide a significant portion of consumer financial
education on predatory lending, sometimes with support from federal,
state, or local agencies. These efforts include both general financial
literacy programs with a predatory lending component and initiatives
that focus specifically on predatory lending issues. For example, the
National Community Reinvestment Coalition, with funding support from
HUD, distributes a training module to help communities across the
country educate consumers about predatory lending.
Some industry trade organizations and companies also have consumer
education initiatives related to predatory lending:
* Freddie Mac has developed the CreditSmart program in partnership with
universities and colleges. CreditSmart is a curriculum on credit
education that is available online and has been used in academic
programs and in community workshops, seminars, and credit education
campaigns. Freddie Mac also helps fund and promote the "Don't Borrow
Trouble" campaign, a comprehensive public education campaign with
counseling services that is designed to help homeowners avoid falling
victim to predatory lenders. The campaign uses brochures, mailings,
posters, public service announcements, transit ads, and television
commercials. Its media toolkit and marketing consultant services have
been provided to the U.S. Conference of Mayors for use in local
communities.
* Fannie Mae supports financial literacy programs through its Fannie
Mae Foundation, which sponsors homeownership education programs that
focus on improving financial skills and literacy for adult students and
at-risk populations, such as new Americans and Native Americans. Fannie
Mae also offers a Web-based tool that allows home-buyers to compare
loan products and prices.
* The Jump$tart Program for Personal Financial Literacy, sponsored by a
coalition of corporations, industry associations--such as the Insurance
Education Foundation and the American Bankers Association Education
Foundation--and several government and nonprofit agencies, includes a
series of modules covering topics such as managing debt and shopping
for credit that are designed to improve the personal financial literacy
of young adults.
* The Mortgage Bankers Association of America, a trade association
representing mortgage companies and brokers and the real estate finance
industry, disseminates a package of information describing some common
warning signs of mortgage fraud and predatory lending, a consumer's
bill of rights, and appropriate contacts for consumers who believe they
have been victimized by predatory lenders.
* The National Association of Mortgage Brokers makes presentations to
first-time homebuyers to educate them on the mortgage process and
credit reports, among other topics.
* The American Financial Services Association's Education Foundation
develops educational materials designed to improve consumers' use of
credit and overall financial literacy.
Mortgage Counseling Can Warn Borrowers of Predatory Lending and Can
Offer a "Third Party" Review of Proposed Mortgage Loans:
Mortgage counseling can be part of general "homeownership counseling"
for new homeowners but may also be offered prior to a refinancing. It
gives borrowers an opportunity to receive personalized advice from a
disinterested third party about a proposed mortgage or other loan. In
addition to providing general advice about the mortgage process and
loan products, counselors typically review the terms of proposed loans
for potentially predatory characteristics. Studies evaluating the
impact of homeownership counseling have found that it helps homeowners
maintain ownership of their homes and avoid delinquencies, particularly
when the counseling is provided one on one.[Footnote 113] HUD supports
a network of approximately 1,700 approved counseling agencies across
the country. The agencies provide a wide variety of education and
counseling services, including homebuyer education and prepurchase
counseling. HUD makes grant funds available to some of these agencies,
and a portion of these funds has been earmarked exclusively for
counseling for victims of predatory lending.
A number of state antipredatory lending laws, such as those in New
Jersey and North Carolina, require some lenders to document that a
borrower has received counseling before taking out certain types of
high-cost loans. In a few cases, however, borrowers may waive their
right to receive such counseling. Several states, including Colorado,
New York, and Pennsylvania, require lenders to provide notice to
borrowers of certain loans that mortgage counseling is available and
encourage them to seek it.
A Variety of Factors May Limit the Effectiveness of Consumer Education
and Mortgage Counseling in Deterring Predatory Lending:
In testimony before Congress and elsewhere, representatives of the
Mortgage Bankers Association, the Consumer Mortgage Coalition, and
other industry organizations have promoted the view that educated
borrowers are more likely to shop around for beneficial loan terms and
avoid abusive lending practices. In searching the literature for
studies on the effectiveness of consumer financial education programs,
we found evidence that financial literacy programs may produce positive
changes in consumers' financial behavior.[Footnote 114] However, none
of the studies measured the effectiveness of consumer information
campaigns specifically on deterring predatory lending practices.
Limitations of Consumer Education:
The majority of federal officials and consumer advocates we contacted
said that while consumer education can be very useful, it is unlikely
to play a substantial role in reducing the incidence of predatory
lending practices, for several reasons:
* First, mortgage loans are complex financial transactions, and many
different factors--including the interest rate, fees, specific loan
terms, and borrower's situation--determine whether the loan is in a
borrower's best interests. Mortgage loans can involve dozens of
different documents that are written in highly technical language. Even
an excellent campaign of consumer education is unlikely to provide less
sophisticated consumers with enough information to properly assess
whether a proffered loan contains abusive terms.
* Second, abusive lenders and brokers may use high-pressure or "push
marketing" tactics--such as direct mail, telemarketing, and door-to-
door contacts--that are unfair, deceptive, or designed to confuse the
consumer. Broad-based campaigns to make consumers aware of predatory
lending may not be sufficient to prevent many consumers--particularly
those who may be uneducated or unsophisticated in financial matters--
from succumbing to aggressive sales tactics.
* Third, the consumers who are often the targets of predatory lenders
are also some of the hardest to reach with educational information.
Victims of predatory lending are often not highly educated or literate
and may not read or speak English. Further, they may lack access to
information conveyed through the Internet or traditional banking
sources, or they may have hearing or visual impairments or mobility
problems.
Limitations of Mortgage Counseling:
Consumer education campaigns have encouraged borrowers to seek
counseling before entering into a mortgage loan, particularly a
subprime refinancing loan. However, unreceptive consumers, lack of
access to loan documents, fraudulent lending practices, and the uneven
quality of counseling services can affect the success of these
counseling efforts. For instance, some consumers may simply not respond
to counseling. Officials at HUD have noted that not all first-time
homebuyers avail themselves of prepurchase counseling, and that some
consumers who do attend counseling sessions ignore the advice and
information given to them. Further, counselors may not have access to
loan documents containing the final terms of the mortgage loan.
Although lenders are required to provide a good-faith estimate of the
mortgage terms, they are not required to provide consumers with the
final and fixed terms and provisions of a mortgage loan until
closing.[Footnote 115] Moreover, predatory lenders have been known to
manipulate the terms of a mortgage loan (sometimes called "bait and
switch") so that the terms of the actual loan vary substantially from
that contained in the good faith estimate.
In addition, counseling may be ineffective against lenders and brokers
that engage in fraudulent practices, such as falsifying applications or
loan documents, that cannot be detected during a prepurchase review of
mortgage loan documents. Finally, the quality of mortgage counseling
can vary because of a number of factors. For example, one federal
official cited an instance of a mortgage company conducting only
cursory telephone counseling in order to comply with mandatory
counseling requirements.
Although some states have mandated counseling for certain types of
loans, serious practical barriers would exist to instituting mandatory
prepurchase mortgage counseling nationally. HUD officials have noted
that instituting a mandatory counseling program for most regular
mortgage transactions nationwide would be an enormous and difficult
undertaking that might not be cost-effective. Lenders originated about
10 million mortgage loans in 2002 in the United States. The cost of
providing counseling for all or many of these loans would be high, and
it is unclear who would or should be responsible for paying it. In
addition, there is a need for trained, qualified counselors, according
to federal officials and representatives of consumer and advocacy
groups, and currently no system exists for effectively training large
numbers of counselors while maintaining quality control.
HUD requires counseling for its reverse mortgages. These mortgages
allow homeowners to access the equity in their home through a lender,
who makes payments to the owner.[Footnote 116] Borrowers who receive a
home equity conversion mortgage insured through FHA must attend a
consumer information session given by a HUD-approved housing counselor.
Mandatory counseling for reverse mortgages may be reasonable because
these products are complex and subject to abuse. However, reverse
mortgages are also relatively uncommon; only approximately 17,610 HUD-
insured reverse mortgages were originated in fiscal year 2003.
Disclosures, Even If Improved, May Be of Limited Use in Deterring
Predatory Lending:
Federally mandated mortgage disclosures, while helpful to some
borrowers, may be of limited usefulness in reducing the incidence of
predatory lending practices. TILA and RESPA have requirements
concerning the content, form, and timing of information that must be
disclosed to borrowers. The goal of these laws is to ensure that
consumers obtain timely and standardized information about the terms
and cost of their loans. Federal agencies, advocacy groups, and the
mortgage industry have said that mortgage disclosures are an important
source of information for borrowers, providing key information on loan
terms and conditions and enabling borrowers to compare mortgage loan
products and costs. Representatives of the lending industry in
particular have said that disclosures can play an important role in
fighting predatory lending, noting that clear, understandable, and
uniform disclosures allow borrowers to understand the terms of their
mortgage loans and thus make more informed choices when shopping for a
loan.
However, industry and advocacy groups have publicly expressed
dissatisfaction with the current scheme of disclosures as mandated by
TILA and RESPA. A 1998 report by the Board and HUD concluded that
consumers cannot easily understand current disclosures, that
disclosures are often provided too late in the lending process to be
meaningful, that the information in disclosures may differ
significantly from the actual final loan terms, and that the
protections and remedies for violations of disclosure rules are
inadequate.[Footnote 117]
Improving the disclosure of pertinent information has been part of
efforts under way over the last few years to streamline and improve the
real estate settlement process. HUD issued proposed rules in July 2002
to simplify and improve the process of obtaining home mortgages and
reduce settlement costs for consumers. HUD stated that the proposed
changes to its RESPA regulations would, among other things, "make the
good faith estimate [settlement cost disclosure] firmer and more
usable, facilitate shopping for mortgages, make mortgage transactions
more transparent, and prevent unexpected charges to consumers at
settlement."[Footnote 118] Debate over the proposed rules, which as of
December 2003 were still under review, has been contentious. Industry
groups claim that the proposal would help fight predatory lending by
helping consumers understand loan costs up front and thus enable
consumers to compare products, or comparison shop. Several advocacy
organizations and an industry group say the proposed rules would still
allow unscrupulous mortgage originators to hide illegal or unjustified
fees.
Although streamlining and improving mortgage loan disclosures could
help some borrowers better understand the costs and terms of their
loans, such efforts may play only a limited role in decreasing the
incidence of predatory lending practices. As noted above, mortgage
loans are inherently complex, and assessing their terms requires
knowing and understanding many variables, including interest rates,
points, fees, and prepayment penalties. Brokers and lenders that engage
in abusive practices may target vulnerable individuals who are not
financially sophisticated and are therefore more susceptible to being
deceived or defrauded into entering into a loan that is clearly not in
their interests. Even a relatively clear and transparent system of
disclosures may be of limited use to borrowers who lack sophistication
about financial matters, are not highly educated, or suffer physical or
mental infirmities. Moreover, as with prepurchase counseling, revised
disclosure requirements would not necessarily help protect consumers
against lenders and brokers that engage in outright fraud or that
mislead borrowers about the terms of a loan in the disclosure documents
themselves.
