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82–969 PDF 2002

S. HRG. 107–774

PREDATORY MORTGAGE LENDING:

THE PROBLEM, IMPACT, AND RESPONSES

HEARING

BEFORE THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

FIRST SESSION

ON

THE EXAMINATION OF THE PROBLEM, IMPACT, AND RESPONSES

OF PREDATORY MORTGAGE LENDING PRACTICES

JULY 26 AND 27, 2001

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

DANIEL K. AKAKA, Hawaii

PHIL GRAMM, Texas

RICHARD C. SHELBY, Alabama

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN ENSIGN, Nevada

STEVEN B. HARRIS, Staff Director and Chief Counsel

WAYNE A. ABERNATHY, Republican Staff Director

PATIENCE SINGLETON, Counsel

JONATHAN MILLER, Professional Staff

DARIS MEEKS, Republican Counsel

GEOFF GRAY, Republican Senior Professional Staff

JOSEPH CWIKLINSKI, Republican Economist

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

(II)

(III)

CONTENTS

THURSDAY, JULY 26, 2001

Page

Opening statement of Chairman Sarbanes ........................................................... 1

Prepared statement .......................................................................................... 51

Opening statements, comments, or prepared statements of:

Senator Gramm ................................................................................................ 2

Senator Johnson ............................................................................................... 5

Senator Reed ..................................................................................................... 6

Senator Schumer .............................................................................................. 6

Senator Miller ................................................................................................... 7

Senator Carper ................................................................................................. 8

Senator Stabenow ............................................................................................. 9

Senator Bennett ................................................................................................ 11

Senator Dodd .................................................................................................... 12

Senator Bayh .................................................................................................... 14

Senator Allard ................................................................................................... 14

Prepared statement ................................................................................... 52

Senator Corzine ................................................................................................ 20

Senator Bunning ............................................................................................... 53

WITNESSES

Carol Mackey, of Rochester Hills, Michigan .......................................................... 12

Paul Satriano, of Saint Paul, Minnesota ............................................................... 14

Leroy Williams, of Philadelphia, Pennsylvania .................................................... 17

Mary Ann Podelco, of Montgomery, West Virginia ............................................... 18

Thomas J. Miller, Attorney General, of the State of Iowa ................................... 29

Prepared statement .......................................................................................... 53

Stephen W. Prough, Chairman, Ameriquest Mortgage Company,

Orange, California ................................................................................................ 31

Charles W. Calomiris, Paul M. Montrone Professor of Finance and Economics,

Graduate School of Business, Columbia University, New York, New York .... 35

Original prepared statement ........................................................................... 81

Revised prepared statement ............................................................................ 101

Martin Eakes, President and CEO, Self-Help Organization

Durham, North Carolina ..................................................................................... 40

Prepared statement .......................................................................................... 120

ADDITIONAL MATERIALS SUPPLIED FOR THE RECORD

Letter to Senator Paul S. Sarbanes from Paul Satriano, dated August 9,

2001 ....................................................................................................................... 143

Statement of Elizabeth Goodell, Counsel, Community Legal Sevices of Philadelphia, on behalf of Leroy Williams, dated July 26, 2001 ............................... 147

Statement of Daniel F. Hedges, Counsel, Mountain State Justice, Inc., on

behalf of Mary Podelco, dated July 26, 2001 ..................................................... 147

Ameriquest Mortgage Company Retail Best Practices, submitted by Stephen

W. Prough ............................................................................................................. 149

Statement of America’s Community Bankers, dated July 26, 2001 .................... 154

Letter to Senator Paul S. Sarbanes from Fred R. Becker, Jr., President

and CEO, National Association of Federal Credit Unions, dated July 24,

2001 ....................................................................................................................... 163

Page

IV

Statement of Gale Cincotta, Executive Director, National Training &

Information Center, National Chairperson, National People’s Action,

dated July 25, 2001 .............................................................................................. 166

Statement of Allen J. Fishbein, General Counsel, Center for Community

Change, dated July 26, 2001 ............................................................................... 173

Letter to Senator Paul S. Sarbanes from Gary D. Gilmer, President and

CEO, Household International, Inc., dated July 26, 2001 ................................ 179

Letter to Senator Paul S. Sarbanes from Susan E. Johnson, Executive

Director, RESPRO, dated August 2, 2001 ....................................................... 184

Letter to Senator Paul S. Sarbanes from Tom Jones, Managing Director

and Amy Randel, Director of Governmental Relations, Habitat for

Humanity International, dated August 13, 2001 .............................................. 190

‘‘A Prudent Approach To Preventing ‘Predatory’ Lending’’ by Robert E. Litan . 193

Statement of Bruce Marks, Chief Executive Officer, Neighborhood Assistance

Corporation of America ........................................................................................ 210

Letter to Senator Paul S. Sarbanes from Richard Mendenhall, President,

National Association of Realtors, July 25, 2001 .............................................. 224

Letter to Senator Paul S. Sarbanes from Jeremy Nowak, President and CEO,

and Ira Goldstein, Director, Public Policy & Program Assessment, The

Reinvestment Fund .............................................................................................. 226

Statement of Jeffrey Zeltzer, Executive Director, National Home Equity Mortgage Association, dated July 26, 2001 ................................................................ 232

FRIDAY, JULY 27, 2001

Opening statement of Chairman Sarbanes ........................................................... 241

Prepared statement .......................................................................................... 288

Opening statements, comments, or prepared statements of:

Senator Miller ................................................................................................... 243

Senator Stabenow ............................................................................................. 243

Prepared statement ................................................................................... 288

Senator Corzine ................................................................................................ 244

Senator Carpo ................................................................................................... 254

Senator Dodd .................................................................................................... 259

Senator Carper ................................................................................................. 259

Senator Santorum ............................................................................................ 267

WITNESSES

Wade Henderson, Executive Director, Leadership Conference on Civil Rights . 244

Prepared statement .......................................................................................... 289

Judith A. Kennedy, President, The National Association of Affordable

Housing Lenders .................................................................................................. 247

Prepared statement .......................................................................................... 294

Response to written questions of Senator Miller ........................................... 416

Esther ‘‘Tess’’ Canja, President, American Association of Retired Persons ........ 249

Prepared statement .......................................................................................... 296

Response to written questions of Senator Miller ........................................... 417

John A. Courson, Vice President, Mortgage Bankers Association of America,

President and CEO, Central Pacific Mortgage Company, Folsom, California 250

Prepared statement .......................................................................................... 311

Irv Ackelsberg, Managing Attorney, Community Legal Services, Inc.,

testifying on behalf of the National Consumer Law Center, the Consumer

Federation of America, the Consumer Union, the National Association of

Consumer Advocates, U.S. Public Interest Research Group ............................ 252

Prepared statement .......................................................................................... 317

Response to written questions of Senator Miller ........................................... 420

Neill A. Fendly, CMC, Immediate Past President, National Association of

Mortgage Brokers ................................................................................................. 254

Prepared statement .......................................................................................... 340

Response to written questions of Senator Miller ........................................... 425

Page

V

David Berenbaum, Senior Vice President, Program and Director of Civil

Rights, National Community Reinvestment Coalition ...................................... 257

Prepared statement .......................................................................................... 344

Response to written questions of Senator Miller ........................................... 428

George J. Wallace, Counsel, American Financial Services Association .............. 259

Prepared statement .......................................................................................... 378

Lee Williams, Chairperson, State Issues Subcommittee, Credit Union

National Association, and President, Aviation Association Credit Union,

Wichita, Kansas ................................................................................................... 262

Prepared statement .......................................................................................... 384

Response to written questions of Senator Miller ........................................... 438

Mike Shea, Executive Director, ACORN Housing ................................................ 264

Prepared statement .......................................................................................... 398

ADDITIONAL MATERIALS SUPPLIED FOR THE RECORD

Statement of the American Land Title Association .............................................. 440

Statement of the Consumer Bankers Association, dated July 27, 2001 ............. 441

Statement of the Consumer Mortgage Coalition, dated July 27, 2001 ............... 445

Letter to Senator Paul S. Sarbanes from Brian A. Granville, President

Appraisal Institute, dated July 27, 2001 ........................................................... 468

Letter to Senator Paul S. Sarbanes from Maude Hurd, National President,

ACORN, dated August 9, 2001 ........................................................................... 481

Statment of Richard Stallings, President, National Neighborhood Housing

Network ................................................................................................................ 489

Statement of Marian B. Tasco, Councilwoman, Ninth District, City of Philadelphia, Pennsylvania .......................................................................................... 492

(1)

PREDATORY MORTGAGE LENDING:

THE PROBLEM, IMPACT, AND RESPONSES

THURSDAY, JULY 26, 2001

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC.

The Committee met at 10:05 a.m., in room SD–538 of the Dirksen Senate Office Building, Senator Paul S. Sarbanes (Chairman of

the Committee) presiding.

OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

Chairman SARBANES. The hearing will come to order.

Today is the first of two initial hearings on predatory mortgage

lending: the problem, the impact, and the responses. This morning,

we will first hear from a number of families that have been victimized by predatory lenders. Later this morning, and again tomorrow

morning, an array of public interest and community advocates, industry representatives, and legal and academic experts will discuss

the broader problem and the impact that predatory lending can

have not only on families, but also on communities.

Homeownership is the American Dream. It is the opportunity for

all Americans to put down roots and start creating equity for themselves and their families. Homeownership has been the path to

building wealth for generations of Americans. And in my view, it

has been the key to ensuring stable communities, good schools, and

safe streets.

Predatory lenders play on these homes and dreams to cynically

cheat people of their wealth. These lenders target lower income,

minority, elderly, and often unsophisticated homeowners for their

abusive practices.

Let me briefly describe how predatory lenders and brokers operate. They target people with equity in their homes, many of whom

may be feeling the pinch of consumer and credit card debts. They

underwrite the property, often without regard to the ability of the

borrower to pay the loan back. They do not use the normal underwriting standards. In fact, they ignore them altogether. They make

their money by charging extremely high origination fees and by

packing other products into the loan, including upfront premiums

for credit life, disability, and unemployment insurance, and others,

for which they get significant commissions right at the outset, but

for which homeowners continue to pay for years since it is folded

into the mortgage.

The premiums for these products get financed into the loan,

greatly increasing the loan’s total balance amount. As a result, and

2

because of the high interest rates being charged, the borrower is

likely to find himself in extreme financial difficulty.

As trouble mounts, the predatory lender will offer to refinance

the loan. Unfortunately, another characteristic of these loans is

that they have high prepayment penalties. So, by the time the refinancing occurs, with all of the fees repeated, the prepayment penalty included, the lender or broker makes a lot of money from the

transaction and the owner finds that they are being increasingly

stripped of their equity and, in the end, it may well be their home.

Nearly every banking regulator, Federal and State, has recognized this as an increasing problem. And I believe, predatory lending really is an assault on homeowners all over America.

Now I want to make one thing clear. These hearings are directed

toward predatory lending practices. There are people who have

credit problems who still need and can justify access to affordable

mortgage credit. They may only be able to get mortgage loans in

the subprime market, which charges higher interest rates. Clearly,

to get the credit, they will have to pay somewhat higher rates because of the greater risk they represent.

So, we make the distinction. We recognize that there is a

subprime lending industry that is performing an important function. But we are concerned to get at those within that industry who

are engaging in these abusive practices. Families should not be

charged more than the increased risk justifies. Families should not

be stripped of their home equity through financing of extremely

high fees, credit insurance, or prepayment penalties. They should

not be manipulated into constant refinancings, losing more and

more of their equity and of their wealth that they have taken a lifetime to build up, but which is consumed by each set of new fees

by each transaction. They should not be stripped of their legal

rights by mandatory arbitration clauses that block their ability to

appropriate legal redress.

Some argue there is no such thing as predatory lending because

it is a practice that is hard to define. Perhaps the best response

to this was given by Federal Reserve Board Governor Edward

Gramlich, who said earlier this year:

Predatory lending takes its place alongside other concepts, none of which are terribly precise—safety and soundness, unfair and deceptive practices, patterns and

practices of certain types of lending. The fact that we cannot get a precise definition

should not stop us. It does not mean this is not a problem.

Others, recognizing that abuses do exist, contend that they are

already illegal. According to this reasoning, the proper response is

improved enforcement.

I support improved enforcement. The FTC, to its credit, has been

active in bringing cases against predatory lenders for deceptive and

misleading practices. However, because it is so difficult to bring

such cases, the FTC further suggested last year a number of increased enforcement tools that would help to move against the

predators. I hope that we will get an opportunity to discuss those

proposals as these hearings progress.

I also support actions by regulators to utilize the authority under

existing law to expand protections against predatory lending. That

is why I sent a letter signed by my colleagues on the Committee

3

strongly supporting the Federal Reserve Board’s proposed regulation to strengthen consumer protections under current law.

Campaigns to increase financial literacy and efforts within the

industry to engage in best practices are also important parts of any

effort to combat this problem. Many industry groups have contributed time and resources to educational campaigns of this sort or

developed practices and guidelines, and I welcome this as part of

a comprehensive reform to the problem of predatory lending.

Neither strong enforcement, nor literacy campaigns are enough.

Too many of the practices we will hear outlined this morning and

in tomorrow’s hearings, while extremely harmful and abusive, are

technically within the law. And while we must aggressively pursue

financial education, we also recognize that education takes time to

be effective.

Again, I want to reiterate that subprime lending is an important

part of the credit markets. But such lending needs to be consistent

with and supportive of the efforts to increase homeownership, build

wealth, and strengthen communities. And in the face of so much

evidence of abuse and of so much pain, we must work together to

address this crisis and that is what we are setting out to do by

launching these hearings this morning.

Senator Gramm.

STATEMENT OF SENATOR PHIL GRAMM

Senator GRAMM. Mr. Chairman, thank you for holding these

hearings.

Let me say that one of the blessings of living in a strong economy, with a healthy savings rate that is made considerably better

by the Federal Government running a surplus, is that for the first

time in American history, we have an active outreach program by

private lenders to lend to people who, under ordinary circumstances, would have a difficult time borrowing money, people who

would end up borrowing from other sources such as, kinfolks or in

the backstreet market where abuses would be substantial.

Let me assure you, Mr. Chairman, that I am committed to cracking down on crooks and people who abuse the system and who

abuse borrowers.

I want to be absolutely certain that in trying to get at the bad

guys we do not put into place policies that destroy a market that

is serving an increasing number of people.

We will hear later today that the default rate in some areas of

subprime lending is as much as 23 percent. That is a massive default rate, the good news is that 77 percent of those borrowers did

pay the loan back, and they, in doing so, established good credit.

This is something that I feel very strongly about. Fifty-two years

ago, my momma bought a house. She had three children and no

husband. She was a practical nurse who worked in a system that

when your number came up, you got to take the job.

And so, she did not have, for all practical purposes, a full-time

job. She borrowed for a house that cost $9,200. She borrowed this

money from a finance company, and she paid 50 percent more than

the market rate for that loan. Now some people would say, prima

facia, that was an abusive loan, that it was predatory lending. I

would beg to differ.

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First, my mother was the first person that I am aware of since

Adam and Eve, in our branch of the human family, who ever

owned the dwelling where she lived. She paid off that loan, and 52

years later, her credit is golden. Any bank in Columbus, Georgia

would lend my momma money because in all her 52 years of record

there was never a time when she has ever borrowed a penny that

she has not paid back.

Now my point is the following. We have to be very careful in trying to deal with an abuse that exists so that we do not create a

situation where credible lenders, non-abusive lenders, good lenders

will get out of the subprime market.

If we end up doing that, if we end up falling victim to this rule

or law of unintended consequences, the problem will be that the 77

percent of the people that are now paying these loans back will not

get the loans. People will end up being forced to borrow in a more

informal market. People will not be able to buy their own homes,

and I think that this is something that we have to measure. All

good public policy is based on cost and benefits, the intended consequence versus the unintended. This is something that I am going

to try to watch very carefully because, again, subprime lending I

view as a very good thing.

I never will forget when I was a Member of the House of Representatives, and someone came up to me and said, ‘‘Do you think

6 percent is a fair interest rate?’’ And I said, ‘‘Fair to whom?’’ He said, ‘‘Well, fair to the borrower and fair to the lender—Do

you think we ought to have a law that says the interest rate is 6

percent?’’ Well, I said that would be great, but if the market did not

produce more than a 6 percent interest rate, then you would have

massive shortages of credit and you would disrupt the credit markets. In fact, I think zero interest would be a great rate. I would

borrow a lot at it. But no one would lend me the money.

We have to be sure that we know what we are doing, not just

focusing on the evil we hope to drive out of the system, but also

take care that the good is not driven out of the system.

Finally, it is hard to define many things in the world, hard to

define pornography, as they say, I agree with the old adage—I

know it when I see it.

But I think when you are making law it is important to try to

define what you are doing. My guess is if you ask 100 people in

America to define predatory lending, you are going to get 100 different definitions.

Many people define predatory lending as lending at above prime.

I am sure what is predatory lending to one person is not the same

thing to another.

But it is important that we know what we are doing and that

we know what we are trying to eliminate, and that we are aware

of what the unintended consequences might be.

And, again, I want to thank you, Mr. Chairman. I have a Finance mark-up, and then we have a big trucking dispute on the

floor, as all my colleagues know. So, I will be in and out.

But I am going to read the testimony that is given today. This

is an area that I am very interested in, and I want to thank all

of our witnesses for participating.

5

Chairman SARBANES. Thank you very much, Senator Gramm.

Senator Johnson.

STATEMENT OF SENATOR TIM JOHNSON

Senator JOHNSON. Well, thank you very much, Mr. Chairman I

appreciate your leadership in calling today’s hearing on predatory

lending. I look forward to hearing from the witnesses who will

come before this Committee both today and tomorrow.

Today’s testimony, I am sure, will be moving. Nobody likes to

hear that vulnerable members of our society have been taken advantage of. No one should be preyed upon to borrow money they

do not need on terms that they do not understand.

We in Congress are in a unique position to shine some light on

shady practices and to think through the best way that we can, in

a constructive way, bring an end to those practices.

At the same time, Mr. Chairman, I urge caution that we not generalize the practices of a subset of lenders to an entire sector.

As we will hear today, predatory lending occurs in the subprime

market. But as you wisely emphasized in your statement, only a

fraction of subprime lending is predatory. Subprime is not, in and

of itself, predatory lending. The subprime market provides a critical source of credit to many Americans who struggle to find economic opportunity in our country. To be sure, lenders can and do

charge a higher rate to account for the higher risk associated with

those borrowers. When it is done right, subprime lending gives people what they need, and that is more, not less, opportunity.

I have been encouraged by some noteworthy improvements in the

subprime marketplace in recent weeks. A number of key players

have announced new practices which I hope will have a salutary

effect on the subprime sector.

We want to encourage lenders with household names who have

every incentive in the world to protect their good reputations to remain in the subprime marketplace. We need to give their initiatives a chance to have an impact.

So, I would offer a word of caution, that while we should be vigorous in our efforts to eliminate the ugly instances of predatory

lending, that we take care not to institute a policy that is in fact

counterproductive, that would increase the cost of credit and, indeed, cut off critical sources of credit to the very members of society

who need it most.

I look forward to today’s hearing and hope that we can have a

balanced and thoughtful discussion of how we can best accomplish

our common goal of making credit available under fair terms to a

broad segment of our society, keeping in mind that we have already a substantial level of law pertaining to these issues from

HOEPA legislation to Truth-in-Lending to the Real Estate Settlement Procedures Act, to the Federal Trade Commission, and the

Federal Credit Opportunity Act legislation.

That is not to say that there is not room for further Federal legislative action. It is to say that there is a context that this has to

fit into and that we need to, on the one hand, address the abuses,

but on the other hand, make it very certain that we do not pursue

public policy that in fact is counterproductive.

Thank you, Mr. Chairman.

6

Chairman SARBANES. Thank you, Senator Johnson.

Senator Reed.

STATEMENT OF SENATOR JACK REED

Senator REED. Thank you very much, Mr. Chairman.

I want to commend you for holding this hearing. This hearing

will shine a light on one of the dark corners of the financial markets. And in doing that, it will be helpful in and of itself.

I hope when we do that, we can not only identify and point out

to the American public abuses, but we also can identify those companies that have high standards that should be emulated by all

their colleagues, and at the end of the day, we can move all companies to the best practices that we will find in the financial services

industry.

And in doing that, I think we can both allow for the continuation

of credit for individuals that may have credit problems, and avoid

the abuses that we will hear about today.

I welcome the witnesses. Your testimony is vitally important because you put a human face on what can be a lot of numbers,

graphs, and statistics.

Again, let me thank you, Mr. Chairman, for holding this hearing

and sending a very strong signal that we want to have a robust financial service industry, but one that certainly respects consumers

and respects their clients.

Thank you.

Chairman SARBANES. Thank you, Senator Reed.

Senator Schumer.

STATEMENT OF SENATOR CHARLES E. SCHUMER

Senator SCHUMER. Well, thank you, Mr. Chairman. I want to add

my voice in thanking you for making this an early topic in your

Chairmanship.

Our Committee is off to a great start under your leadership and

we are doing a lot of good things. And this is at the top of the list.

Thank you for that. I would like to make just three points.

One—two are a little bit in counter to what my colleague and

friend from Texas, Senator Gramm, said. It is easy to talk about

this stuff in the abstract. I hope, and one of our goals should be

that Senator Gramm not only reads your stories, but hears it and

just goes through what some of us have gone through when we

meet people who are victims of predatory lending, the horror of it.

It is people who have lived by the American Dream. They are

often people of color. They are often people who buying the home

is the first time in their whole family that they have ever bought

a home, and they live by the rules. They save their $25 and their

$50 every month, did not serve meat on the table so they could

achieve their piece of the American Dream and own a home.

And some bottom crawler comes in and not only sells them at a

higher interest rate—that is what subprime is—but says, I will get

you the right appraiser, I will get you the right lawyer, I will get

you the right this and that. And what are they left with?

They end up buying a home where the boiler might break down,

even though they were certified. Someone came in and said, this

is a good boiler. Or the roof leaks the minute they move in.

7

They end up often paying with a balloon payment they cannot

pay off, or the interest rates goes from 4 percent the first year to

12 percent the second and they have to give up their home. And

these people are crushed for the rest of their lives, most of them,

because they played by the rules and scrounged and then nothing

happened. I have sat in my State of New York and listened to

these folks. That is what motivates us, and I believe it is really important to remember that.

Second, also in reference to Senator Gramm and you, Chairman

Sarbanes. You are both right to emphasize that the subprime market is a good market. And I know there is a tendency of people just

to say anything above conventional mortgage is bad.

