For Release Upon Delivery
9:30 a.m., May 24, 2000
JOHN D. HAWKE, JR.
COMPTROLLER OF THE CURRENCY
COMMITTEE ON BANKING AND FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
May 24, 2000
Statement required by 12 U.S.C. § 250:
The views expressed herein are those of the Office of the Comptroller of the Currency and do not necessarily represent the views of the President.
Mr. Chairman, Ranking Member LaFalce, and members of the Committee, I appreciate this opportunity to appear before you today to testify on issues regarding predatory lending practices in the consumer credit industry. As you have recognized in the questions posed in your letter of invitation, the proper definition of "predatory lending" remains somewhat unsettled, and, in part for that reason, the scope and extent of the problem are difficult to ascertain. Despite these uncertainties, however, the subject of abusive lending practices raises important supervisory issues for the Office of the Comptroller of the Currency ("OCC") and the other bank and thrift regulatory agencies, as well as significant public policy issues appropriate for Congressional consideration.
While there is legitimate debate over precisely what practices should be characterized and criticized as predatory or abusive, we should all be able to agree that lending practices that take unfair advantage of borrowers are inconsistent with important national policies. For one thing, misleading, manipulative, or otherwise abusive lending practices frustrate our common objective that a competitive market economy should benefit all who participate in it. The competitive market works best when consumers have a wide array of choices and, importantly, the necessary information about price, other terms and conditions, and their available options to make well-advised decisions. Furthermore -- and something I want to emphasize -- many practices that have been characterized as predatory tend, and in some cases may be designed, to strip away borrowers' equity in their homes, and to make foreclosure more likely, if not inevitable. Thus, some forms of predatory lending undermine a central objective of our national social and economic policies for many decades: the promotion of home ownership and its attendant virtues of neighborhood stability, decreased crime, and the building of wealth for a broader spectrum of American families. These practices should be condemned.
My remarks today will focus on four areas, while addressing the specific questions raised in the Chairman's letter of invitation: first, the difficulties associated with defining and measuring predatory lending, and therefore in assessing trends in predatory practices; second, the OCC's supervisory efforts to address predatory lending issues within the framework of existing laws, including the safety and soundness implications of loans that the borrower cannot repay without resort to collateral; third, the limitations of existing laws and the regulatory implementation of those laws; and finally, the legislative proposals relating to predatory lending now pending before the Congress.
As I hope my remarks will make clear, the OCC does have tools at its disposal, under current law, to deal with many abusive lending practices where they exist in the institutions we regulate, and we are fully prepared to use those tools aggressively to combat predatory practices. There are, however, limitations in the current legal framework that reduce the effectiveness of those tools. Legislative action may help to remedy those deficiencies, and is certainly worthy of further discussion. We must always be cautious, however, that legislative intervention be carefully considered so as not unintentionally to obstruct access to credit on the part of borrowers whose credit needs can only be satisfied at rate levels that reflect the higher costs and risks of meeting those needs. I hope that this discussion will yield a better understanding of how to address abusive lending practices while preserving credit access, consumer choice, and competition in the provision of financial services to low- and moderate-income families. I also hope that this discussion will include consideration of increased support for financial education, which may be a necessary adjunct to addressing these issues.
Defining and Measuring Predatory Lending
1. The Concept of Predatory Lending.
The term "predatory lending," while frequently to describe certain abusive lending practices, does not have a common definition. As I indicated in my introductory remarks, there is some uncertainty, and legitimate debate, concerning exactly what practices constitute predatory lending. As a general matter, the term often is used to refer to a variety of practices that typically share one or more of the following characteristics:
loans made in reliance on the value of the borrower's home or other collateral, without a proper evaluation of, or reliance on, the borrower's independent ability to repay, with the possible or even intended result of foreclosure or the need to refinance under duress;
pricing terms -- whether interest rates or fees -- that far exceed the true risk and cost of making the loan;
targeting persons or areas that are less financially sophisticated or otherwise vulnerable to abusive practices, or have less access to mainstream lenders, such as the elderly and persons living in low- or moderate-income areas;
inadequate disclosure of the true costs and risks of the transaction;
practices that are fraudulent, coercive, unfair, or deceptive, or otherwise illegal;
loan terms and structures -- such as negative amortization -- that make it more difficult or impossible for borrowers to reduce their indebtedness;
aggressive marketing tactics that amount to deceptive or coercive conduct;
"packing" of loan contracts with unearned, inadequately disclosed, or otherwise unwarranted fees;
"balloon" payments that may conceal the true burden of the financing and force borrowers into costly refinancing or foreclosure situations; and
loan "flipping" -- frequent refinancings with additional fees which strip equity from a borrower.