[End of section]
Chapter 6: Elderly Consumers May Be Targeted for Predatory Lending:
Although little data is available on the incidence of predatory lending
among the elderly, government officials and consumer advocacy
organizations have reported consistent observational evidence that
elderly consumers have been disproportionately victimized by predatory
lenders.[Footnote 119]Abusive lenders are likely to target older
consumers for a number of reasons, including the fact that older
homeowners are more likely to have substantial equity in their homes
and may be more likely to have diminished cognitive function or
physical impairments that an unscrupulous lender may try to exploit.
Most educational material and legal activity related to predatory
lending targets the general population rather than elderly borrowers in
particular. Some federal agencies and nonprofit organizations provide
consumer education materials on predatory lending that specifically
target the elderly.
A Number of Factors Make Elderly Consumers Targets of Predatory
Lenders:
Nearly all federal, state, and consumer advocacy officials with whom we
spoke offered consistent observational and anecdotal information that
elderly consumers have disproportionately been victims of predatory
lending. Little hard data exist on the ages of victims of predatory
lending or on the proportion of victims who are elderly. Nonetheless,
several factors explain why unscrupulous lenders may target older
consumers and why some elderly homeowners may be more vulnerable to
abusive lenders, including higher home equity, a greater need for cash
to supplement limited incomes, and a greater likelihood of physical
impairments, diminished cognitive abilities, and social isolation.
On average, older homeowners have more equity in their homes than
younger homeowners, and abusive lenders could be expected to target
consumers who have substantial home equity.[Footnote 120] By targeting
these owners, unscrupulous lenders are more easily able to "strip" the
equity from a borrower's home by including unjustified and excessive
fees into the cost of the home equity loan.[Footnote 121] Federal
officials and consumer groups say that abusive lenders often try to
convince elderly borrowers to repeatedly refinance their loans, adding
more costs each time. "Flipping" loans in this way can over time
literally wipe out owners' equity in their homes.
In addition, some brokers and lenders aggressively market home equity
loans as a source of cash, particularly for older homeowners who have
limited cash flows and can use money from a home equity loan for major
home repairs or medical expenses. In the overall marketplace it is
common, and can be advantageous, to tap into one's home equity when
refinancing. However, unscrupulous brokers and lenders can take
advantage of an elderly person's need for cash to steer borrowers to
loans with highly unfavorable terms.
Further, diseases and physical impairments associated with aging can
make elderly borrowers more susceptible to abusive lending. For
example, declining vision, hearing, or mobility can restrict elderly
consumers' ability to access financial information and compare credit
terms. In such situations potential borrowers may be susceptible to the
first lender to offer what seems to be a good deal, especially if the
lender is willing to visit them at home or provide transportation to
the closing. Physical impairments like poor hearing and vision can also
make it difficult for older borrowers to fully understand loan
documents and disclosures.
Similarly, while many older persons enjoy excellent mental and
cognitive capacity, others experience the diminished cognitive capacity
and judgment that sometimes occurs with advanced age. Age-related
dementias or mental impairments can limit the capacity of some older
persons to comprehend and make informed judgments on financial issues,
according to an expert in behavioral medicine at the National Institute
on Aging. Furthermore, a report sponsored by the National Academy of
Sciences on the mistreatment of elderly persons reported that they may
be more likely to have conditions or disabilities that make them easy
targets for financial abuse and they may have diminished capacity to
evaluate proposed courses of action. The report noted that these
impairments can make older persons more vulnerable to financial abuse
and exploitation.[Footnote 122] Representatives of legal aid
organizations have said that they frequently represent elderly clients
in predatory lending cases involving lenders that have taken advantage
of a borrower's confusion and, in some cases, dementia.
Finally, both the National Academy of Sciences report and
representatives of advocacy groups we spoke with noted that elderly
people--particularly those who live alone--may feel isolated and
lonely, and may lack support systems of family and friends who could
provide them with advice and assistance in obtaining credit. Such
individuals may simply be more willing to discuss an offer for a home
equity loan made by someone who telephones or knocks on their door,
makes personal contact, or makes an effort to gain their confidence.
These personalized marketing techniques are common among lenders and
brokers that target vulnerable individuals for loans with abusive
terms.
Federal officials, legal aid services, and consumer groups have
reported that home repair scams targeting elderly homeowners are
particularly common. Elderly homeowners often live in older homes and
are more likely to need someone to do repairs for them. The HUD-
Treasury report noted that predatory brokers and home improvement
contractors have collaborated to swindle older consumers. A contractor
may come to a homeowner's door, pressure the homeowner into accepting a
home improvement contract, and arrange for financing of the work with a
high-cost loan. The contractor then does shoddy work or does not finish
the agreed-on repairs, leaving the borrower to pay off the expensive
loan.
The result of lending abuses, such as losing a home through
foreclosure, can be especially severe for the elderly. The National
Academy of Sciences report noted that losing financial assets
accumulated over a lifetime can be devastating to an elderly person,
and that replacing them is generally not viable for those who are
retired or have physical or mental disabilities. The financial losses
older people can suffer as a result of abusive loans can result in the
loss of independence and security and a significant decline in quality
of life. Moreover, older victims of financial exploitation may be more
likely to become dependent on social welfare services because they lack
the funds to help compensate them for their financial losses.
Elderly consumers represent just one of several classes of people that
predatory lenders appear to target. The HUD-Treasury task force report
noted that many predatory lenders also specifically target minority
communities. Consumer advocacy and legal aid organizations have
reported that elderly African American women appear to be a particular
target for predatory lenders. This population may be targeted by
predatory lenders at least in part because of their relatively low
literacy levels--the result of historical inequalities in educational
opportunities--which, as discussed earlier, may increase vulnerability
to abusive lending.[Footnote 123]
Some Education and Enforcement Efforts Focus on Elderly Consumers:
Because elderly people appear to be more susceptible to predatory
lending, government agencies and consumer advocacy organizations have
focused some educational efforts and legal assistance on this
population. Several booklets, pamphlets, and seminars are aimed at
helping inform elderly borrowers about predatory lending. In addition,
while most legal activities related to predatory lending practices are
designed to assist the general population of consumers, some have
focused on elderly consumers in particular.
Federal and Nonprofit Agencies Sponsor Some Financial Education Efforts
Targeted at Older Consumers:
Consumer financial education efforts of government and nonprofit
agencies and industry associations generally seek to serve the general
consumer population rather than target specific subpopulations.
However, some federal and nonprofit agencies have made efforts to
increase awareness about predatory lending specifically among older
consumers. For example:
* DOJ has published a guide entitled Financial Crimes Against the
Elderly, which includes references to predatory lending. In 2000, the
agency cosponsored a symposium that addressed, among other topics,
financial exploitation of the elderly.
* OTS has produced an educational training video addressing financial
abuse of the elderly.
* The U.S. Department of Health and Human Services' Administration on
Aging provides grants to state and nonprofit agencies for programs
aimed at preventing elder abuse, including predatory or abusive lending
practices against older consumers. Supported activities include senior
legal aid programs, projects to improve financial literacy among older
consumers, and financial educational materials directed at senior
citizens.
* FTC publishes a number of consumer information products related to
predatory lending and home equity scams that discuss abusive practices
targeted at the elderly.
* AARP, which represents more than 35 million Americans age 50 and
over, offers a borrowers' kit containing consumer tips for avoiding
predatory lenders, supports a toll-free number to call for assistance
regarding lending issues, and distributes fact sheets on predatory
lending. Some of these materials are provided in Spanish and in formats
accessible to the hearing-and visually impaired. AARP also provides
information on its Web site that is designed to educate older Americans
on predatory lending issues. In addition, the organization has
conducted focus groups of older Americans to gather data on their
borrowing and shopping habits in order to better develop strategies for
preventing older people from becoming the victims of predatory lending.
* The National Consumer Law Center has developed a number of consumer
materials aimed in part at helping elderly consumers recover from
abusive loans, including a brochure titled Helping Elderly Homeowners
Victimized by Predatory Mortgage Loans.
Some Legal Assistance Is Aimed Specifically at Helping Older Victims of
Predatory Lending:
Federal consumer protection and fair lending laws that have been used
to address predatory lending do not generally have provisions specific
to elderly persons. For example, age is not a protected class under the
Fair Housing Act, which prohibits discrimination in housing-related
transactions. In addition, HMDA--which requires certain financial
institutions to collect, report, and disclose data on loan applications
and originations--does not require lenders to report information about
the age of the applicant or borrower. However, ECOA does specifically
prohibit unlawful discrimination on the basis of age in connection with
any aspect of a credit transaction. In the case against Long Beach
Mortgage Company noted earlier, the lender was accused of violating
ECOA by charging elderly borrowers, among other protected classes,
higher loan rates than it charged other similarly situated borrowers.
Federal and state enforcement actions and private class-action lawsuits
involving predatory lending generally seek to provide redress to large
groups of consumers. Little hard data exist on the age of consumers
involved in these actions, but a few cases have involved allegations of
predatory lending targeting elderly borrowers. For example, FTC, six
states, AARP, and private plaintiffs settled a case with First Alliance
Mortgage Company in March 2002 for more than $60 million. According to
AARP, an estimated 28 percent of the 8,712 borrowers represented in the
class-action suit were elderly. The company was accused of using
misrepresentation and unfair and deceptive practices to lure senior
citizens and those with poor credit histories into entering into
abusive loans. The company used a sophisticated campaign of
telemarketing and direct mail solicitations, as well as a lengthy sales
presentation that FTC said was designed to mislead consumers in general
and elderly consumers in particular about the terms of its loans.
Some nonprofit groups provide legal services focused on helping elderly
victims of predatory lending:
* The AARP Foundation Litigation, which conducts litigation to benefit
Americans 50 years and older, has been party to 7 lawsuits since 1998
involving allegations of predatory lending against more than 50,000
elderly borrowers. Six of these suits have been settled, and the other
is pending.
* The National Consumer Law Center has a "Seniors Initiative" that
seeks to improve the quality and accessibility of legal assistance with
consumer issues for vulnerable older Americans. One focus of the
initiative is preventing abusive lending and foreclosure. The center
publishes a guide for legal advocates to help them pursue predatory
lending cases, and has been involved in litigation related to cases of
predatory lending against senior citizens.
