THE FINANCIAL SERVICE ROUNDTABLE
The Financial Services Roundtable
United States House of Representatives
Committee on Banking and Financial Services
May 24, 2000
My name is Steve Bartlett and I am the President of The Financial Services Roundtable. In my testimony today, I will explain how millions of Americans benefit from subprime lending and propose to this Committee an approach that will help put predatory lenders out of business.
The Financial Services Roundtable is a national association whose membership is reserved for 100 companies selected from the nation's 150 largest integrated financial services firms. The member companies of the Roundtable engage in a wide range of financial activities, including banking, securities, insurance, and other financial service activities.
The Roundtable is a CEO-driven association that advocates the interests of integrated financial institutions primarily in the Congress, the federal agencies, and federal courts.
The Roundtable commends Chairman Leach and Ranking Member LaFalce for holding this important hearing today. I had the great honor of serving on this influential Committee in the 1980s when many laws were written to help promote housing opportunities for all Americans. I am pleased that the Committee continues its long tradition of promoting honest and open discussion on topical and important issues such as those we are addressing today. This hearing will help the Committee to identify the scope of the predatory lending problem, to consider potential solutions to protect victims of unscrupulous and unethical mortgage brokers and lenders and to do so in a manner that preserves the subprime market that helps millions of Americans receive access to credit markets when they might not have otherwise.
Let me begin by stating clearly for the record that illegal "predatory lending" exists and should be stopped. Sadly, there are lenders and brokers who use illegal and unethical techniques to prey on homeowners. Such individuals use high pressure sales techniques, provide incomplete or incorrect information, and use other deceptive practices that lead to consumers losing some or all of the equity in their home, and in some cases, to eventual foreclosures.
The Financial Services Roundtable strenuously objects to predatory practices and supports appropriate policy changes and regulatory efforts that will help protect homeowners from abusive lending practices. My testimony will provide a clear and specific approach to fighting predatory practices that relies on better enforcement of existing laws.
However, predatory lending and subprime lending are not one and the same. It is important for the Committee to know that several of the legislative proposals to address the problem of predatory lending will have unintended consequences on the millions of American homeowners who have better housing due to the subprime market.
I am here today to talk about a few of the unintended consequences. But first, let me define subprime lending in layman's terms. Subprime lending is a flexible approach for lending to borrowers with little or poor credit experience. This credit history serves as a barrier to traditional or conforming credit markets. Subprime loans are priced according to risk, although pricing is only one characteristic of such loans. Subprime lending also includes structuring payments, offering credit enhancements, and providing otherwise nontraditional loan terms to allow customers to best meet their financial needs.
Loans are considered to be subprime for several reasons, including no prior credit experience, poor credit history or high debt to income ratios. Risk-based pricing techniques, which many lenders employ, dictate that such loans are priced according to increased risk, and so, such loans often have higher rates than so called "prime" loans.
My experiences as President of The Financial Services Roundtable, as Mayor of Dallas, and a member of this Committee have taught me that subprime lending has played an important role in the growth and quality of American homeownership. Today, close to seventy percent of American's own their own home, an all time record in this country and the highest rate of any nation in the world.
Subprime lending has contributed not only the rate of home ownership, but also to the quality of homeownership. Borrowers who rely on subprime loans for funding repairs such as a fixing leaky roof, replacing aging plumbing or installing a new water heater would have reduced access to credit if hastily crafted legislation is adopted. While I don't want to overstate the role of this market, for certain consumers, subprime borrowing serves as an important tool, and sometimes the only tool, for improving the quality of their housing and their credit.
Subprime loans allow individuals that several decades ago may not have been considered creditworthy to achieve the dream of homeownership, provide opportunities consumers to improve the quality of their housing and provide sufficient and appropriate flexibility for homeowners to meet many of their financing needs. When I was Mayor, I learned from my constituents how access to credit, through the subprime markets, had opened the doors to a better life.
So who benefits from subprime loans? For the most part, they are working men and women of moderate income. They may be just starting out and looking to establish a credit history, or they may have had past credit problems and are seeking to reestablish their credit. Many of these borrowers, after establishing a good payment record with a subprime lender, can thereafter qualify to borrow from other lenders at the best rates offered to consumers. Subprime customers include a college student jut starting his or her first job and looking to establish a credit history. Or, a single mother whose husband has left her with a child and a poor record of bill repayments. Or a middle-aged couple seeking to repair a poor credit history. Or a couple with a sick child that has been unable to make timely credit payments due to massive health care expenses.
It's ordinary Americans that benefit from subprime lending. And, ordinary Americans will be closed out of credit markets and homeownership if legislation or regulation shuts down legitimate subprime lending activities by responsible lenders.
I will repeat my earlier statement that there are individuals and firms which engage in predatory lending practices. The Roundtable strongly supports efforts to identify, investigate, and prosecute abusive individuals and companies. However, the Roundtable is concerned that some proposals that have been put forward have the potential to limit or even prohibit many legitimate lending practices that allow millions of Americans to achieve their financial dreams.
Let me provide several examples of practices that some have identified as "predatory" but, in practice, provide borrowers with the flexibility to receive loans that meet their needs. One example, is "balloon payments." These loans allow for lower up front payments, with a larger payment at the end of the loan term. Some proposals would prohibit balloon payments on certain loans. But take the example of a person who is only expecting to stay in their home for several years. For such a person, a balloon loan might be the most appropriate type of loan.
Another example involves proposals to limit or prohibit the sale or financing of optional credit insurance. Credit insurance, like other types of insurance, protects policyholders who face adverse circumstances in the event they lose their job or have a run of bad luck. Responsible lenders make this product optional and clearly state that it is not a condition of the loan. Under current laws, customers must sign a separate request for this insurance before it can be sold. Some lenders also allow a "free-look" period during which the borrower can cancel their policy and receive a full refund of their premiums. Some have questioned whether this product should be paid up front and financed over the life of the loan, but the Roundtable believes that there is a good reason for this approach.