It is necessary to make two caveats here. First, it should be noted that certain of the loan terms and structures described above are not inherently abusive. Negative amortization, for example, was a feature of many mortgage loans taken out by informed, middle-class homeowners in the interest rate environment of the 1980's, and helped to make housing more affordable for a wide range of consumers. But, these sorts of provisions can be abusive in other circumstances, particularly where the borrower does not comprehend the relevant risks, or where the provisions are inserted into loan agreements in a deceptive or coercive manner.
Second, the foregoing list of criteria should not, by any means, be construed as a working definition of predatory lending, but instead as an effort to illustrate the difficulty of arriving at a general definition of the term. This difficulty is compounded both by disagreement about what lending practices should be considered predatory and by the fact that the term is used to refer to practices employed in a wide range of loan products and markets. Thus, we should be concerned that any general definition may be over- or under-inclusive, and quite possibly both.
I do not think it is necessary, however, or even particularly helpful, to arrive at a general definition of predatory lending in order to address the particular troubling practices that we should all wish to remedy. In fact, the attempt to do this may simply create confusion and misdirect our efforts to address real problems. In particular, attempts to attack an abstract conception of predatory lending may tend to focus on broad classes of lending activity, and to distract us from the particular troubling practices we wish to address.
For example, the idea that predatory lending is a unified problem, capable of being generally defined, may have contributed to a tendency to equate predatory lending, mistakenly, with subprime lending. While predatory lending may be concentrated to date in a sector of the subprime market, it is important to make clear that not all subprime lending is predatory lending. The OCC, in fact, encourages responsible, risk-based subprime lending to borrowers who are willing and able to repay their loans. Lending to subprime credit applicants, whose credit histories, or lack thereof, indicate a higher than normal risk of default, can be conducted in a fair and responsible manner. The basic principles of such lending should be that it is priced based on risk and cost, that it provides adequate disclosure for full borrower comprehension, and that it contains repayment terms that the borrower appears reasonably likely to meet, based on an assessment of the borrower's ability to repay. Such fair and responsible subprime lending can be of benefit to a wide range of borrowers who might otherwise not have access to credit.
Payday lending, similarly, is often broadly characterized as a predatory type of lending activity, without qualification. This form of short-term credit is often used by consumers -- generally consumers with regular paychecks and bank accounts -- to meet unexpected financial emergencies or other temporary cash flow problems. These loans are often priced at a fixed dollar amount, or a percentage of the loan amount, which, when annualized, produces a very high annual percentage rate. There are, to be sure, some very troubling aspects in the way that this business is conducted by some in the industry. For example, there have been concerns raised about the use of intimidation and unwarranted threats of criminal prosecution in loan collection, unlimited and costly renewals of the initial loan that perpetuate indebtedness, and failures to ascertain whether borrowers are truly in a position to repay the loans in accordance with their terms, or whether the product is otherwise appropriate for them. However, if and when conducted in a responsible manner, with appropriate disclosures and other consumer protections, payday lending can serve a need for short-term credit for some consumers. I believe that such responsible payday lending is possible -- for example, when conducted in conjunction with low-cost electronic accounts linked to direct deposit arrangements.
2. Measuring Trends in Predatory Lending.
It is difficult to determine with any precision the prevalence or the rate of growth of predatory lending. In addition to the lack of generally accepted criteria for classifying a loan as predatory (as discussed above), there are no ready tools for identifying such loans or assembling information about them in order to compile aggregate data. For these reasons, the available information contained in a number of reports describing or analyzing predatory lending and its prevalence is, thus far at least, primarily anecdotal.