Well, that is not true. We want to give people the ability to buy

a home when their credit is not so good that they would get a conventionally rated loan. And I agree with Phil that the free market

has to help govern here.

There is a little statement that we make to remind ourselves of

this. And that is, not all subprime loans are predatory, but all

predatory loans are subprime.

Why? How come no conventional loans are predatory? You could

have the same practices at a lower interest rate.

It is because we regulate the conventional market. And conventional lenders cannot get away with doing this. If someone tries to

set up a little shady bank in the conventional way, regulators will

come down on them.

Regulation makes a big difference. And the idea that we should

shy away from any regulation when it has been so successful at

keeping the conventional market on the up and up, does not make

sense to me.

I want to commend some of the banks, for instance, that recently

changed the way that they issued insurance on their own. They deserve credit. And all too often, I think many in the community

lump everybody together and we have to separate the good ones

from the bad ones. But we are not going to get rid of the bad ones

unless we regulate. And just one quick final point.

Part of this is created because there is a vacuum of conventional

lending in the inner city. All I want to say is we can make a large

difference today where we could not 20 years ago, in getting conventional mortgages into working-class and middle-class neighborhoods of people of color which we could not before.

CRA has done that. Banks are eager to make those loans. But

they do not have the ins. And we have to explore ways to get them

the ins there. We are doing that in New York and I will share that

with my colleagues later.

Thank you, Mr. Chairman. Sorry I went on too long.

Chairman SARBANES. Thank you, Senator Schumer.

Senator Miller.

STATEMENT OF SENATOR ZELL MILLER

Senator MILLER. I will take only a minute.

Thank you very much, Mr. Chairman, for holding this hearing.

This is a very serious matter. This is an important topic and I commend you for holding this hearing. And I want to welcome all of

8

the witnesses here this morning. I look forward to hearing from

you. I look forward to listening to the debate on this issue.

In the State of Georgia, we just got through a debate that raged

for a long time and very heatedly, in the State legislature, where

a predatory lending law was passed in the State Senate, but then

died in the house.

So, this is a topic that I am very interested in hearing from the

witnesses on, and I thank you for holding this hearing.

Chairman SARBANES. Senator Miller, thank you. We have had

some good discussions between ourselves about this issue and I appreciate that very much.

Senator Carper.

STATEMENT OF SENATOR THOMAS R. CARPER

Senator CARPER. Mr. Chairman, thank you.

To our witnesses, I want to echo the words of welcome from Senator Zell Miller. We are glad that you are here. Thank you for taking time out of your lives to share this part of your day with us.

Mr. Chairman, and my colleagues, I am struck sometimes by

how helpful simply scheduling a hearing on a particular subject

can be.

[Laughter.]

I just want to point to a couple of examples.

One, I serve on the Energy Committee where Chairman Bingaman invited folks who serve on the Federal Energy Regulatory

Commission to come and testify earlier this month. Two or 3 days

before they testified, they took some remarkably positive steps to

help alleviate the energy crisis in California.

Just yesterday, Chairman Joesph Lieberman held a hearing on

legislation that he and others have sponsored dealing with the entertainment industry and questions about the quality of the entertainment that is provided to us from the music industry, the video

game industry, the television industry, and the movie industry.

I found the comments from some of the industry representatives,

talking about things that they had done voluntarily, were willing

to do even more and better voluntarily, coming out of that hearing

were encouraging.

Others of my colleagues have spoken here today about some of

the very positive steps that some who are represented in this room

have taken to make sure that some of the questionable practices

they were involved in have been stopped or will be stopped. I join

my colleagues in applauding those of you who have taken those

steps or will take those steps.

I read an interesting piece by Robert Litan, whom some of you

may recall. He used to be the number-two guy at OMB when Alice

Rivlin was the head of OMB, and he is now over at the Brookings

Institution. He has a very thoughtful piece that some of you may

have seen. It is too long for me to go into at any length, but I think

the points that he makes are good. They reflect the concerns that

we have already heard that we want to make sure that the steps

that we take here in this Committee and in this body, that we do

no harm, that we make sure that those who are riskier borrowers

still have access to credit, but they are not exposed to the kind of

predatory practices which in many cases are already illegal.

9

And as we face this challenge and listen to our witnesses, we

have to be smart enough and thoughtful enough to come up with

ways to better ensure, one, that the laws that already make these

predatory practices illegal are actually enforced, at the Federal, the

State, and the local level.

Two, I think there is a lot to be said for embarrassing publicly

those financial institutions who are actually violating the law and

to put them under a spotlight and glare that they will not enjoy

and will help to ensure that they and others cease those practices.

Three, we have an obligation to work with the private sector and

others to better ensure that consumers are educated and know full

well what is legal and what is not, and that they are better able

to police those who are offering credit in ways that are inappropriate or illegal.

And last, I understand in reading this piece by Robert Litan that

the Federal Reserve has undertaken the gathering of a fair amount

of data that deserve to be studied, scrutinized, analyzed, as we prepare to take any action here in the Senate.

So let me conclude where I started, Mr. Chairman. Thanks for

bringing us together today. And to those who have joined us to testify, both in this panel and other panels, we appreciate very much

your presence and your testimony.

Thank you.

Chairman SARBANES. Well, thank you, Senator Carper.

Senator Stabenow.

And let me acknowledge Senator Stabenow’s tremendous help

and support in helping to put these hearings together and moving

this issue forward and ensuring that it is high on our priority list

and our agenda.

STATEMENT OF SENATOR DEBBIE STABENOW

Senator STABENOW. Well, thank you, Mr. Chairman very much

for holding this hearing and for the witnesses that are here today.

This is an incredibly important issue and I hope that we can come

together and put forward a positive solution.

I know that there are literally thousands of horror stories around

the country and I have heard many of them personally from my

constituents in Michigan. Unfortunately, we do have unscrupulous

lenders that are in the subprime market, while we also have ethical and responsible lenders in that market as well. But I have

been pleased to invite one of our panelists today, Carol Mackey.

Carol Mackey is from Rochester Hills in the metro Detroit area.

She came to a hearing that I held in May on this very issue, where

I learned of her own difficult and tragic experience. Ms. Mackey,

I am very appreciative that you are here with us today to share

your experiences and help us to learn from what happened to you.

Mr. Chairman, I also, would like to recognize a very special

friend and guest of mine who I have asked to attend this hearing

today—Rev. Wendell Anthony, who is the President of the Detroit

NAACP chapter, which I might brag is the largest chapter in the

United States.

Under the leadership of Rev. Anthony and the NAACP, they

have been working very hard to raise awareness and to combat the

issues of predatory lending, as well as increase affordable housing.

10

There was a very successful hearing and conference that was

held on June 9 that I was pleased to be a part of in Detroit under

Rev. Anthony’s leadership. He informed me last evening there was

a second follow-up meeting on issues of access to affordable housing

and predatory lending issues, where on just a few days’ notice, they

invited people to come, expected 100 people and had 500 people

show up. This is an example of how important issues of affordable

housing and fair lending practices are, I believe, to the people that

we represent.

I think, as this hearing gets underway, I would like to underscore, Mr. Chairman, something that I said earlier that many of

my colleagues have said. And that is, subprime lending is not predatory lending. In fact, subprime lending serves a legitimate purpose

in providing credit to consumers with risky credit histories. We

know that. A thriving subprime market can serve higher credit risk

communities well.

Our challenge is to focus on the bad actors, if you will, without

giving the entire industry a bad name. And I think that is our challenge. And what we do not want to do is dry up capital in the

subprime market. We do want to stop predatory lending practices.

I hope we are going to sort out these issues, and to increase educational outreach, that we are going to make sure that existing

laws are enforced. I also hope we also will pass new legislation that

will make illegal what is now unethical.

I do not believe it is enough just to promote education and enforcement without new legislation. Frankly, I think it is extremely

important, given the fact that we are talking about thousands of

dollars that have been taken from hard-working Americans, as well

as their dreams—the dream of homeownership, the opportunity to

build a secure future for themselves and their families. And that

is why this practice is absolutely outrageous.

Again, Mr. Chairman, I want to thank you for your leadership

in calling this hearing. I want to thank Ms. Mackey for being here,

and Rev. Anthony for his leadership. I am very anxious to move

forward in a way that allows us to be constructive and address

what I believe is a very serious issue for our families.

Senator CARPER. Would the Senator yield for just a moment,

please?

Senator STABENOW. Yes, I would be happy to yield.

Senator CARPER. Mr. Chairman, I misspoke earlier. I mentioned

the hearings involving the Federal Energy Regulatory Commission

and I gave the credit to the Energy Committee for holding them.

Those were actually hearings called by Senator Lieberman, also,

before the Governmental Affairs Committee. He held the hearings

on the entertainment industry yesterday, the Federal Energy Regulatory Commission a week or two earlier.

He is probably going to have hearings now on predatory lending.

I do not know what he is running for, but——

[Laughter.]

—he is a busy boy. But I want to give him the credit for it, and

his staff.

Thank you.

Senator STABENOW. Thank you, Mr. Chairman.

Chairman SARBANES. Senator Bennett.

11

COMMENTS OF SENATOR ROBERT F. BENNETT

Senator BENNETT. Thank you, Mr. Chairman. I do not have an

opening statement, but I have read through the statements of the

witnesses here and appreciate their willingness to come share their

experiences with us.

I know it has to be a painful experience to come before the public

and admit that you have gone through something like this and that

you have been taken advantage of. Many people would prefer to

simply hide and live with the sense of outrage that comes. We are

very grateful to you for your willingness to expose yourselves to the

lights and the heat of this kind of a circumstance because your information is very helpful. Once again, my gratitude to you. Thank

you, Mr. Chairman

Chairman SARBANES. Thank you, Senator Bennett.

Our first panel consists of four individuals who have suffered

from predatory lending practices. I am very quickly going to touch

on each of the witnesses before I recognize them.

Carol Mackey is a retired substitute teacher who, as Senator

Stabenow indicated, lives in Rochester Hills, Michigan. Her monthly mortgage payment doubled after she was encouraged to refinance her mortgage to pay off debt and undertake repairs to her

condominium. And we will hear more about that in some detail.

Paul Satriano is a retired steel worker from St. Paul, Minnesota.

He was solicited for a loan with high points and excessive fees, including single premium credit life insurance and prepayment penalties as well.

Leroy Williams is a retired shoe store assistant manager from

Philadelphia, Pennsylvania. Mr. Williams received three mortgages, including two refinancings by three separate lenders over a

15 month period and he is currently fighting off a foreclosure.

And Mary Ann Podelco is a widow who resides in Montgomery,

West Virginia. Mrs. Podelco’s home was foreclosed upon in 1997,

after her mortgage was refinanced seven times in 16 months by

four separate lenders.

Let me say before we turn to you for your testimony, I want to

express my appreciation to all of you, as Senator Bennett has just

done, for your willingness to leave your homes and to come to

Washington and to speak publicly about what you have been

through. I know it must be very difficult for each of you. But I hope

you appreciate and understand and take some pride in the fact

that you will be contributing to a process that I trust will lead to

action to put an end to the kind of practices that have caused each

of you such heartache and such trouble.

I hope you will draw some strength and comfort from understanding that you are an important part of this process that we are

undertaking here to try to correct this situation and to ensure that

others do not go through the same experience which each of you

have suffered. And so we are deeply appreciative to you for coming

to be with us today.

Now Ms. Mackey, before I start with you, Senator Dodd has

joined us. I do not know what his schedule is, but I will yield to

him for just a moment for a statement.

12

STATEMENT OF SENATOR CHRISTOPHER J. DODD

Senator DODD. Thank you, Mr. Chairman. I will be very brief. I

apologize to my colleagues and the witnesses.

First, I want to underscore the comments just made by Chairman Sarbanes. The admiration I have for people who step out of

private lives before a bank of microphones and cameras to talk

about very personal matters deserves a special commendation. All

of us are deeply appreciative of your willingness to do this. I want

to thank Senator Sarbanes for holding this hearing. It is important.

But I think all of us up here, I hope, anyway, feel very strongly

that predatory lending is a cancer. There is no other way to describe it in my view. Its causes should be catalogued, its manifestations should be carefully studied, its victims should be treated and

made whole, and these practices should be cut from the body of

healthy mortgage lending so that more people in our Nation can

enjoy the American Dream of homeownership.

This hearing is going to go a long way to help us do that. We

are already seeing reaction by the banking industry in this country,

responding to it. So, if nothing else happens, just merely having

these hearings has already had salutary effects. And a great deal

of credit for that goes to the Chairman of this Committee, Senator

Sarbanes, for insisting upon these hearings, that they be held.

And so, I thank you, Mr. Chairman, for doing so, and I thank our

witnesses for your courage to be here with us this morning.

Chairman SARBANES. Thank you very much, Senator Dodd.

Ms. Mackey, we would be happy to hear from you now.

STATEMENT OF CAROL MACKEY

OF ROCHESTER HILLS, MICHIGAN

Ms. MACKEY. My name is Carol Mackey. I am from Rochester

Hills, Michigan. I am a senior citizen and I am working. I was substitute teaching. That was really my calling. But because of retirement ages for teachers, I am now working as a secretary, which I

find to be an interesting and challenging occupation as well.

I appreciate the opportunity to share my experience as a victim

of what I believe to be predatory lending practices of American Equity Mortgage. I have been a stay-at-home mom most of my life.

I just recently in the last 12 years had to go back to work full time.

I first heard about American Equity Mortgage in August 2000,

from an advertisement on WJR radio in Detroit. Ray Vincent, the

President of American Equity Mortgage, was on every morning as

I was getting ready for work. I had been considering a home equity

loan so I called the Southfield office of American Equity Mortgage

and spoke with a loan officer. I told him that I wanted to get a

home equity loan to pay off my debts and make some minor improvements to my condo.

According to the loan officer at American Equity Mortgage, even

though I wanted a home equity loan to pay off some bills and do

some minor home improvements, it was in my best interest to do

a consolidation, which meant refinancing my old mortgage loan.

The mortgage loan officer of American Equity Mortgage explained that it was best for me because I would only have to make

one payment instead of two, it would all be tax deductible, and

with my bills paid off, I should be able to handle the new payment.

13

In addition, he implied that I would have difficulty getting a second

mortgage because of my credit history. Not being a financial whiz,

I relied on his expertise. My old mortgage loan had a remaining balance of about $74,000,

an interest rate of about 7.5 percent, and a monthly payment of

about $510. Based on the State Equalized Value used for tax purposes, my home is worth about $151,000. My new mortgage is for $100,750, has an interest rate of 12.85, an APR of 13.929 percent, a monthly payment of $1,103, and a prepayment penalty of 1 percent. The $100,750, new mortgage was comprised of the $74,000 payoff of the old mortgage, $18,645, in additional funds to pay off bills

and perform the minor improvements to my home, and points and

fees totaling $8,105.

I did not understand the full cost of the additional money I received until several weeks later when I finally discussed the situation with one of my sons. Based on my son’s calculations, American

Equity Mortgage and their loan officer thought it was in my best

interest:

To pay $8,105 in points and fees to receive $18,645 in additional funds; to pay an effective interest rate of 44 percent on the $18,645

in additional funds; to pay an extra $593 a month for the $18,645

in additional funds; and to pay an additional $201,608 in interest

over the life of the loan for the $18,645 in additional funds.

After funds were disbursed to pay off some of my bills I ended up with just over $9,000 to spruce up my condo, but I had to pay

off a credit card debt of $1,200 out of that, leaving me with $7,800.

Since closing last September, I have had to dip into the $7,800

to make the mortgage payments that American Equity Mortgage

arranged for me.

When my son and I discussed the outrageous cost of my attempt

to get a home equity loan, it was apparent to us both that I had

been victimized by a predatory lender.

My son contacted American Equity Mortgage on my behalf, and

was directed to the General Counsel of the company. He explained

to the General Counsel that he believed that I had been a victim

of predatory lending practices by American Equity Mortgage.

Through a series of conversations, he discussed the facts of the

situation as I have outlined them here today, and requested that

American Equity Mortgage cancel the new mortgage and replace it

with a revised mortgage that reflected the interest rate of my original mortgage, blended with what a reasonable interest rate on a

second mortgage would have been.

American Equity Mortgage refused, on the basis that the mortgage loan officer stated that I had wanted to refinance my original

mortgage from the outset. That is absolutely false. Why would I

want to lose a perfectly good 7.5 percent mortgage?

If I had been able to get a home equity loan for $20,000, as I had

sought, all of my debts would have been paid and I would still have

the $10,000 that I wanted to spruce up my home. And I most assuredly would not be paying more than double what my mortgage

payment was before this all started. All I needed was $20,000.

I am sharing my bad experience because I believe that I have

been victimized. That American Equity Mortgage has perpetrated

14

a fraud and that they should be held accountable for their actions.

I hope that by sharing my experience, other homeowners can recognize and avoid the predatory practices that I fell victim to. Moreover, I hope that appropriate laws can be put into place, at both

the State and Federal level, to protect homeowners from being victimized and to punish lenders engaging in predatory practices.

Chairman SARBANES. Let me interject to be clear. This is the

new mortgage the loan officer said that you should consolidate.

Ms. MACKEY. Yes.

Chairman SARBANES. And when you sought an equity loan for

$20,000, just to pay the debts and fix up your condo, he suggested,

no, what you should do is consolidate that with your old mortgage.

So you, in effect, would get a new mortgage.

Ms. MACKEY. Well, what he suggested was a consolidation, yes.

Chairman SARBANES. Right. And so, this new mortgage is the result of that consolidation.

Ms. MACKEY. That is correct. And the new mortgage is for

$100,750.

Chairman SARBANES. Yes.

Ms. MACKEY. The interest rate is 12.85 percent, with an APR of

13.929 percent, and a monthly payment of $1,103, with a prepayment penalty of 1 percent.

The new mortgage, which is $100,750, was comprised of $74,000

that paid off the old mortgage, $18,645 in additional funds to pay

off the bills and do the spruce-up on my condo, and points and fees

totalling $8,105. I think I have everything in there now.

Chairman SARBANES. Well, thank you very much.

Ms. MACKEY. Thank you. And I especially thank you for asking

me to testify. And Senator Stabenow, thank you so much for taking

an interest in my case. I appreciate that.

Chairman SARBANES. Mr. Satriano, just before I turn to you, we

have been joined by Senator Bayh and Senator Allard. I do not

know whether either has a statement they may wish to make.

COMMENT OF SENATOR EVAN BAYH

Senator BAYH. Thank you, Mr. Chairman. I do not want to interrupt our witnesses.

Thank you for the offer.

COMMENT OF SENATOR WAYNE ALLARD

Senator ALLARD. Mr. Chairman, I do have a statement.

I would just ask that it be made a part of the record. I would

agree that we go on and hear the testimony from the witnesses.

Chairman SARBANES. Fine. Of course, it will be included in the

record.

Mr. Satriano, we would be happy to hear from you.

STATEMENT OF PAUL SATRIANO

OF SAINT PAUL, MINNESOTA

Mr. SATRIANO. Thank you very much. Good morning. My name

is Paul Satriano and I am a member of Minnesota ACORN. Last

November, I got a terrible home loan from Beneficial, which is part

of Household, and over the last few months I have become active

in ACORN’s campaign against predatory lending, so that I can help

15

make sure that more people do not have the same problems that

I do now.

For the last 8 years, I have been working as an auditor for Holiday Inn, and before that, I was working for the steel workers. I was

also a member of the U.S. Air Force and I am a disabled vet. My

wife, Mary Lee, works as a customer service representative for

Road Runner Delivery Service and we have a daughter and two

children that live with us in our house.

My father-in-law built our house in 1947. Four years ago, after

my wife’s mother passed away, we took out a mortgage to buy the

house. Interest rates were falling, so we refinanced the following

year. And then we found out that the windows, which were original, had to be replaced, so we took out a second mortgage for them.

Our monthly payments were $791 on the first mortgage and $166

on the second, and we never had a problem with these loans, were

never late on any payments.

A few years ago we dealt with Beneficial for the first time. They

refinanced our car loan. They were very friendly at that time. Then

they started sending letter after letter telling us how we can get

up to $35,000 in cash. We had some credit card bills totalling

$7,000, so we called and figured we are take care of them. Once

they have you calling back, they had us. We were hooked.

We told the Beneficial representative that we just wanted to pay

off our credit card bills. She convinced us that we should do that

at the same time that we consolidate our first and second mortgages with them. But the loan they ended up giving us only paid off $1,200 of our credit card bills. To do that cost us $10,000 in fees, plus almost

$5,000 in credit insurance, and left us with a higher total interest

rate and a couple of hundred dollars more each month to pay on

our debts. We lost $15,000 in equity in our home and now we are

locked into the higher rate in payments, both because the loan has

a 5 year prepayment penalty for about $6,000, and because we now

owe much more on our house than it is worth, and it is going to

be harder to refinance it. Let me tell you how it happened.

A few hours before we were supposed to go to the signing for the

closing papers, Beneficial faxed us the first written information we

ever received about the loan. The paper they sent said the house

was worth $106,000, and that would be the maximum amount of

the loan. They laid out what the $106,000 would go to and none

of it was for points or fees to Beneficial.

When my wife and I went in for the closing, they went through

all the paperwork so fast, it was like a barker in a circus—they just

keep talking, you put your money down, and you try to find the

two-headed boy and you never saw one. It was over in less than

a half hour.

During the closing, the branch manager said they could not pay

off all our credit cards with this loan. But because you have a car

loan with us and you are such a good person and you paid every

month, that we can get you more money on that and we will pay

off the credit cards. So, we thought that was okay.

When we got home later, we found out that there was a letter

in our mailbox that the change in our car loan to include the credit

card debt had been denied.

16

Beneficial implied that if we did not take our credit insurance, we would not get the loan. So, they added $4,900 to our loan

amount for that. After talking with ACORN, I realized that we

could ask for a refund on this $4,900. With what we got back, we

paid off some of our credit card loans. But we are going to be paying the $4,900 for the rest of the loan, so it really does not matter

at this point.

Also, the offer sheet Household sent us said our payments would be $1,168 a month, which was already more than we were paying

before. But now we are paying them $1,222 a month, plus we are

paying another $49 a month on the bills the Beneficial offer sheet

said would be paid off, but were not. And despite our history of not

a single late mortgage payment, Beneficial charged us an interest

rate of nearly 12 percent. Standard bank ‘A’ rates were below 8

percent at the time.

Although we did not realize it, the fees and credit insurance put our loan amount over $119,000. Even without the prepayment penalty, the fact we owe more than the value of our house means we

might be stuck in this loan for a while. ACORN was the one that

really let us know that there was a prepayment penalty. We did

not even know that there was a prepayment penalty.