What happens when a borrower who is purchasing credit insurance on a monthly basis faces adverse financial circumstances? Unfortunately, in such cases, the borrower may choose to cancel their policy and lower their monthly payments just at the time they may need insurance protection the most.
Other proposals would limit financing of points and fees into the principal balance of the loan. While I was Mayor, I heard from many constituents that the biggest obstacle to homeownership was closing costs. Many borrowers simply cannot afford to pay upfront the necessary and routine closing costs that are required for all borrowers, not just subprime borrowers, to enter into a real estate loans. These costs including appraisal fees, title insurance, discount points and origination fees. To prohibit lenders from financing these costs would simply deny access to credit to many otherwise qualified borrowers.
It also has been suggested that borrowers should be required to obtain credit counseling prior to entering into a subprime loan. While this may sound on the surface to be a good idea, there are practical implications. Apart from the reasonable resistance that many borrowers would have to this intrusive requirement, the number of qualified, HUD-approved credit counselors is extremely small, and the ultimate result would be, again that many otherwise qualified borrowers would be denied access to credit.
Limiting points or fees to a percentage of the loan amount could hurt lower income borrowers seeking small loans. Up-front fees are used to cover fixed costs for the loans. If closing costs are limited, lenders cannot cover their expenses to set up smaller loans. Further, it should be noted that fees and points are part of the overall pricing structure that reflects inherent risks. If points are limited, then access to credit for many borrowers will be limited as well.
Yet another example is so-called "negative amortization." Negative amortization occurs when payments are low, interest is added to the loan's principal and the loan does not provide a way to reverse this process. However, negative amortization is not harmful in every situation. Take for example a loan with an adjustable rate but with a fixed payment. Such a loan benefits consumers that wish to have a predetermined monthly payment, but also want the advantages that come with a floating rate note. Depending on interest rates, such a loan could have negative amortization for some period of time. This is appropriate, particularly since interest rates are capped on these loans and the possibility of negative amortization has been disclosed.
Some proposals suggest, with all good intentions I'm sure, imposing caps on interest rates. No matter the good intentions, however, usury caps have always had the unintended consequence of shutting out some individuals from the credit markets.
As the examples I have just provided demonstrate, many of lending practices that some may identify as "predatory" are actually innovative and flexible methods that, when used properly, help segments of society that several decades ago were denied access to credit markets. So what can be done to address those anecdotal but real cases where unscrupulous lenders take advantage of unsophisticated borrowers?
The good news is that regulators and prosecutors already have widespread tools available to combat predatory practices. While I will defer to my fellow panelists to provide more detailed explanations of these, I will briefly highlight a few of these tools. First, the Home Ownership Equity Protection Act imposes restrictions on high cost loans. The Truth-in-Lending Act requires that lenders disclose costs and fees in a uniform and consistent manner. Perhaps most importantly, the Truth-in-Lending Act gives all home equity borrowers the right to cancel their loan, without obligation, for any reason at all, for three days following loan closing. The Real Estate Settlement Procedures Act requires additional disclosures and the payment of fees to brokers that do not perform substantial services. The Equal Credit Opportunity Act makes discrimination illegal and requires clear and standardized notification of the reasons for credit denial.
Under existing laws, the Federal Trade Commission and many states have broad authority to address "unfair and deceptive practices." In fact, the FTC's record in obtaining judgements against a number of predatory lenders suggests that they have a great deal of authority to take action. Here in Washington, D.C. there is a highly publicized case where the FTC cracked down against a lender who engaged in abusive practices. This case alleges that a mortgage company misrepresented an interest-only balloon payment as an amortizing loan, illegally withheld loans proceeds, foreclosed on borrowers that met their loan terms and imposed borrower penalties without legal merit.
In another recent case, the FTC, working with the Departments of Justice and Housing and Urban Development, filed suit against a consumer finance company. The lawsuit alleges that the company violated federal law by engaging in a pattern or practice of lending. According to the FTC, the company's "practice of approving loans without regard to borrowers' ability to repay exposed borrowers to unwanted risk of default and foreclosure."
A third example of the FTC's success is "Operation Home Inequity" which resulted in settlement by seven mortgage lenders. FTC action resulted in the lenders paying civil money penalties, providing funds for customer redress and agreeing to discontinue certain practices.
Despite these successes, more can be done. The Roundtable supports additional common-sense reforms. First and foremost, the Roundtable encourages the Congress to work with the FTC and other regulators to ensure that federal agencies have appropriate monetary and staff resources to enforce existing laws.
Additionally, the Roundtable encourages the Federal Reserve Board to use its broad authority granted under HOEPA to take appropriate steps to crack down on abusive lending practices. Further, the Roundtable encourages the agencies to help educate consumers to identify and protect themselves from predatory lenders. The Roundtable and a number of our member companies would work gladly with the agencies in this regard.
The Roundtable also suggests that further research be undertaken to better understand the scope and causes of predatory lending as well as the benefits that have accrued from subprime lending. This information can then be used to devise a targeted solution to predatory lending that will not limit subprime borrowers access to credit from responsible lenders.
The Financial Services Roundtable shares the concern of every member of this Committee about abusive lending practices. The Roundtable calls upon policymakers, consumer groups, the lending industry, and other interested parties to work together to promote responsible lending practices and the American Dream.
The Roundtable believes reform can protect consumers from abusive practices while preserving affordable access to credit for all Americans. Once again, Mr. Chairman, Ranking Member LaFalce, thank you for giving me the opportunity to appear before this Committee and I will be glad to answer any questions that the Committee might have.