Drawing on this anecdotal evidence, some studies have concluded that predatory practices persist to a sufficient degree as to warrant legislative or regulatory action. For example, the Joint Report to the Congress Concerning Reform to the Truth in Lending Act and the Real Estate Settlement Procedures Act, prepared by the Federal Reserve Board and the Department of Housing and Urban Development in 1998, concluded that "[a]busive practices continue to exist in some segments of the home-equity lending market, demonstrating the need for additional protections," and that "substantive protections dealing with predatory lending practices are necessary to ensure that all consumers benefit from reform of TILA and RESPA."
Other studies have indicated that there has been a substantial increase in subprime lending in recent years, and some observers have deduced from this increase in subprime lending that predatory lending activity also is increasing. However, the situation in these markets is too complex to make that judgment based on the information currently available. For one thing, as noted above, subprime lending should not automatically be equated with predatory lending. Furthermore, though it is certainly possible that predatory lending is increasing proportionately to subprime lending -- given that predatory lending is believed to be occurring primarily in subprime markets -- I am not aware of any studies that demonstrate this to be the case. It is also possible that increased competition in subprime markets in recent years from regulated lenders may have reduced to some extent the growth in predatory practices in these markets that might otherwise have accompanied the general increase in activity. However, we simply do not have reliable information adequate to quantify the level of, or trends in, predatory lending at this time.
3. Types of Institutions that Engage in Predatory Lending.
Also relevant to questions relating to the scope of predatory activity -- particularly for the OCC -- is the extent of involvement by national banks and other insured depository institutions. For the same reasons that it is difficult to define and measure predatory lending activity in general, it is also difficult to state precisely the degree to which any particular group of lenders is making predatory loans. This depends greatly on the definition that is employed -- for example, whether all subprime or payday loans are classified as predatory. Reports to date suggest that the problem of predatory lending primarily concerns unregulated lenders -- those not subject to routine examinations. As a general matter, our supervisory and other activities, as well as the other information that has been developed concerning predatory lending practices, have not led us to conclude that national banks and their subsidiaries are engaged to any noteworthy extent in these sorts of practices. I note, however, that the OCC does not examine affiliates of national banks that are not subsidiaries of the bank, and we therefore cannot speak to such entities' lending activities.
It is important to remember, however, that even if predatory activity is not expanding, or being conducted to any significant degree by insured depository institutions, the mere existence of some practices that have such potentially disastrous effects on homeowners warrants the attention of policy makers and financial institution supervisors. For these reasons, the OCC is striving to gain a more comprehensive understanding of predatory lending activity. Through our participation in an interagency working group -- which includes representatives from the bank and thrift regulatory agencies, the Departments of Justice and Housing and Urban Development, and the Federal Trade Commission -- we are working to learn more about predatory lending issues and to formulate possible responses.
Other government agencies have undertaken projects in the past few months that could shed further light on the issues surrounding predatory lending. For example, the Departments of Treasury and Housing and Urban Development ("HUD") recently established a task force on predatory lending practices that is holding public forums around the country to ascertain the dimensions of the problem (including the types of lenders involved and the impact of the secondary market on predatory lending) and to assist in formulating protective measures. In addition, the Office of Thrift Supervision ("OTS") has issued an Advance Notice of Proposed Rulemaking that seeks, in part, to gather information and views about predatory lending practices, including by state-chartered, non-depository institution creditors that are covered by the OTS regulations. We look forward to the results of these initiatives, and to using the information developed to assist us in determining what supervisory or regulatory actions -- in addition to those, discussed below, that we have already taken or are currently pursuing -- may be appropriate for us to take in this area, either alone or on an interagency basis.
4. The Role of the Secondary Market.
The Chairman's letter of invitation specifically asked me to address the impact of the secondary market on the incidence of predatory lending. There is strong evidence that, in contrast to a decade ago, there is a significant secondary market for subprime consumer debt instruments. And, it is certainly likely that this secondary market has functioned, in part, to finance the extension of more subprime loans than would otherwise have been made. To the extent that some of these additional loans may possess predatory characteristics, and assuming no change in practices due to the influence of secondary market participants, then it can be said that the secondary market has helped these practices to persist and, at least in a marginal sense, to expand beyond what would have existed had this secondary market not developed.