Beneficial had also charged us 7.4 percent of the loan amount as discount points, and that is close to $8,900 on top of the $1,100

that they took out for third-party fees. Our loan also contains a

mandatory arbitration clause which says, we cannot take Household to court.

After we sent in a complaint to the Minnesota Commerce Department, we eventually got a district manager from Household on the

phone. But he told us everything was fine with our paperwork and

that he could not do anything and he sent all the paperwork to the

Commerce Department.

So, we are left with a loan amount much higher than the value

of our home, higher payments, more debt staked against our house,

a higher interest rate than before, and they paid off only a fraction

of our credit card debt, which had been the original reason to refinance. Plus a prepayment penalty and Beneficial is protected from

legal action by the mandatory arbitration clause.

My wife and I have faced some difficult times this year, and the

financial stress caused by this loan has made things worse. In January, my sister died and I had to travel out to New Jersey, and

I had to drive because my one sister could not fly. On the way

back, our brakes went out and I had to pay $500 to get new brakes.

Three weeks ago, my daughter-in-law died, and now my son and

three children are going to need help.

This is not Beneficial’s fault. But if we would have had the right

kind of loan, we would have been in a better position to help these

people now. Even without a predatory loan, we would be in a tough

spot. Now we have higher payments on our debts each month and

we owe more against our house. For the first time, this month, we

were not able to make our mortgage payment.

What surprised me most in all of this is that I am not alone in

getting a predatory loan. In the last few months I have heard from

a lot of people who have also been hurt by bad loans, from Household and from other lenders.

17

The basic problem is that when you sit down at that closing

table, the lender knows more than you do. You expect honest dealings, like you have had on past loans. And with predatory loans,

that is just not what happens. That is why we are counting on our

Senators to support strong protection for borrowers against abusive

loan terms. And to say I am pissed is an understatement.

Thank you.

Chairman SARBANES. Thank you, Mr. Satriano.

Mr. Williams.

STATEMENT OF LEROY WILLIAMS

OF PHILADELPHIA, PENNSYLVANIA

Mr. WILLIAMS. Good morning. And thank you for inviting me.

My name is Leroy Williams. I am 64 years old. I live at 5617

Larchwood Avenue, Philadelphia, Pennsylvania. My income from

Social Security is $826 a month.

I bought my home in 1975 for $10,000. I had a mortgage with

payments of about $150 a month. The payments included my taxes

and insurance. I finished paying my mortgage in 1996, and I retired the same year as an assistant manager of a shoe store.

Between October 1998 and January 2000, I ended up with three

different mortgages on my home. My taxes and insurance were not

included in the payments on any of the three loans.

In 1998, I was having trouble paying my gas bill. I was behind

in the payments and I did not want the city to dig up the gas line

in front of my home and turn off the gas. I saw an ad in the paper

about loans to pay off your bills and I called. A man came out to

my home and talked to me about getting a loan. He brought loan

papers to my home for me to sign. The loan was with EquiCredit.

The payments ended up being $215 a month. The payments were

higher than my gas bill had been and I still had a high gas bill

every month in the winter. My Social Security income when I got

the EquiCredit loan was $779 a month.

The date I signed the loan was October 2, 1998. The loan from

EquiCredit was $19,000. They gave me $3,000 in cash that I did

not ask for. I used the $3,000 to pay the gas bill and other bills

and help my sister. Her husband had just died and I used some

of the money to go to the funeral in North Carolina and to help

pay some of the expenses and to help my sister in general. I do not

remember where the rest of the loan money went, just that they

told me that the loan had to pay all my bills.

As far as I remember, I was making the EquiCredit payments

okay. I do not remember just how I got into the next loan, with

New Jersey Mortgage. There was a broker named Joe, but I do not

remember his last name or what company he worked for. I threw

out the papers from that loan because I was so mad about it. I had

to take a bus outside the city to go sign for the loan. The date I

signed for the loan was October 6, 1999, about 1 year after the

EquiCredit loan.

The loan from New Jersey Mortgage was $26,160. I do not remember what all the loan paid for, but I think I received $400. The

payments ended up being $320 a month. I did not want payments

that high, so I cancelled the loan. But they called me and told me

18

I had to make payments or I was in jeopardy of losing my home.

I kept telling them that I cancelled the loan.

Right after I signed the loan from New Jersey Mortgage, I got

a card in the mail from someone named Keeler. The card said I

could get a better deal on my mortgage. I called Keeler and he told

me not to send payments to New Jersey Mortgage and he would

get me a better deal. Then it took a long time for him to set up

the loan, and I kept getting calls from New Jersey Mortgage.

Keeler drove me to an office in New Jersey to sign for the loan.

He would not come into the office with me. He told me he had to

go get gas. The loan Keeler set up was from Option One. The date

was January 3, 2000. The loan was for $32,435. The payments are

$315, but I know now the payments can go up to $348 or higher

after 3 years because the interest rate will change.

I signed for the Option One loan because I thought I was going

to lose my home if I did not, even though I told Mr. Keeler that

I needed payments around $240 a month. I tried to make the payments at first, but I had too many bills to pay and it was so hard.

And it was making me more and more angry, so I stopped making

the payments.

I know now that Option One paid New Jersey Mortgage around $2,300 more than the amount of the New Jersey Mortgage loan— because of interest and a penalty of 5 percent of the loan if I paid

it off early. I have also learned that the New Jersey Mortgage loan

had a balloon payment. I understand now that means I could have

paid $320 every month for 15 years and still owe most of the loan.

When you are a certain age and you have lived in a place for 20

years, you just want to dwell there until your time comes, but I do

not have any peace because of all this.

Thank you again for inviting me to talk with you.

Chairman SARBANES. Thank you very much, Mr. Williams.

Mrs. Podelco.

STATEMENT OF MARY PODELCO

OF MONTGOMERY, WEST VIRGINIA

Ms. PODELCO. Mr. Chairman, thank you for the invitation to

speak here today. My name is Mary Podelco and I live in Montgomery, West Virginia. I grew up in West Virginia and went

through the 6th grade. I moved to Indiana where my husband and

I worked in factories. I had four children with my husband of 19

years and was widowed for the first time in 1967. After I was widowed the first time, I moved back to West Virginia and worked as

a waitress, paid all my bills and rent in cash. When I remarried

in 1987, my husband Richard and I were very proud that we were

finally able to purchase our own small home. He worked as a maintenance worker and passed away in June 1994. I became the sole

owner. In July 1994, I paid off the $19,000 owed on the home from

the insurance from my husband’s death. Before my husband’s

death, I had never had a checking account or a credit card. I had

always paid my bills in cash and tried to be an upstanding, responsible citizen. I do not drive and never owned a car.

In 1995, I received a letter from Beneficial Finance offering to

lend me money to do home improvements. I thought it was a good

idea to put some new windows and a new heating system in my

19

home. I signed a loan with Beneficial in May 1995. This was the

beginning of my troubles. My monthly income at that time was

$458 from Social Security and my payments were more than half

of this. They took a loan on my house of about $11,921. The very

next month, Beneficial talked me into refinancing the home loan

for $16,256. I did not understand that every time I did a new loan,

I was being charged a bunch of fees.

I began getting calls from people trying to refinance my mortgage

all hours of the day and night. I received a letter from United Companies Lending telling me that I could save money by paying off

the Beneficial loan. On September 28, 1995, I signed papers in

their office. More fees were added and the loan went to $24,300,

at an interest rate of 13.5 percent.

Just a few months later, I received a letter from Beneficial telling me I could save money by paying off United and going back to

Beneficial. The loan was about $26,000. On December 14, 1995, according to the papers, Beneficial paid off United again, charging me

more fees and costs.

In February 1996, Beneficial advised me that it was time for me

to refinance again. The loan papers show that I was charged a finance charge of $18,192 plus other fees and an interest rate of 14

percent. By the end of February, I had five different loans in 10

months. I did not understand that they were adding a lot of

charges each time.

After that I was called by Equity One by telephone to refinance

the loan. On May 28, 1996, I signed papers with Equity One in

Beckley, West Virginia. The new loan paid off the Beneficial loan— which was for 60 months—and replaced it with a loan for $28,850

for 180 months which I understand increased my total loan from

$45,000 to over $64,000. I got $21.70 cash out of the loan. My

monthly payments were $355.58. They charged me closing costs of

over $1,100. Then on June 13, Equity One suggested that I needed

another loan to pay off a side debt and they loaned me $1,960, at

over 26 percent interest. Monthly payments were $79. This loan

brought my monthly payments to Equity One to over $434 a

month. My monthly income at that time was $470. I really could

not make the payments. My granddaughter had a monthly income

from SSI, but by law, I cannot use her money for my benefit.

Then on August 13, Equity One started me on another loan. I

was later told that Equity One was acting as a broker for an outof-state lender—Cityscape. This new loan was all arranged through

the Equity One office to help me by lowering my payments. This

loan included $2,770 in new fees and costs. There were a whole lot

of papers with this Cityscape loan that I did not understand. The

payments were still too much.

I missed my first payment when my brother died in December

1996. Cityscape said they would not take a late payment from me

unless I made up for the missed payment. I could not do it. Later

in 1997, I lost my home to foreclosure by Cityscape. I now understand that these lenders pushed me into loans I could not pay.

Adding all of these fees and costs each time caused me to lose my

home, one I owned free and clear shortly after my husband died.

Thank you.

Chairman SARBANES. We thank all the witnesses.

20

We have been joined by Senator Corzine from New Jersey.

Jon, I do not know if you have an opening statement.

COMMENT OF SENATOR JON S. CORZINE

Senator CORZINE. I just appreciate very much your holding this

hearing, Mr. Chairman, and to all of the witnesses, I respect and

admire your willingness to speak out on this issue.

Chairman SARBANES. Thank you very much. I am going to be

very brief, but I just want to—Ms. Mackey, I would like to go

through your situation because you skipped over a part and then

you put it at the end and I want to try to do it in sequence so that

we get a very clear picture on what happened.

As I understand it, before you responded to this radio ad that

you heard because they were advertising that you could get a home

equity loan and you wanted to do some fixing up of your condo and

also pay off some other debts, you had a mortgage loan of $74,000,

before you went to them.

Ms. MACKEY. Before I went to the home equity loan, yes.

Chairman SARBANES. $74,000, at an interest rate of 71⁄2 percent,

and you were making a monthly payment of about $510.

Now, as I understand it, they said to you that, to get this home

equity loan, it would be in your best interest to do a consolidation,

which meant refinancing your old mortgage loan and then having

a new loan included therein. And you went ahead and that is what

you did. Is that correct?

Ms. MACKEY. Yes, that is correct.

Chairman SARBANES. All right. Now the new mortgage that re- sulted out of all of this was for just over $100,000, instead of

$74,000.

Ms. MACKEY. That is right, $100,750.

Chairman SARBANES. That mortgage had an interest rate of

12.85 percent.

Ms. MACKEY. That is correct.

Chairman SARBANES. The old mortgage had 71⁄2 percent. Correct?

Ms. MACKEY. That is correct.

Chairman SARBANES. 12.85 percent. Your monthly payment jumped to $1,103, and there was a prepayment penalty included of

1 percent.

Ms. MACKEY. That is correct.

Chairman SARBANES. Okay. This meant you got this $100,750

new mortgage, $74,000 of that to pay off the old mortgage.

Ms. MACKEY. Right.

Chairman SARBANES. There were points and fees of $8,105.

Ms. MACKEY. That is right.

Chairman SARBANES. And then that left you with $18,645, in additional funds to pay off bills and do the improvements.

Ms. MACKEY. Yes.

Chairman SARBANES. So that is how you arrive at this point that

to get the $18,645 additional, you paid $8,105 in points and fees.

Ms. MACKEY. That is right.

Chairman SARBANES. Actually, you went to an interest rate on

the new mortgage of 12.85 percent for all of it, whereas before, you

had an interest rate of 71⁄2 percent on the $74,000 mortgage. You

now ended up paying an extra $593 a month in monthly payments.

21

That jumped from $510 to $1,103. And you will pay over a couple

hundred thousand dollars in interest over the life of the loan.

Ms. MACKEY. Yes.

Chairman SARBANES. Well, that is a pretty dramatic example of

what we are trying to address here today and I very much appreciate your coming and telling us that story.

Now, Ms. Podelco, in the time that is left to me, because I explained to the panel, we do 5 minute periods amongst the Members

and then we move on to the next Member. I am not going to go

all the way through this, but I want to explain it.

When your second husband died, you and your second husband

had finally purchased a small home of your own. Correct?

Ms. PODELCO. Yes.

Chairman SARBANES. Then he passed away. You became the sole

owner. You received an insurance policy payment after his death.

Ms. PODELCO. Yes, that is right.

Chairman SARBANES. And you took $19,000 of that insurance

policy payment to pay off the mortgage on your home. Correct?

Ms. PODELCO. Yes, so that I would have a home.

Chairman SARBANES. That is right. And you had a home free and

clear of any debt. Correct?

Ms. PODELCO. Yes, at that time.

Chairman SARBANES. That is right. And then you got this letter

about doing home improvements and you thought, you needed some

new windows. You needed a new heating system and so forth.

Ms. PODELCO. Yes.

Chairman SARBANES. So, you went and signed a loan just under $12,000—$11,921. Right? To begin with.

Ms. PODELCO. Yes.

Chairman SARBANES. Okay. At that time, your income was $458

a month from Social Security and the payments on this loan would

be more than half of that.

Ms. PODELCO. I know.

Chairman SARBANES. Of course, that is a dramatic illustration of

the fact that these predatory loans are made without relationship

to the borrower’s ability in terms of their income to repay the loan.

It is completely geared to the equity in the home, which is one of

the points that we are trying to stress.

And then what happened over time, one or another company

kept coming to you to get you to refinance your loan. And unfortunately, you proceeded to do that. Of course, they charged you fees

and everything each time they did it. So the amount of mortgage

on your home and the monthly payment you had to make kept

going up. Is that correct?

Ms. PODELCO. Yes.

Chairman SARBANES. In fact, it went up to the point—well, the

last figure I have here—of course, there were some add-ons after

that. It reached over $64,000, the mortgage.

The total loan went over $64,000. And of course, your monthly

payments escalated as well. And in the end, you were not able to

meet the payments. Is that correct?

Ms. PODELCO. That is correct.

Chairman SARBANES. And you lost your home.

Ms. PODELCO. Yes.

22

Chairman SARBANES. I believe that is a very dramatic example.

I just say to my colleagues, we have really have to pinpoint this

thing and do something about it.

Here is someone who worked all their lives, bought a home, took

the insurance policy money on their husband’s death in order to

pay off the remaining mortgage on a home to own the home free

and clear, and then was manipulated over a period of time, successively, by these operators, until finally they ran the mortgage loan

way up, ran the monthly payments way up. In effect, they stripped

the equity out of the home, when they foreclosed and took it away.

Thank you very much for coming and being with us.

Ms. PODELCO. You are welcome.

Chairman SARBANES. Thank you all.

Senator Johnson.

Senator JOHNSON. Mr. Chairman, I thought the testimony here

was extraordinary and I am appreciative of your calling this panel.

I do not have any questions of my own here, other than simply to

say thank you to all four members of this panel. I think that you

have contributed in a very meaningful way to the overall debate on

this very difficult issue.

Chairman SARBANES. Senator Reed.

Senator REED. Well, Mr. Chairman, the testimony is disturbing,

shocking, to think that, as you so aptly characterized it, people

work all their lives and then have their homes taken from them

through manipulation, through a pattern of deceit and dissembling,

is despicable. I do not think there is any other word for it.

I do not know what I can add in terms of questioning, but it

struck me when I was listening to Mr. Satriano and reading his

testimony, that because of an arbitration clause in your own mortgage, you could not even go to court. Is that correct?

Mr. SATRIANO. That is right, sir.

Senator REED. And I wonder, Ms. Mackey, did you ever address

some type of court filing?

Ms. MACKEY. I have spoken with the Legal Aid Society of Oakland County. They referred me to an attorney who never returned

my calls. I am going to pursue it. It is just not fair.

Senator REED. And Ms. Podelco, when you were in your dilemma,

did you try to get any legal assistance to try to upset the contract?

Ms. PODELCO. No, that is where I made my mistake, until I realized that they were ready to foreclose.

Senator REED. The other thing I should point out, Mr. Chairman

which I find disturbing is that, when we have had our debate upon

the bankruptcy bill, and we have had companies come in and argue

about how we have to reform the bankruptcy laws because they are

being taken advantage of.

And we now have stripped away many basic rights that previously people had to protect themselves. And you find out that—

and I would not suggest the linkage between specific companies,

but you find out that within the same financial services operations,

there is a great deal of shenanigans going on. And yet, we are

hearing that we should not take any action. We cannot do anything. That it is the market.

But certainly, when it comes to the bankruptcy bill, we were implored that we had to take action. It just seems to me unfair.

23

Thank you, Mr. Chairman.

Chairman SARBANES. I just want to underscore, in Ms. Podelco’s

case, her income was her Social Security payment. And these companies were clearly making loans to her that could not be repaid

from her income. Obviously, they were targeting this home that

had been paid free and clear and which had equity. So the whole

process was geared to taking the equity out of that home.

Senator Stabenow.

Senator STABENOW. Well, thank you, Mr. Chairman. And thank

you again to each of you for coming.

As we are wrestling with what to do, I would like very much to

know from each of you, from the information standpoint, consumer

information, what you would suggest to us as we look at not only

defining what predatory lending is, so that we can clearly state

that it is illegal and existing laws need to be enforced aggressively,

and we need to make sure the resources are there to do that. But

we all understand that more consumer awareness and education is

very important. And that is why your being here today is so important and the Chairman’s focus on this issue is so important.

I would also say on the side that I am pleased and appreciate

that Freddie Mac is coming to Detroit to help us focus in September on the whole question of community awareness and education through an effort that they do which is called Don’t Borrow

Trouble. We are appreciative in their leadership in this, as well as

the support and involvement of Fannie Mae in efforts as well.

But I am wondering if any of you would like to comment on what

kind of information would be helpful to you to have on the front

end? Did any of you receive information in writing about the terms,

the costs, anything comparing what you were paying? For instance,

Ms. Mackey, your current—the loan before all of this happened

versus the new loan and the points and fees and costs and so on?

Did you receive any information in writing? And if not, what would

you suggest as being something that we should focus on in terms

of public information?

Ms. MACKEY. I received a good-faith estimate, which I think is

something that is required from American Equity Mortgage, before

the final paperwork. I did not see any paperwork other than that

until the final paperwork that I went in to sign. And everything

had been increased significantly at that time.

Senator STABENOW. I am not sure I understood correctly. Did you

have paperwork that said something different for the exact

same——

Ms. MACKEY. I am sorry. I had this bug in my ear.

Senator STABENOW. That is okay. You received information on

the front end. What exactly did they give you information about?

What were the numbers? What were the terms that they shared

with you?

Ms. MACKEY. They went over the rates that I already had and

they gave me the suggested interest rate or estimated interest rate,

which was 11-something. The monthly payment would be probably

around $900 and something.

At that time, my income was about, take-home was about $1,800

a month. So $900 sounded like a whole lot. But sounded do-able

if I was not going to have all of these other debts to take care of.

24

All the information on that good-faith estimate, and I am sorry

I do not have it right before me, the figures were all significantly

lower. The costs, the points, whatever, all were lower than the final

paperwork.

I would like to see something that could be put in the hands of

the borrower by the lender in advance that was the final paperwork, final numbers. An estimate is wonderful, but when they up

everything by several hundred dollars or more, it does not really

do much good. And you get there and you think, oh my gosh, what

have I done? And you are embarrassed and you do not know.

I sat there thinking, I really should just walk out of here. But

I cannot do that. It is silly to even think that way. But I think if

I had something to look over at home before I went in to sign those

papers, it would have given me a better opportunity.

I could have taken it to someone, although I do not know that

I would, because I did not want to—now I am talking about it all.

But at that point—what I am doing now is not for me. But at that

point, I did not want anybody to know what I had done.

Senator STABENOW. Thank you. And so, you were given a piece

of paper that said the payment would be around $900.

Ms. MACKEY. Yes.

Senator STABENOW. Instead, it was $1,103.

Ms. MACKEY. Yes.

Senator STABENOW. And a different interest rate.

Ms. MACKEY. Correct.

Senator STABENOW. And so, you walked in assuming one thing

and found out something else.

Ms. MACKEY. And you know, Senator Stabenow, it was several

days after I went home with this paperwork and looked it over

thoroughly on my own, that I discovered that my main reason for

getting this, one of my credit card debts had not been paid. And

when I called the young man who did the work, he said we could

not pay everything and give you what you wanted for the improvements on your condo. But they could charge me over $8,000 in fees.

You are talking about equity stripping. I had the difference between $150,000 and $74,000, what is that? $75,000? And now I

may have $50,000 equity in my home, if I am lucky.

I just think that there has to be more education. And it is not

just the responsibility of the Committee or the industry, but it is

also our responsibility to avail ourselves of that information.

And that again was my own fault for not doing that because I

know that there is information out there. But it is that embarrassment situation again, which is—I am not embarrassed any more.

I have learned.

Senator STABENOW. Well, thank you so much.

Chairman SARBANES. Senator Dodd.

Senator DODD. Thank you, Mr. Chairman. Again, I think that

this has been tremendously helpful to have all four of you share

your testimony.

I realize, something you just said, Ms. Mackey, was very worthwhile because in all of this, obviously, there are some other sources

of responsibility here. But you properly point out, if nothing else,

we hope people watching this or listening to this will take note of

what you just said.

25

The important thing is to always check and ask other people.

There are people you can go to in most communities that will help

you find out whether what you are being offered is—my mother

used to say, if it sounds too good to be true—remember that?

Ms. MACKEY. It usually is.

Senator DODD. It usually is, yes. And when you hear these radio

ads and so forth and they are offering to make your life easy, offering you more money at less cost, that is usually a good signal.

Ms. MACKEY. I understand that. And I was at a point where I

was very, almost desperate to get this taken care of.

Senator DODD. Yes, I understand that.

Ms. MACKEY. So, I lost all good sense.

Senator STABENOW. Would my friend yield for just one moment?

I would just want to add that in this particular situation, Ms.

Mackey got information ahead of time, saying, it would be a $900

payment and it changed at closing. So, I would just add that even

when we ask ahead of time, if it is changed, there is a problem.

Senator DODD. No, I agree. But my point is, again, for people listening out there, or who are watching this, who have not yet done

this, but who are being approached by people, your testimony here

is a good warning. It does not offer you any immediate relief, obviously, but maybe just by being here, you may be saving some people from the same kind of tragedy.

