In the past few weeks the American public has been made aware of an unprecedented number of individuals who are defaulting on their home loans. Many of these loans are considered “subprime,” which means that they deviate in some important aspect from what is arguably fair. For example, they could include prepayment penalties, balloon payments or unmanageable interest rates. Many of these loans will go into foreclosure and a number of individuals will thereby lose home ownership.
We can understand why this is happening from the perspective of professional ethics. Typically, a professional is someone with specialized knowledge and a certification of substantive competency, along with a pledge to a written code of ethics within the industry. Some examples of professionals are medical doctors, lawyers, CPAs and Realtors. Furthermore, the typical standard of practice of a professional is at the level of a fiduciary duty. This requires the highest standards of good faith and fair dealing, as well as the charge to never put one’s interest above the interest of a client. There is an implicit economic tradeoff here. In exchange for the honor, prestige and income of a typical professional, there is an agreement to owe fiduciary duties to clients.
Historically, we have seen and are continuing to see the emergence of new professional groups. For instance, in the past few decades we have seen the rise of paralegals, who operate alongside lawyers and judges, and who provide a valuable service within the legal community. Law enforcement is also becoming more professionalized, as barriers to entry rise and the standards of competency and ethics increase. This brings us to the question about the status of residential mortgage lenders, including brokers, loan officers and support staff. If they belong to a professional class then they would have to follow an ethics code with fiduciary duties. In contrast, if they are not professionals then mortgage products and services should be treated like any other retail establishment and fiduciary duties do not apply.
We submit that mortgage lenders have been in an ambiguous status for a number of years, which is perhaps at part of the root of the default/foreclosure problem. Huge numbers of consumers actually believe that they can trust their mortgage lenders to look out for their best financial interest. They walk into lending establishments with the expectation that their lenders owe them fiduciary duties. The problem is that there is no well-formed code of ethics that requires a fiduciary standard of practice. This incongruence of basic assumptions then allows some unscrupulous lenders to take unfair advantage of their clients. This is not to say that all lenders violate trust or take advantage of unsuspecting clients. Yet, because there has not been a precise written code of ethics, there are no standards of practice that have been agreed upon and publicized, much less the instantiation of a fiduciary duty in this regard.
The industry of mortgage lending is at a historical crossroads. It can either go left and become a professional group with fiduciary standards or it can go right and clearly remain as a retail establishment in which most of the burden of information is with consumers. Yet, they can no longer have it both ways. Because of the harm that is occurring, both state and federal governments are stepping to externally regulate the industry. This will result in greater costs being passed on to consumers. Perhaps a more expeditious and economically friendly plan would be for lenders to write a code of ethics with fiduciary standards and thereby internally regulate themselves. In any case, the cat is now out of the bag and the ambiguity no longer. It is quite possible that we are seeing the emergence of a brand-new professional group, although some are being dragged along while kicking and screaming.
Jillayne Schlicke and Kevin Boileau are co-executive directors of the Ethical Lending Foundation.