Recently, the two principal government-sponsored housing enterprises -- Fannie Mae and Freddie Mac -- each announced initiatives to help ensure that their very significant participation in the secondary mortgage markets does not lend support to predatory lending practices. Among other things, these institutions both have indicated that they will require full-file reporting of borrower payment histories; will not purchase loans involving single-premium credit insurance; will require limitations on prepayment penalties to ensure that such provisions are not being employed in an abusive manner; and will not purchase loans that are priced so high as to qualify as "high-cost home loans" under the federal Home Ownership and Equity Protection Act. One or both of these entities also will implement enhanced due diligence and audit review; adopt procedures to prevent the purchase of loans with excessive fees and points, or that are priced above the level justified by the borrower's risk profile; and undertake reviews to ensure that loans have been made with an adequate analysis of the borrower's capacity to repay. While it is clearly too early to judge the effectiveness of these measures, it is certainly possible that substantial initiatives by Fannie Mae and Freddie Mac will have a salutary effect on the level of predatory lending by directing secondary market financing toward responsibly-made subprime loans.
OCC Supervisory Efforts to Address Predatory Lending Issues
I believe it is important for the OCC vigorously to confront predatory lending issues if and as they arise, and try to prevent problems whenever possible. Our efforts to address predatory lending concerns have, to date, been focused upon ascertaining, and using the tools we do have to stem, potential problems. The OCC is fully prepared to use these tools to combat objectionable lending practices, and we will employ our supervisory powers -- including safety and soundness, fair lending, and consumer compliance examinations -- to address lending practices that can be characterized as abusive or predatory.
1. Safety and Soundness Supervision.
One of these tools -- and one particularly appropriate to our role as banking supervisors -- is to review, criticize, and require action to correct the adverse safety and soundness implications of predatory loans. This approach encompasses not only the legal, compliance, and reputation risks associated with such loans, but also the more traditional credit risks presented by some predatory practices: for example, lending under circumstances where the lender cannot reasonably expect repayment of the loan without resort to a foreclosure on the collateral. Lenders following safe and sound lending practices will assure themselves that the borrower has the capacity to repay without resort to collateral, taking into account all of the borrower's obligations, including other indebtedness, insurance, and taxes, as well as principal and interest. These principles should apply not only to loans that the institution originates but also to loans that the institution purchases from an affiliate or a third party.
As I suggested previously, lending in reliance on collateral, without an analysis of the borrower's capacity to repay, raises serious supervisory concerns, particularly when credit is extended on the basis of a homeowner's equity. There are significant social implications to lending transactions in which people who cannot afford credit place their homes at risk of foreclosure. Difficulties in repayment not only risk loss of the home, but also the depletion of accumulated home equity -- a primary source of wealth building for many Americans. It is hard to see how such loans could be suitable for the borrower.
These transactions also raise fundamental supervisory concerns for the OCC as a bank regulatory agency, concerns that we believe can be addressed through our safety and soundness examinations and other supervisory activities. In our view, a loan for which there is no reasonable expectation of repayment without recourse to collateral is presumptively an unsafe and unsound loan, and making or purchasing such loans on a regular basis is inconsistent with safe and sound banking practices.
This is a fundamental principle of safety and soundness supervision. To emphasize the application of this principle in the specific context of consumer home lending, we plan to direct our examiners to be actively watchful for loan policies or practices that permit loans to be made without a reasonable expectation of repayment absent resort to a borrower's home equity. In appropriate circumstances, examiners also will be instructed to review a sample of loan files to help ensure that loans are not being made in contravention of this principle.(1) Loans predicated on real estate collateral where the borrower does not demonstrate the capacity to repay the loan as structured will be adversely classified, and, depending on the specific circumstances presented, further accrual of interest may not be allowed. Further, we are prepared to take enforcement action against any unsafe and unsound practices that we find in this area -- including practices that raise unwarranted legal or reputation risks -- under the enforcement authority Congress granted to us in the Federal Deposit Insurance Act.
In addition, if examiners find particular loan terms, lending practices, or other factors that may indicate a heightened risk of problems in this area, we will take a closer look, from both safety and soundness and other appropriate perspectives. For example, if a lender is making loans in circumstances where a reliance on collateral is apparent or likely -- as in cases involving very high debt-to-income and low loan-to-value ratios -- and other features associated with abusive lending practices are present, the situation will be referred to consumer compliance or fair lending examiners for further review.