You have been through basically a financial mugging. That is

what this is. You were mugged. It is almost like walking down the

street and being mugged. Now it took longer and it was more subtle and it was cute. But it is as much as if someone had held you

up, in my view.

Senator Reed made a very good point. There are some of us who

have strongly objected to this so-called bankruptcy reform bill. One

of the reasons that the bill has not become law today is because

there are a couple of States in this country where affluent homeowners do not want their homes subject to bankruptcy laws—the

Homestead Exemption. And Ms. Podelco, if you just moved to Palm

Beach and bought yourself a nice big condo, you might not be in

this trouble today.

[Laughter.]

I do not know if that was possible for you in West Virginia. But

it is somewhat ironic in a way that we are talking about so-called

reforms here, where people want to prohibit the discharge of credit

card responsibility and make it more difficult for people who get

caught in difficult situations to be able to get themselves out of it.

But that is an aside that I raise to you here today.

Let me just ask you, because one thing was common in all of

your stories here. They all have a poignancy to them. But it just

seemed to me in every case, with some variations on it—Mr.

Satriano, you have something next to you there. What is that?

Mr. SATRIANO. It is just a picture of my house.

Senator DODD. Why not get it the right side up?

[Laughter.]

There we go. That is your home?

Mr. SATRIANO. Yes.

Senator DODD. How long had you been in that house?

Mr. SATRIANO. My wife grew up in there.

26

Senator DODD. Your father-in-law built that house?

Mr. SATRIANO. Right. 1947.

Senator DODD. Well, the one thing I saw as I was listening to

you talk about it here is that the solicitors in every case withheld

information, it seems to me, in every case. And correct me if I am

wrong, but you had very important information withheld from you

as the solicitations were being made. And important information

about the terms of the loan, you were directly misled in every single case. Is that true?

Mr. SATRIANO. [Nods in the affirmative.]

Ms. MACKEY. [Nods in the affirmative.]

Mr. WILLIAMS. [Nods in the affirmative.]

Ms. PODELCO. [Nods in the affirmative.]

Senator DODD. You are nodding your head yes.

Ms. MACKEY. Yes.

Senator DODD. Now the marketing of this just seems to me it is

fraud in your cases here. I do not know how else to describe it. The

marketing techniques that were used against you were all in the

case promising you a much better deal, obviously, than you had in

every single case.

Again, I thank you, Mr. Chairman. I know we have other witnesses to hear from. I hope maybe some of our colleagues when we

look at it—there was a piece in The Wall Street Journal, I think

it is today’s home economics—refinancing boom helps explain

strength of consumer spending.

An unprecedented cashflow may prevent recession. Economists

figure that all of the refinancing activity contributed nearly half of

1.2 percent annualized growth in the first quarter gross domestic

product.

I mean, this is going on. There is a lot of refinancing going on

all over the country. Now I am not suggesting, obviously, that the

refinancing, all of it is predatory lending. But I get nervous when

I see this, a lot of these solicitations going out. And as long as

home prices stay up—I remember in Hartford, Connecticut a few

years ago, we had the mid-1980’s. And there was this tremendous

inflation in values of homes. And then we had the real estate market crash. And people had mortgages on their homes that vastly exceeded the value of these homes.

I have an uneasy feeling that we may be entering a period like

that. And we are going to find that not just people like yourselves

sitting here that have been through and dealt with unscrupulous

lenders out there that have taken advantage of you by withholding

information and lying to you, basically, deceiving you, that we may

find a more compounded problem here as a result of this effort to

convince people that they can refinance their homes and ought to

do so, and find that these homes are not going to be worth as much

as they thought they were.

Again, I thank all four of you. You are courageous people. We are

grateful to you for being here.

Chairman SARBANES. Senator Corzine.

Senator CORZINE. I will be brief, Mr. Chairman.

I certainly concur that you are courageous to sit and tell us these

stories, which I think accentuate a major flaw, a reprehensible flaw

in our economic system. I hope we can get at some of the fundaVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 82969.TXT SBANK4 PsN: SBANK4
27

mental problems here with precise but important legislation as we

come through this.

One thing that yells out at us is the need for financial literacy

exposure. This morning I was with a group of people from the

Urban League and Historic Black Colleges and Freddie Mac on a

Credit Smart program that is designed to deal with getting financial literacy out in the community so that we can deal with this

when you are faced with people that are smooth talking and fast

talking and trying to give you something for nothing.

But I have one question. How many of you had an independent,

outside participant with you as you went through this, for example,

a lawyer?

For the life of me, I have never gone to a closing on a mortgage

without a lawyer. And I am wondering whether any of you in the

situations you had had some independent party that would challenge the efficacy of this process.

Ms. PODELCO. [Nods in the negative.]

Ms. MACKEY. [Nods in the negative.]

Mr. WILLIAMS. [Nods in the negative.]

Mr. SATRIANO. [Nods in the negative.]

Chairman SARBANES. I think the record should show that all four

panelists, they did not have someone with them.

Senator CORZINE. I am not sure on all of the steps that we need

to take in this process, but the idea that people who deal in the

subprime market and this secondary lending have the ability to

have a one-on-one relationship without someone who has the financial skills to evaluate some of these programs makes a lot of sense.

You are courageous. I appreciate very much your statements and

participation and help in this process, and I look forward to us

pushing aggressively forward. And I also have to identify with the

bankruptcy remarks that the Senators from Connecticut and Rhode

Island made. This is not a one-sided affair, as I think we heard it

mostly debated on the floor of the Senate.

Chairman SARBANES. Thank you very much, Senator Corzine.

I want to tell the panel members how much we appreciate their

testimony. As I said at the outset, I know it is difficult to appear

in this public atmosphere to tell your personal story, but it constitutes a valuable contribution to this effort we have undertaken.

Some of my colleagues made note of it, and I think I ought to,

for the completeness of the record, observe that there are a number

of financial institutions that have announced recently, subsequently to when we scheduled these hearings, a number of steps

that would address some of the concerns that are here today.

In particular, a number of companies have announced that they

will no longer finance single premium insurance in their loans, roll

it into the mortgage and then you end up paying interest over a

sustained period of time. Other practices have also been changed.

Those are important steps and we welcome them. But there is

more to be done, obviously, and we intend to continue to press forward with really laying out exactly what the problem is, so it is

fully understood.

We want the regulators to exercise more effective control. We

want tougher enforcement of existing laws, which may well need

the commitment of more resources.

28

But there are practices going on that are not illegal under existing laws. The repeated refinancing of a loan and the stripping out

of equity is technically not illegal.

And so, we need to address those problems. We need to address

the education dimension which Senator Corzine talked about. And

I encourage the industry itself to continue to try to establish best

practices and raise the level of activity within the industry.

It is very helpful in all of this that people will come in and speak

out about their own experience. I know it is, in some respects, as

Ms. Mackey said, embarrassing for you, although you have passed

that threshold, I gather, now.

But you have made a very substantial contribution here today

and we thank you very much. We will excuse this panel and move

on to our next panel.

Thank you all very much.

The Committee will take just a brief pause while we move this

panel out and bring the other panel on.

[Pause.]

Chairman SARBANES. I want to welcome the second panel. I

know you have been waiting quite a while.

On this panel we have: Tom Miller, the long-time Attorney General of Iowa, and the Chairman of the Predatory Lending Working

Group of the National Association of State Attorneys General;

Steve Prough, the Chairman of Ameriquest Mortgage Company,

one of the larger subprime lenders in the country. And Ameriquest

has developed a program, with a number of civil rights and community organizations, which we are looking forward to hearing about

this morning; Charles Calomiris, professor of finance at the Columbia Business School and the Codirector of the Project on Financial

Deregulation at the American Enterprise Institute; and Martin

Eakes, who is the President and CEO of the Self-Help Credit Union

in North Carolina. Mr. Eakes has, as I think we all know, been a

leader in the effort to fight predatory practices, both in his home

State of North Carolina and nationally. And of course, North Carolina has taken a number of very important initiatives that I think

are worthy of attention. We welcome all of you.

Gentlemen, we are running late this morning. I think what we

will do is we will include your full statements in the record. I very

much appreciate the obvious effort and time and thought that was

devoted to preparing these statements. They are quite comprehensive and they will be of enormous help.

If you could summarize your statements in 8 to 10 minutes, we

would appreciate that. And then we will go to a question period.

Attorney General Miller, why don’t we start with you? We are

pleased to welcome you before the Committee, and I might note

that many years ago, in his younger life, Attorney General Miller

worked as a Vista volunteer in Baltimore, Maryland. We were

pleased to have him there and we are pleased to have him here

today before the Committee.

Mr. Miller.

29

STATEMENT OF THOMAS J. MILLER

ATTORNEY GENERAL, THE STATE OF IOWA

Mr. MILLER. Thank you, Mr. Chairman.

You might add that I was also a very enthusiastic volunteer in

your campaign.

Chairman SARBANES. I did not want to make it political.

[Laughter.]

Mr. MILLER. I will try and summarize as you suggested. In a

way, a summary is made easy because of what happened before.

The testimony that we heard before was compelling. It was strong.

It was complete. And it tells the story. It tells the story because

it did not happen to just those four individuals. It happens to many

people throughout the country.

Even in a place like Iowa. I met 2 days ago with three very similar people to the four you heard this morning, very similar stories

and very sad stories. Indeed, the conduct is bad enough and it is

being done often enough throughout the country, that I believe it

is truly a national scandal.

I think you summarized the elements that are used by various

people against low income people to do this in America and I will

just mention them briefly. And keep in mind that it is the combination of these tricks and these gimmicks and these charges that accomplishes the draining of their equity and the loss of their house.

First of all, as was mentioned, it is the points and related

charges that can add up to thousands of dollars, often 5 to 10 percent and more. Then it is the credit insurance. And there is absolutely no reason for this insurance. Let us look at this.

A low income person that is trying, struggling to buy a house,

going to an equity loan, a second mortgage, in terms of what they

need and what they would choose, would they choose insurance

payments at a large level? It just does not make sense. It is pure

exploitation. And I am pleased, as you mentioned, that three companies have decided not to use that.

One of the people we talked to earlier this week had paid $10,000 for a single premium credit insurance. And then they were

going to pay $66,000 in interest. So $76,000 for a product that they

do not need, would not choose, given their other needs.

The interest rate is higher, sometimes even getting into the highteens and into the 20 percent. And one thing that was alluded to

by the earlier speakers that I want to point out is a whole group

of people that are involved in this. And they are called bird dogs.

They are independent brokers or they are home improvement people that often do very fraudulent home improvement. And they are

out looking for these people.

They are out looking for the four people that you saw this morning, the three people that I saw on Tuesday. And they have various

ways of finding them. And they do find them. And all of this is

below the radar screen. They will lie about everything. It reminds

me a little bit about telemarketing fraud that we fought a few

years ago. When people got on the phone, those telemarketing

fraud operators, they would lie about everything to close that deal.

These bird dogs do exactly the same thing.

Another abusive practice is the balloon payment. Because of

everything that these people are being charged and the interest

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rate that is high in addition, people cannot pay off the loans. So

what they do is they give them a 15 year balloon payment at about

the same price of the loan itself. So there is no chance that they

will ever pay it off.

Then there is flipping that the lady from West Virginia so eloquently laid out, the flipping from company to company to company, adding on those charges, those 10-, 20-, 30-percent charges

each time—that is part of it.

And then just to make sure, once they have people hooked, that

they do not get off the hook somehow by maybe a family member

helping or a friend helping, there is the prepayment penalty, to

hold them on onerous terms. And if they decide that they might

want to go to court, it is the arbitration clause.

It is all of these things that are brought together. They are a national scandal because of what they do to people. And you can tell

they are the part of business plans of some of these companies.

The bird doggers that I mentioned are part of just a fraudulent

operation. This is just a whole set of people and circumstances that

are exactly out to abuse people in the way that is described. And

of course they do it primarily with poor people, primarily with minorities, primarily with elderly, the ones that are most vulnerable

in our society. As I say, I believe it is a national scandal. The question is what do we do about it?

Well, first of all, society has to recognize that this is totally unacceptable. We as a society need to push back. And that is why I

think it is so important that you have called this hearing. Putting

the light of day on these practices is extremely important. But of

course much more has to be done.

Some things have to be done by the companies. Some very reputable companies are involved by owning some of the subsidiaries,

by buying some of the loans, in some instances dealing with the

bird dogs.

They have to change their companies. And I think some of them

are about doing that. You mentioned on credit insurance. I talked

to one other company. It is amazing, when my name showed up on

the witness list, I started to get calls, Senator from one of the large

companies that indicated perhaps some real constructive change.

The industry has to clean this up because what we have seen

happen is totally intolerable. And any self-respecting individual or

company cannot be involved with what I just described. They need

to recognize that and I think they are starting to get the message.

We need enforcement. We attorney generals recognize this as a

problem, a big problem. We have just recently put together a working group, as you mentioned, of attorney generals to work on this,

that I lead as well as Attorney General Roy Cooper of North Carolina and Attorney General Betty Montgomery of Ohio.

It is something we are concerned about. The FTC is involved.

Other law enforcement people are involved, and understanding the

grievous nature of this problem and what needs to be done.

The Federal Reserve needs to act on the regulations that are proposed before them. Thirty-one States and 31 State Attorney Generals have endorsed and pushed for those regulations. I think it is

very important that those reforms go forward.

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Congress needs to act. They need to look at some of the features

perhaps that are preemptive on States. There may be a role for

States to play, a somewhat larger role, realizing that we are dealing with a national problem.

And you need to take a look at HOEPA. HOEPA has changed

some things in a constructive way. But there are more things that

you can do on credit insurance, on balloon payments, on the size

of fees and charges, and on the ability to pay. We need to look at

this from a whole range of people.

Like many problems in the public policy arena, there is no silver

bullet. There is no one thing that we can do. But we can focus on

it from a number of different aspects in combination. Much like

they put those various combinations of bad things together to

achieve the result, we can push back and make a difference.

And I appreciate what the Senator said about this being a problem that needs to be dealt with in a way that does not harm legitimate subprime credit. It is very important that low income people

have the opportunity to get loans and buy houses through subprime credit that is reasonable and fair.

And companies can tell the difference. Companies can tell the

difference of these elements and the kind of lending that Senator

Gramm and others talked about.

It is very important that people like Senator Gramm’s mom be

able to buy a house like she did. But I will tell you what. If these

people got a hold of her, she would not have been able to buy that

house. She would either be paying yet today, 52 years later, or be

out of the house.

That is what is at stake here—to preserve what is good in the

credit industry, constructive credit, and to deal strongly and effectively with destructive credit, which drains the equity and the

hopes and the dreams from the people of America that are affected.

Mr. Chairman, thank you for inviting me to testify and thank

you for bringing this issue to the fore. It is a very important issue.

Chairman SARBANES. Thank you very much, Attorney General

Miller.

Mr. Prough.

STATEMENT OF STEPHEN W. PROUGH

CHAIRMAN, AMERIQUEST MORTGAGE COMPANY

ORANGE, CALIFORNIA

Mr. PROUGH. Good morning, Mr. Chairman. My name is Steve

Prough and I am Chairman of Ameriquest Mortgage Company.

Ameriquest Mortgage Company is a specialty lender. We provide

affordable loans to average American homeowners who have imperfect credit profiles. We are headquartered in Orange, California.

We have 220 offices nationally in 33 States and we have 3,200 professionals assisting our customers to utilize their most important

asset—their home—in order to obtain affordable credit to help meet

their own personal needs. Virtually all of our loans are to allow

homeowners to refinance and access capital. Our loan production

grew to approximately $4.1 billion in originations in 2000, and we

anticipate that growth will continue in 2001, resulting in approximately $5.5 billion of loan originations. Our servicing portfolio

totals $8.5 billion in loans.

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From the company’s senior management down through our newest hires, we at Ameriquest Mortgage Company believe that borrowers are best protected against abusive lending practices when

lenders adopt firm lending practices and when borrowers are given

the information they need to make informed decisions in their own

best interests. That is why we instill in all our employees a commitment to promoting the importance of fair lending practices and

consumer awareness.

As we developed our business, we found that the financial needs

of many average Americans with impaired credit were not being

met at all, or at affordable prices by the home financing industry.

Ameriquest sought to meet those needs by providing financing on

more favorable terms and at lower cost than had historically been

offered to credit impaired individuals by other lenders.

Leveraging secondary market sources and capital from Wall

Street, we originate, package, and then sell our loans. As a result

of the efficiency of these markets, we are able to offer lower costs

to our customers. Thus, through our Wall Street financing model,

we have substantially lowered the cost of financing for Ameriquest

borrowers.

We help working families and individuals whose credit may be

impaired for a variety of reasons. Our average customer is: 47

years old, from a suburban community, a 10 year homeowner, stable income with an average of 12 years’ employment and, finally, an average income of $70,000. This is a portrait of the Ameriquest

customer who has special credit needs that we have helped achieve

their goals.

We at Ameriquest are very proud of our history of making loans

available to borrowers who have been denied credit, but have credit

needs. It should be recognized that the specialty lending industry

has contributed to the highest homeownership in the Nation’s history and has helped open access to capital for traditionally underserved communities. We feel very strongly that all lenders must be

subject to rules that effectively prevent them from engaging in misleading or deceptive practices and from imposing unfair terms or

practices. These actions are wrong. They have no place in the real

estate lending industry or, for that matter, in any credit transaction whatsoever.

While we believe that it is important that lenders refrain from

acting in a manner that seeks to take advantage of borrowers, we

also believe that it is equally important that responsible lenders

take action to adopt and implement practices specifically designed

to promote fair lending and to enable borrowers to make intelligent, informed decisions about their credit needs. It is for this

reason that our business philosophy is ‘‘Do The Right Thing.’’

Ameriquest Mortgage Company has fostered long-standing relationships with the Leadership Conference on Civil Rights, the Nation’s oldest and largest civil rights coalition, the National Fair

Housing Alliance, the National Association of Neighborhoods, and

more recently, with the Association of Community Organizations

for Reform Now—ACORN. These groups have been our allies in the

cause to promote fair lending and consumer awareness. Ameriquest

Mortgage Company has partnered with these committed advocates

to develop and implement a set of best practices to ensure that our

33

borrowers receive top quality service and fair treatment and are

able to obtain loans that meet their financial needs on reasonable

terms and at fair prices.

In developing our set of best practices, we asked our key community group allies to help us identify their principal concerns regarding subprime lending activities. While Ameriquest had long ago

addressed many of those concerns, we implemented practices and

policies to address others as part of our constant effort to improve

our programs to meet our customers’ needs.

Ameriquest Mortgage Company provides to every customer: reasonable rates, points, and fees; full and timely disclosure of loan

terms and conditions in plain English; recommended credit counseling; a full week to allow customers to evaluate whether our loan

best suits their needs; a highly qualified loan servicing officer who

has been trained in fair lending practices.

In addition, we: report all borrower repayment history to credit

bureaus; maintain arm’s-length relationship with third parties

such as title companies, loan appraisers, and escrow companies.

The following practices, although legal and conducted by some,

are not offered by Ameriquest: no single premium credit life insurance to borrowers; no refinancing of a loan within 24 months of its

origination; no loans with mandatory arbitration clauses; no loans

with balloon payments; no negative amortization loans.

Our best practices include providing each customer a one-page

document, written in plain English, that clearly identifies all of the

important terms of the loan using very simple phrases.

We are very concerned about the fact that you receive a big, huge

bundle of information and there is no one page that this is all put

on. So that is why we clearly state on one page: your interest rate

is—; you have a prepayment charge of—; your total fees are—

Very simple, very straightforward. We prepare a side-by-side

comparison for prospective borrowers of our initial loan quote and

the final loan offering so that people can see exactly what they are

getting from what we originally had offered them in order to ensure dialogue that would take place during the process.

We recommend credit counseling to all our customers by providing the 800–number for HUD-certified loan counseling. Instead

of the standard three-day rescission period called for under existing

law, we provide all of our customers in our retail lending network

with a full week to allow them to shop for better loans. That added

time allows them to determine without pressure and with the help

of trained credit counselors if ours is the best loan for them. Our

loan servicing associates go through a stringent training program,

with a minimum of 80 hours of training. We want to ensure that

in the case of every borrower, we are being sensitive to that borrower’s needs.

All of our best practices empower consumers to make the right

choice for them. Why do we do this? We do it because it is the right

thing to do. But we also do it because we honestly believe our business benefits from our best practices. We benefit when we have

fully informed borrowers who recognize that they have been treated

fairly, rather than dissatisfied customers who feel that they have

been taken advantage of.

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There are many of us in the specialty lending sector that have

been fairly and responsibly assisting traditionally underserved

communities, and have helped countless, hard working families

gain access to capital. I know you want us to continue to lend to

this segment of America, since homeownership is one of the key

elements of our society that most embodies the American Dream.

No responsible lender wishes to engage in abusive lending practices. And I am sure everyone in this room would agree that a single deceitful loan is one too many. Regulatory authorities need to

use the full range of their existing enforcement powers and to devote more resources to enforcement of existing laws designed to

guarantee that customers receive loans appropriate for their needs

and fair terms. We at Ameriquest Mortgage Company believe that

our set of best practices is designed to achieve that very result in

three ways: one, our best practices prohibit certain specific kinds

of abusive practices; two, our best practices provide clear and full

disclosure of the critical loan terms in plain English; and three, we

make credit counseling available to our borrowers and encourage

them to make use of it and provide a one-week, post-approval

period during which the borrower can shop our loan and evaluate,

with the help of a credit counselor, whether the loan we have offered is truly a loan the borrower wants.

In short, strong enforcement of existing laws coupled with a

strong set of best practices is the best tools to ensure that consumers are best served. Although we do not believe that additional

laws or regulations are needed, it would be best, if there is to be

action, for it to come at the Federal level, rather than adding to

the existing patchwork of State and local ordinances.

Ameriquest Mortgage Company creates loans the old-fashioned

way—we take the time to develop a loan for each borrower based

on their individual needs. This is how I started my lending career

30 years ago, when banks were more personal and took the time

to get to know their customers. It is important to recognize that

this form of lending is more subjective at the individual level and

requires increased personal attention from the loan officer.

We hope as this Committee considers any proposed new legislation, you are careful as you proceed to ensure that there are no unintended consequences that would have the effect of limiting access

to credit for those who need it most. In that way, we ask for your

support in helping us to continue to serve Middle America and

reach traditionally underserved communities.

Ameriquest commends you for focusing attention on these issues.

As one of the Nation’s largest retail special lenders, we share your

commitment to making the dream of homeownership affordable

and fairly accessible for all Americans. We at Ameriquest look forward to continuing to work with you.

Thank you very much.