* Some local legal aid organizations that help victims of predatory
lending have traditionally served older clients. For example, the
majority of clients assisted by South Brooklyn Legal Services'
Foreclosure Prevention Project are senior citizens.
The limited number of education and enforcement efforts related to
predatory lending that specifically target older consumers--as opposed
to the general population--is not necessarily problematic. Given
limited resources, the most efficient and effective way to reach
various subpopulations, including the elderly, is often through general
education and information campaigns that reach broad audiences.
Similarly, enforcement actions and private lawsuits that seek to curb
the activities of the worst predatory lenders in general are likely to
aid the elderly borrowers that these lenders may be targeting.
[End of section]
Appendixes:
Appendix I: FTC Enforcement Actions Related to Predatory Lending:
Primary defendant: Capital City Mortgage Corporation[B];
Date of settlement[A]: (litigation ongoing);
Federal laws cited: FTC Act, TILA, ECOA, Fair Debt Collection
Practices Act;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to manipulate borrowers into loans, ECOA
recordkeeping and notice violations, unfair and deceptive loan
servicing violations.
Primary defendant: OSI Financial Services, Inc., and Mark Diamond[C];
Date of settlement[A]: November 2003;
Federal laws cited: FTC Act;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to charge excessive loan fees.
Primary defendant: First Alliance Mortgage Company[D];
Date of settlement[A]: March 2002;
Federal laws cited: FTC Act, TILA;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to charge excessive loan fees.
Primary defendant: Associates First Capital Corporation, Associates
Corporation of North America, Citigroup Inc., and CitiFinancial Credit
Company;
Date of settlement[A]: September 2002;
Federal laws cited: FTC Act, TILA, ECOA, FCRA;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to manipulate borrowers into loans, packing
undisclosed products (insurance) into loans, unfair debt collection.
Primary defendant: Mercantile Mortgage Company, Inc.[E];
Date of settlement[A]: July 2002;
Federal laws cited: FTC Act, TILA, HOEPA, RESPA, Credit Practices
Rule;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to manipulate borrowers into loans, illegal
kickbacks, HOEPA disclosure violations, taking unlawful security
interests.
Primary defendant: Action Loan Company, Inc.[F];
Date of settlement[A]: August 2000;
Federal laws cited: FTC Act, TILA, RESPA, Credit Practices Rule, ECOA,
FCRA;
Alleged unfair or deceptive practices: Packing undisclosed products
(insurance) into loans, kickbacks for the referral of loans, ECOA
violation for failing to meet requirements upon adverse actions,
taking unlawful security interest.
Primary defendant: FirstPlus Financial Group, Inc.;
Date of settlement[A]: August 2000;
Federal laws cited: FTC Act, TILA;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to manipulate borrowers into home equity loans, TILA
disclosure violations.
Primary defendant: Nu West, Inc.;
Date of settlement[A]: July 2000;
Federal laws cited: FTC Act, TILA, HOEPA;
Alleged unfair or deceptive practices: HOEPA disclosure violations,
right of rescission violations.
Primary defendant: Delta Funding Corporation and Delta Financial
Corporation[G];
Date of settlement[A]: March 2000;
Federal laws cited: HOEPA, RESPA, ECOA, Fair Housing Act;
Alleged unfair or deceptive practices: Pattern or practice of asset-
based lending and other HOEPA violations, paying kickbacks and
unearned fees to brokers, intentionally charging African American
females higher loan prices than similarly situated white males.
Primary defendant: Fleet Finance, Inc. and Home Equity USA, Inc.;
Date of settlement[A]: October 1999;
Federal laws cited: FTC Act, TILA;
Alleged unfair or deceptive practices: Failure to provide, or provide
accurately, (1) timely disclosures of the costs and terms of home
equity loans and/or (2) information to consumers about their rights to
cancel their credit transactions.
Primary defendant: Barry Cooper Properties;
Date of settlement[A]: July 1999;
Federal laws cited: FTC Act, HOEPA;
Alleged unfair or deceptive practices: Pattern or practice of asset-
based lending and other HOEPA violations.
Primary defendant: Capitol Mortgage Corporation;
Date of settlement[A]: July 1999;
Federal laws cited: FTC Act, TILA, HOEPA;
Alleged unfair or deceptive practices: HOEPA disclosure violations,
right of rescission violations.
Primary defendant: CLS Financial Services, Inc.;
Date of settlement[A]: July 1999;
Federal laws cited: FTC Act, HOEPA;
Alleged unfair or deceptive practices: Pattern or practice of asset-
based lending and other HOEPA violations.
Primary defendant: Granite Mortgage, LLC and others;
Date of settlement[A]: July 1999;
Federal laws cited: FTC Act, TILA, HOEPA;
Alleged unfair or deceptive practices: Pattern or practice of asset-
based lending and other HOEPA violations.
Primary defendant: Interstate Resource Corporation;
Date of settlement[A]: July 1999;
Federal laws cited: FTC Act, HOEPA;
Alleged unfair or deceptive practices: HOEPA disclosure violations.
Primary defendant: LAP Financial Services, Inc.;
Date of settlement[A]: July 1999;
Federal laws cited: FTC Act, TILA, HOEPA;
Alleged unfair or deceptive practices: Pattern or practice of asset-
based lending and other HOEPA violations, right of rescission
violations.
Primary defendant: Wasatch Credit Corporation;
Date of settlement[A]: July 1999;
Federal laws cited: FTC Act, TILA, HOEPA;
Alleged unfair or deceptive practices: Pattern or practice of asset-
based lending and other HOEPA violations, right of rescission
violations.
Primary defendant: R.A. Walker and Associates;
Date of settlement[A]: July 1991;
Federal laws cited: FTC Act;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to convince borrowers to transfer title to
defendant.
Primary defendant: Nationwide Mortgage Corporation;
Date of settlement[A]: May 1988;
Federal laws cited: FTC Act, TILA;
Alleged unfair or deceptive practices: Using deception/
misrepresentation to manipulate borrowers into unaffordable loans with
balloon payments.
Source: FTC.
Note: In addition to the cases listed, FTC has also recently addressed
abuses in the mortgage loan servicing industry. In November 2003, it
announced settlements with Fairbanks Capital Holding Corp., its wholly
owned subsidiary Fairbanks Capital Corp., and their founder and former
CEO (collectively, Fairbanks) on charges that Fairbanks violated the
FTC Act, RESPA, and other laws by failing to post consumers' mortgage
payments in a timely manner and charging consumers illegal late fees
and other unauthorized fees. The settlement will provide for $40
million in redress to consumers. The case was jointly filed with HUD.
United States of America v. Fairbanks Capital Corp. et al., Civ. Action
No. 03-12219-DPW (D. Mass.)(filed 11/12/03).
[A] In some cases, the date of settlement listed is the date of the
press release announcing the settlement.
[B] DOJ filed an amicus curiae brief in a private suit alleging
discrimination in violation of the ECOA and Fair Housing Act, which was
joined with the FTC case, but settled separately.
[C] The state of Illinois was also a plaintiff in this case.
[D] The states of Arizona, California, Massachusetts, Florida, New
York, Illinois, AARP, and private attorneys were also plaintiffs in
this case.
[E] HUD and the state of Illinois were also plaintiffs in this case.
Violations of Illinois state law were also claimed.
[F] HUD was also a plaintiff in this case, and DOJ formally filed the
complaint on behalf of FTC and HUD.
[G] DOJ and HUD were also plaintiffs in this case.
[End of table]
[End of section]
Appendix II: Comments from the Board of Governors of the Federal
Reserve System:
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM:
WASHINGTON, D. C. 20551:
EDWARD M. GRAMLICH:
MEMBER OF THE BOARD:
January 16, 2004:
Mr. David G. Wood:
Director, Financial Markets and Community Investment:
General Accounting Office:
Washington, DC 20548:
Dear Mr. Wood:
This is in response to your request for the Federal Reserve Board's
comments on the draft GAO report entitled Consumer Protection: Federal
and State Agencies Face Challenges in Combating Predatory Lending.
Predatory mortgage lending has been an important issue of concern to
federal and state regulators, consumer advocates, members of Congress
and others. [NOTE 1] The increase in responsible subprime lending in
recent years has generally benefited consumers by making credit
available to borrowers who may not have otherwise qualified for loans.
But as the draft report notes, it is widely accepted that predatory
lending occurs most often in connection with subprime loans albeit in
a small portion of that market.
As the report notes, there is no precise definition of predatory
lending in any federal statute. The term in common parlance, however,
is generally used to describe cases in which a broker or lender takes
unfair advantage of a borrower, often through deception
or fraud to make a loan that is not in the borrower's interest. As the
report explains, while there are no Federal statutes that specifically
define and address "predatory" lending, a number of consumer protection
statutes address various practices that occur in abusive lending.
The draft report contains a number of findings and a recommendation to
Congress that focuses on enforcement of these existing Federal consumer
protection statutes. To enable greater oversight of, and potentially
deter predatory lending at, certain nonbank lenders, the report
recommends that the Congress consider making certain statutory changes.
The changes would grant the Board the clear authority to routinely
monitor and, as necessary, examine the nonbank mortgage lending
subsidiaries of bank and financial holding companies for compliance
with federal consumer protection laws that may relate to predatory
lending practices. Further, the draft report recommends that Congress
consider giving the Board specific authority to undertake enforcement
actions under those laws against nonbank mortgage lending subsidiaries
of bank and financial holding companies.
The Board currently has the general legal authority to monitor and
examine nonbank subsidiaries of bank and financial holding companies,
but primary responsibility for enforcement of existing federal consumer
protection statutes with respect to these nonbank subsidiaries is
specifically granted to the FTC. The report concludes, however, that
the FTC's mission and resource allocation are directed primarily at
conducting investigations based on consumer complaints rather than
routine monitoring. The report finds that the Federal Reserve System is
better equipped to monitor and examine the nonbank subsidiaries of bank
holding companies, apparently by virtue of our role as holding company
regulator, and, thus, potentially deter predatory lending activities;
and finds that Congress consider giving the Federal Reserve clear and
direct authority to do so.
The Federal Reserve regularly conducts examinations of state member
banks for compliance with a number of federal consumer protection laws.
Examinations of nonbank subsidiaries for compliance with specific
statutes are not routinely conducted.
