ON BEHALF OF
THE CONSUMER BANKERS ASSOCIATION
PREDATORY LENDING PRACTICES
THE COMMITTEE ON BANKING AND FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
MAY 24, 2000
Good morning. I am Ralph Rohner, Special Counsel to the Consumer Bankers Association. CBA represents most of the major banks engaged in consumer lending. CBA members include most of the top bank holding companies and hold two-thirds of the industrys total assets, including billions of dollars of expanding lending activity in subprime markets.
We are pleased to participate, with the Committee and with our colleagues on the panel, in this effort to address the problem of unfair and deceptive mortgage lending.
On this subject, CBA is an agreeable group to a point.
We quite agree with the observations from regulators, legislators and others that the growth of subprime, or maybe better called risk-based, mortgage products has been healthy for our economy, and of enormous value to consumers with imperfect credit profiles. That growth has permitted more consumers than ever before to purchase, improve or retain their homes, at affordable prices, in mainstream mortgage markets. The data on mortgage volumes, including the encouraging figures on loans to minorities and in previously under-served communities, are a source of great pride to the banking industry.
The past decade has witnessed a virtually unprecedented economic boom. In particular, credit to low and moderate income borrows and to minorities has exploded in recent years, and this expansion has been shared by all sectors of the economy. It has been called by some the democratization of credit.
As Federal Reserve Board Governor Gramlich recently observed, conventional home-mortgage lending to low-income borrowers between 1993 and 1998 increased nearly 75%, compared with a 52% increase for upper-income borrowers. Conventional mortgages to African-Americans increased 95%, and to Hispanics 78%, over the same time period, compared to a 40% increase overall.
That expansion has been due in part to a good economic run, innovative alternative credit products, and other factors. Certainly, much of the credit goes to banks for their outreach efforts in lower-income communities. But all the evidence suggests that much of the increase is also the result of the dramatic growth in risk based lending.
CBA also agrees that there are continuing problems in segments of the mortgage market, instigated by unscrupulous lenders or brokers who through deception, distortion or fraud impose on mortgage borrowers obligations that are simply unconscionable. This recognition, however, ought not surprise anyone. Deceptive and heavy-handed lending practices are not new; there have always been rogues or out-riders willing to skirt the boundaries of the law to take advantage of consumers who are vulnerable, out of lack of sophistication or out of sheer desperation. The right to "cool off" and rescind certain mortgage transactions was included in the original Truth in Lending Act more than 30 years ago for just that reason. And Congress acted again, in the Home Ownership and Equity Protection Act (HOEPA) of 1994, to curb abuses in these riskier mortgage markets. It is regrettable that the problem of over-reaching persists, and perhaps has increased with the growth of subprime lending, but its persistence is altogether predictable.
The question before us today is what can be done effectively to curtail unconscionable mortgage lending.
1. Step one, CBA believes, is to recognize that virtually every instance of bad practices reported in the court cases and in the press is riddled with deceptive and hard-sell practices, distortion and ignoring of existing rules on disclosure and documentation, and outright fraud. These patterns do not need new law. They need effective enforcement of existing law, by the Federal Trade Commission and the banking agencies at the federal level, and by the attorneys general and similar officials at the state level. There is nothing like a visible, active "cop on the beat" to discourage and apprehend law breakers.
Numerous laws, state and federal, already exist in this area. On the federal level, the Truth in Lending Act (TILA) creates a regime of disclosure that includes the APR, a figure that represents the cost of credit and is intended to permit comparison shopping. TILA includes numerous additional disclosures and consumer protections, designed, for the most part, to inform the consumer of the terms of the loan transaction. The HOEPA amended TILA in 1994 in order to deal with many of the issues that we are discussing today. HOEPA defines a class of "high cost" home loans, which have closing costs of 8 points or more, or have an annual percentage rate (APR) 10 points above Treasury rates with comparable maturities. HOEPA loans have additional disclosures beyond those normally required by TILA, and HOEPA prohibits a number of practices. Balloon payments are prohibited within the first 5 years of the loan; certain prepayment penalties are also prohibited; as is negative amortization and some advance payments. It is a violation of HOEPA to engage in a pattern or practice of making loans without regard to the consumers ability to repay, or to make direct payments to home improvement contractors.
Other federal laws also address many consumer protections relevant to the issue of predatory lending. The Real Estate Settlement Procedures Act (RESPA) requires that consumers be provided with timely information about the nature and costs of the real estate settlement process, including the costs of obtaining a mortgage loan. RESPA also protects consumers from unnecessarily high settlement charges caused by kickbacks and unearned fees involved in real estate settlement services.