Chairman SARBANES. Well, thank you very much, Mr. Prough,

and we appreciate, as Chairman of Ameriquest Mortgage Company, you coming across the country from California, in order to be

here with us at this hearing and to give us this testimony.

I am also very appreciative of the attachment that you have to

your statement setting out in considerable detail Ameriquest MortVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 82969.TXT SBANK4 PsN: SBANK4
35

gage Company’s retail best practices. It is very helpful to the Committee to have that information.

Professor Calomiris.

STATEMENT OF CHARLES W. CALOMIRIS

PAUL M. MONTRONE PROFESSOR

OF FINANCE AND ECONOMICS

GRADUATE SCHOOL OF BUSINESS, COLUMBIA UNIVERSITY

NEW YORK, NEW YORK

Mr. CALOMIRIS. Thank you, Mr. Chairman. It is a pleasure and

an honor to address you today on the important topic of predatory

lending.

Predatory lending is a real problem. It is, however, a problem

that needs to be addressed thoughtfully and deliberately, with a

hard head as well as a soft heart.

Chairman SARBANES. That is what we are trying to do, yes.

Mr. CALOMIRIS. There is no doubt that people have been hurt by

the predatory practices of some creditors and we have heard about

that today quite a bit. But we must make sure that the cure is not

worse than the disease. Unfortunately, many of the proposed or enacted municipal, State and Federal statutory responses to predatory lending would have adverse consequences and in fact already

have had adverse consequences that are worse perhaps than the

problems they seek to redress. Many of these initiatives would reduce the supply or have reduced the supply of credit to low income

homeowners, raise their cost of credit, and restrict the menu of

beneficial choices available to borrowers.

Fortunately, there is a growing consensus in favor of a balanced

approach to this problem. That consensus is reflected in the viewpoints expressed by a wide variety of individuals and organizations,

including Robert Litan of the Brookings Institution, Fed Governor

Edward Gramlich, most of the recommendations of last year’s HUD

Treasury report, the voluntary standards set by the American

Financial Services Association, the recent predatory lending statute

passed by the State of Pennsylvania, and the recommendations and

practices of many subprime lenders.

An appropriate response to predatory practices should occur, I

think, in two stages. First, there should be an immediate regulatory response to strengthen enforcement of existing laws, enhance disclosure rules, provide counseling services, amend existing

regulation in some ways, and limit or ban some practices. I believe

that these initiatives, which I will describe in detail in a minute,

will address all of the serious problems associated with predatory

lending.

Second, in other areas, especially the regulation of prepayment

penalties and balloons, any regulatory change, I think, should

await a better understanding of the extent of remaining predatory

problems that result from these features. And the best way to address those is through appropriate regulation. The Fed is currently

pursuing the first systematic scientific evaluation of these areas as

part of its clear intent to expand its role as the primary regulator

of subprime lending. Given its authority under HOEPA, the Fed

has the regulatory authority and the expertise necessary to find

36

the right balance between preventing abuse and permitting beneficial contractual flexibility.

I think the main role Congress should be playing at this time is

to rein in actions by States and municipalities that seek to avoid

established Federal preemption by effectively setting mortgage

usury ceilings under the guise of consumer protection rules. Immediate Congressional action to dismantle these new undesirable barriers to individuals’ access to mortgage credit would ensure that

consumers throughout the country retain their basic contractual

rights to borrow in the subprime market.

The problems that fall under the rubric of predatory lending are

only possible today because of the beneficial democratization of consumer finance and mortgage markets in particular that has

occurred over the past decade. Predatory practices are part and

parcel of the increasing complexity of mortgage contracting in the

high-risk, subprime mortgage area. That greater contractual complexity has two parts: One, the increased reliance on risk pricing

using Fair Issac scores rather than the rationing of credit via a yes

or no lending decision. And second, the use of points, credit insurance, and prepayment penalties to limit the risks lenders and borrowers bear and the costs borrowers pay.

These practices make economic sense and can bring great benefits to consumers. Most importantly, these market innovations

allow mortgage lenders to gauge, price, and control risk better than

before and thus allow them to tolerate greater gradations of risk

among borrowers.

According to last year’s HUD-Treasury report, subprime mortgage originations skyrocketed since the early 1990’s, increasing by

ten-fold since 1993. The dollar volume of subprime mortgages was

less than 5 percent of mortgage originations in 1994, and in 1998,

it was 12.5 percent. As Governor Gramlich has noted, between

1993 and 1998, mortgages extended to Hispanic-Americans and

African-Americans increased the most, by 78 and 95 percent, respectively, largely due to the growth in subprime mortgage lending.

Subprime lending is risky. The reason that so many low-income

and minority borrowers tend to rely on the subprime market is

that, on average, these classes of borrowers tend to be riskier. It

is worth bearing in mind that default risk varies tremendously in

the mortgage market. The probability of default—based on Standard & Poor’s credit ratings—for the highest risk class of subprime

mortgage borrowers is roughly 23 percent, which is more than

1,000 times the default risk of the lowest risk class of prime mortgage borrowers.

When default risk is that great, in order for lenders to participate in the market, they must be compensated with unusually high

interest rates. But, default risk is not the only risk that lenders

bear. Indeed, prepayment risk is of a similar order of magnitude

in the mortgage market.

In the subprime market where borrowers’ creditworthiness is

also highly subject to change, prepayment risk results from improvements in borrower riskiness, as well as changes in U.S. Treasury interest rates.

Borrowers in the subprime market are subject to significant risk

that they could lose their homes as a result of death, disability, or

37

job loss of the household’s breadwinners. Because single premium

insurance commits the borrower to the full length of the mortgage,

the monthly cost of single premium credit insurance is much lower

than the cost of monthly insurance.

Single premium insurance has been much maligned here today.

Mr. Miller said there is no reason to have single premium insurance. But I checked on some facts. I called up Assurant Group,

which is a major provider ultimately of credit insurance in the

mortgage market, and asked for a cost comparison. The monthly

cost, that is, taken on a monthly basis over the life of the mortgage,

the monthly present-value cost for monthly credit insurance that is

paid each month, not all at once, on a 5 year mortgage, on average,

is about 50 percent more expensive than the monthly cost of single

premium credit insurance.

A lot of these intermediaries have left the market because the

bad public relations about single premium insurance has been bad

for their business. That is unfortunate, I think, and I will come

back to how I think we can regulate single premium insurance

without doing harm to borrowers.

The Congress recognized that substantial points, prepayment

penalties, short mortgage maturities, and credit insurance, have

arisen in the primary market in large part because these contractual features offer preferred means of reducing overall costs and

risks to consumers. Default and prepayment risks are higher in the

subprime market and therefore, mortgages are more expensive and

mortgage contracts are more complex.

The goal of policymakers should be to define and address predatory practices without undermining real important opportunities in

the subprime market. So what are those practices? They have already been mentioned.

According to the HUD-Treasury report, they are loan flipping,

packing or excessive fee charges, lending without regard to the borrower’s ability to repay, and outright fraud.

Many alleged predatory problems revolve around questions of

fair disclosure and fraud prevention. But the critics of predatory

lending are correct when they say inadequate disclosure and outright fraud are not the only ways borrowers may be fooled. Let me

now turn to an analysis of specific proposed remedies.

First, I would recommend enhanced disclosure and new counseling opportunities for mortgage applicants. In my statement, I go

through a very long list of ways to improve disclosure and counseling, but I will omit that here in the interest of time.

Credit history reporting. It is alleged that some lenders withhold

favorable information about customers in order to keep and use

that information privately. I think it is appropriate to require lenders not to selectively report information to credit bureaus.

Now single premium insurance. Keep in mind, roughly one in

four households do not have any life insurance. And so, single premium credit insurance or monthly credit insurance can be very

beneficial. To prevent abuse, though, of single premium, there

should be a mandatory requirement that lenders that offer single

premium insurance have to do three things. One, they must give

borrowers a choice between single premium and monthly premium

credit insurance. Second, they must clearly disclose that credit inVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00047 Fmt 6633 Sfmt 6633 82969.TXT SBANK4 PsN: SBANK4
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surance, whether single premium or monthly, is optional and that

the other terms of the mortgage are not related to whether the borrower chooses credit insurance. And third, they must allow borrowers to cancel their single premium credit insurance and receive

a full refund of the payment within a reasonable time after closing.

What about limits on flipping? Well, I think there have been several new proposals. I agree that there needs to be some action. The

Fed rule that has been proposed would prohibit refinancing of

a HOEPA loan by the lender or its affiliate within the first 12

months, unless that refinancing is, ‘‘in the borrower’s interest.’’ This is a reasonable idea so long as there is a clear and reasonable

safe harbor in the rule for lenders that establishes criteria under

which it will be presumed that the refinancing was in the borrower’s interest. For example, if a refinancing either, A, provides

substantial new money or debt consolidation, B, reduces monthly

payments by a certain amount or, C, reduces the duration of the

loan, then any one of those features should protect the lender from

any claim that the refinancing was not in the borrower’s interest.

What about limits on refinancing of subsidized government or

not-for-profit loans? It has been alleged that some lenders have

tricked borrowers into refinancing heavily subsidized government

or not-for-profit loans. Lenders that refinance these loans, I believe

should face very strict tests for demonstrating that the refinancing

was in the interest of the borrower.

Should we have any outright prohibitions? Well, I believe that

some mortgage structures really do add little real value to the

menu of consumer options and are especially prone to abuse. In my

judgment, the Federal Reserve Board has properly identified payable-on-demand clauses or call provisions as examples of such contractual features that should be prohibited.

How should we deal with prepayment penalties? We should require lenders to offer loans with and without prepayment penalties.

Rather than regulate prepayment penalties at this time, I would

recommend requiring that HOEPA lenders offer that choice.

What about balloons? I think that, again, limits on balloons and

also proposed limits on new brokers’ practices may be a good idea,

but I think that we should await more data before we know exactly

how to shape those rules.

My final point and I know I am running out of time is dealing

with usury laws. These are very bad ideas. I want to focus on the

recent legislation that has been enacted and the problems that

have come from it. Because of legal limits on local authorities to

impose usury ceilings because of Federal preemption, explicitly,

that is, they cannot explicitly impose usury ceilings, they have

adopted what I would call an alternative stealth approach to usury

laws. The technique is to impose unworkable risks on subprime

lenders that charge rates or fees in excess of government-specified

levels and thereby, drive high-interest rate lenders from the market. Several cities and States have passed or are currently debating

these stealth usury laws for subprime lending.

For example, the City of Dayton, Ohio, this month passed a Draconian antipredatory lending law. This law places lenders at risk

if they make high-interest loans that are, ‘‘less favorable to the borrower than could otherwise have been obtained in similar transVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 82969.TXT SBANK4 PsN: SBANK4
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actions by like consumers within the City of Dayton.’’ And lenders

may not charge fees and/or costs that, ‘‘exceed the fees and/or costs

available in similar transactions by like consumers in the City of

Dayton by more than 20 percent.’’ In my opinion, it would be imprudent for a lender to make a loan

in Dayton governed by this statute. Indeed, I believe that the statute’s intent must be to eliminate high-interest loans, which is why

I describe it as a stealth usury law. Immediately upon the passage

of the Dayton law, Banc One announced that it was withdrawing

from origination of loans that were subject to the statute. No doubt,

others will exit, too. The recent 131 page antipredatory lending law

passed in the District of Columbia is similarly unworkable.

What about North Carolina, which pioneered this area in 1999?

As Donald Lampe points out, massive withdrawal from the

subprime lending market has occurred in response to the overly

zealous initiative against predatory lending by North Carolina.

Michael Staten of the Credit Research Center of Georgetown

University has compiled a new database on subprime lending that

permits one to track the damage, the chilling effect, of the North

Carolina law on subprime lending in the State.

Staten’s statistical research, which I reproduced with his permission in the appendix to my testimony, compares changes in mortgage originations in North Carolina with those of South Carolina

and Virginia before and after the passage of the 1999 North Carolina law.

Staten finds that originations of subprime mortgage loans, especially first lien subprime loans, in North Carolina, plummeted after

passage of the 1999 law, both absolutely and relatively to its neighbors, and that the decline was almost exclusively in the supply of

loans available to low- and moderate-income borrowers, those most

dependent on high-cost credit. For borrowers in the low income

group, with annual incomes less than $25,000, originations were

cut in half. For those in the next income class, with annual incomes between $25,000 and $49,000, originations were cut by

roughly a third. The response to the North Carolina law provides

clear evidence of the chilling effect of antipredatory laws on the

supply of subprime mortgage loans to low-income borrowers. And

in fact, was anticipated in the critical remarks that Bob Litan

made about these laws.

The history of the last two decades shows that usury laws are

highly counter-productive. Limits on the ability of States to regulate consumer lenders headquartered outside their State were undermined happily by the 1978 Marquette National Bank case and

furthered by the 1982 passage of the Alternative Mortgage Transaction Parity Act.

I will not go into all my details in this discussion, but I want to

emphasize that it would be very useful for Congress to reassert

Federal preemption to prevent any more damage from taking place.

Let me conclude, for the most part, predatory lending practices

can be addressed by focusing effort on better enforcing laws, improving disclosure rules, offering government finance counseling,

and placing a few well thought-out limits on credit industry practices. The Fed already has the authority and the expertise to formulate those rules and is in the process of doing so based on a new

40

data collection effort that will permit an informed and balanced approach to regulating subprime lending.

And again, I emphasize, the main role of Congress should be to

reestablish Federal preemption. And I hope also Members of Congress, and especially Members of this Committee, will speak out in

defense of honest subprime lenders, of which there are many. The

possible passage of State and city usury laws is not the only threat

to the supply of subprime loans. There is also the possibility that

bad publicity, orchestrated perhaps by well-meaning community

groups, itself could force some lenders to exit the market.

Thank you, Mr. Chairman.

Chairman SARBANES. Well, thank you. This is a very useful

statement and appendix for the Committee to have because it puts

together a lot of the assertions that have been made, which I think

will require very careful analysis on our part.

We are approaching this issue with a hard head and we would

be interested to see how this analysis withstands a hard head analysis, how this statement withstands a hard head analysis. So, it is

helpful to have it all put together the way you have done it and

I want to thank you because, obviously, a good deal of effort has

gone into it.

Mr. CALOMIRIS. Thank you, Mr. Chairman.

Chairman SARBANES. Mr. Eakes.

STATEMENT OF MARTIN EAKES

PRESIDENT AND CEO, SELF-HELP ORGANIZATION

DURHAM, NORTH CAROLINA

Mr. EAKES. Thank you, Mr. Chairman.

I too in the last couple of weeks since my name has been on this

list have been called by numerous lenders telling me that they are

giving up single premium credit insurance, hoping that I would not

mention their names in this hearing, including one as late as yesterday. I come to you today in two roles.

The first is in my role as CEO of Self-Help, which is an $800 million community development financial institution. That makes us

the largest nonprofit community-development lending organization

in the Nation, which is also about the size of one large bank

branch, to put it into perspective. Self-Help has been making

subprime mortgage loans for 17 years. We are probably one of the

oldest, still-remaining, subprime mortgage lenders. We have provided $1.6 billion of financing to 23,000 families across the country.

We charge about one-half of 1 percent higher rate than a conventional-rate mortgage. We have had virtually no defaults whatsoever

in 17 years. If you have a 23 percent default, I can almost assure

you, it is the result of lending with fraud in that process. Subprime

lending can be done right. We agree that there are good subprime

lenders. We hope that we are one.

I come to you, second, as a spokesperson for an organization that

started in North Carolina, called the Coalition for Responsible

Lending. The coalition that formed in North Carolina was a really

remarkable event for anyone who watches politics among financial

institutions. This coalition started in early 1999 and started with

120 CEO’s of financial institutions who came together to ask for a

41

law to be passed in order that they could squeeze the bad apples

out of the lending industry in North Carolina.

Let me ask you on this Committee, how many times have you

had credit unions and every bank in the country come together and

ask you to pass a bill that would regulate them as well as everyone

else? Ever?

Chairman SARBANES. We are working at that right now.

Mr. EAKES. We are working at that.

[Laughter.]

We ended up with a coalition that had 88 organizations that represented over 3 million people in the membership of those organizations in North Carolina. North Carolina only has 5 million adult

voters in the State. This group included all the credit unions, every

thrift, every bank, the Mortgage Bankers Association, the Mortgage

Brokers Association, the realtors, the NAACP, civil rights groups,

housing groups, AARP and seniors groups—every single organization that had something to say about mortgage lending in the State

of North Carolina came together to pass what was not a perfect

bill, it was a compromise bill among all those parties. And we

passed a bill. The bill in North Carolina in 1999 passed both the

Senate and the House virtually unanimously. We had one vote

against in the Senate and two in the House out of 120 members.

Let me tell you what the philosophy of the North Carolina bill

was, which shows you why there was such an encompassing consensus. We started with two key principles. The first principle was

that this bill would add no additional disclosures whatsoever. The

industry representatives and the consumer representatives agreed

that real estate closings now have 30 plus documents to sign and

go through.

I am a real estate attorney. I have closed hundreds, if not thousands, of real estate loans. And I am not sure that I can understand every little piece of fine print in those 30 forms. I assure you

that no ordinary real person can read those documents and understand them. It is also unfair to say that education or disclosure will

solve the problem. I will give you an example.

My father, who was this ornery—some people think I am ornery

and hard to get along with. I used to be nicer. My father was at

least twice as mean as I am. He ran a business, contracting business. No one could take advantage of him until the last 6 months

of his life when he was bedridden with cancer. And then, all of a

sudden, he had people calling him, saying, can you refinance your

house? And even my father, mean, technically competent, a business person, could fall prey to a lender who approached him in his

own house.

The second principle that we had was that we would place no cap

on the interest rate on mortgages. Now this was somewhat controversial. We did that for an explicit reason. We said, by putting

no cap on the interest rate, there can be no rationing of legitimate

subprime credit in the State of North Carolina.

Instead, we focused on all the hidden elements of pricing in a

mortgage loan. And we said, we are going to try to prohibit those

and force the price into the interest rate, the one factor that most

borrowers understand best. It has been said that it is hard to define predatory lending. Well, in North Carolina, whether you like

42

what we did or did not do, that is precisely what we did. We identified six practices that we thought were the essence of predatory

lending.

In the North Carolina bill, we dealt with only four of them. That

is all we could do in the first bill. But what we did in legislation

was precisely define these four predatory lending practices in legal,

legislative language, and enact them into law. The following four

practices are what we focused on in the North Carolina bill.

First, we put a threshold limit on upfront fees. It is simply a

problem, as we heard from the woman from West Virginia, when

you have upfront fees, you can never get them back. The moment

you sign the document, you may have lost your entire life savings

in less than one second of signing your name. Instead, what the

North Carolina bill said was, no financing of fees if the amount of

fees is greater than 5 percent. Now, in all honesty, 5 percent fee

to originate a mortgage is a very large number. The standard

amount paid for a conventional, middle-class mortgage that most

of us would go and obtain is 1.1 percent. That is the standard

across the country.

So 5 percent is a pretty extreme compromise. It is not something

I went home and was proud of after the bill was passed. And we

said 5 percent of fees, not counting lawyer fees, not counting

appraisals, any of the third-party fees that you normally pay at a

mortgage closing, that is a limit beyond which there are some protections in the North Carolina law. And I guess I would call that

a stealth usury provision if you want to say that charging more

than 5 percent fees is a good thing.

Second, we focused on the practice of flipping. The reason that

this was so poignant for us in North Carolina is that we had done

research—you may know this—but President Carter came to Charlotte. We have one of the most active Habitat For Humanity networks in North Carolina of any State. We found researching loan

by loan at courthouses that more than 10 to 15 percent of all Habitat for Humanity borrowers who had $40,000, zero-percent first

mortgages from Habitat, had been refinanced into 14 percent finance company mortgages. Now what does that tell you?

That 10 to 15 percent could not have been acting rationally in

the way that in academia we assume is a fully functioning perfect

market. Moreover, it shows that if lenders will take advantage of

10 to 15 percent of people who have zero percent mortgages and

refinance them into 14 percent mortgages, what do you think that

says about the people who have those measly 71⁄2 and 8 percent

mortgages. They are certainly fair game for flipping. We passed a

prohibition for all home loans in North Carolina that says you may

not flip, refinance a home loan, unless there is a net tangible benefit to the borrower.

Third, we prohibited prepayment penalties on all mortgage loans.

Well, that is nothing new. In North Carolina, we had that prohibition already since 1973. In fact, 31 States across the country have

limitations prohibiting or restricting prepayment penalties on mortgages currently. This one really drives me crazy.

We tell poor people that it is your goal and your message is to

get out of debt. That is what we charge people with. And yet, for

the average African-American family with a $150,000 loan on a

43

home, the average prepayment penalty is about 5 percent. To pay

off that debt, get out of debt, or refinance to another borrower, is

5 percent of $150,000, $7,500. That is more than the median net

wealth of African-American families in this country. So in one second, when you sign up for this mortgage, you can put at risk an

entire lifetime savings of wealth for the average median AfricanAmerican family in this country.

And four, we prohibited in North Carolina the financing of credit

insurance on all home loans in North Carolina. Before predatory

lending, I was a nicer human being. But as I listened to Professor

Calomiris, I hope in the question and answer session you will let

me come back and maybe engage him in a little academic questioning on those terms.

To say that monthly pay insurance costs 50 percent more than

single premium insurance is the worst kind of analytic mistake or

intellectual dishonesty that I can imagine. Every analyst who has

looked at single premium insurance finds it more expensive, which

it is. I will give you an example.

If I came to you and said, you pay for your electric bill on a

monthly basis every month for the next 5 years and you pay it with

no interest. Instead, I give you the option to finance all 60 months

of your electric payment into a loan at the front end and pay the

interest on it over the next 5 years. And a typical case would come

to, say, $7,000 or $8,000 of interest. At the end of the 5 years, you

still owe all of the electric payments because you have not paid

anything off. Everyone who has analyzed single premium credit insurance will tell you that it costs twice as much as monthly pay,

no matter how you run the assumptions, no matter what you do.

The predatory lenders use this tactic with a borrower the same

way it is used in public—to say that your monthly cost will be

lower because all you are paying is the interest. But the cost for

the single premium credit insurance, like financing your electric

payments, is still 100 percent, 99 percent due at the end of 5 years.

I used to not lose my temper, but this is really driving me nuts.

Let me tell you how I came to this work.

For 17 years, I worked and was a preacher preaching that we

needed to get access to credit, particularly for African-American

homeowners. Access to credit was my watchword.

In the last 2 years, it has turned totally on its head and I no

longer worry about whether there is access to credit. It is now the

terms of credit. And where there were sometimes lenders who were

starving communities from getting credit they needed, the problem

now is that many lenders are actually eating those communities.