2. Use of Chartering and Licensing Process.
The OCC's supervisory function also is carried out through our chartering and licensing role with respect to national banks and their subsidiaries. In this role, we act to ensure the safe and sound operations of national banks and their subsidiaries, as well as the objectives of the other statutory and regulatory factors we are required to consider when acting on proposals such as bank mergers and new national bank charters.(2) When confronted with proposals involving subprime lending that require our approval, we have acted to ensure that any such lending activity by national banks or their subsidiaries will be conducted responsibly, and with appropriate consumer protections, in accordance with the applicable legal criteria. We will continue to do so in the future, and will not approve proposals that are inconsistent with these principles.
3. Enforcement of Consumer Protection and Fair Lending Laws.
A third aspect of our supervisory role is to enforce consumer protection and other laws applicable to national banks. I noted previously that one characteristic often associated with predatory lending is the targeting of products toward persons or areas that are less financially sophisticated or otherwise vulnerable to abusive practices, or have less access to mainstream lenders. In addition, abusive practices may be targeted toward particular consumers or groups of consumers on the basis of age, race, or other prohibited bases in violation of the Equal Credit Opportunity Act or the Fair Housing Act. We will bring enforcement action where we find such violations.
We also examine banks for compliance with specific laws that may be relevant to predatory lending practices, particularly the disclosure provisions of the Truth in Lending Act ("TILA") and the special provisions for high-cost home loans included as part of the Home Ownership and Equity Protection Act ("HOEPA"). We expect strict compliance with both the substantive limitations and the disclosure requirements of these consumer protection laws. I note that, in addition to engaging in an unsafe and unsound banking practice, a bank or other lender engaged in a pattern or practice of making high-cost home loans based on consumers' collateral, without regard to repayment ability, is in violation of HOEPA.
Moreover, we recognize that predatory practices, in and of themselves, may warrant enhanced fair lending and consumer protection scrutiny to ensure that customers of these lenders are not being made the victims of discrimination or other illegal practices. In the near future, the OCC will be issuing an advisory to our examiners identifying particular factors associated with abusive lending practices that may indicate an increased risk of illegal discrimination or noncompliance with consumer protection laws (as well as harm to the bank's reputation). On the fair lending front, this advisory will be used to help set the scope and focus of our fair lending examinations, and will supplement our ongoing efforts to identify circumstances indicating a higher than normal risk of illegal discrimination.(3) In addition, if we find that a bank has a high risk of noncompliance with the fair lending laws on account of these factors, we will take appropriate supervisory action, such as conducting a special, targeted fair lending examination to review, for example, issues relating to racial steering or the use of differential pricing on a prohibited basis.
4. Prevention of Unfair or Deceptive Practices.
Many lending practices that may be characterized as abusive or predatory can be treated as unfair or deceptive trade practices, which are illegal under the Federal Trade Commission Act. Where warranted by the facts presented in individual cases, the OCC is prepared to take action against national banks or their subsidiaries engaging in unfair or deceptive lending practices.
Alternative Mortgage Transaction Parity Act and State Law Preemption
In your letter of invitation, you asked us to address certain matters relating to the preemption of state laws that directly or indirectly affect predatory lending practices. The OCC's regulations with respect to real estate lending, under long-standing principles of federal preemption and specific authority Congress granted in the Alternative Mortgage Transactions Parity Act ("AMTPA"), are specifically directed to certain state laws restricting the ability of lenders to offer variable-rate and other nonstandard mortgage loans, including state limitations on prepayment fees. The AMTPA portions of this regulation also apply to state-chartered banks. The OCC's AMTPA regulation does not affect non-depository institution lenders. The OTS has similar, somewhat broader rules applicable to federal and state thrifts and state-chartered non-depository institution housing creditors.(4) Recently, the OTS issued an Advance Notice of Proposed Rulemaking that seeks, in part, to gather information and views about predatory lending practices, including the possible effects of that agency's AMTPA regulations on the fees charged by non-depository institution lenders.