The Fair Housing Act prohibits discrimination on the basis of race, color, religion, sex, familial status, national origin, or handicap in residential real-estate related transactions, which are defined to include the making or purchasing of mortgage loans. The Equal Credit Opportunity Act has overlapping coverage for discriminatory practices in lending.
Section 5 of the FTC Act declares unfair or deceptive acts or practices in or affecting commerce to be unlawful and gives the FTC the authority to enforce that prohibition.
As Federal Reserve Board Governor Gramlich recently stated: "A significant component of predatory lending involves outright fraud and deception, practices that are clearly illegal. The policy response should simply be better enforcement."
It is worth pointing out, as Governor Gramlich also noted, that over 70% of the lenders on the HUD list of subprime lenders are only regulated by the FTC, so the FTCs enforcement authority, if exercised with vigilance, would go a long way. Recently, the FTC exercised that authority to target seven lenders for violations of existing law (HOEPA), and has worked jointly with the Department of Justice and HUD to obtain a high-profile settlement with another lender.
Suggestions have been floated to establish a national system of licensing for loan originators and brokers in the mortgage process, and a tracking mechanism to monitor licensee behavior. CBA has reservations about creating a new, expensive bureaucracy, but would consider supporting an efficient system created by federal law or industry-wide collaboration. The threat of license revocation, and notoriety for bad practices, could be important disincentives for such practices.
2. Secondly, and ironically, part of the opportunity for over-reaching comes from the intricate structures of disclosure and documentation under existing law. It is easy for a manipulative lender or broker to dissuade borrowers from paying attention to or reacting to disclosures that, even if accurate, are voluminous, complicated, and at times at odds with one another. Congress several years ago instructed the Federal Reserve Board and HUD to consider improvements to TILA and RESPA to streamline and rationalize the mortgage disclosure rules. Despite the difficulty of reaching consensus among the interested parties, the agencies issued thoughtful reports in 1998 to which there has been no regulatory or legislative follow-up.
Although the two agencies were not able to agree on everything in the report, they did recommend a number of changes to TILA in general that would have a profound impact on the mortgage lending process, by among other things, clarifying the disclosures and changing the timing of disclosures to improve shopping. The two agencies also agreed on additional reforms to address substantive abuses in lending. For loans subject to HOEPA, they recommended further restrictions against balloon payments and a prohibition on the advance collection of lump sum premiums for credit insurance. For all loans, they also recommend that, prior to any foreclosure sale, creditors first provide a written explanation of any right to cure or redeem, the steps to exercise that right, a description of the foreclosure process, and information about the availability of third party counseling.
Although CBA did not endorse the overall package of reforms (we believed, for example, that disclosures needed to be still simpler than was being proposed), we encouraged a continued review of the possible reforms to improve TILA and RESPA. Regarding the predatory practices, we supported additional state licensing and examination of marginal lenders, including maintaining national data bases on those who engage in fraudulent and illegal loan practices, and increased education for consumers.
At the same time, CBA was a participant in the broad-based "Mortgage Reform Working Group," a loose-knit coalition of industry and consumer representatives, which worked to refine various reform options that, we believe, ought to get further attention. CBA suggests that a critical part of addressing unfair mortgage practices is to improve the "transparency" of the mortgage process as a whole, so that from the borrowers perspective "what you see is what you get," without surprises or unexpected or hidden terms and costs.
3. A third essential step is to increase significantly our public education about mortgage finance. This cannot remain a theoretical or illusory goal. Recent studies have pointed out the abysmal levels of "financial literacy" among our youth and young adults. All of us involved in these hearings lawmakers, regulators, industry, consumer representatives share responsibility for the inculcation of a basic understanding of consumer finance in our citizenry. CBA absolutely pledges its support to efforts in this direction, which should include ready public access by shoppers to reliable data on mortgage products through institutional bulletin boards, on site, in the press, and over the Internet.
As OTS Chairman Ellen Seidman recently said: "An informed consumer, and one with options, is less likely to fall victim to loan scams. Community organizations and others (such as faith-based organizations and schools) can and do play an essential role in this education process."
Banks, of course, are actively engaged in this process. A survey that CBA did of its members showed that almost 90% of banks had mortgage counseling programs in place in 1995, and the percentage had been rising annually. Banks routinely engage in other financial education programs, including first-time home buyer and foreclosure prevention programs, often in partnership with local non-profit organizations serving low-and moderate income consumers. Continued bank involvement in the community and in partnerships with community based organizations can be a positive force for change.