They are eating the equity of these families.

I had a borrower who came into my office and he told me this

story which I really did not believe. I said, bring me your paperwork for your loan, which he did. We sat down. He showed me his

loan. He had gotten a refinance loan from the Associates in 1989.

It refinanced a Wachovia Veterans Administration loan and it was

a $29,000 loan. On his paperwork, it showed that he had $15,000

of charges added into the loan for what was a $29,000 refinance.

So, he had $44,000 of total debt. He paid on that loan for 10 years

until he came to see me in early 1999. He told me that he had

three different times tried to pay the loan and that the Associates,

44

recently purchased by Citigroup, would not allow him to pay off the

loan and refinance it.

I said, I am a lawyer. I know that cannot be true. That is illegal.

I do not believe it. As I got ready to call the company on his behalf,

he sat down and tears welled up in his eyes and he said, let me

tell you one more thing. The reason that this house means so much

to me is not just the shelter, that it is the house I have lived in,

but I lost my wife 3 years ago and I have a 9-year-old daughter.

And this house is the only connection that my 9-year-old daughter

will ever have with her mother. And I am sitting here, oh, God.

And I call the company and the woman on the phone says, ‘‘I am

not going to give you the pay-off quote.’’ Well, there are people who

have worked with me for 18 years who have never really seen me

get mad. But at that point, I really lost it and I told her—she

said,‘‘You are just a competing lender. Why should I give you the

pay-off quote?’’ You are just going to refinance them.

And I told her, if it takes me the rest of my life, I will sue you

to hell and back and we will get this person out from under your

thumb. And we will refinance this loan if I lose every penny of it.

I do not care any more.

And we did. We refinanced it. We litigated. We reduced the loan

in half. And that was the beginning, my first knowledge of the

Associates, which many people knew was the rogue company in

predatory lending. There are a lot. But that one is just a horrible

company. That was the beginning for me of this coalition that

started in North Carolina.

I have since traveled around the country and I have said that I

will spend every penny that Self-Help owns, I will spend every

penny that I own until we stop this practice of basically stealing

people’s homes in the guise of lending. A couple more stories and

I will end and then we can have some questions.

I got called as an expert witness by the banking commissioner

in North Carolina who was trying to remove the license of a lender.

The story was this. The lender has made 5,000 loans in North

Carolina. This can only happen in the South. He had advertised on

the radio that this is a good Christian company. Please come here

and we will take care of you. He did take care of them. The average

fees—he would not close a loan for less than 11 points on the front

end for any of those loans. The person who was the principal of this

business had met his other senior management in prison for trafficking cocaine.

What came out in the hearing, and I am on the witness stand

and his lawyer is cross-examining me, saying, why are you picking

on this company? We are not nearly as bad as three others he

named. The problem in North Carolina we found was unbelievable.

We found that between 10,000 and 20,000 families in North

Carolina were losing the equity in their homes or losing their

homes outright every year. For me, personally, this was really an

affront. I had spent 18 years at that point helping families own

homes. And what I found was one or two lenders—I do not have

to look at the average for the industry—but one or two lenders who

are undoing in a month’s time every possible step of good that SelfHelp had done with its 23,000 loans over 18 years. It stopped being

45

an academic issue for me at that point, although I think I would

be pleased to argue it on academic terms.

There are things that Congress needs to do. We need to repeal

the Parity Act in its entirety. We need to strengthen HOEPA.

But I will stop there. Thank you.

Chairman SARBANES. Thank you very much, Mr. Eakes.

I am going to ask a few questions. I hope that no one on the

panel is under an immediate time pressure.

I want to go to this single premium credit life insurance and the

assertion that it is cheaper than paying it by the month. I just

have great difficulty with that analysis. First of all, the mortgage

is usually for 30 years. The single premium is for 5 years. Correct,

in most instances?

Mr. CALOMIRIS. That is not what I am talking about, Senator.

Chairman SARBANES. Are you talking about a 30 year single premium?

Mr. CALOMIRIS. No.

Chairman SARBANES. No one does a 30 year single premium because the cost of that premium would be so huge, that it just would

not fly.

Mr. CALOMIRIS. I am talking about a 5 year single premium.

Chairman SARBANES. That is right. And then they get to the end

of the 5 years and then they refinance, and then they throw in another 5 year single premium. Is that right? Is that what happens

in almost every instance?

Mr. CALOMIRIS. I do not think anyone knows what happens in almost every instance, Mr. Chairman. But I think we can agree on

some basic arithmetic principles. I hope we can.

First of all, we are talking about a stream of cashflows, whether

you talk about the monthly premium or the single premium. And

then the question is, if it is monthly premium, you have to decide

what discount rate do you discount those cashflows to arrive at a

present value because the right comparison, I think you will agree,

is that you want to ask whether the present value of monthly premium insurance or the present value of single premium insurance

is larger. If you discount, which is the correct way to do it, at the

interest rate that is charged in the loan, because that is the borrower’s discount rate, you arrive at a calculation that single premium is half as costly.

Whether you are financing that single premium up front or paying it up front, it is equivalent. It does not matter. The fact that

you are only paying the interest and then 5 years from now, you

still have to continue paying the interest because you have not repaid the balance on the money you borrowed to pay the single premium insurance, is irrelevant to the computation. I think what we

are really having a problem with here is what I would call basic

finance arithmetic. And I think that is unfortunate.

Chairman SARBANES. Well, Martin, do you want to address that?

Mr. EAKES. I would love to get into basic finance arithmetic with

someone because now you are really on my turf. I have been a

lender for almost 20 years. There is no way that you can have a

cashflow that includes interest and discount it back at any interest

rate and have that come out to be lower than something that has

no interest whatsoever.

46

It does not matter. You still have the terminal amount that is

the full amount of the premium. It does not matter. I am absolutely

certain that this is an analytic bad mistake in every way it can be.

Chairman SARBANES. My perception of it is that it is like trying

to walk up the down escalator. You just keep losing ground.

Let me give you an example from one company. They had a

$50,000, 15 year mortgage loan with a single premium life insurance policy costing $1,900 that was in force for 5 years. At the end

of the 5 years, the homeowner still owed about $1,600 on the original insurance premium. So then he refinances. He takes out another policy. So there is another $1,900 that is thrown into the

loan. Now it is $3,500 that has been pulled out of him. We do not

really go after the protections of the insurance if they pay it on a

monthly basis. But that is outside of being folded into the loan and

then paying interest on that large charge. Then the person ends up

losing their home because you have packed all these fees into it.

Mr. MILLER. Senator, if I could just make a couple of practical

points, too. Think about the income level of the people we are talking about.

Chairman SARBANES. I want to get to that, too, in a minute on

the balloon payment, yes.

Mr. MILLER. In this context. All the demands on their financial

resources. Life insurance would not naturally be high on their list.

It would not fit in, except for what the lenders are doing.

And think, too, to finance insurance, would that be something

they would want to put their home in jeopardy for and put that in

the mortgage? No. It just does not make sense from the consumer’s

point of view. It is only in there for the lenders. And indeed, in my

view, it is a litmus test of whether a lender is in good or bad faith.

They are out to drain the consumer, if they are selling single premium credit life insurance. It is just very clear to me where they

are headed.

Mr. CALOMIRIS. Mr. Chairman, if I could just interject.

Chairman SARBANES. Certainly.

Mr. CALOMIRIS. What I am proposing, of course, is not to leave

things as they are. I am proposing some pretty big changes. I am

proposing that the lender has to offer both products—single premium and monthly premium—that the lender has to fully disclose

what is the cash that I am going to get back? What is the monthly

payment I am going to have to make in totality? All the charges.

And then let the borrower choose.

And make it also clear that this is entirely optional because a lot

of the complaints have been that people did not understand it was

optional, that all of the other terms in the loan do not change.

Somebody has to explain to me why, when somebody is being

given a choice that is clearly spelled out, and we are going to make

sure that the disclosure is right, and they decide that they would

prefer what I would regard, in some cases, at least, and from what

I understand, on average, cheaper insurance over the life of that

5 years, somebody has to explain to me why, because a Senator or

an activist or an attorney general believes that is not the right

choice, why they, with counseling, on their own, with all information, cannot do it?

47

Mr. MILLER. Charles, were you here this morning? Did you hear

what was going on?

Mr. CALOMIRIS. I was here this morning.

Mr. MILLER. And do you have any sense of the power and influence of the industry making these loans and running them

through? Yours is an academic approach. What we really need to

do is deal with the real people that we saw this morning, and in

that setting, to set up these complicated disclosures just does not

make any sense in the real world.

Mr. EAKES. This is a product that never benefits the consumer.

Never. Not a single case. That is why it is so easy. And if we have

a trained economist who cannot get it right, how do we expect a

borrower to get it right? When you offer a choice between something that in every case costs you the extra interest, every single

case, it makes it a false choice.

And so the borrower, yes, they can be deceived into choosing it

because the predatory lender focuses on the monthly payment. And

they say, this example of a $100,000 loan with $10,000 of up front

credit insurance, if you pay for that interest only, it would be $133

a month, which is what financing it as single premium is. If you

pay for it on a monthly basis, your monthly payment will be $167.

So, he is right. It does, on the monthly basis, cost a little bit less. But at the end, you still owe $9,900 of the single premium credit

insurance. To offer a choice of something that, in every single case,

is worse for the borrower, is merely a deception. How can we possibly have the consumer understand that. Put it in the interest

rate if the lender needs that compensation. This is ridiculous.

Chairman SARBANES. Let me ask this question.

How is a borrower in the subprime market who almost by definition is right at the limit of their ability to handle the matter, going

to handle a balloon payment at the end of the mortgage period?

Is that not, to a large extent, building up a huge risk of default,

or perhaps more likely which keeps happening, a refinancing when

they get to that point, again in which a lot of fees are packed into

the loan and we get the sort of process that was laid out here this

morning where the equity is being stripped out of this loan? Does

anyone want to address that?

Mr. CALOMIRIS. When I was younger, I borrowed balloon loans

because the interest rates are lower because, by keeping maturity

lower, typically, in a loan, risk is lower—and then I rolled it over

with the same bank.

Chairman SARBANES. And what were your earning prospects

when you did that?

Mr. CALOMIRIS. I do not know. I was in my early 20’s. I was a

graduate student at the time. I suppose that if you were optimistic

about my career ability, you would say they were pretty good.

Chairman SARBANES. They were pretty good. Now suppose you

were 70 years old and you were living on Social Security.

What is the rationale for the balloon payment in that case? That

is your income. You are at the end of your working life. That is

your income. And you take out a subprime loan. They slap on this

balloon payment. Now what is the rationale there?

Mr. CALOMIRIS. Again, balloon payments tend to reduce interest

cost, so they can be beneficial. In my statement, of course, I recogVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6633 82969.TXT SBANK4 PsN: SBANK4
48

nize that you may want to limit balloons in some cases. And, in

fact, I argue that was one of the things that I hope the Fed will

look at. But I do not believe we want to rashly decide whether a

1 year balloon or a 3 year balloon or a 5 year or 7 year, is the right

route.

Chairman SARBANES. We are not going to decide anything rashly.

Mr. CALOMIRIS. Right.

Chairman SARBANES. Let me make that very clear. Nothing will

be decided rashly.

Mr. CALOMIRIS. Balloon payments reduce interest costs and that

is the main benefit anyone derives from them. If there is rollover

risk, as I think you are suggesting there can be in some cases, or

if people are tricked and do not understand that they are facing a

balloon, then I think there is a real issue. But let us again not

throw the baby out with the bathwater.

But if I can just make one other comment about flipping. Again,

I have specific ideas about how you can prevent flipping. The problem with the North Carolina law, and the reason that it is had

such a chilling effect on subprime lending already in North Carolina is that it does not give anybody safe harbor.

If you are going to say people cannot flip, that is fine. I am all

for it. But let us define what flipping is in a very clear way, because if we do not define what it is, the legal risk that comes from

being potentially sued for having flipped puts a chilling effect on

lending. Let us go after flipping. But let us not go after it in a

vague way, which is what the North Carolina law does. And that

is why I think it is had such a negative effect.

Chairman SARBANES. Well, Mr. Eakes, Professor Calomiris to

some extent, took out after North Carolina.

Mr. EAKES. Yes, I think he called me out to a duel, right?

Chairman SARBANES. So, you are entitled to some response to it,

if you choose to make it.

Mr. EAKES. Let me respond and maybe I will ask a question.

The data that is cited is from a study paid for by industry that

looked at nine lenders. Nine lenders. That is the study. What it

shows is that there has been a drop in lending, which I have not

seen before today, that says that North Carolina dropped in the

third quarter of 1999 and the fourth quarter and the first two

quarters of 2000. That was the data that I saw in that study.

I wish that data were correct. I really do, because it would show

that the goal that we had in North Carolina—Mr. Calomiris may

or may not know this—but of the four practices that I mentioned,

only one of them had gone into effect as of the third quarter of

1999 and that is the flipping. So that had to be what would show

a reduction in originations, by 25 and 50 percent.

I wish that number were right because when we passed the bill,

the goal of the North Carolina legislation was to reduce flipping.

And the way you reduce flipping is have less loans originate. That

data would show that gap.

Here is what I would like to ask, is whether Mr. Calomiris knows

of any other events that were active in North Carolina during the

third quarter of 1999? Are you aware of any other environmental

changes?

Mr. MILLER. Was there a hurricane?

49

Mr. EAKES. We had in North Carolina, on September 15, 1999,

the largest flood in the history of North Carolina ever recorded. It

took 15,000 units directly down the river. As many as 100,000 families were dislocated. September 15, 1999. They could not have borrowed money if the predatory lenders had come to them in a boat.

[Laughter.]

So, his assessment—I wish it were right. I wish that really had

seen a, ‘‘chilling effect because the only provision that we had in

effect was the antiflipping.’’ That is what we wanted to do, was to reduce the number of flips.

But, unfortunately, I am afraid—I actually have heard this. It is

remarkable. I travel around the country and I hear the North

Carolina bill—first, I heard that every lobbyist who supported it

lost their job. Totally false.

Chairman SARBANES. Mr. Prough, I want to put a couple of questions to you. You have been very patient.

Mr. PROUGH. Yes, sir. Well, I would have liked to have participated in the conversation on credit life and balloons, but since we

do not offer those products, there was no need.

Chairman SARBANES. Yes. Ameriquest does not engage in those

practices. Correct?

Mr. PROUGH. Never. We never have.

Chairman SARBANES. I have the impression by establishing this

high level of performance, you have been able to make it succeed.

But I am concerned about—I want to ask this question, which may

not be fully applicable to you because you have really made it

work. But if lenders try to follow that course, would they be at a

competitive disadvantage with respect to others in the industry?

Let me put it this way. I guess they would be missing out on the

opportunity to make some fast money. Now they choose to do that.

But they are passing up such an opportunity, are they not?

Mr. PROUGH. Everybody runs their own business model, Senator.

Our approach is that by using the secondary market, using Wall

Street, and bundling our loans, we are able to create efficiencies

and create our profits through moving loans that way. And that

way, we can pass that cost savings on to the consumer.

Some of these other products just do not fit for that model because you are adding costs to the loan which eventually then have

to be financed through Wall Street. That causes complications. We

prefer to keep it very simple, very straightforward, and do exactly

what the customer expects us to do, provide home financing.

Chairman SARBANES. Well, it is a very interesting model and we

appreciate your coming here today to tell us about it. No question.

I am going to draw this to a close.

Mr. CALOMIRIS. May I just make one comment, Mr. Chairman?

Chairman SARBANES. Certainly.

Mr. CALOMIRIS. Because I did not get a chance to respond.

Chairman SARBANES. I do not want you to go away feeling that.

We try to be eminently fair here. Yes.

Mr. CALOMIRIS. I mean respond on one fact.

Chairman SARBANES. Yes.

Mr. CALOMIRIS. The evidence that I presented in the appendix

showed that the decline in subprime lending occurred only in some

income classes. So it seems a little strange to say it was the result

50

of a flood, because then you would have to believe that the flood

only affected people with incomes below $50,000.

Chairman SARBANES. But the subprime lending occurs primarily

in certain income classes, does it not?

Mr. CALOMIRIS. The point, Mr. Chairman, is that I have it for the

different income classes, only subprime lending. I am not looking

at all lending. Just subprime. The point is that it only affected people who are really subject to these particular rules. And I did note

that was phased in over 2000 and the data are about 2000, not

about the end of 1999. I just want to emphasize that we do not

have all the facts here before us. I do not claim that we do.

Chairman SARBANES. You want to get out from under the flood,

I take it. Is that it?

Mr. CALOMIRIS. Exactly.

[Laughter.]

As I say, that dog is not going to hunt.

Mr. EAKES. If I could just—and I promise I will be quick.

Chairman SARBANES. Yes, I have to draw this to a close.

Mr. EAKES. The poor people, where they own homes, happens to

often be in low-lying land that ends up being flood plain.

Rich people do not live in flood areas. And so it is extremely reasonable that you would have families in the lower income brackets

who are homeowners who are subject to these loans.

I really wish I could bring—you are at Columbia? I would love

to bring him just for a few days to actually see how the marketplace works, both in floods and out of floods, because he does not

get it right now.

[Laughter.]

Chairman SARBANES. Mr. Prough, you sat quietly through all of

this. Is there any comment you want to add before I draw this to

a close?

Mr. PROUGH. No, sir.

[Laughter.]

Chairman SARBANES. No wonder you all have been so successful.

[Laughter.]

Well, I want to thank this panel very much. I am sure we will

be back to you about one thing or another as we proceed to explore

this matter. Again, I want to thank you for your helpful testimony

and for the obvious careful thought that went into the statements.

The hearing now stands adjourned.

[Whereupon, at 1:10 p.m., the hearing was adjourned.]

[Prepared statements, response to written questions, and additional materials supplied for the record follow:]

51

PREPARED STATEMENT OF SENATOR PAUL S. SARBANES

Today is the first of two hearings on ‘‘Predatory Mortgage Lending: the Problem,

Impact, and Responses.’’ This morning we will hear first, from a number of families

that have been victimized by predatory lenders. Then, later this morning and tomorrow, an array of public interest and community advocates, industry representatives,

and legal and academic experts will have the opportunity to discuss the broader

problem and the impact predatory mortgage lending can have on both families and

communities.

Homeownership is the American Dream. It is the opportunity for all Americans

to put down roots and start creating equity for themselves and their families. Homeownership has been the path to building wealth for generations of Americans; it has

been the key to ensuring stable communities, good schools, and safe streets.

Predatory lender play on these hopes and dreams to cynically cheat people of their

wealth. These lenders target lower income, minority, elderly, and, often, unsophisticated homeowners for their abusive practices. It is a contemptible practice.

Let me briefly describe how predatory lenders and brokers operate. They target

people with a lot of equity in their homes, many of whom may already be feeling

the pinch of growing consumer and credit card debts; they underwrite the property

often without regard to the ability of the borrower to pay the loan back. They make

their money by charging extremely high origination fees, and by ‘‘packing’’ other

products into the loan, including upfront premiums for credit life, disability, and unemployment insurance, and others, for which they get significant commissions but

for which homeowners continue to pay for years beyond the terms of the policies.

The premiums for these products get financed into the loan, greatly increasing the

loan’s total balance amount. As a result, and because of the high interest rates

being charged, the borrower is likely to find himself in extreme financial difficulty.

As the trouble mounts, the predatory lender will offer to refinance the loan. Unfortunately, another characteristic of these loans is that they have high prepayment

penalties. So, by the time the refinancing occurs, with all the fees repeated and the

prepayment penalty included, the lender or broker makes a lot of money from the

transaction, and the owner has been stripped of his or her equity and, oftentimes,

his home.

Nearly every banking regulator has recognized this as an increasing problem.

Taken as a whole, predatory lending practices represent a frontal assault on homeowners all over America.

I want to make clear that these hearings are aimed at predatory practices. There

are people who may have had some credit problems who still need access to affordable mortgage credit. They may only be able to get mortgage loans in the subprime

market, which charges higher interest rates. Clearly, to get the credit they will have

to pay somewhat higher rates because of the greater risk they represent.

But these families should not be charged more than the increased risk justifies.

These families should not be stripped of their home equity through financing of extremely high fees, credit insurance, or prepayment penalties. They should not be

forced into constant refinancings, losing more and more of the wealth they have

taken a lifetime to build to a new set of fees, with each transaction. They should

not be stripped of their legal rights by mandatory arbitration clauses that block

their ability to go to court to vindicate their protections under the law.

Some people argue that there is no such thing as predatory lending because it

is a practice that is hard to define. I think the best response to this was given by

Federal Reserve Board Governor Edward Gramlich, who said earlier this year:

‘‘Predatory lending takes its place alongside other concepts, none of which

are terribly precise safety and soundness, unfair and deceptive practices,

patterns, and practices of certain types of lending. The fact that we cannot

get a precise definition should not stop us. It does not mean this is not a

problem.’’

Others, recognizing that abuses do exist, contend that they are already illegal. According to this reasoning, the proper response is improved enforcement.

Of course, I support increased enforcement. The FTC, to its credit, has been active

in bringing cases against predatory lenders for deceptive and misleading practices.

However, because it is so difficult to bring such cases, the FTC further suggested

last year a number of increased enforcement tools that would help to crack down

on predators. I hope we will get an opportunity to discuss these proposals as the

hearings progress.

I also support actions by regulators to utilize authority under existing law to expand protections against predatory lending. That is why I sent a letter, signed by

a number of my colleagues on the Committee, strongly supporting the Federal Reserve Board’s proposed regulation to strengthen the consumer protections under curVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00061 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
52

rent law. I also note that the Federal Trade Commission voted 5 to 0 last year in

support of many of the provisions of the proposed regulation.

Campaigns to increase financial literacy and industry best practices must also be

a part of any effort to combat this problem. Many industry groups have contributed

time and resources to educational campaigns of this type, or developed practices and

guidelines, and I applaud and welcome this as an integral part of a comprehensive

response to the problem of predatory lending.

But neither stronger enforcement, nor literacy campaigns are enough. Too many

of the practices we will hear outlined this morning and in tomorrow’s hearing, while

extremely harmful and abusive, are legal. And while we must aggressively pursue

financial education, we must also recognize that education takes time to be effective,

and thousands of people are being hurt every day. At his recent confirmation hearing, Fed Governor Roger Ferguson summed it up well when he said that ‘‘legislation, careful regulation, and education are all components of the response to these

emerging consumer concerns.’’

Again, I want to reiterate, subprime lending is an important and legitimate part

of the credit markets. But such lending must be consistent with and supportive of

the efforts to increase homeownership, build wealth, and strengthen communities.

