Congress should pass legislation spelling out a national anti-predatory-lending standard requiring lenders to analyze borrowers’ capacity to repay loans and prohibiting misleading marketing and disclosures, a top federal bank regulator advised lawmakers Tuesday.
FDIC chairman Sheila Bair, testifying before members of a House subcommittee conducting hearings on mortgage lending, said she recognizes the benefits of providing home loans to consumers with “less-than-perfect” credit.
“This does not mean, however, that lenders should make loans that borrowers will inevitably have difficulty repaying, or impose terms that will exacerbate borrowers’ credit problems,” Bair said in her prepared testimony.
Bair said predatory lending includes not only fraud and deception that conceals the true nature of a loan from an unsophisticated borrower, but making unaffordable loans based on a borrower’s collateral instead of the ability to repay or inducing a borrower to refinance many times in order to charge points and fees.
Officials with the Federal Reserve, Office of Thrift Supervision and Office of the Comptroller of the Currency did not join Bair’s Federal Deposit Insurance Corp. in calling for new legislation governing mortgage lenders, saying regulations and market forces are proving effective in tightening lending standards.
OCC’s senior deputy comptroller Emory Rushton said his office is working to obtain “appropriate corrections to underwriting practices that cause us concern.”
Given the importance of the housing sector to the economy, however, “It is imperative that we all use the right degree of pressure when applying the brakes to avoid putting in jeopardy the segments of the market that are working well and that have helped to raise home-ownership rates to historic levels,” Rushton said in his prepared testimony.
Bair agreed that regulators and Congress should not “overreact” in developing tighter standards. Overly rigid rules or introduction of unfamiliar new concepts could create “heightened uncertainty and confusion,” Bair said.
But, she said, “Clear, common-sense standards regarding the underwriting and marketing of subprime adjustable mortgages will reinforce market discipline and preserve an adequate flow of capital to fund responsible lending.”
Bair called for a national predatory lending standard that would require underwriting based on the borrower’s ability to repay the true cost of the loan, rather than payments based on an artificially low introductory rate.
“This requirement would go a long way toward helping borrowers avoid loans that they cannot repay, and would improve the quality of lender portfolios and mortgage-backed securities,” Bair said. It also would help balance the role of mortgage brokers by curtailing the incentives to steer customers to high-cost products that they cannot afford.
Bair said national standards are also needed to address “misleading or confusing marketing” that prevents borrowers from properly evaluating loan products.
She said one key area of concern is the misuse of the word “fixed” to describe negative-amortization loans where the payment may be fixed for a time, but the interest rate adjusts. The term is also used misleadingly to describe hybrid adjustable-rate mortgages where the rate is fixed only for the first few years, Bair said.
Some lenders and brokers disclose information about comparably priced 30-year fixed-rate mortgages less prominently than more profitable “exotic” loans, she said.
Bair recommended that a national predatory lending standard require that rate and payment information for nontraditional mortgages or hybrid ARMs include a comparison of the rate and payment being offered by the same lender for a 30-year fixed-rate mortgage.
The standard also could require that all rate and payment disclosure information include full disclosure of the borrower’s monthly payment at the fully amortized, fully indexed rate.
That’s essentially the approach outlined in guidance federal regulators have already put in place for so-called “exotic” payment option and interest-only loans. The guidance, rolled out in September, applies only to federally regulated lenders. But 26 states and the District of Columbia have adopted the guidelines for lenders they oversee, Bair said.
One purpose of Tuesday’s hearing by the House Subcommittee on Financial Institutions and Consumer Credit was to discuss the impacts of extending the guidance to hybrid ARM loans, such as 2/28 and 3/27 loans. The FDIC and other federal regulators proposed such a step on March 2, at the urging of members of the Senate banking committee.
Bair said a national anti-predatory-lending standard could also draw on provisions of laws adopted by 36 states, including limits on loan flipping and prepayment penalties.
States have been “innovative laboratories” for developing consumer protections, especially in the area of predatory lending, Bair said, and “Congress should draw from their experience in drafting national standards.”
But Massachusetts Commissioner of Banks Steven Antonakes said federal regulators have undermined that role, even as states were forced to step up as the primary regulator of the subprime lending industry because of federal inaction.
Some 90,000 mortgage lenders with 63,000 branches and 280,000 employees are under state jurisdiction, Antonakes said. But states have been hampered in their attempts to curb abusive lending practices because federal regulators have claimed their authority preempts state consumer protection laws, Antonakes said.
“The decision was made to preempt state laws in favor of developing (federal) laws that offer advantages to the financial services industry,” Antonakes testified.
State regulators do not eschew responsibility, but Congress, federal regulatory agencies, mortgage lenders and brokers, insured depository institutions and borrowers must all accept a measure of responsibility for aiding in the creation of our current residential mortgage marketplace,” Antonakes said.
The subprime crisis came about in part because borrowers, mortgage brokers, lenders and investors have “misaligned interests,” Bair said.
Mortgage brokers made risky — and more profitable loans — because lenders offered them incentives in the form of yield spread premiums.
Lenders who keep the mortgages they originate lose out if the borrowers can’t make their payments. But when loans are resold to investors in the secondary market, “lender’s preferences are heavily influenced by what market investors want to buy, which may not match what is appropriate for the borrower,” Bair said.
In Bair’s view, investors’ appetite for more volume led many lenders to loosen their underwriting standards, offering products like piggyback mortgages that required little or no down payments.
Instead of verifying a buyer’s income or the true value of the property used as collateral, many lenders employed risk-based pricing, which relied on sophisticated software models that priced loans to provide a loss cushion to cover losses and expenses related to underwriting, servicing and collecting portfolios of loans, Bair said.
Antonakes said states have tried to take steps to address to address such issues, by making investment banks that buy and securitize subprime mortgages liable for losses and prohibiting prepayment penalties on “troublesome” loans.
The OCC and OTS “have essentially undermined the states as the laboratory for innovation in the protection of their consumers,” he said. With most lenders under supervision of federal regulators, “states have been neutralized in their response to predatory practices,” Antonakes said.
In some instances, regulations may be a better way to address some abuses than legislation, Bair said — especially in areas like misleading marketing, where abusive techniques frequently change.
The Federal Reserve Board could exercise the authority it has under the Home Ownership Equity Protection Act (HOEPA) to address abusive practices by all mortgage lenders — not just those that relate to high-cost loans, Bair said, echoing statements made by Sen. Chris Dodd, D-Conn., at a Senate hearing last week.
Bair said it’s also important to find ways to help loan servicers work with stressed borrowers to restructure their loans or find other ways to allow them to keep their home and make more affordable payments.
She said the FDIC, the Office of Thrift Supervision, the Office of the Comptroller of the Currency and the Federal Reserve Board will host an April 14 forum on that issue, where lenders, servicers and others will be invited to explore alternatives to foreclosure.