Nevertheless, examiners assess consumer compliance risk across the
broad range of a banking organization's activities to determine its
impact on the organization's overall risk profile and to identify
appropriate supervisory activities. In addition, the Board may on
occasion direct an examination of a nonbank lending subsidiary of a
holding company when necessary in the context of applications to expand
in which serious fair lending or compliance issues are raised.[NOTE 2]
Although it may be useful to clarify jurisdictional issues in this
area, the existing structure has not been a barrier to Federal Reserve
oversight. There could be some value in the approach the report is
recommending in that it is likely that some abusive practices could be
caught that might not be otherwise; however, the selection of either
concurrent or exclusive jurisdiction over this population of nonbank
entities poses tradeoffs. Changing the federal law expressly to give
the Federal Reserve exclusive or even joint enforcement authority for
nonbank mortgage lending subsidiaries would result in one supervisory
scheme being applied to that group of entities (with attendant costs)
and a different supervisory scheme under the sole jurisdiction of the
FTC being applied to the same type of nonbank companies not affiliated
with a bank. Providing for concurrent jurisdiction between the Federal
Reserve and the FTC would subject these nonbank subsidiaries within
holding companies to potentially greater oversight than similar
entities that are not holding
company subsidiaries without any indication that affiliates of a bank
act more often in a predatory manner than creditors that are not
affiliated with a bank. Moreover, any jurisdictional change
contemplated by the report would increase costs to the Federal Reserve
and thus to the taxpayer, in much the same way as would increasing the
FTC's responsibilities in this regard.
As the report illustrates, the challenges of combating predatory
lending are difficult and complex. Finding solutions to these
challenges merits careful attention by Congress to a broad range of
approaches.
Sincerely,
Signed by:
EDWARD M. GRAMLICH:
NOTES:
[1] The scope of the report was limited to home mortgage lending.
[2] For example, in connection with Citigroup's application to acquire
European American Bank (which the Board approved on July 2, 2001), the
Board directed that an examination of certain subprime lending
subsidiaries of Citigroup be carried out to determine whether Citigroup
is effectively implementing policies and procedures designed to ensure
compliance with fair lending laws and to prevent abusive lending
practices.
[End of section]
Appendix III: Comments from the Department of Justice:
U.S. Department of Justice
Civil Rights Division:
Office of the Assistant Attorney General
Washington, D.C. 20035:
JAN 14 2004:
Mr. Harry Medina, Assistant Director
Financial Markets and Community Investments
United States General Accounting Office
301 Howard Street, Suite 1200
San Francisco, CA 94105-2252:
Dear Mr. Medina:
Thank you for the opportunity to review the draft of the General
Accounting Office (GAO) report entitled "CONSUMER PROTECTION. Federal
and State Agencies Face Challenges in Combating Predatory Lending, GAO-
04-280." Representatives of the Department of Justice's (DOJ) Criminal
Division, and the Civil Rights Division reviewed this draft report.
This letter constitutes the DOJ's formal comments and I request that it
be included in the final report.
The extensive effort that your staff has put into this report and the
opportunity to work with them on this important issue is appreciated.
The Civil Rights Division would like to comment on several aspects of
the draft report as follows.
Highlights one-pager (First paragraph, 8th line):
a reference to the Equal Credit Opportunity Act should be added after
the reference to the Fair Housing Act:
Executive Summary:
(Page 7, second bullet): This truncated explanation is a bit misleading
and does not fully summarize the discussion in the text. We would
suggest adding the language in bold: "DOJ, which is responsible for
enforcing certain federal civil rights laws, filed two of these
enforcement actions on behalf of the FTC and identified two additional
enforcement action it has taken that were related to predatory lending
practices. The statutes DOJ enforces only address predatory lending
practices when they also are alleged to be discriminatory.
(page 12, first paragraph, line 7): Including DOJ in this list of
federal agencies is a bit misleading, because all the other listed
agencies have regulatory powers and
we do not. We would suggest omitting DOJ from the list on line 7, and
adding a reference to DOJ at the beginning of the next sentence, which
would then read "Federal agencies, including these agencies and the
DOJ, have also taken some actions to coordinate their efforts related
to educating consumers about predatory lending.
Body of the Report:
(Page 19, 2nd paragraph). The third sentence should be clarified to
read as follows: DOJ has addressed predatory lending that is alleged to
be discriminatory by enforcing fair lending laws in a limited number of
cases.
(Page 22, first bullet). Last sentence should be clarified to read:
"The settlement placed restrictions on the company's future lending
operations and referred victims were compensated from previously
established monetary relief funds.
(Page 22, footnote 31). Last sentence should be corrected to read: "In
addition, according to DOJ filed complaints in both U.S. v. Action
Loan, Civ. Action No. 3:000V-51 1-H (W.D. KY), and U.S. v. Franklin
Acceptance Corp., Civil No. 99-CV-2435 (E.D. Pa.), cases involving
allegations of predatory mortgage lending that resulted from
enforcement efforts by the FTC. HUD was also involved in the
Action Loan case.
(Page 30, bullet at bottom of page): The referenced working group had
the dual purpose of strengthening enforcement and consumer education
from the beginning and the consumer education subcommittee never
stopped meeting, so several clarifications should be made, as follows:
--In the fourth line, the end of that sentence should read
"...determine how enforcement and consumer education could be
strengthened.":
--In the seventh line, the phrase "and stopped meeting" should be
deleted.
--In the eighth line, the beginning of that sentence should be changed
to read: "The Task Force continued its efforts related to consumer
education...":
(Page 72, last bullet): The referenced brochures and conumser materials
are also available on our website (www.usdoj.gov/crt/housing), and this
fact should be listed, as the website is one of our primary means of
distributing information about our work.
The Criminal Division comments are as follows:
The GAO report purports to address the problem of "predatory lending,"
for which there is no commonly accepted definition. In attempting to
define the term, the GAO uses examples of the kinds of practices which
it associates with "predatory lending." The problem with this is that
some of the GAO's examples are not what is commonly thought of as
predatory lending practices. A substantial portion of the report
discusses property or loan flips, which is a traditional fraud scheme
but not a type of predatory lending that deserves discussion in this
report. The Criminal Division's main objection to the report is the
misleading way that GAO has defined predatory lending and the DOJ's
enforcement efforts.
In conclusion, the Department of Justice would like to commend the GAO
analysts who worked on this report. DOJ representatives met with them
on several occasions and they worked diligently to analyze all aspects
of this issue in a constructive manner. Their observations and
conclusions will be most helpful in assessing the Department's role in
the federal government's efforts to develop strategies regarding the
important issue of predatory lending.
Sincerely,
Signed by:
Wan J. Kim:
Deputy Assistant Attorney General:
cc: Julie Wellman, Audit Liaison, Criminal Division:
[End of section]
Appendix IV: Comments from the Department of Housing and Urban
Development:
ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER:
U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
WASHINGTON, DC 20410-8000:
January 16, 2004:
Mr. David G. Wood
Director:
Financial Markets and Community Investment
United States General Accounting Office
Washington, DC 20548:
Dear Mr. Wood:
The Department appreciates the opportunity to comment on the draft GAO
Report entitled: Consumer Protection: Federal and State Agencies Face
Challenges in Combating Predatory Lending (GAO-04-280). Our substantive
comments will cover two areas of particular importance to HUD: the FHA
Mortgage Insurance Programs and RESPA.
HUD agrees that there is no common definition of predatory lending in
the context of the provision of mortgage credit. However, HUD is
aggressively attacking abusive and deceptive lending practices in FHA
insured lending, which we feel targets the behavior most indicative of
predatory lending. Action by HUD and the Federal Housing Administration
(FHA) to eliminate these practices is significant because it impacts
over one million loans that FHA insures each year, including a
substantial number of first time and minority buyers who use FHA and
the exemplary influence FHA exerts on the marketplace.
To protect FHA borrowers and set industry examples, FHA has developed a
series of new requirements specifically targeting lending practices
indicative of predatory lending. To this end, the following have been
published as final rules:
24 CFR Part 203, Anti-Flipping Rule. The rule prohibits FHA insurance
on a property resold within 90 days of the previous sale and also
prohibits sale of a property by anyone other than the owner of record.
Effective June 2003.
24 CFR Part 200, Appraiser Qualifications for Placement on FHA Single
Family Appraiser Roster. The rule establishes the changes designed to
strengthen the licensing and certification requirements for placement
on the FHA appraiser roster. Effective June 2003.
24 CFR Part 5 § 5.801, Electronic Submissions of Audited Financial
Statements. The rule allows HUD to accept electronic submissions of
lenders' financial audits to identify and remove noncompliant lenders
more quickly. Effective September 2002.
24 CFR Part 200 and 203, Single Family Mortgage Insurance: Section
203(k) Consultant Placement and Removal Procedures. The rule
establishes placement and removal procedures for HUD's roster of 203(k)
consultants. Effective September 2002.
24 CFR Part 200, Nonprofit Organization Participation in Certain FHA
Single Family Activities; Placement and Removal Procedures (Nonprofit
Roster). The rule establishes placement and removal procedures for
HUD's Nonprofit Organizations Roster. Effective July 2002.
Additional rules for program participants have been proposed. These
proposed rules include:
* Lender Accountability for Appraisals. This rule holds lenders
accountable for the appraisal validity. (Proposed Rule published
January 2003):
* Revision to FHA Credit Watch/Termination Initiative. Revises Credit
Watch to capture underwriting lenders; prevents a lender from opening a
new branch within the area covered by the proposed termination.
(Proposed Rule published April 2003):
The Department is in the process of developing other rules that will
tighten the requirements relating to becoming an FHA-approved
mortgagee, serving as a loan officer for an FHA insured mortgage, and
maintaining approved status as a lender. In addition, rules are being
developed to increase HUD control over false and misleading
advertising, to limit the number of FHA insured loans a nonprofit may
have outstanding, to strengthen the qualifications of owners/officers
of FHA-approved lending institutions, and to define the duties and
responsibilities of loan correspondents and underwriting lenders.
In addition to establishing more stringent procedures for participating
in FHA insured programs, the Department is taking aggressive action
concerning mortgagees who demonstrate poor performance through early
claim and default rates. The Department has created the Credit Watch
Program by which the Department tracks quarterly the default rates for
the 25,000 offices that originate FHA loans and terminates those
operations where the default rate exceeds twice that of the local
jurisdiction. In addition to being used to protect the integrity of the
FHA insurance funds and sanction those lenders who demonstrate
imprudent or possible abusive lending practices, the default rates of
these lenders are published on the Web and thereby serve as a source of
information by which other lenders and interested parties can judge a
lender's performance.
FHA also produces Neighborhood Watch, a web-based software application,
for HUD oversight of lenders and lender self-monitoring. Neighborhood
Watch complements the Credit Watch Termination initiative by providing
FHA approved lenders with statistical views of their performance. As a
self-policing tool it has enabled
lenders to monitor their performance in comparison to other lenders,
take corrective actions within their own organizations, and/or sever
relationships with poorly-performing business partners.