In the face of so much evidence and so much pain, we must work together to address this crisis. Before taking your testimony, let me express my appreciation to

all of you for your willingness to leave your homes and come to Washington to speak

publically about your misfortunes. I know it must be very difficult. In my view, you

ought to be proud that you are contributing to a process that I hope will lead to

some action to put an end to the kinds of practices that have caused each of you

such heartache and trouble.

—————

PREPARED STATEMENT OF SENATOR WAYNE ALLARD

I would like to thank Chairman Sarbanes for holding this hearing. This is an

important topic, and I am glad that this Committee will have an opportunity to examine it more closely. I know that predatory lending is an issue that Chairman Sarbanes has followed very closely, as the so-called ‘‘flipping’’ form of predatory lending

has been a particular problem in Baltimore.

In the various Housing and Transportation Subcommittee hearings over the last

3 years, predatory lending came up on several occasions. It is an abhorrent practice,

and as Ranking Member of the Subcommittee I am particularly concerned about

predatory lending that involves FHA loans. The fraud perpetrated in those cases not

only victimizes the individual family, but also robs the taxpayers, who are responsible for backing the loan through FHA.

During my years as Chairman, and now as Ranking Member of the Housing Subcommittee, I have seen firsthand how important homeownership is to Americans,

after all, it is the American Dream. It is reprehensible that a small number of individuals prey upon those hopes and dreams, turning the dream into a nightmare.

I am pleased that this Committee will have an opportunity to examine some of

the issues surrounding predatory lending. While we hear a great deal about predatory lending, much of what we know seems to come from anecdotes. I believe it is

important that we examine the problem in a careful, reasoned way. In this manner

we can first get a clear idea of exactly what constitutes predatory lending, and how

great the scope of the problem is. Next, we can consider whether current laws are

adequate or whether we need additional laws.

I particularly wish to focus on the matter of enforcement. While predatory lending

is obviously occurring under the current laws, it may very well be that the current

laws are adequate, but simply not well enforced. Similarly, any additional laws that

this Committee may pass would be of little value if they are not enforced.

As important as it is to curb predatory lending, any actions considered by Congress, the States, or regulatory bodies must be made with caution. While predatory

lending is by its nature deceptive and fraudulent and should be stopped, there is

certainly room for a legitimate subprime lending market. Subprime lending expands

homeownership opportunities for those families that may have experienced credit

problems or who have not had an opportunity to establish credit. The subprime

market gives them access to financing that allows them to experience the dream of

homeownership.

Without access to this market, far fewer people would own a home. It is no coincidence that subprime lending has greatly expanded as the country is experiencing

record homeownership rates. If we are not careful with any legislation, we could end

up hurting the very people that we are trying to help.

53

1 Homeownership reached a record level of 66 percent in 1998. Arthur B. Kennickell, et al.,

Recent Changes in U.S. Family Finances: Results from the 1998 Survey of Consumer Finances,

86 Fed. Res. Bull. 1, 15–18 (2000).

We also cannot lose sight of the fact that laws cannot solve all problems. Because

there will always be those who disregard the laws, we must also find ways to promote personal protection and responsibility. I believe that we need to find a better

way to educate and empower consumers. I believe that knowledge can be a very

powerful weapon, and this is particularly true for financial matters. Survey after

survey has found that Americans lack basic financial knowledge. This lack of information can lead to financial disaster. Better consumer and financial knowledge will

leave consumers better protected—regardless of what the laws may be.

Again, I would like to thank the Chairman for holding this hearing. While today’s

cases are genuine tragedies, I hope that we will be able to learn from their situations to help stem predatory lending in America. I thank the witnesses for being

willing to come forward to share their stories. I look forward to your testimony.

—————

PREPARED STATEMENT OF SENATOR JIM BUNNING

Mr. Chairman, I would like to thank you for holding this hearing, and I would

like to thank our witnesses for testifying today and tomorrow.

Nobody is in favor of ‘‘Predatory’’ lending. We have all heard the horror stories

of unscrupulous people preying on the elderly, going through an entire neighborhood

and negotiating home improvement loans. These same individuals then strip the

equity from these homes, usually without even doing the repairs. There is a word

for these practices, and it is fraud. These practices should not and cannot be tolerated. The perpetrators of these practices should be prosecuted to the fullest extent

of the law.

But we must not throw the baby out with the bath water. Sixty-eight percent of

Americans own their own homes. While I do not know the exact statistics, I am willing to bet not all of that 68 percent were candidates for the prime rate. I am pretty

sure many of them did not qualify for prime.

So then, how are these people, who are not rich, or may have missed a payment

or two in their lifetime able to afford homes? The answer, of course, is the subprime

market.

The subprime market has been the tool for many Americans to achieve the American Dream of owning their own home. Many of our largest and most reputable financial institutions are a part of the subprime industry. I believe this is a good

thing, and a viable subprime market is good for our country.

We need to punish the bad actors. When fraud is committed, the perpetrators

should be punished and punished severely. But we also should encourage the good

actors. Citibank and Chase, to name two, have put into practice new guidelines to

help eliminate abuses or even the possibility of abuses. Companies taking these

steps should be commended.

When we try to eliminate abuse, we must make sure we do not kill the subprime

market. We must not drive out the reputable institutions that make home ownership possible to so many who otherwise would not be able to achieve that dream.

Thank you Mr. Chairman.

—————

PREPARED STATEMENT OF THOMAS J. MILLER

ATTORNEY GENERAL, THE STATE OF IOWA

JULY 26, 2001

Introduction

I would like to thank you, Mr. Chairman, and the Committee for giving me the

chance to speak on this critically important issue. This is one of the most important

challenges among the issues within this Committee’s jurisdiction, and I welcome the

opportunity to participate in the public discussion.

Homeownership is ‘‘the American Dream,’’ and America is rightfully proud of its

record in the number of Americans who have achieved that.1 The mortgage market

we normally think of, and are proud of, is ‘‘productive credit’’—a wealth-building

credit that millions of Americans have used to make an investment in their lives

and their childrens’ futures: the market that has helped those 66 percent of AmeriVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00063 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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2Part of the problem with the subprime market generally is it is not offering what many people need. Overwhelmingly, it offers refinance and consolidation loans—irrespective of whether

that is wanted, warranted, or wise. See section I–C, below. 3See Alan White and Cathy Lesser Mansfield, Subprime Mortgage Foreclosures: Mounting Defaults Draining Home Ownership, (testimony at HUD predatory lending hearings, May 12,

2000), indicating 72,000 families were in or near foreclosure.

While the foreclosures are devastating for the families, the impact on the lenders is less clear.

First, there is a distinction to be made between delinquencies/defaults and actual credit loss.

Second, as we note below, some of this risk to the lender is self-made. See Section II–A , below.

See also Appendix B, page 1, in which insurance padding added $76,000 to the cost of the loan,

raised the monthly payment nearly $100, and all by itself, created a $54,000 balloon payable

after the borrower would have paid over $204,000. 4We should also keep in mind that this prediction has been made of most consumer protection

and fair lending legislation in my memory—from the original Truth in Lending up through

HOEPA. And it has never happened. 5See Gene A. Marsh, ‘‘The Hard Sell in Consumer Credit: How the Folks in Marketing Can

Put You in Court,’’ 52 Cons. Fin. Law Qtrly Rep. 295, 298 (Summer, 1998) (quoting from a sales

training manual: another instruction—‘‘sell eligible applicants to his maximum worth or high

credit.’’) 6 As is discussed below, many homeowners do not select the lenders they use, but are delivered to those lenders by middlemen. In the case of some of the abusive land contracts, a contract

cans buy their homes; keep those homes in good repair; help finance the kids’ education, and for some, helped them start a small business. But make no mistake:

what we are talking about today is a threat to that dream and a very different mortgage market. Today, we are talking about asset-depletion. This is ‘‘destructive debt,’’ with devastating consequences to both the individual homeowners and to their communities. We are talking about people who are being convinced to ‘‘spend’’ the

homes they already own or are buying, often for little or nothing in return.2 Tens

of thousands of Americans, elderly Americans and African-Americans disproportionately among them, are seeing what for many is their only source of accumulated

wealth—the equity in their homes—siphoned off. Too often, the home itself is lost.3

Then what? How do they—particularly the elderly—start over?

Please keep this in mind when you hear the caution that legislative action will ‘‘dry up credit.’’ Drying up productive credit would be of grave concern; drying up

destructive debt is sound economic and public policy.4

In the previous panel, some of those affected by this conduct shared their experiences with you. Earlier this week, some Iowans shared their experiences with me.

Their stories were typical, but the suffering caused by these practices is keenly felt

by each of these individuals. One consumer who has paid nearly $18,000 for 4 years

would have had her original $9,000 mortgage paid off by now, had she not been delivered into one of these loans by an unscrupulous contractor. The lender who

worked with the contractor to make the home improvement loan refinanced that

mortgage with the $27,000 home improvement cost. But the contractor’s payment

was little more than a very large broker’s fee, for he did incomplete and shoddy

work, and then disappeared. The lender’s promises to make it right were all words

for 4 years, while they took her money. In the other cases, the homeowners I visited

with were not looking for loans, but they have credit cards from an issuer who also

has a home equity lending business. They were barraged by cross-marketing telemarketers, and convinced that it would be a sound move to refinance. Indeed a

sound move—for the lender who charged $6,900 in fees on $57,000 of proceeds. (The

fees, of course, were financed.) These families are the faces behind these lenders’ sales training motto: ‘‘These loans are sold, not bought.’’ 5 These families are the

faces behind the sordid fact that predatory lending happens because people trusted;

and because these lenders and the middlemen who deliver the borrowers to them

do not deserve their trust. These lives have been turned upside down by a business

philosophy run amuck: a philosophy of total extraction when there is equity at hand.

I know that my counterparts in North Carolina heard similar stories, which is

why Former Attorney General, now Governor Easley and Attorney General Cooper

as well, have been so instrumental in North Carolina’s pioneering reform legislation.

This problem is about these people—in Iowa, West Virginia, Pennsylvania, North

Carolina—and all over this country; this is not about abstract market theories. And

it is a problem that Congress has a pivotal role in curbing.

In some of our States, we are finding other types of predatory practices that are

preying on the vulnerable by appealing to—and subverting—their dreams of buying

a home. Some cities are seeing a resurgence of property flipping. In some areas of

my State, we are seeing abusive practices in the sale of homes on contracts. In fact,

it appears that such contracts may be taking their place along with brokers and

home improvement contractors as another ‘‘feeder’’ system into the high-cost mortgage market.6

55

seller will sell a home to an unsophisticated borrower at a greatly inflated price on a 2–5 year

balloon, telling the buyer that their contract payments will help establish a credit record. The

hitch is that it is likely to be difficult, if not impossible, to get conventional mortgage financing

when the balloon comes due because the inflated sales price would make the loan-to-value ratio

too high for a conventional market. The result? Another way of steering the less sophisticated

home buyer into the high-cost refinancing market. 7See section III–B, below on how preemption has hampered the ability of States to deal with

the kind of predatory lending practices we are talking about in these hearings. 8 A graph of the distribution of loans around the median rate shifted from a bell-curve distribution in 1995 to a ‘‘twin peaks’’ distribution around the median in 1999, indicating greater

segmentation within the subprime market, and shows the ‘‘rate creep’’ on the high side of the

distribution. See Cathy Lesser Mansfield, The Road to Subprime ‘‘HEL’’ Was Paved With Good

Congressional Intentions, 51 So. Car. L. Rev. 473, p. 578, Graph 2; p. 586, Graph 6 (2000).

Percent of loans in securitized subprime pools sold on Wall Street:

above 12 percent in 1995 was 30 percent; and 1999 was 44 percent;

above 15 percent in 1995 was 3 percent; and 1999 was 8 percent;

above 17 percent in 1995 was .02 percent; and 1999 was 1.5 percent.

See id., p. 577 Table 1.

Collecting price data on subprime lending is extraordinarily difficult, as the author of this article, one of my constituents, Professor Mansfield of Drake University law school, reported to

the House Committee on Banking and Financial Services a year ago. (May 24, 2000). As noted

above, unlike the prime market, there is no advertising information about rates and points in

the subprime market available to most consumers. Furthermore, that information is not reported for any regulatory purposes. It is not information required by the Home Mortgage DiscloContinued

My office has made predatory lending a priority—both in the home equity mortgage lending context and in the contract sales abuses. In addition to investigations,

we are considering adopting administrative regulations to address some of the areas

within the scope of our jurisdiction, and are working with a broad-based coalition

on education and financial literacy programs. But today I am here to talk to this

Committee solely about the home equity mortgage lending problem, because that is

where Congressional action is key. HOEPA has been a benefit, but improvements

are needed. Federal preemption is hindering States’ ability to address these problems on their own. The measures which have been introduced or passed at the State

and municipal levels dramatically demonstrate the growing awareness of the serious

impact on both individuals and communities of predatory lending, and the desire

for meaningful reform.7

What Is Predatory Lending and How Does It Happen?

The Context: The Larger Subprime Marketplace

Predatory lending is, at its core, a mindset that differs significantly from that operating in the marketplace in which most of us in this room participate. It is a marketplace in which the operative principle is: ‘‘take as much as you think you can

get away with, however you can, from whomever you think is a likely mark.’’ This

is not Adam Smith’s marketplace.

Today’s prime market is highly competitive. Interest rates are low, and points and

fees are relatively so. Competition is facilitated by widespread advertisement of

rates and points. Newspapers weekly carry a list of terms available in the region

and nationwide, and lenders advertise their rates. The effectiveness of this price

competition is demonstrated by the fact that the range of prime rates is very narrow, and has been for years. But in the subprime mortgage market, there is little

price competition: there are virtually no advertisements or other publicity about the

prices of loans, and it is difficult for anyone seeking price information to get it. Marketing in the subprime market, when terms are mentioned at all, tends to focus on

‘‘low-monthly payments.’’ This marketing is, at best, misleading, given the products

being sold, and is often simply an outright lie.

I do not mean to imply that all subprime lending is predatory lending, nor does

my use of statistics about the subprime generally so imply. However, most of the

abuses do occur within the subprime market. We must understand the operations

and characteristics of that marketplace in order to recognize how and why the

abuses within it occur, and to try to address those problems.

• Interest rates in the subprime market are high and rising. During a 5 year period

when the median conventional rates ranged from 7–8 percent, the median

subprime rate was 10–12 percent. But that 5 year period saw two disturbing

trends. First, the distribution around that median has changed—with the number

of loans on the high side of that median rising. Second, rates have increased, with

the top rates creeping up from a thinly populated 17-plus percent to nearly 20

percent.8

56

sure Act (HMDA). These statistics relate solely to pools of loans packaged as securities, where

interest rate information is required by SEC rules for prospective investors. 9Figures cited in U.S. Department of Treasury Comment on Regulation Z (HOEPA) Proposed

Rulemaking, Docket No. R–1090 (January 19, 2001), at page 7. 10 Estimate courtesy of the Coalition for Responsible Lending. Recently, three major lenders,

Citigroup, Household, and American General, announced they will stop selling single-premium

credit insurance. 11 Howard Lax, Michael Manti, Paul Raca, Peter Zorn, Subprime Lending: An Investigation

of Economic Efficiency, p. 9 (unpublished paper, February 25, 2000). 12Twelve percent of subprime loans are taken out by African-Americans. Subprime loans are

51 percent of home loans in predominately African-American neighborhoods, compared with

9 percent in white neighborhoods. Blacks in upper-income neighborhoods were twice as likely

to be in the subprime market as borrowers in low-income white neighborhoods. HUD, Unequal

Burden: Income and Racial Disparities in Subprime Lending in America.

The Zorn, et. al study also notes that lower income borrowers are also twice as likely to be

in the subprime market ‘‘despite the fact that FICO scores are not strongly correlated with income.’’ p. 9. The Woodstock Institute study also found that the market segmentation ‘‘is considerably stronger by race than by income. Daniel Immergluck and Marti Wiles, Two Steps Back:

The Dual Mortgage Market, Predatory Lending, and the Undoing of Community Development,

p. iii (Woodstock Institute, November 1, 1999.)

With the aid of a Community Lending Partnership Initiative grant, the Rural Housing Institute is gathering information on lending in Iowa. Preliminary data indicates a similar picture

of racial disparities in Iowa, though the researchers are awaiting the results of the 2000 Census

income data to see whether the correlation in Iowa is similarly more correlated to race than

income. 13The per family figure was found in Coalition for Responsible Lending Issue Paper, ‘‘Quantifying the Economic Cost of Predatory Lending.’’ (March 9, 2001). Mr. Eakes’ testimony today

may reflect revised figures. 14 According to 1990 census, the median net worth for an African-American family was $4,400.

Comparing that to Mr. Eakes estimate of $4,600 per family loss is, to put it mildly, sobering. 15 Howard Lax, Michael Manti, Paul Raca, Peter Zorn, Subprime Lending: An Investigation

of Economic Efficiency, p. 3–4 (unpublished, February 25, 2000). While risk does play a key role,

‘‘borrowers’ demographic characteristics, knowledge, and financial sophistication also play a statistically and practically significant role in determining whether they end up with subprime

mortgages.’’ Id. p. 3.

• Points and fees in the subprime market, while down from the 10–15 percent frequently seen prior to the enactment of HOEPA (with its 8 percent points-and-fees

trigger), are still high, in the 5–7.9 percent range, while the typical cost in the

prime market is 1–3 percent.

• Subprime loans are disproportionately likely to have prepayment penalties, making it expensive to get out of these loans, and sometimes trapping the borrower

in an overly expensive loan. (Seventy–seventy-six percent, compared to less than

2 percent in the prime market.) 9

• Single-premium credit insurance, virtually nonexistent in the prime mortgage

market, has been estimated to be as much as 50 percent of subprime loans,

though accurate statistics are not available. (The penetration rate varies considerably, depending upon the provider. Some subprime lenders market it heavily,

others very little.) 10

The demographics of the subprime marketplace are significant. Thirty-five percent

of borrowers taking out subprime loans are over 55 years old, while only 21 percent

of prime borrowers are in that age group.11 (This despite the fact that many of the

elderly are likely to have owned their homes outright before getting into this market.) The share of African-Americans in the subprime market is double their share

in the prime market.12

My co-panelist, Martin Eakes and his colleagues have estimated that the cost of

abuses in these four areas cause homeowners to lose $9.1 billion of their equity annually, an average of $4,600 per family per year.13 When I look at that figure in

the context of who is most likely to be hurt by those abuses, my concern mounts.14

Others will be talking to this Committee about the fact that predatory lending is

at the intersection of civil rights and consumer protection, so I will only say that,

for what may be the first time, our civil rights and consumer protection divisions

in Attorneys General offices around the country are beginning to work together on

this common problem.

The most common explanation offered by lenders for the high prices in the

subprime market is that these are risky borrowers, and that the higher rates are

priced for the higher risk. But that is far too simplistic. Neutral researchers have

found that risk does not fully explain the pricing, and that there is good reason to

question the efficiency of subprime lending.15 That core mindset I mentioned earlier

57

16 It is beyond the scope of my comments to discuss the relationship between risk and pricing.

But it is important that policymakers look not just at delinquency and foreclosure rates without

also looking at actual losses and revenues. 17 An ‘‘upcharge’’ is when the loan is written at a rate higher than the underwriting rate. For

example, an evaluation of the collateral, the borrower’s income and debt-to-income ratio, and

credit history indicates the borrower qualifies for a 11.5 percent interest rate. But the broker

has discretion to write the note at 14 percent, and the broker gets extra compensation from that

rate spread. He may get it all, or there may be a sharing arrangement with the lender, for example, the broker gets first 1 percent, and they split the other 1.5 percent. The Eleventh Circuit

has recently found that a referral fee would violate RESPA. Culpepper v. Irwin Mtg. Corp., 253

F. 3d 1324 (2001).

A recent review of yield-spread premiums in the prime market found that they added an aver- age cost of over $1,100 on each transaction in which they were charged. The author found that

the most likely explanation for the added cost was not added value, nor added services. Rather,

it is a system which lends itself to price discrimination: extra broker-compensation can be extracted from less sophisticated consumers, while it can be waived for the few who are savvy

about the complex pricing practices in today’s mortgage market. See Report of Howell E. Jackson, Household International Professor of Law, Harvard Law School, pp. 72 , 81 (July 9, 2001),

submitted as expert witness’ report in Glover v. Standard Federal Bank, Civ. No. 97–2068 (D.

Minn.)

leads to opportunistic pricing, not pricing that is calibrated to provide a reasonable

return, given the actual risk involved.

Moreover, the essence of predatory lending is to push the loan to the very edge

of the borrower’s capacity to handle it, meaning these loans create their own risk.

We cannot accept statistics about delinquencies and foreclosure rates in the

subprime market without also considering how the predatory practices—reckless underwriting, push marketing, and a philosophy of profit maximization—create a selffulfilling prophecy.16 And even with comparatively high rates of foreclosures, many

lenders continue to be profitable.

How and Why It Happens?

If neither risk nor legitimate market forces explain the high prices and disadvantageous terms found so frequently in the subprime market, then what does explain it?

‘‘Push marketing:’’ The notion of consumers shopping for a refinance loan or a

home improvement loan, comparing prices and terms, is out of place in a sizeable

portion of this market. Frequently, these are loans in search of a borrower, not the

other way around, as was the case with the Iowa borrowers I spoke with this week.

Consumers who buy household goods with a relatively small installment sales contract are moved up the ‘‘food chain’’ to a mortgage loan by the lender to whom the

retailer assigned the contract; door-to-door contractors come by unsolicited with

offers to arrange manageable financing for home improvements; telemarketers offer

to ‘‘lower monthly payments’’ and direct mail solicitations make false representations about savings on consolidation loans. Another aspect of push marketing is

‘‘upselling.’’ (‘‘Upselling’’ a loan is to loan more money than the borrower needs,

wants, or asked for.)

‘‘Unfair and deceptive, even downright fraudulent sales practices:’’ In addition to

deceptive advertisements, the sales pitches and explanations given to the borrowers

mislead consumers about high prices and disadvantageous terms (or obscure them)

and misrepresent benefits. Some of these tactics could confuse almost anyone, but

when the consumer is unsophisticated in financial matters, as is frequently the case,

the tactics can be quite fruitful.

While Federal and State laws require disclosures, for a variety of reasons, these

laws have not proven adequate against these tactics.

Reverse competition: Price competition is distorted when lenders compete for referrals from the middlemen, primarily brokers and contractors. When the middleman

gets to take the spread from an ‘‘upcharge’’ 17 on the interest rate or points, it

should come as no surprise to anyone that some will steer their customers to the

lenders offering them the best compensation. (Reverse competition is also a factor

with credit insurance because of commission incentives and other profit-sharing programs.) It should also come as no surprise that the people who lack relevant education, are inexperienced or have a real or perceived lack of alternatives, are the

ones to whom this is most likely to happen.

