A consumer advocacy group says a bill intended to combat predatory lending contains too many loopholes protecting Wall Street investors from lawsuits when they purchase mortgage loans from deceptive or predatory loan originators.
Michael Calhoun, the head of the Center for Responsible Lending, told House lawmakers that investor demand for securities backed by subprime loans “lies at the heart of today’s mortgage meltdown.”
During the housing boom, Calhoun said, “The demand from Wall Street (for mortgage-backed securities) was so intense that it encouraged subprime lenders to abandon reasonable qualifying standards, to forget about standard documentation requirements, and to ignore whether borrowers could actually afford the loan.”
CRL and other consumer groups say borrowers who were the victims of deceptive or predatory lending practices should have the right to file class-action lawsuits against investors who purchase mortgages from loan originators such as mortgage brokers and banks.
The bill, the Mortgage Reform and Anti-Predatory Lending Act of 2007, stops short of creating full “assignee liability” for those who take possession of loans after they are originated, a step the industry maintains would dry up a major source of funding for lenders.
HR 3915, introduced by House Democrats Monday, would allow individual borrowers to sue companies that securitize loans for sale on the secondary market when the originators of those loans break the law. But it provides many loopholes for securitizers and other “assignees,” and exempts pools of securitized loans and investors in those pools from lawsuits, Calhoun said.
During a hearing on the bill Wednesday, advocates for the mortgage lending industry made the opposite argument — that HR 3915 creates enough legal pitfalls for investors that it could worsen the current credit crunch in mortgage lending.
Industry groups also complained that other provisions of the bill — including a ban on yield spread premiums and prohibitions on prepayment penalties on subprime loans — could raise the cost of borrowing and make it harder for subprime borrowers facing payment resets to refinance into more affordable loans.
And while the bill’s backers say it would require all mortgage loan officers to be licensed, industry critics say it stops short of creating uniform national lending standards and would leave a patchwork of state and local laws in place.
HR 3915 would create new minimum standards for all mortgages, including requirements that lenders make a good-faith determination of a borrower’s ability to repay a loan, and only arrange refinance loans when there is “a net tangible benefit to the consumer,” according to a summary of the bill.
While the bill would penalize lenders who violated those and other minimum standards, Calhoun said the best way to “re-align the interests of borrowers and lenders” is to make secondary market investors accountable for the actions of loan originators.
In his prepared testimony to the House Financial Services Committee, Calhoun said the demand for mortgage-backed securities during the housing boom led lenders to create “new, dangerous loan products that appeared deceptively affordable to borrowers.” Brokers pushed these products to earn high fees, Calhoun said.
HR 3915 would give consumers the right to sue “assignees” — companies that take possession of loans after they are originated — but only as individuals, not as members of a class-action suit.
The bill would also exempt securitizers and other assignees from lawsuits if they could demonstrate they have implemented policies against buying such loans, or if they agree to remedy provisions of loans violating the minimum standards within 90 days of being challenged by a borrower.
There are so many loopholes in the proposed law, Calhoun said, that most consumers whose mortgage loans are resold in the secondary market would be able to raise violations of the act only when faced with an impending foreclosure.
“We believe that the secondary market has too much insulation in this proposal for it to have adequate incentive for change, and consumers have too little opportunity to vindicate their rights,” Calhoun said.
Marc Lackritz, president of the Securities Industry and Financial Markets Association (SIFMA), warned several of the bill’s provisions “could significantly reduce funding from the secondary mortgage market and cut off mortgage credit for worthy subprime borrowers.”
Although the bill was written with the intention of exempting pools of loans or investors of those pools from lawsuits, Lackritz said language spelling that out more explicitly is needed.
In his prepared testimony, Lackritz said SIFMA recommends that the term “assignee” be narrowly defined to be “the entity, other than a securitization vehicle, that owns the residential mortgage loan at the time the consumer makes the claim.”
The Mortgage Bankers Association warned that, as written, the bill could be interpreted as defining loan servicers and warehouse lenders as “assignees.” Any move to strengthen assignee liability should be “careful and surgical,” the group said, or the bill could shut down the flow of money into mortgage lending.
“Instituting assignee liability to correct errors in the mortgage origination process potentially threatens the availability and cost of mortgage loans,” said Kurt Pfotenhauer, the MBA’s senior vice president for government affairs and public policy, in his prepared testimony. Pfotenhauer said abuses that arise during origination “should be addressed in that arena.”
In an attempt to prevent abuses in the origination process, the bill’s provisions include a ban on incentives paid to loan officers and mortgage brokers who steer borrowers into more costly — and more profitable — loans.
Calhoun said the proposed ban on incentives, such as the yield spread premiums collected by mortgage brokers, are “among the most significant reforms proposed” by the bill, as they would eliminate “the perverse incentive to place borrowers in higher-cost loans than they qualify for to maximize brokers’ compensation.”