FHA has created a _companion program for appraisers, known as
"Appraiser Watch," to target appraisers for review. Appraiser Watch
uses traditional risk factors - such as loan volume, loan performance,
and loan type - to compare appraisers across peer groups and identify
appraisers for review. There are about 25,000 FHA-approved appraisers
(about the same number as lender offices).
As stated before, FHA is aggressively policing its participants and
imposing significant sanctions on mortgagees found to be violating
procedures or otherwise engaged in abusive or deceptive behavior. To
demonstrate the effectiveness of the Department's emphasis on program
monitoring and enforcement, the following table shows the increase in
activity on recent years:
Sanctions: On-site Monitoring Review;
FY 1998-2000: 2,297;
FY 2001-2003: 2,777.
Sanctions: Sanctions by MRB;
FY 1998-2000: 128;
FY 2001-2003: 137.
Sanctions: Withdrawn by MRB;
FY 1998-2000: 28;
FY 2001-2003: 36.
Sanctions: Civil Money Penalties;
FY 1998-2000: $6.17m;
FY 2001-2003: $6.5m.
Sanctions: Lenders Assessed Civil Money Penalties;
FY 1998-2000: 103;
FY 2001-2003: 116.
Sanctions: Indemnifications;
FY 1998-2000: 2,906;
FY 2001-2003: 8,980.
Sanctions: Potential Savings from Indemnifications;
FY 1998-2000: $87.2m*;
FY 2001-2003: $209m**.
Sanctions: Suspensions/Proposed Debarments/Final Determinations;
FY 1998-2000: 742;
FY 2001-2003: 1,384.
Sanctions: Referrals to OIG;
FY 1998-2000: 204;
FY 2001-2003: 1,101.
* The dollar amount is based on the historical average loss of $30,000
** The dollar amount is based on the more recent average loss of
$23,300:
[End of table]
HUD also addresses predatory lending through its Loss Mitigation
Program, which is often able to help a victim of predatory lending who
has defaulted on the mortgage and faces possible foreclosure. Under
this program, lenders have options that may help homeowners stay in
their homes or may mitigate the financial consequences of the default
if the homeowner does not have the resources to make that possible. FHA
regulations require that mortgagees explore all available loss
mitigation options prior to proceeding to foreclosure. The success of
this program is clear. In 2002 the number of loss mitigation cases
resolved by the borrower retaining homeownership exceeded the number of
cases resolved through foreclosure.
HUD also supports efforts to provide pre-purchase counseling, at little
or no cost to potential homeowners, and consumer education specifically
targeting predatory
lending. Housing awards grants to HUD-Approved Counseling Agencies.
During FY 2002, HUD-approved counseling agencies provided assistance to
423,000 homeowners or potential homeowners; HUD provided grant funds to
directly support 226,000 of those clients. In addition, HUD has
developed a Homeownership Education and Learning Program (HELP) that is
offered through sponsoring groups such as nonprofits, community-based
organizations, and community colleges. HUD also plans to launch a
national advertising campaign specifically warning the public of the
dangers of predatory lending, and HUD distributes literature concerning
the subject at Homeownership Fairs and other public exhibitions
throughout the country.
With respect to RESPA, the final rule has been submitted to OMB and is
now being reviewed. During that review, the Department cannot comment
on the rule. However, the Department recognizes and has stated that
RESPA was not intended to eliminate predatory lending, and regulatory
reform under RESPA cannot achieve that objective. The Department's
rules concerning FHA lenders and appraisers are based on that
recognition.
As evidenced by the aforementioned, the Department is strongly
committed to curbing the abusive practices associated with predatory
lending and would appreciate the final report acknowledging these
efforts.
The Department also has several comments specific to the report that we
have included as an enclosure to this letter.
Again, we wish to thank the GAO for the opportunity to add our comments
to the report prior to finalization.
Sincerely,
Signed by:
John C. Weicher:
Assistant Secretary for Housing-Federal Housing Commissioner:
Enclosure:
[End of section]
Appendix V: Comments from the National Credit Union Administration:
National Credit Union Administration:
Office of the Executive Director:
January 14, 2004:
Harry Medina, Assistant Director:
Financial Markets and Community Investments:
U.S. General Accounting Office:
301 Howard Street, Suite 1200
San Francisco, CA 94105-2252:
Re: Predatory Lending Draft Report.
Dear Mr. Medina:
You have asked for our review and comment on the draft report prepared
by the General Accounting Office (GAO) discussing challenges faced by
federal and state agencies in combating predatory lending (Report). We
appreciate the opportunity to comment and offer the following
observations.
The Report is a comprehensive treatment of this difficult topic and
provides a useful discussion of the issues. While we have no specific
experience with non-bank subsidiaries of financial holding companies,
we accept the characterization in the Report that these entities
frequently escape meaningful regulatory oversight. Thus, we concur in
GAO's recommendation that Congress consider providing the Federal
Reserve with clearer statutory authority to supervise them.
As the Report notes, NCUA has supervisory responsibility for federally
insured credit unions. Consistent with the experience of the other
federal banking regulators, we have not observed predatory lending
practices among the depository institutions that we regulate. Credit
unions are nonprofit cooperatives, owned by their members and
democratically controlled, that may only lend and pay dividends to
their members and, as such, are disinclined by their nature and
structure to engage in the kinds of practices regarded as predatory or
abusive.
In Chapter 2 of the Report about guidance issued by the federal
regulatory agencies on subprime lending, we request that the following
language be added. On page 27, after the first sentence in the second
paragraph, insert the following new sentence: "The NCUA issued similar
guidance to insured credit unions in 1999." A footnote should be
inserted at the end of this sentence, to read as follows: "NCUA Letter
to Credit Unions No. 99-CU-05, Risk Based Lending, June, 1999."
Inclusion of this language and footnote will help document that NCUA,
consistent with the other federal financial institution regulators, has
also issued guidance addressing this issue.
The Report accurately describes NCUA's experience and position on the
issue of federal preemption. Given the lack of evidence that federal
credit unions are engaging in predatory lending practices, we remain
comfortable that enforcement of the Federal Credit Union Act and the
other federal laws pertaining to real estate lending provides
sufficient safeguards for consumers. We note that state efforts to
strengthen licensing and qualification requirements for mortgage broker
activity by persons not associated with federally regulated depository
institutions may be an effective way to limit predatory and abusive
behavior.
While we acknowledge, as described in Chapter 5 of the Report, that
there may be limits to the effectiveness of consumer education efforts
and enhanced disclosure requirements, NCUA remains committed to
promoting and supporting financial awareness and education for
consumers. NCUA has been very active in encouraging credit unions to
educate and provide service to those with limited access to financial
services. Our "Access Across America" is one such example. This program
has focused on creating economic empowerment through expanded credit
union service into underserved neighborhoods and communities and
facilitating the sharing of resource information for credit unions
expanding into these areas. As part of "Access Across America" NCUA
supported many programs including the "Money Smart" training materials
developed by the FDIC, as well as numerous other workshops and training
programs developed in collaboration with organizations such as the
Neighborhood Reinvestment Corporation and the Department of Housing and
Urban Development. We believe that credit unions themselves are part of
the solution to predatory lending, and we are committed to helping them
present alternatives for their members.
We hope these comments are useful and will be happy to respond to any
questions.
Sincerely,
Signed by:
J. Leonard Skiles
Executive Director:
[End of section]
Appendix VI: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
David G. Wood, (202) 512-8678 Harry Medina, (415) 904-2000:
Staff Acknowledgments:
Jason Bromberg:
Emily R. Chalmers:
Randall C. Fasnacht, Jr.:
Rachelle C. Hunt:
Alison J. Martin:
Marc W. Molino:
Elizabeth Olivarez:
Carrie Puglisi:
Mitchell B. Rachlis:
Peter Rumble:
Paul Thompson:
James D. Vitarello:
(250118):
FOOTNOTES
[1] Throughout this report, the terms "predatory lending" and "abusive
lending" are used to refer to such practices.
[2] Information relating to state and local laws and their provisions
is from a database maintained by Butera & Andrews, a Washington, D.C.,
law firm that tracks predatory lending legislation, and is current as
of January 9, 2004. These laws only include state and local laws that
placed actual restrictions on lending. For example, they do not include
local ordinances that consisted solely of a resolution that condemned
predatory lending.
[3] HUD's FHA mortgage insurance program makes loans more readily
available for low-and moderate-income families by providing mortgage
insurance to purchase or refinance a home. Lending institutions such as
mortgage companies and banks fund the loans.
[4] These nonbank subsidiaries are owned by the financial holding
companies or bank holding companies and are not the direct operating
subsidiaries of the bank itself.
[5] Originators of mortgage loans--which can include banks, other
depository institutions, and mortgage lenders that are not depository
institutions--may keep the loans or sell them on the secondary market.
Secondary market purchasers may then hold the loans or pool together a
group of loans and issue a security that is backed by a pool of
mortgages (a "mortgage-backed security").
[6] Throughout this report, the terms predatory lending and abusive
lending are used interchangeably.
[7] As discussed in chapter 4, the secondary market is where existing
mortgage loans and mortgage-backed securities are sold and purchased.
[8] There is no uniform definition across the lending industry for what
characterizes a loan as subprime. Subprime loans are generally given to
borrowers with credit scores that are below a certain threshold, but
that threshold can vary according to the policies of the individual
lender.
[9] HUD annually identifies a list of lenders that specialize in either
subprime or manufactured home lending. HUD occasionally updates data
related to past years. The information provided here was based on data
available as of November 7, 2003.
[10] A "yield spread premium" is a payment a mortgage broker receives
from a lender based on the difference between the actual interest rate
on the loan and the rate the lender would have accepted on the loan
given the risks and costs involved. The higher the actual loan rate
compared with the acceptable loan rate, the higher the yield spread
premium.
[11] One of the few studies that sought to quantify the extent of
predatory lending was "Quantifying the Economic Cost of Predatory
Lending," E. Stein, Coalition for Responsible Lending, July 25, 2001
(revised Oct. 30, 2001). We were not able to verify the reliability of
the study's data, which were based on several sources. Other empirical
data appears in a study by Freddie Mac on its automated underwriting
system, "Automated Underwriting: Making Mortgage Lending Simpler and
Fairer for America's Families," September 1996. The company evaluated a
sample of 15,000 subprime mortgage loans originated by four financial
institutions and provided preliminary estimates that between 10 and 35
percent of the borrowers who received these loans could have qualified
for a loan in the prime market. Some consumer advocates have said these
data suggest that some borrowers may be "steered" to high-cost loans
even though they qualify for conventional loans with better terms. A
Freddie Mac official told us that the data are insufficient to
necessarily draw that conclusion.