In addition, federal, state, and local governments could do a lot more to target these practices through public awareness campaigns. If the issue is indeed a priority, then resources should be devoted to teaching the public how to recognize and avoid bad mortgages. CBA recently joined forces with the Department of the Treasury in a coordinated national campaign to enhance financial education and awareness. The National Partners for Financial Empowerment (NPFE) is a public-private partnership to promote personal financial skills development to improve financial literacy, personal savings and financial empowerment. As the Treasury Department has stated: "We firmly believe that NPFE can help raise public focus on the challenges of less-skilled Americans who confront daily a complicated and fast-moving market." This Partnership, and others like it, adequately funded, can be a part of the overall campaign.
Ultimately, this will require a coordinated effort by all of us, public and private, for profit and not for profit, lenders and consumers, to bring consumers to the level of awareness that will make it harder for unscrupulous lenders or brokers to operate with impunity.
4. An additional issue concerns the process and range of any new law reform effort. CBA questions whether new federal legislation is necessary at this time, or whether reform options might not better be developed at the agency level rather than by statute. Every federal agency with jurisdiction over mortgage lending has begun an examination of unconscionable practices. The Federal Trade Commission has broad authority to regulate unfair or deceptive acts or practices, and the bank agencies are required to emulate FTC initiatives. Under HOEPA [TILA § 129(l)(2)], the Federal Reserve has a mandate to regulate practices that are "unfair, deceptive, or designed to evade the provisions of [HOEPA], or that are "abusive . . . or . . . otherwise not in the interest of the borrower." These are adequate authorizations to permit the agencies to develop regulatory restraints that draw on the agencies technical expertise and continuing access to information through their investigative and examination powers. This approach law reform by regulation rather than statutory dictate is preferable for two reasons: (1) it permits more flexible and nuanced rules that are more easily adjusted as circumstances dictate; and (2) it allows the agencies to assess, on a continuing basis, how much preemptive effect the federal rules should have on state lawmaking on the same topic.
You may have noticed that my comments have not yet included the "P" word. "Predatory" is a pejorative description, but that is the extent of its usefulness. It does not begin to define itself, nor to identify those characteristics of a mortgage loan that ought to be unlawful. The abusive mortgage loans described in these hearings and elsewhere almost always involve a mix of features: very aggressive marketing, contract terms that enhance the borrowers cost, irregular underwriting criteria, mis-disclosure, and again almost always deception, high-pressure or "scare" tactics, misrepresentation, outright fraud. Outlaw lenders or brokers, or their bird dogs, can package and repackage their loan products in dozens of different combinations, and it is the combination of the loans features that one eventually may characterize as obscene, unconscionable, or "predatory."
The thrust of the bills currently before the Congress is to target specific loan terms or circumstances and either curtail or prohibit them. While CBA appreciates that the objective is to prevent consumer abuse, we are very apprehensive about direct limitations on a lenders pricing strategies. As Governor Gramlich of the Federal Reserve Board put it last month: "[T]he harder analytical issue involves abuses of practices that do improve market efficiency most of the time." That is, the frustration in trying to identify "predatory" loans is that they contain features that may be quite appropriate individually, or in the credit markets in general, or in some contexts, but when combined and marketed in a certain way become overbearing. Arbitrary prohibitions of certain terms affecting the lenders yield and risk assessment may superficially protect consumers from that particular perceived abuse. But the lender may have other options. For instance, a lender forbidden to charge a certain number of points may adjust to an acceptable level of risk by raising the interest rate, or requiring private mortgage insurance, or lowering the LTV ratio. Each term or practice that is "limited" in the pending bills may be defended under some circumstances in the larger market.
Our major concern about the pending bills, therefore, is that they target certain provisions and practices as unlawful without any apparent empirical base for knowing what the effect will be on covered transactions, whether those transactions are the predatory ones in the first place, and what other unintended consequences the restrictions may produce. All of our experience since 1968 (TILA) or 1994 (HOEPA) suggests that piling legal restraint on top of legal restraint does not work very well on scofflaws. New disclosures or prescriptions on certain loan terms, will do little to deter or prevent the true "predator" from ensnaring its prey through misrepresentation, guile or fear. It would be tragic, we believe, if a well-intentioned effort to deal with a fringe of fraudulent practices inhibited the ability or willingness of mainstream lenders to continue to engage in subprime, or risk-based, mortgage lending, or exposed those lenders to a new range of litigation and class action exposure for technical violations if they did so.
We thank you for considering our views, and I will be happy to answer your questions.