Although not, strictly speaking, a matter of preemption, it also should be noted in this context that under federal law, national banks, state banks, and thrifts generally may charge the interest rates permitted by the states where they are located in transactions with borrowers located in other states, even if the law of the borrower's state would not permit such charges. This is essentially a choice of law principle that Congress has enacted to afford multistate lenders the benefit of operating under a single set of rules.
It is questionable, however, whether these choice of law principles have had a significant effect relating to predatory lending. These principles relate to insured depository institutions, and, as noted previously, there is little evidence to indicate that such institutions are involved to any significant degree in predatory lending. As noted previously, however, we will use the information developed by the OTS in its pending rulemaking in this area to assist us in determining what additional supervisory or regulatory actions may be appropriate for us to take.
Legal and Regulatory Limitations
While there are some tools that the OCC and the other federal financial institution supervisory agencies have, there are limitations in the existing legal and regulatory framework that might help to permit abusive lending practices to persist. For the most part, these limitations and the related troublesome practices raise policy issues appropriate for Congress to consider, though there are some actions that supervisory agencies may be able to take as well, under existing authority.
On the legislative side, it should be acknowledged that the current HOEPA requirements are fairly easy to avoid. First, they apply only with respect to a narrow range of loan products -- closed-end refinancings and home equity loans secured by the borrower's dwelling -- and thus can be circumvented simply by structuring the loan as an open-end home equity credit line. Moreover, HOEPA requirements apply only if the interest rate or other pricing for the loan is very high, and thus can be avoided by pricing just below the HOEPA thresholds. The HOEPA sets the annual percentage rate threshold for the applicability of its special disclosure requirements and substantive protections at 10 percentage points over the yield on U.S. Treasury securities with a comparable maturity. HOEPA also empowers the Federal Reserve Board to lower this threshold to 8 percentage points in certain circumstances. Finally, HOEPA addresses only a specified range of problematic practices, albeit an important subset of the practices often classified as predatory.
The remainder of TILA, outside of the HOEPA provisions, is addressed primarily to disclosures about loan costs: the annual percentage rate and finance charge. TILA does not, as a general matter, impose substantive limitations on loan pricing or other practices. Moreover, the TILA disclosure requirements may not cover loan terms and other practices that could have potentially disastrous consequences for some borrowers. To take one example, a principal criticism of payday loans is that they frequently are rolled over several times before they are finally paid off, with additional fees being assessed at each renewal just as though a new loan were being made. Borrowers trapped in this cycle find it very difficult to escape their indebtedness, in part because they may soon find themselves paying the lender all of what they borrowed in the form of fees, yet still owe the entire principal. It is noteworthy that, under TILA, a borrower approaching a payday lender will not receive a disclosure indicating the total finance charges that may be imposed, assuming an average, or maximum permitted, number of rollovers.
Other laws are similarly limited. The fair lending laws may not implicate these practices, so long as they are employed against all borrowers regardless of age, race, or other prohibited bases. The Federal Trade Commission Act ("FTCA") generally bars unfair or deceptive acts or practices, which would seem to encompass most lending practices that are characterized as predatory. In this regard, both HOEPA and the FTCA authorize the issuance of regulations to specifically prohibit acts or practices found to be unfair or deceptive. Under HOEPA, which applies to mortgage loans, this authority rests with the Federal Reserve Board, and under the FTCA, this authority is divided between the Federal Trade Commission and certain other agencies, including, with respect to banks and thrifts, respectively, the Federal Reserve Board and the OTS. The very limited use of this regulatory authority to declare certain practices to be unfair or deceptive limits HOEPA's and the FTCA's effectiveness in proscribing predatory practices and make it more difficult for the OCC and other agencies to bring enforcement actions to correct these practices.