[12] Citigroup acquired Associates First Capital Corporation and
Associates Corporation of North America in November 2000 and merged The
Associates' consumer finance operations into its subsidiary,
CitiFinancial Credit Company.
[13] See HUD-Treasury Task Force on Predatory Lending, Curbing
Predatory Home Mortgage Lending: A Joint Report (June 2000), 34-35. The
report noted that from January 1998 through September 1999, foreclosure
rates averaged 0.2 percent for prime mortgage loans and 2.6 percent for
subprime mortgage loans.
[14] Harold L. Bunce, Debbie Gruenstein, Christopher E. Herbert, and
Randall M. Scheessele, "Subprime Foreclosures: The Smoking Gun of
Predatory Lending?" Paper presented at the U.S. Department of Housing
and Urban Development conference "Housing Policy in the New
Millennium," Crystal City, VA, October 2000.
[15] Hearing on "Equity Predators: Stripping, Flipping and Packing
Their Way to Profits," Special Committee on Aging, U.S. Senate, March
16, 1998. Hearing on "Predatory Mortgage Lending: The Problem, Impact
and Responses," Committee on Banking, Housing, and Urban Affairs, U.S.
Senate, July 26 and 27, 2001. Hearing on "Predatory Mortgage Lending
Practices: Abusive Uses of Yield Spread Premiums," Committee on
Banking, Housing, and Urban Affairs, U.S. Senate, January 8, 2002.
Hearing on "Protecting Homeowners: Preventing Abusive Lending While
Preserving Access to Credit," Subcommittees on Financial Institutions
and Consumer Credit and Housing and Community Opportunity, Committee on
Financial Services, House of Representatives, November 5, 2003.
[16] A Rural Housing Institute report found that predatory lending did
not appear to have infiltrated rural counties in Iowa as much as urban
counties. However, the institute also noted there have been reports of
many cases of predatory lending in rural areas of the country overall,
with comparably severe effects on rural victims. See Rural Voices, Vol.
7, No. 2, Spring 2002, 4-5.
[17] See Pub. L. 103-325 §§ 151-158, 108 Stat. 2190-2198.
[18] Board of Governors of the Federal Reserve System and Department of
Housing and Urban Development, Joint Report to the Congress Concerning
Reform to the Truth in Lending Act and the Real Estate Settlement
Procedures Act, July 1998.
[19] HUD-Treasury Task Force on Predatory Lending, Curbing Predatory
Home Mortgage Lending: A Joint Report, June 2000.
[20] During 2003, there were at least two bills introduced in Congress
that addressed predatory or abusive lending practices--the Responsible
Lending Act (H.R. 833, Feb. 13, 2003) and the Predatory Lending
Consumer Protection Act of 2003 (S. 1928, Nov. 21, 2003).
[21] HOEPA amended various provisions of the Truth In Lending Act. In
the context of this report, the term "federal banking regulators"
refers to the Board, the federal supervisory agency for state-chartered
banks that are members of the Federal Reserve System; OCC, which
supervises national banks and their subsidiaries; FDIC, the federal
regulator responsible for insured state-chartered banks that are not
members of the Federal Reserve System; OTS, the primary federal
supervisory agency for federally insured thrifts and their
subsidiaries; and NCUA, which supervises federally insured credit
unions.
[22] TILA, as amended, is codified at 15 U.S.C. §§ 1601 - 1667f (2000 &
Supp 2003). The pertinent consumer protection provisions of the FTC Act
are contained in 15 U.S.C. §§ 41 - 58 (2000). RESPA is codified at 12
U.S.C. §§ 2601 - 2617 (2000 & Supp 2003).
[23] See 15 U.S.C. § 1635.
[24] HOEPA covers closed-end refinancing loans and home equity loans
with either (i) an annual percentage rate that exceeds the rate for
Treasury securities with comparable maturities by more than a specified
amount, or (ii) points and fees that exceed the greater of 8 percent of
the loan amount or $400, which is adjusted annually for inflation. 15
U.S.C. § 1602(aa)(1), (3); see 12 C.F.R. § 226.32 (2003). HOEPA does
not apply to purchase money mortgages (i.e., loans to purchase or
construct a residence), open-end credit (i.e., a line of credit), and
reverse mortgages. See, e.g., 15 U.S.C. § 1639.
[25] The Board has cited a study conducted for the American Financial
Services Association that estimated that--using current triggers--
HOEPA would have covered nearly 38 percent of subprime first mortgage
loans originated by nine major national lenders from 1995-2000. See M.
Staten and G. Elliehausen, "The Impact of The Federal Reserve Board's
Proposed Revisions to HOEPA on the Number and Characteristics of HOEPA
Loans" (July 24, 2001). In the past, the Board has also cited estimates
from data from OTS that, using the current triggers, HOEPA would cover
roughly 5 percent of all subprime loans, but the Board noted to us that
this estimate may be conservative. See 65 Fed. Reg. at 81441.
[26] Negative amortization occurs when loan payment amounts do not
cover the interest accruing on a loan, resulting in an increasing
outstanding principal balance over time. See 15 U.S.C. § 1639(f).
[27] See Pub. L. No. 103-325 § 153(a), 15 U.S.C. § 1640(a).
[28] Among other things, RESPA requires the good faith disclosure of
estimated settlement costs within 3 days after an application for a
mortgage loan and, at or before settlement, a uniform settlement
statement (HUD-1) that enumerates the final cost of the loan.
[29] Banking regulators are also authorized to enforce standards
imposed pursuant to the FTC Act with respect to unfair or deceptive
acts or practices by the institutions they supervise. See 12 U.S.C. §
57a(f).
[30] On January 20, 2004, FDIC announced approval of a joint
interagency notice of proposed rulemaking regarding the Community
Reinvestment Act. The proposed rule would amend the act's regulations
to expand and clarify the provision that an institution's Community
Reinvestment Act evaluation is adversely affected when the institution
has engaged in specified discriminatory, illegal, or abusive credit
practices in connection with certain loans. FDIC said that the Board,
OCC, and OTS were expected to announce their approval of the proposed
rulemaking shortly.
[31] Even in instances where charging high interest rates or fees or
steering borrowers to subprime loans do not violate federal consumer
protection statutes, imposing such rates and fees on a discriminatory
basis against groups protected under the Fair Housing Act and ECOA
could constitute violations of those laws.
[32] A pattern of making loans without regard to the ability of
borrowers to repay can be considered a violation of the safety and
soundness requirements imposed on federally insured depository
institutions and could also reflect poorly on an institution's
compliance with the Community Reinvestment Act. See OCC Advisory Letter
2003-2 (Guidance for National Banks to Guard Against Predatory and
Abusive Lending Practices), February 21, 2003. For loans that are
covered under HOEPA, making a loan without regard to a borrower's
ability to repay is not prohibited unless it can be demonstrated that
an institution has engaged in a "pattern or practice" of doing so. OCC
in its recent rulemaking prohibited national banks or their operating
subsidiaries from making consumer loans based predominantly on the
foreclosure or liquidation value of a borrower's collateral. See 69
Fed. Reg. 1904 (Jan. 13, 2004).
[33] Most enforcement actions discussed in this chapter were civil
judicial actions brought and settled by FTC, DOJ, and HUD.
[34] HUD's FHA mortgage insurance program makes loans more readily
available for low-and moderate-income families by providing mortgage
insurance to purchase or refinance a home. Lending institutions such as
mortgage companies and banks fund the loans.
[35] FTC has also recently addressed abuses in the mortgage loan
servicing industry. In November 2003, it announced settlements with
Fairbanks Capital Holding Corp., its wholly owned subsidiary Fairbanks
Capital Corp., and their founder and former CEO (collectively,
Fairbanks) on charges that Fairbanks violated the FTC Act, RESPA, and
other laws by failing to post consumers' mortgage payments in a timely
manner and charging consumers illegal late fees and other unauthorized
fees. The settlement will provide $40 million in redress to consumers.
The case was jointly filed with HUD. United States of America v.
Fairbanks Capital Corp. et al., Civ. Action No. 03-12219-DPW (D.
Mass.)(filed 11/12/03).
[36] Citigroup, Inc., acquired The Associates in a merger that was
completed in November 2000. The FTC complaint named Citigroup and
CitiFinancial Credit Company as successor defendants.
[37] Prepared statement of the Federal Trade Commission before the
House Committee on Banking and Financial Services on "Predatory Lending
Practices in the Subprime Industry," May 24, 2000. Since then, many
mortgage lenders have said they are abandoning lump-sum credit
insurance.
[38] In addition to these cases, DOJ filed an amicus curiae brief in a
private case, Hargraves v. Capital City Mortgage Corp., Civ. Action No.
98-1021 (JHG/AK) (D DC), in which the department contended that certain
alleged predatory lending practices violated the Fair Housing Act and
ECOA. The case involved a mortgage lender that allegedly engaged in a
pattern or practice of deceiving African American borrowers about the
terms of their loans and other information, such as the total amount
due. In addition, DOJ filed a complaint in United States v. Action
Loan, Civ. Action No. 3:00CV-511-H (W.D. KY), which resulted from
enforcement efforts by the FTC and HUD and involved allegations of
predatory mortgage lending.
[39] United States v. Delta Funding Corp., Civ. Action No. CV 00 1872
(E.D. N.Y. 2000).
[40] Two monetary relief funds totaling over $12 million were set up
under a previous remediation agreement involving Delta and the New York
State Banking Department.
[41] United States v. Long Beach Mortgage Company, Case No. 96-6159
(1996). Prior to December 1990, Long Beach Bank was a savings and loan
association, chartered by the state of California. Between December
1990 and October 1994, Long Beach Mortgage Company operated under the
name of Long Beach Bank as a federally chartered thrift institution. In
1999, Washington Mutual, a federally chartered thrift, acquired Long
Beach Mortgage Company and owns it at the holding company level.
[42] DOJ has also taken enforcement actions to address other practices,
such as credit repair schemes, that do not involve abusive lending but
that nonetheless serve to illegally strip homeowners of their equity.
[43] GAO has issued a number of reports on the FHA single-family
insurance program, a high-risk program area. For example, see U.S.
General Accounting Office, Major Management Challenges and Program
Risks: Department of Housing and Urban Development, GAO-03-103
(Washington, D.C.: January 2003).
[44] In property flipping schemes, properties are purchased and quickly
resold at grossly inflated values. In some cases the inflated value is
established by an interim sale to a "straw buyer" and then flipped to
an unsuspecting purchaser. In other cases, first-time buyers who have
been turned down for home loans because of poor credit or low income
are targeted by flippers who arrange loans well in excess of the real
value of the property using fabricated employment and deposit records.