The National Association of Mortgage Brokers said it supports the concept of “disconnecting compensation” from the origination of specific loan products.
But the group warned that yield spread premiums are not the only form of indirect compensation paid to loan originators. Allowing mortgage brokers to collect such compensation is an incentive for them to do business in communities that are underserved by banks, the group said. Allowing those fees to be folded into a loan allows consumers who might otherwise be unable to cover closing costs to obtain a loan, NAMB maintains.
“The financing of points, fees and indirect originator compensation, regardless of what it is called, helps consumers by lowering the cash needed to close a mortgage transaction while compensating the originator for his or her services,” said Marc Savitt, NAMB president-elect in his prepared remarks.
Pfotenhauer said the Mortgage Bankers Association “might support” a provision forbidding brokers from receiving compensation based on the terms of a loan, but that a better approach would be to require full disclosure of a broker’s compensation when the borrower is shopping for a loan.
HR 3915 would permit borrowers to finance origination fees if they are fully disclosed to the consumer early in the application process, Pfotenhauer said, and that provision “should be clarified to expressly permit the use of yield spread premiums to defray some or all of the borrower’s closing costs through a higher interest rate as well as financing these costs.”
From the perspective of mortgage bankers, the bill’s biggest flaw is that it would not preempt state and local laws, Pfotenhauer said. The current patchwork of state and local laws “is a barrier to the entry of competitors and an enormous compliance burden on those who compete,” the MBA spokesman said.
Although HR 3915 would require all mortgage originators to be licensed by either state or federal regulators, it stops short of creating uniform national lending standards advocated by the MBA.
Currently, the operations of federally chartered banks are governed by several federal regulatory agencies, while states regulate other lending institutions and independent mortgage brokers who arrange loans through multiple lenders.
Some states have stricter rules on lending than those governing federally-chartered banks, while others have fewer restrictions.
HR 3915 would give states two years to adopt laws that meet the minimum standards proposed in the bill. The Department of Housing and Urban Development (HUD) would then draft regulations requiring mortgage brokers in states that don’t pass equivalent laws to act “solely in the best interest of the consumer.”
By allowing states to adopt their own rules rather than putting national standards in place, HR 3915 would establish a floor, leaving the door open for states to adopt even more stringent rules, and allow states that already have stricter rules to keep them.
The MBA favors a single national standard that would preempt state laws.
“No matter how well intentioned, those who advocate that a federal law be a floor — to be supplemented by state laws above and beyond its provisions — the plain fact is that the current patchwork of state and local laws only increases costs for consumers across the market,” Pfotenhauer said. “To add a new federal overlay without subsuming current laws will only add confusion and costs.”
But the Center for Responsible Lending’s Calhoun welcomed the approach taken by HR 3915, saying he was “pleased” the bill did not contain explicit provisions to allow preemption of state laws.
“Over the years, we have seen many states respond swiftly and effectively to the growth of predatory lending practices in their jurisdictions, and we believe that it is critical for states to continue to have the ability to respond to new challenges as they arise,” Calhoun said.
But Calhoun warned that some new regulations the bill envisions federal agencies drafting could be interpreted as preempting state laws under the National Bank Act and the Homeowners Loan Act.
HR 3915 would subject all loan originators — including bank loan officers and mortgage brokers — to a “federal duty of care” requiring them to present consumers with a range of loans appropriate to their existing circumstances and provide full and timely disclosures. The bill would create a nationwide registration system with a unique identification for each loan originator that would be included on all loan documents.
The MBA’s Pfotenhauer called the duty of care approach “far preferable to the establishment of a subjective, vague, suitability-type standard.”
The group said mortgage brokers should be required to disclose the amount of any compensation they receive from the lender funding the loan or that is paid by the borrower.
“Mortgage brokers function as intermediaries to shop for borrowers, and borrowers working only with brokers cease shopping for themselves,” Pfotenhauer said. “The payment from a lender to the broker should be known to the borrower because it affects the borrower’s rate.”
Bank lenders, Pfotenhauer said, “are vendors selling their own loan products. Loan officers are the lender’s representatives and neither they nor lenders hold themselves out as shopping for borrowers. Borrowers shop and compare lenders’ costs. For these reasons, MBA believes that it is appropriate for brokers to disclose any fees from lenders.”
The National Association of Mortgage Brokers maintains that mortgage brokers should be treated no differently than bank loan officers.
“The acts of originating, funding, selling, servicing and securitizing may all be conducted separately and independently, or may be engaged in collectively under one corporate structure or through affiliated business arrangements,” said NAMB’s Savitt. “This is why we believe it is important for consumer protections to relate to the function, as opposed to the structure of an entity. Consumers deserve the same level of protection no matter where they choose to obtain a mortgage loan.”