Another, less direct, way in which we can address predatory lending practices is to encourage responsible competition in lending to low- and moderate-income and other communities that may be targeted by predatory lenders. The OCC has issued guidance relating to the responsible conduct of subprime lending activities, both on its own and as part of the Federal Financial Institutions Examination Council. Furthermore, our examination and other activities relating to the CRA also are designed to promote competitive alternatives for low- and moderate-income borrowers. We will continue to explore, both on our own and on an interagency basis, how we might be able to make more effective use of these and other tools to enhance competition in the provision of financial services to low- and moderate-income consumers. For example, greater encouragement for the development of low-cost electronic accounts linked to direct deposit arrangements could result in lower-cost, less risky credit alternatives to the kind of payday lending that now is carried on in some communities. Another idea that I think has great promise in this area is the consortium bank, through which a number of institutions could join together to provide loans and other banking and financial services in underserved communities.
Finally, many have raised a significant regulatory concern about the appropriate consideration under the CRA of loans -- whether made or purchased -- that can be characterized as abusive or predatory. Certainly, it is fair to ask how an institution can be helping to "meet the credit needs of its entire community" if it engages in lending that is designed to strip equity from low- or moderate- income homeowners. Others have raised questions about the CRA treatment of routine business financing arrangements in which an insured depository institution might make a loan to a company engaged in predatory lending practices. The bank and thrift regulatory agencies need to address how loans with these characteristics could be identified in a CRA exam and whether they should receive discounted, or no, CRA credit, or even "debits" akin to the treatment of loans found to be discriminatory. I welcome the opportunity to work with our fellow regulators on an interagency basis to achieve a consistent interagency approach to this issue. In addressing these issues, we will need to be careful to ensure that we target abusive practices in a manner that will not have the unintended effect of discouraging responsible financial institutions from serving low- and moderate-income areas and families with both prime and subprime credit products that carry appropriate risk-based pricing. While it is certainly anomalous to give CRA credit for loans that harm, rather than help, communities, it could be even more unfortunate to attack this problem in a way that undermines the CRA's central purpose of enhancing credit access.
1. Matters Warranting Legislative Consideration.
Because of the limitations of the current legal framework, and the importance of the public policy issues raised by predatory lending practices, it is appropriate for the Congress to be considering proposals to address these issues. Many of the concerns raised in connection with abusive lending practices involve important questions of social and economic policy that are appropriate for legislative deliberation.
As the Committee is aware, there are various bills now pending in the Congress to respond to predatory lending issues. I commend the sponsors of these bills for putting forth proposals that will generate needed policy debate on these matters. These proposals have the potential to fill gaps in the current statutory and regulatory scheme, and to address many of the concerns that have been raised about abusive lending practices. For one thing, they build on the existing framework in HOEPA, which is targeted to preventing abuses that place a family's home and home equity at risk. The case for Congressional intervention against abusive practices is clearly strongest in just these circumstances, where such practices tend to undermine the important national priorities associated with home ownership. Pending proposals would expand HOEPA requirements by including more types of products (such as open-end home equity lines of credit), tightening existing requirements on practices such as negative amortization and balloon payments, and other mechanisms, as well as by lowering the threshold for covered loans.
Rather than simply declaring "predatory practices," however defined, to be unlawful, these bills instead focus on specific improvements to be made to existing law and the consumer credit markets. For example, many of the proposals are designed to strengthen the safety and soundness principle I discussed earlier in connection with the OCC's supervisory policies: lenders should not extend credit without analyzing the borrower's ability to repay the loan, and satisfying themselves about the prospects of being repaid without resorting to a foreclosure on collateral. Whereas current law bars such activity in connection with HOEPA-covered loans only where the activity amounts to a pattern or practice, the proposals generally would provide that any failure to perform such an analysis would be a violation of the statute.
Another positive aspect of the bills, which I am very pleased to note, would require the "full file" reporting of positive payment performance to credit bureaus, so that borrowers who deserve more favorable credit terms are more likely to have access to them. More than a year ago, I began to speak out on the unfairness to consumers, particularly subprime borrowers, of lenders' failing to report a borrower's payment history to credit bureaus. When satisfactory payment performance is not made a part of credit reports, consumers are deprived of the ability to establish or improve their credit profiles, and thereby qualify for the lower-cost loans that their actual credit histories would say they deserve.
Because predatory lenders may target consumers who are less financially sophisticated, it is critical that any legislative effort include, as some of the proposals do, a focus on enhanced disclosure of loan terms and consumer financial counseling in an effort to ensure that borrowers are more likely to understand their loan transactions. I have stated previously that predatory lending and financial illiteracy go hand in hand, and that part of the solution to the predatory lending problem is to educate borrowers to understand their obligations and options, legal and financial. Thus, I would urge Congress to explore a number of possibilities for further encouraging and supporting financial education and literacy.