These schemes often involve many players, including mortgage lenders,
mortgage brokers, underwriters, and home-improvement workers. Almost
all flipping schemes involve false appraisals. While HUD categorizes
property flipping as a predatory lending practice, not all federal
agencies concur with this categorization.
[45] For example, a complaint filed jointly by HUD, FTC, and Illinois
authorities against Mercantile Mortgage Company in 2002 alleged that
for almost 3 years, a broker referred virtually every one of his loan
customers to Mercantile in exchange for a fee as high as 10 percent.
The other two cases involving RESPA include Delta Funding (2000) and
Action Loan Company (2000).
[46] United States of America v. Fairbanks Capital Corp., 03-12219-DPW
(D. MA, filed Nov. 12, 2003).
[47] Banking regulators have broad enforcement powers and can take
formal actions (cease and desist orders, civil money penalties, removal
orders, and suspension orders, among others) or informal enforcement
actions (such as memoranda of understanding and board resolutions). Not
all informal actions are publicly disclosed.
[48] Matter of Clear Lake National Bank, AA-EC03-25 (OCC Nov. 7, 2003).
The lender that made the loans, Clear Lake National Bank of San
Antonio, Texas, merged with another bank in April 2003 to become Lone
Star Capital Bank, N.A. OCC brought the action under the enforcement
authority provided by Section 8 of the Federal Deposit Insurance Act,
12 U.S.C. 1818.
[49] OCC Advisory Letter 2003-2 (Guidance for National Banks to Guard
Against Predatory and Abusive Lending Practices), February 21, 2003;
and OCC Advisory Letter 2003-3 (Avoiding Predatory and Abusive Lending
Practices in Brokered and Purchased Loans), February 21, 2003.
[50] 69 Fed. Reg. 1904 (Jan. 13, 2004).
[51] The Board, FDIC, OCC and OTS, Interagency Guidance on Subprime
Lending, March 1, 1999; and Expanded Guidance for Subprime Lending
Programs, January 31, 2001. The 2001 guidance applies to institutions
with subprime lending programs with an aggregate credit exposure
greater than or equal to 25 percent of Tier 1 capital.
[52] NCUA Letter to Credit Unions No. 99-CU-05, Risk Based Lending,
June 1999.
[53] See OCC Advisory Letter 2000-7 (abusive lending practices); OCC
Advisory Letter 2000-10, OCC Advisory Letter 2000-11, OTS Chief
Executive Officers Letter 131, OTS Chief Executive Officers Letter 132,
and NCUA Letter 01-FCU-03 (title loans and payday lending); OCC
Bulletin 2001-47 (third-party relationships); and OCC Advisory Letter
2002-3 and FDIC Financial Institution Letter 57-2002 (unfair or
deceptive acts or practices).
[54] The Board adjusted the annual percentage rate (APR) trigger from
10 to 8 percentage points above the rate for Treasury securities with
comparable maturities. The change applies only to first lien mortgages;
the subordinate lien mortgage APR trigger remained at 10 percent.
[55] 66 Fed. Reg. 65604 (Dec. 20, 2001).
[56] More specifically, lenders are required to report the difference
or spread between a loan's annual percentage rate (a value reflecting
both the interest rate and certain fees associated with a loan) and the
yield on a Treasury security of comparable maturity, for loans where
this spread exceeds certain thresholds set by the Board. See,
generally, 67 Fed. Reg. 7222 (Feb. 15, 2002) and 67 Fed. Reg. 43218
(June 27, 2002).
[57] Id.
[58] See 15 U.S.C. § 1639(l)(2).
[59] In its 2001 amendments to the HOEPA rules, the Board added single-
premium credit insurance to HOEPA's fee trigger.
[60] See 15 U.S.C. § 1012.
[61] The agencies that participated in the working group were OCC, OTS,
FDIC, the Board, NCUA, DOJ, FTC, HUD, the Federal Housing Finance
Board, and the Office of Federal Housing Enterprise Oversight.
[62] The Federal Financial Institutions Examination Council is a formal
interagency body composed of representatives of each of the five
federal banking regulators. The council was established in 1979 and is
empowered to (1) prescribe uniform principles, standards, and report
forms for the federal examination of financial institutions and (2)
make recommendations to promote uniformity in the supervision of
financial institutions.
[63] U.S. Department of the Treasury and U.S. Department of Housing and
Urban Development, Curbing Predatory Home Mortgage Lending: A Joint
Report, June 2000.
[64] A subsidiary of a bank, thrift, or credit union is controlled
through partial or complete ownership by the institution. Federal laws
and regulations set more specific requirements that dictate whether an
institution is a subsidiary. For the purposes of this report, the term
holding company refers to both (traditional) bank holding companies and
bank holding companies that qualify as financial holding companies as
defined by the Board.
[65] OCC Advisory Letter 2002-9 (Questions Concerning Applicability and
Enforcement of State Laws: Contacts From State Officials, November 25,
2002.); see also 69 Fed. Reg. 1904 (Jan. 13, 2004).
[66] See Brief of Amicus Curiae State Attorneys General, National Home
Equity Mortgage Ass'n v. OTS, Civil Action No. 02-2506 (GK) (D D.C.)
(March 21, 2003) at 10-11.
[67] Another jurisdictional issue is uncertainty as to whether the FTC
shares jurisdiction with federal banking regulators over bank
subsidiaries that are not themselves banks (operating subsidiaries).
While OCC maintains it has exclusive regulatory jurisdiction over the
operating subsidiaries of national banks, FTC argues that a provision
of the Gramm-Leach-Bliley Act provides for the two agencies to share
jurisdiction. See Pub. L. No. 106-102 § 133(a). A federal district
court has upheld FTC's interpretation. (See Minnesota v. Fleet Mortg.
Corp., 181 F. Supp. 2d 995 (D MN 2001)). We are not aware of any
instance in which this matter has interfered with an FTC enforcement
action.
[68] In addition to financial and bank holding companies, there are
thrift holding companies, which can include thrifts and other financial
institutions. Each thrift holding company is regulated and subject to
examination by OTS. See 12 USC §1467a (b)(4).
[69] Citigroup acquired The Associates in November 2000 and merged The
Associates' consumer finance operations into its subsidiary,
CitiFinancial Credit Company, a nonbank subsidiary of the holding
company. In 1999, Fleet Finance, Inc., and its successor company, Home
Equity U.S.A., Inc., agreed to pay $1.3 million to settle an FTC
complaint alleging deceptive disclosures and TILA violations in
conjunction with Fleet Finance, Inc., loans. At the time of the
settlement, Fleet Finance had become Home Equity U.S.A., Inc. Both
Fleet Finance, Inc., and Home Equity U.S.A., Inc., were nonbank
subsidiaries of bank holding companies. At the time of the settlement,
the bank holding company was Fleet Financial Group, Inc., which has
been renamed FleetBoston Financial Corporation. Home Equity U.S.A.,
Inc., continues to operate as a nonbank subsidiary of FleetBoston
Financial Corporation, a bank holding company.
[70] See U.S. General Accounting Office, Large Bank Mergers: Fair
Lending Review Could be Enhanced With Better Coordination, GAO/GGD-00-
16 (Washington, D.C.: Nov. 3, 1999), 20 and 47.
[71] Except where citations to provisions of state laws are provided,
all information relating to state and local laws and their provisions
is from a database maintained by Butera & Andrews, a Washington, D.C.,
law firm that tracks predatory lending legislation. These laws include
only state and local laws that place actual restrictions on lending and
do not include, for example, local ordinances that consist solely of a
resolution that condemned predatory lending. As noted in chapter 1, we
took measures to verify the reliability of these data.
[72] North Carolina enacted the first state law (N.C. Gen. Stat. 24-1-
.1E[1999]) in 1999; it took effect on July 1, 2000. Nearly all the
other state laws were enacted between 2001 and 2003.
[73] Massachusetts has imposed similar restrictions on high-cost loans,
but it was done through regulatory changes rather than legislation.
[74] See, e.g., Fla. Stat. Ann. §§ 494.0079, 494.00791 (2003); Ohio
Rev. Code Ann. §§ 1394; Ohio Rev. Code Ann. § 1349.25 (2003); 63 PA
Stat. § 456.503 (2003).
[75] See GA Code Ann. § 7-6A-2(2003); N.J. Stat. Ann. § 46:10B-24 (West
2003); N.C. Gen. Stat. § 24-1.1E (2003).
[76] N.C. Gen. Stat. § 24-1-1E; N.M. Stat. Ann § 58-21A-3 (2003).
[77] W. VA. Code §§ 46A-3-110, 31-17-8 (2003).
[78] See Mich. Comp. Laws § 445.1634 (2003).
[79] In some cases, these laws were enacted but pending litigation
stayed enforcement.
[80] N.C. Session Law 1999-332.
[81] N.C. Sessions Laws 2001-393 and 2001-399.
[82] The North Carolina predatory lending law defines a high-cost loan
as a home loan of $300,000 or less that has one or more of the
following characteristics: (1) points, fees (excluding certain amounts
specified in the law), and other charges totaling more than 5 percent
of the borrowed amount if the loan is $20,000 or more, or the lesser of
8 percent of the amount borrowed or $1,000 if the loan is less than
$20,000; (2) an interest rate that exceeds by more than 10 percent per
annum the yield on comparable Treasury bills; or (3) a prepayment
penalty that could be collected more than 30 months after closing or
that is greater than 2 percent of the amount prepaid. According to the
North Carolina Commissioner of Banks, the $300,000 cap is based on the
presumption that those able to borrow $300,000 or more are able to
adequately protect themselves. "Consumer home loans" are loans in which
(i) the borrower is a natural person, (ii) the debt is incurred by the
borrower primarily for personal, family, or household purposes, and
(iii) the loan is secured by a mortgage or deed of trust upon real
estate upon which there is located or there is to be located a
structure or structures designed principally for occupancy of from one
to four families which is or will be occupied by the borrower as the
borrower's principal dwelling.
[83] Elliehausen and Staten, Regulation of Subprime Mortgage Products:
An Analysis of North Carolina's Predatory Lending Law, Georgetown
University School of Business (November 2002).
[84] Quercia, Stegman, and Davis, The Impact of North Carolina's Anti-
Predatory Lending Law: A Descriptive Assessment, Center for Community
Capitalism, The Frank Hawkins Kenan Institute of Private Enterprise,
University of North Carolina at Chapel Hill (June 25, 2003).
[85] See Ohio Rev. Code. Ann. § 1349.32 (2003).
[86] Ohio Rev. Code Ann. § 1349.27 (2002).