Further, the bills raise other matters that may warrant legislative attention. For example, some proposals would expand Home Mortgage Disclosure Act reporting requirements to include loan pricing information. Before such a requirement is enacted, of course, I would hope that the additional paperwork burden on mortgage lenders -- and associated costs to consumers -- will be carefully assessed. Still, this proposal is a useful introduction of the idea that some mechanism may need to be constructed for obtaining better information about lending practices.
Finally, I hope that the pending bills spur a serious and comprehensive debate that would take up a number of other matters related to predatory lending and address weaknesses in existing law or regulation that I noted earlier, including:
defining more particularly what practices are unfair or deceptive for purposes of both HOEPA and the Federal Trade Commission Act, a subject that is introduced by at least one of the pending proposals;
enhanced disclosures for payday loans so that borrowers are aware of the total finance charges that eventually may be imposed if they are not in a position to repay the loan in accordance with its terms without multiple rollovers;
fortifying the enforcement mechanisms under existing laws, particularly for lenders not subject to routine examinations; and
considering whether other important consumer assets -- such as retirement savings accounts -- should receive special protection from abusive lending practices akin to that now afforded to homes.
I recognize, of course, that the ensuing debate will not be able to address all possible issues in consumer credit markets. For example, broader TILA and Real Estate Settlement Procedures Act reform of the sort discussed in the 1998 joint study by the Federal Reserve Board and HUD, including a general review of whether TILA disclosure requirements are sufficiently inclusive to ensure borrower comprehension of loan costs, should be taken under consideration as soon as it is feasible, but need not impede a more immediate effort to address abusive lending practices.
2. The Need to Preserve Credit Access for Low- and Moderate-Income Persons.
I also hope that this debate results in legislative action that addresses concerns about abusive lending practices without obstructing fair access to credit. While I will defer comment on the merits of other aspects of the pending bills, I urge the Congress carefully to consider all the potential consequences of the different proposals for reform. It is important that any reform not have the unintended consequence of interfering with the flow of credit or limiting the availability of legitimate credit options, including responsibly-made subprime loans. This is perhaps especially important for low- and moderate-income persons and underserved communities. For example, at some point, lowering the interest rate and fee thresholds for loans subject to the HOEPA restrictions risks limiting credit access for subprime borrowers. Further, a general ban on prepayment premiums could limit a consumer's product choices and ability to negotiate other concessions, such as a reduced interest rate, in exchange for accepting the risk of a prepayment premium. Such a ban also could raise safety and soundness concerns, and constitute a subsidy to one class of consumers (those who prepay) at the expense of another (those who do not).
Thus, while we clearly need to address the real abuses that exist, particularly in connection with home loans, we also need to preserve and encourage, to the greatest extent possible, consumer access to credit, meaningful consumer choice, and competition among responsible lenders in the provision of financial services to low- and moderate-income families. Determining how to draw the line between predatory and legitimate credit practices in a way that will both combat abuses and advance these other objectives is the great challenge of this effort.
1. These examiner instructions will be issued either in the form of an OCC advisory or through the Federal Financial Institutions Examination Council on an interagency basis.
2. For example, under the OCC's regulations, a charter proposal must include plans for achieving appropriate Community Reinvestment Act ("CRA") objectives (including compliance with the fair lending laws), for attracting and maintaining community support, and for serving the community consistently with the safe and sound operation of the bank.
3. Conversely, we also are exploring whether our ongoing efforts to identify fair lending-related risks (in connection with implementation of our risk-based approach to fair lending examinations) may have the collateral benefit of helping us to ascertain which institutions are more likely to be engaged in abusive lending practices that should be targeted for scrutiny under the consumer protection laws and safety and soundness standards.
4. Both the OCC and the OTS regulations were promulgated shortly after the passage of the AMTPA in the early part of the 1980's, a time of relatively high interest rates when Congress sought to ensure the continued flow of housing credit by permitting greater flexibility in mortgage loan terms.