[87] See Ohio. Rev. Code Ann. §§ 1322.01 - 1322.12 (2003).
[88] 2002 Ohio Laws HB 386 § 5.
[89] Ordinance No. 271-03. As of November 17, 2003, the City of Toledo
was temporarily enjoined from enforcing application, enforcement, or
other effectuation of this ordinance as a result of a lawsuit asserting
that the ordinance is preempted by the Home Ownership and Equity
Protection Act of Ohio. AFSA v. City of Toledo, Ohio, No. C10200301547
(Lucas County).
[90] See U.S. General Accounting Office, Role of the Office of Thrift
Supervision and Office of the Comptroller of the Currency in the
Preemption of State Law, GAO/GGD/OGC-00-51R (Washington, D.C.: Feb. 7,
2000) for additional information on federal preemption of state banking
laws.
[91] 2 C.F.R § 560.2(a).
[92] 69 Fed. Reg. 1904 (Jan. 13, 2004).
[93] Office of Thrift Supervision, P-2003-5, Preemption of New Jersey
Predatory Lending Act (July 22, 2003).
[94] Several state law enforcement authorities have also said that
predatory lending generally occurs outside of banks and direct bank
subsidiaries. See Brief of Amicus Curiae State Attorneys General,
National Home Equity Mortgage Ass'n v. OTS, Civil Action No. 02-2506
(GK) (D D.C.) (March 21, 2003) at 10-11.
[95] For example, see Comments on OCC Working Paper, Center for
Responsible Lending, 7-10, October 6, 2003, http://
www.predatorylending.org/pdfs/CRLCommentsonOCCWorkingPaper.pdf.
[96] A government-sponsored enterprise (GSE) is a congressionally
chartered, publicly owned corporation established and accorded favored
regulatory treatment to increase access to the capital market for
specific economic sectors, including housing.
[97] K. Temkin, J. Johnson, D. Levy, "Subprime Markets, the Role of
GSEs, and Risk-Based Pricing," prepared by The Urban Institute for the
U.S. Department of Housing and Urban Development, March 2002. Other
estimates of the GSEs' share of securitization of the subprime market
have varied, in part because--as noted earlier--there is no consistent
industry definition of what constitutes subprime.
[98] The Federal Housing Enterprises Financial Safety and Soundness Act
of 1992 requires Fannie Mae and Freddie Mac to meet annual percent-of-
business housing goals established by HUD for three categories: low-and
moderate-income, underserved, and special affordable. HUD set the
following goals for 2001 through 2003: low-and moderate-income--50
percent of the total number of units financed; underserved--31 percent
of the total number of units financed; and special affordable--20
percent of the total number of units financed.
[99] Reputation risk is the current and prospective impact on a
company's earnings and capital arising from negative public opinion
from other market participants. This risk may expose a misbehaving
originator or lender to litigation, financial loss, and a decline in
its customer base if its behavior injures its customers or clients.
[100] OCC has issued guidelines stating that national banks are
expected to undertake appropriate due diligence to avoid purchasing
predatory loans. See OCC Advisory Letter 2003-3 (Avoiding Predatory and
Abusive Lending Practices in Brokered and Purchased Loans), February
21, 2003.
[101] Some securitizers have begun to use fraud detection software as
part of their due diligence of residential mortgage loans. Such
software analyzes specific data fields within a loan file and looks for
characteristics and inconsistencies that may signal fraud in the
appraisal, loan application, or loan itself. In some cases, a fraud
review can also be incorporated as part of the regular due diligence
process.
[102] A prepurchase financial due diligence review may not look at
point and fee data because the risks and returns to the loan purchaser
depend not on payments that were made at origination but rather on
future payments by the homeowner. However, a review of points and fees
is often done during a subsequent loan-level file review.
[103] Fannie Mae and Freddie Mac officials note that their
antipredatory lending policies and compliance measures are only one
element in their efforts to fight predatory lending. For example, both
companies also have special programs that provide appropriately priced
loans to credit-impaired borrowers and other consumers who tend to be
targeted by predatory lenders; support homebuyer education and
counseling for at-risk individuals; and have special loan programs
designed for borrowers who have been targeted or victimized by
predatory lenders.
[104] One example would be steering borrowers to higher-cost loans than
is justified by their credit histories. This practice is often
considered abusive but is not per se a violation of federal law, nor
does it necessarily increase credit risk to the lender.
[105] Reputation risk can also be an issue for sellers of loans to the
secondary market. Regularly selling loans that later create risks and
costs for secondary market purchasers may close off the seller's access
to the secondary market.
[106] Under New York's law, an assignee seeking to enforce a loan
against a borrower in default or in foreclosure is subject to the
borrower's claims and defenses to payment that the borrower could
assert against the original lender. See NY Banking Law § 6-l (2003).
Under Maine's law, an assignee may be subject to all claims and
defenses that the borrower may assert against the creditor of the
mortgage. See Maine Rev. Stat. Ann. Title 9-A § 8-209 (2003).
[107] See, e.g., N.J. Stat. Ann. § 46:10B-27 (West 2003); see also, 815
Ill. Comp. Stat. 137/135 (2003).
[108] City of Toledo Ordinance No. 291-02 (Oct. 4, 2002).
[109] The Georgia Fair Lending Act is codified at GA Code Ann. §§ 7-6A-
1 et. seq. OTS, NCUA, and OCC have determined that the Georgia law does
not apply to the institutions they supervise because it is preempted by
federal law. See Office of Thrift Supervision, P-2003-1, Preemption of
Georgia Fair Lending Act (Jan. 21, 2003); National Credit Union
Administration, 02-0649, Applicability of Georgia Fair Lending Act to
Federal Credit Unions (July 29, 2002); National Credit Union
Administration, 03-0412, NCUA Preemption of the Georgia Fair Lending
Act (Nov. 10, 2003); and OCC Preemption Determination and Order, Docket
No. 03-17 (July 30, 2003). Because Georgia law contains a parity
provision under which its state-chartered banks are treated similarly
to national banks, Georgia's Commissioner of Banking and Finance ruled
that Georgia-chartered banks also are not subject to the Fair Lending
Act. See Declaratory Ruling: Effect of Preemption of Georgia Fair
Lending Act by the OCC on July 30, 2003 (Aug. 5, 2003).
[110] The Fair and Accurate Credit Transactions Act of 2003 (Pub. L.
No. 108-159), which was enacted on December 4, 2003, addresses
financial literacy in a number of its provisions. Among other things,
it establishes a financial literacy and education commission consisting
of representatives of FTC, the federal banking regulators, HUD, the
Department of the Treasury, and other federal agencies.
[111] See National Endowment for Financial Education, "Financial
Literacy in America: Individual Choices, National Consequences," report
based on the symposium "The State of Financial Literacy in America:
Evolutions and Revolutions," October 2002 (Greenwood Village, Colorado,
2002), 1 and 6; Maude Toussaint-Comeau and Sherrie L.W. Rhine,
"Delivery of Financial Literacy Programs," Policy Studies, Consumer
Issues Research Series, Consumer and Community Affairs Division,
Federal Reserve Bank of Chicago (2000), 1; Marianne A. Hilgert, Jeanne
M. Hogarth, and Sondra Beverly, "Household Financial Management: The
Connection between Knowledge and Behavior," Federal Reserve Bulletin,
July 2003, 309 and 311.
[112] OCC Advisory Letter 2001-1, Financial Literacy, January 16, 2001.
[113] See, for example, Abdighani Hirad and Peter M. Zorn, "A Little
Knowledge is a Good Thing: Empirical Evidence of the Effectiveness of
Pre-Purchase Homeownership Counseling," in Low-Income Homeownership:
Examining the Unexamined Goal, ed. Nicolas P. Retsinas and Eric S.
Belsky (Washington, D.C.: Brookings Institution Press and Harvard
University Joint Center on Housing Studies, 2001), 2.
[114] See for example, B. Douglas Mernheim, Daniel M. Garrett, and Dean
M. Maki, Education and Saving: The Long-Term Effects of High School
Financial Curriculum Mandates (Cambridge, Mass.: National Bureau of
Economic Research, 1997), 29-30.
[115] For example, TILA requires federal lenders to make certain
disclosures on mortgage loans within 3 business days after the receipt
of a written application. It also requires a final disclosure statement
at the time of closing that includes the contract sales price,
principal amount of the new loan, interest rate, broker's commission,
loan origination fee, and mortgage and hazard insurance, among other
things.
[116] The loan is not repaid in full until the homeowner permanently
moves out of the home, passes away, or other specified events have
occurred.
[117] Board of Governors of the Federal Reserve System and the
Department of Housing and Urban Development, Joint Report to the
Congress Concerning Reform to the Truth In Lending Act and the Real
Estate Settlement Procedures Act (Washington, D.C.: July 1998).
[118] See 67 Fed. Reg. 49134 (Jul. 29, 2002).
[119] No clear agreement exists on the age at which someone is
considered "elderly." While we do not designate any specific age in
this report with reference to the terms "older" or "elderly," we are
generally referring to persons over the age of 65.
[120] For example, a study by the Board found that in 1997, some 55
percent of the homeowners who had fully paid off their mortgage were 65
years of age or older. See Glenn B. Canner, Thomas A. Durkin, and
Charles A. Luckett, "Recent Developments in Home Equity Lending,"
Federal Reserve Bulletin, April 1998, 241-51. Borrowers may have
substantial equity in their homes but still not qualify for a prime
loan because their capacity to repay the loan is limited or their
credit score is beneath a certain threshold.
[121] For example, a loan might be offered to a borrower who owns a
home worth $100,000 and owes $20,000 from a previous mortgage. An
abusive lender might refinance the loan for $25,000 (providing the
borrower with a $5,000 "cashout") but then charge fees of $15,000,
which are financed into the loan. The borrower then would owe $40,000,
but might not be aware of the excessive fees that were charged because
the monthly repayment schedule had been spread over a much longer
period of time.
[122] Richard J. Bonnie and Robert B. Wallace, eds., "Elder
Mistreatment: Abuse, Neglect, and Exploitation in an Aging America,"
Panel to Review Risk and Prevalence of Elder Abuse and Neglect,
National Research Council (Washington, D.C.: National Academies Press,
2003), 393.
[123] For example, about 25 percent of elderly black Americans had
graduated from high school in 1992, compared with about 58 percent of
elderly white Americans, and about 57 percent of elderly black
Americans were reported to have had fewer than 9 years of formal
education. See Robert Joseph Taylor and Shirley A. Lockery, "Socio-
Economic Status of Older Black Americans: Education, Income, Poverty,
Political Participation and Religious Involvement," African American
Research Perspectives 2 (1): 3-4.
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