Even without rate upcharges, the brokers, who may have an agreement with the

borrower, often take a fee on a percentage-basis, so they have an incentive to steer

the borrower to a lender likely to inflate the principal, by upselling, fee-padding, or

both. These are self-feeding fees. A 5 percent fee from a borrower who needs—and

wants—just $5,000 for a roof repair is only $250. But if the broker turns that into

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18See Section III, below, for a discussion of the adequacy of these laws to address predatory

mortgage lending. 19See, Comments from John Bley, Director of Financial Institutions, State of Washington, on

Responsible Alternative Mortgage Lending to OTS (July 3, 2000). (I note that some abuses also

occur in the servicing and collection of these loans, so limiting a statutory definition to the origination stage only would leave gaps.) Mr. Bley’s letter notes that the HUD/Treasury definition,

quoted in his letter, is similar: ‘‘Predatory lending—whether undertaken by creditors, brokers,

or even home improvement contractors—involves engaging in deception or fraud, manipulating the borrower through aggressive sales tactics, or taking unfair advantage of a borrower’s lack of understanding about loan terms. These practices are often combined with loan terms

that, alone or in combination, are abusive or make the borrower more vulnerable to abusive

practices.’’ 20 940 C.M.R. § 8.00, et seq. See also United Companies Lending Corp. v. Sargeant, 20 F. Supp.

2d 192 (D. Mass. 1998). 21 N.C. Gen. Stat. § 24–1–.1E. See also 209 C.M.R. 32.32 (Massachusetts Banking Commission); Ill. Admin. Code 38, 1050.110 et seq.; N.Y. Comp Codes & Regs. Tit. 3 § 91.1 et seq. Some

cities have also crafted ordinances along these lines, Philadelphia and Dayton being two examples. While legal concerns about preemption and practical concerns about ‘‘balkanization’’ have

been raised in response to this increasingly local response much care and thought has gone into

the substantive provisions, building on the actual experience under HOEPA, and may be a good

source of suggestions for improvements on HOEPA itself. 22 ‘‘[P]rovisions of this subtitle preempt State law only where Federal and State law are inconsistent, and then only to the extent of the inconsistency. The Conferees intend to allow States

to enact more protective provisions than those in this legislation.’’ H.R. Conf. Rep. No. 652, 103d

a refinance loan, of $40,000, further padded with another $10,000 of financed points,

fees, and insurance premiums, his 5 percent, now $2,500, looks a lot better.

This divided loyalty of the people in direct contact with the homeowner is particularly problematic given the complexity of any financing transaction, considerably

greater in the mortgage context than in other consumer credit. As with most other

transactions in our increasingly complex society, these borrowers rely on the good

faith and honesty of the ‘‘specialist’’ to help provide full, accurate, and complete information and explanations. Unfortunately, much predatory lending is a function of

misplaced trust.

These characteristics help explain why the market forces of standard economic

theory do not sufficiently work in this market. There are too many distorting forces.

Factor in the demographics of the larger subprime marketplace in which these players operate, and we can better understand how and why it happens.

Definition

Having looked at the context in which predatory lending occurs, we come to the

question of definition. I know that some have expressed concern over the absence

of a bright line definition. I do not see this as a hurdle, and I believe that Attorneys

General are in a position to offer reassurance on this point. There is a real question

as to whether a bright line definition is necessary, or even appropriate. All 50 States

and the United States have laws which employ a broad standard of conduct: a prohibition against ‘‘deceptive practices,’’ or ‘‘unfair and deceptive practices.’’ 18 Attorneys

General have enforcement authority for these laws, and so are in a position to assure this Committee that American business can and has prospered with broad,

fairness-based laws to protect the integrity of the marketplace. Indeed, a good case

can be made that they have helped American business thrive, because these laws

protect the honest, responsible, and efficient businesses as much as they protect consumers, for unfair and deceptive practices are anticompetitive.

While statutes or regulations often elaborate on that broad language with specific

lists of illustrative acts and practices, it has never been seriously advanced that illustrations can or should be an exhaustive enumeration, and that anything outside

that bright line was therefore acceptable irrespective of the context. There is a simple reason for this, and it has been recognized for centuries: the human imagination

is a wondrous thing, and its capacity to invent new scams, new permutations on

old scams, and new ways to sell those scams is infinite. For that reason, it is not

possible, nor is it probably wise, to require a bright line definition.

Several models for defining the problem have been used. One model relates to

general principles of unfairness and deception. The Washington State Department

of Financial Institution defines it simply as ‘‘the use of deceptive or fraudulent sales

practices in the origination of a loan secured by real estate.’’ 19 The Massachusetts

Attorney General’s office has promulgated regulations pursuant to its authority to

regulate unfair and deceptive acts and practices to address some of these practices.20 Improving on the HOEPA model has been the basis for other responses

within the States, most notably North Carolina’s legislation.21 (In enacting HOEPA,

Congress recognized that it was a floor, and States could enact more protective legislation.22)

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Cong. Sess. 147, 162 (1994), 1994 U.S. C.C.A.N. 1992. That has not prevented preemption challenges, however. The Illinois DFI regulations have been challenged by the Illinois Association

of Mortgage Brokers, alleging that they are preempted by the Alternative Mortgage Transaction

Parity Act. 23While most of these loans are more than amply secured by the home, well within usual

loan-to-value ranges, some lenders are upselling loans into the high LTV range, which bumps

the loan into a higher rate. Some lenders do this by ‘‘loan-splitting,’’ dividing a loan into a large

loan for the first 80–90 percent if the home’s equity, at, for example, 13–14 percent, and a smaller loan for the rest of the equity (or exceeding the equity) at 16–21 percent. These loans are

often made by ‘‘upselling,’’ not because the borrower sought a high LTV loan. The practice seems

to involve getting inflated ‘‘made-to-order’’ appraisals, then upselling the loan based on the

phony ‘‘appreciation.’’ As with some of the other tactics, like stiff prepayment penalties, these

loans marry the homeowner to this lender. The homeowner cannot refinance with a market-rate

lender. 24See text accompanying note 8. 25See Appendix B, p. 2 line 5. Compare columns 5 and 6. This is not a hypothetical example.

It is a loan made to an Iowa couple.

There is considerable consensus about a constellation of practices and terms most

often misused, with common threads.

The terms and practices are designed to maximize the revenue to the lenders and

middlemen, which maximizes the amount of equity depleted from the borrowers’

homes. As mentioned earlier, when done by means which do not show in the credit

price tags, or may be concealed through confusion or obfuscation, all the better.

That makes deceptive sales techniques easier, and reduces the chances for any real

competition to work.

Among those practices:

• Upselling the basic loan (includes inappropriate refinancing and debt consolidation). The homeowner may need (and want) only a relatively small loan, for example, $3,000 for a new furnace. But those loans tend not to be made. Instead these

loans are turned into the ‘‘cash-out’’ refinancing loan, that refinances the first

mortgage or consolidation loans (usually consolidating unsecured debts along with

a refinance of the existing first mortgage). In the most egregious cases, 0 percent

Habitat for Humanity loans, or low-interest, deferred payment rehabilitation

loans have been refinanced into high rate loans which stretch the limits of the

homeowner’s income. But even refinancing a 9–10 percent mortgage into a 14 percent mortgage just to, get the $3,000 for that furnace is rarely justifiable. Like

other practices, this has a self-feeding effect. A 5 percent brokers fee; or 5 points

will be much more remunerative on a $50,000 loan than on a $3,000 loan. Since

these fees are financed in this market, they, in turn, make the principal larger,

making a 14 percent rate worth more dollars. For the homeowner, of course, that

is all more equity lost.23

• Upcharging on rates and points (includes yield spread premiums and steering).

The corrosive impact of yield spread premiums generally was described above in

connection with the discussion of reverse competition. (See note 17.) The problem

is exacerbated in the subprime market, where the much greater range of interest

rates 24 makes greater upcharges possible, and the demographics of the subprime

market as a whole lends itself to the type of opportunistic pricing that Professor

Jackson posed as the likely explanation.

• Excessive fees and points/padded costs. Since the fees and charges are financed

as part of the loan principal, and since some of them are percentage-based fees,

this kind of loan padding creates a self-feeding cost loop (an example is described

earlier in the discussion of upselling), which makes this a very efficient practice

for extracting more equity out of the homes.

• Financing single-premium credit insurance. Appendix B is a good example of how

effective single-premium credit insurance is as a tool for a predatory lender to

strip equity from a borrower’s home. It is also a good example of how well it lends

itself to manipulation and deceptive sales tactics. Appendix B shows that adding

a $10,000 insurance premium (of which the lender keeps approximately 35–40

percent as commission) over the life of the loan, will cost the borrower an extra

$76,000 in lost equity over the life of the loan. Even if the borrower prepays (or

more likely refinances) at 5 years, the credit insurance adds $9,400 to the payoff.

And the lender’s estimated commission from the premium was double the amount

of revenue the lender got from the three points charged on that loan.25

• Prepayment penalties. Prepayment penalties trap borrowers in the high cost

loans. They are especially troublesome, since borrowers are often told that they

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26This is another instance which demonstrates the limits of disclosures. A recent loan we saw

has an ‘‘Alternative Mortgage Transactions Parity Act Prepayment Charge Disclosure,’’ which

explains that State law is preempted, and provides an example of how their formula would

apply to a $100,000 loan. It is doubtful the example would score on any literacy scale below

upper college-level. 27Truncated credit insurance is insurance sold for a term less than the loan term in the example in Attachment B, page 1, the loan premium financed in the 20 year balloon note purchased

a 7 year policy. That frontloads the premium, so if the loan was refinanced at 5 years, over

90 percent of the premium would have been ‘‘earned,’’ and rolled over into the new loan principal—but without any insurance coverage from that extra $9,400 in the new loan. 28This was the technique at issue in the FAMCO cases, see Section III, below. 29The practice is a variation of ‘‘spiking.’’ (‘‘Spiking’’ means to start work or otherwise proceed

during the cooling off period, which leads the consumer to believe they cannot cancel, ‘‘because

work has begun.’’) By trying to separate the sale of the home improvement from the financing

for it, the borrowers’ right to cancel under either the State door-to-door sales act or the TIL

are subverted. This practice, which appears to be common, is described more fully in National

Consumer Law Center, Truth in Lending § 6.8.4.2, esp. 6.8.4.2.2 (4th Ed. 1999.) 30Oral presentation of an AARP lawyer at a conference on predatory mortgage lending in Des

Moines, Iowa, June 1999.

It is a fertile area for misrepresentations. When looking at mortgage lending in the prime

market, the Boston Federal Reserve Bank found that approximately 80 percent of applicants

had some ding on their credit record which would have, looked at in isolation, justified a denial.

The recent move by Fair Isaac to bring transparency to credit scores may help, but it will

more likely be a help in the prime market than in the subprime market. Again, a knowledgeable

broker or contractor-cum-broker would assure that the consumer knew that, but the reverse

competition effect may impede that.

need not worry about the high payments, because these loans are a bridge, that

can be refinanced after a couple of years of good payment history.26

• Flipping. Flipping is the repeated refinancing of the consumer’s loan. It is especially useful for equity-stripping when used by lenders who frontload high fees

(points, truncated credit insurance,27 and so forth). The old fees are pyramided

into the new principal, and new fees get added. My staff has seen loans in which

nearly 50 percent of the loan principal simply reflected pyramided fees from serial

refinancing. • Balloons. While HOEPA did succeed in reducing the incidence of 1 and 2 year balloons, what we are seeing now is long-term balloon loans which seem to be offered

solely to enable the lender, broker, or contractor to sell the loan based on the low

monthly payment. We are seeing 15, and even 20 year balloon loans. The Iowa

couple whose loan is discussed in Appendix B borrowed $68,000 (including a

$10,000 insurance premium). Over the next 20 years of scheduled payments, they

would pay $204,584, and then they would still owe a $54,300 balloon.

Unfair and deceptive sales practices in sales of the credit: In addition to misleading advertisements, the sales pitches and explanations given to the borrowers

mislead consumers about high prices and disadvantageous terms (or obscure them)

and misrepresent benefits. Again, just a few examples:

• While Federal and State laws require disclosures, for a variety of reasons, these

laws have not proven adequate against these tactics. Techniques such as ‘‘mixing

and matching’’ the numbers from the note and the TIL disclosure low-ball both

the loan amount (disguising high fees and points), and the interest rate, thus completely pervert the basic concept of truth in lending.28

• When door-to-door contractors arrange financing with these high-cost lenders

(often with lenders who use the opportunity to upsell the credit into a refinancing

or consolidation loan), it appears to be common to manipulate the cancellation

rights so that the consumer believes he must proceed with a loan which costs too

much.29

Some of the front-line personnel selling these loans even use the lack of transparency about credit scores to convince people that they could not get a lower-cost

loan, either from this lender or anywhere else. As one lawyer who has worked for

a decade with elderly victims put it, when the broker gets through, the homeowners

feel lucky if anyone would give them a dime.30

Ability to pay: These lenders pay less attention to the ability of the homeowner

to sustain the loan over the long haul. The old standard underwriting motto of ‘‘the

3–C’s: capacity, collateral, and creditworthiness’’ is shortened to ‘‘1–C’’—collateral.

Capacity is, at best, a secondary consideration. Creditworthiness, as mentioned

above, becomes an instrument for deceptive sales practices in individual cases.

A recent example from Iowa: A 72 and 64 year old couple were approached by

a door-to-door contractor, who sold them on the need for repairs to their home, and

offered to make arrangements for the loan. The work was to cost approximately

$6,500. The contractor brought in a broker, who arranged for a refinance plus the

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31The homeowners tried to exercise their right to cancel. But the lender claims they never

got the notice, and the contractor told them not to worry about those payments, they would

lower them . . . . 32 A good example is the FTC Credit Practices Rule, 16 C.F.R. 444, which prohibited certain

practices common in the consumer finance industry as unfair or deceptive. At the time it was

under consideration, opponents predicted it would ‘‘dry up credit to those who need it the most.’’

It did not. (Indeed, it was predicted that HOEPA would ‘‘dry up credit to those who need it the

most.’’ It has not.) 33FAMCO’s practices were the subject of a New York Times article, Diana B. Henriques,

‘‘Mortgaged Lives,’’ NYT, A1 (March 15, 2000).

cash out for the contractor. (The broker took a 5 percent fee on the upsold loan

($1,800) plus what appears to be a yield-spread premium amounting to another

$1,440. Now the payments on their mortgage, (including taxes and insurance) are

$546. That is nearly 60 percent of their income: It leaves them $389 a month for

food, car and health insurance, medical expenses, gasoline and other car expenses,

utilities, and everything else. This terrific deal the broker arranged was a 30 year

mortgage. The loan amount was $36,000, and the settlement charges almost $3,900

(though not all in HOEPA trigger fees). The APR is 14.7 percent.31

The consequence of all this? ‘‘Risk’’ becomes a self-fulfilling prophecy. Home ownership is threatened, not encouraged.

It is not an insurmountable challenge to bring this experience to bear in crafting

legislation and regulation, as our experience with illustrative provisions in UDAP

statutes and regulations, and in HOEPA itself, show.32

What Can Be Done Now?

State Attorneys General have used our State Unfair and Deceptive Acts and Practices (UDAP) laws against predatory mortgage lenders, including most notably, First

Alliance Mortgage Company (FAMCO).33 FAMCO demonstrates that lenders can be

in technical compliance with disclosure laws like Truth in Lending and RESPA, yet

nonetheless engage in widespread deception. When regulators did routine examinations, they would see very expensive loans, but no violations of any ‘‘bright line’’ disclosure laws. The problem was that FAMCO employees were rigorously trained as

to how to disguise their 20 point charges through a sales script full of tricky and

misleading information designed to mislead consumers into thinking that the

charges were much lower than they were. This sales script was dubbed ‘‘The Monster Track.’’ Attorneys General in Minnesota, Massachusetts, Illinois, Florida, California, New York, and Arizona have taken action against the company, along with

the Department of Financial Institutions in Washington State. (In the wake of all

the litigation and enforcement actions, the company filed bankruptcy.)

(States which either opted-out of Federal preemption of State limitations on

points or reenacted them may have effectively prevented companies like FAMCO

from doing business in their State. Iowa opted-out of the Federal preemption on first

lien points and rates, and kept a two-point limit in place. While there is no concrete

proof that this point-cap is why FAMCO did not do business in Iowa, it seems a

reasonable assumption.)

But our UDAP laws, and our offices are by no means as much as is needed for

this growing problem.

Impediments to Enforcement of Existing Laws

Some of the predatory lending practices certainly do fall afoul of existing laws.

But there are important loopholes in those laws, and there are also serious impediments to enforcement of those laws against predatory lenders.

• Public enforcement

Resource limitations: One of the most significant impediments to public enforcement of existing applicable laws is insufficient resources. While State and Federal

agencies have many dedicated public servants working to protect consumers and the

integrity of the marketplace, in the past 15 or so years we have seen an ever-growing shortfall in the personnel when compared to the workload. The number of credit

providers, the volume of lending, and the amount of problem lending have all exploded at the same time that the resources available to examine, monitor, investigate them, and enforce the laws have declined in absolute numbers. The resulting

relative disparity is even greater. The experience in my State is probably not atypical. The number of licensed nondepository providers of household credit has roughly

tripled in, the past 15 years, and the volume of lending has risen accordingly. (And

not all out-of-State lenders operating through mail, telephone, or the Internet are

licensed.) Three entire new categories of licensees have been created during those

years. Yet, the staff necessary to examine these licensees and undertake any invesVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00071 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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34The theory for exempting lenders is generally that other regulators are monitoring the conduct of the entity. Yet, the regulator may not have the jurisdictional authority to address unfair

and deceptive acts and practices generally. 35The European Union recognizes the problems inherent in mandatory arbitration in consumer transactions, and includes it among contract terms that are presumptively unfair. See

European Union Commission Recommendation No. 98/257/EC on the Principles Applicable to

the Bodies Responsible for the Out-of-Court Settlement of Consumer Disputes, and Council Directive 93/13/EC of April 5, 1993 on Unfair Terms in Consumer Contracts. 36See, for example Mansfield, The Road to Subprime ‘‘HEL,’’ note 8, above.

tigations and enforcement actions have decreased. This is undoubtedly true at the

Federal level, as well as the State level.

This disparity between need and supply in the Attorneys General offices is exacerbated by the fact that credit is only one of many areas for which we have some responsibility. For example, telecommunications deregulation and the explosion in

e-commerce have resulted both in expanded areas of concern for us, and an expanded volume of complaints from our citizens.

Holes in coverage: Some State UDAP statutes do not include credit as a ‘‘good or

service’’ to which the Act applies, or lenders may be exempted from the list of covered entities.34 Some State statutes prohibit ‘‘deceptive’’ practices, but not unfair

practices. In my State, we have no private right of action for our UDAP statute,

magnifying the impact of the problem of inadequate resources for public enforcement. Other claims which might apply to a creditors’ practices may be beyond the

jurisdictional authority given to public agencies.

The silent victim: There is also a threshold problem of detection. Most of the people whose homes are being drained of their equity do not complain. Like most Americans, they are unfamiliar with applicable laws and so are unaware that the lender

may have crossed the bounds; many people are embarrassed, or simply feel that it

is yet one more of life’s unfortunate turns. Coupled with the ‘‘clean paper’’ on many

of these loans, this silence means activity goes undetected—at least until it is too

late for many. As mentioned above, regulatory examinations of the records in the

lenders’ offices (even if there was sufficient person-power), often do not reveal the

problems.

• Private enforcement

Mandatory arbitration: We have always recognized that the public resources for

enforcement would never be adequate to assure full compliance. Thus, the concept

that consumers can vindicate these rights themselves is built into many of the statutes which apply to these transactions. Under these statutes, as well as common

law, these actions may be brought in our courts, where impartial judges and juries

representing the community at large can assess the evidence and apply the law.

Some of these statutes help assure that the right is not a phantom one, by providing

for attorney’s fees and costs as part of the remedy against the wrong-doer. Critically, the legal system offers an open and efficient system for addressing systemic

abuses—abuses that Governmental enforcement alone could not address.

But private enforcement faces a serious threat today. Mandatory arbitration

clauses which deny consumers that right to access to impartial judges and juries

of their peers are increasingly prevalent. This denies all of us the open system necessary to assure that systemic problems are exposed and addressed. This is not the

forum to discuss in detail the way the concept of arbitration has been subverted

from its premise and promise into a mechanism used by one party to a contract—

the one that is holding all the cards—to avoid any meaningful accountability for

their own misconduct. These are not, as arbitration was envisioned, simple consensual agreements to choose a different forum in which to resolve differences cheaply

and quickly; these are intended to insulate the ones who insist upon them from the

consequences of their improper actions. While not unique to predatory mortgage

lending, this rapidly growing practice in consumer transactions is a serious threat

to effective use of existing laws to address predatory lending, as well as to enforcement of any further legislative or regulatory efforts to curb it. It is within Congress’

power to remove this barrier.35

Preemption

Federal laws which, by statute or by regulatory action, preempt State laws, have

played a role in the growth of predatory mortgage lending.36 Unlike some examples

of Federal preemption, preemption in the credit arena did not replace multiple State

standards with a single Federal standard. In important areas, it replaced State

standards with no real standards at all.

With commerce increasingly crossing borders, the industry asks that it not be subjected to ‘‘balkanized’’ State laws, and now, even municipal ordinances. But the inVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00072 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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37 It is also possible that AMTPA has contributed to the prevalence of the ‘‘exploding ARM’’

by predatory lenders, as the existence of a variable rate is one of the triggers for AMTPA coverage. 12 U.S.C. § 3802. Although we are focused today on mortgage lending, we are also concerned about overbroad preemption interpretations by the OCC affecting our ability to address

problems in other areas, such as payday lending, and, now, perhaps even car loans. 38 Illinois Assoc. of Mortgage Brokers v. Office of Banks and Real Estate, (N.D. Ill, filed July

3, 2001); National Home Equity Mortgage Association v. Face, 239 F. 3d 633 (4th Cir. 2001),

cert. Filed June 7, 2001. 39 It is not a violation to make unaffordable loans, it is only a violation to engage in a ‘‘pattern

and practice of doing so,’’ a difficult enforcement challenge. See Newton v. United Companies,

24 F. Supp. 2d 444 (E.D. Pa 1998).

dustry and Congress should recognize that these efforts are born of concern for what

is happening now to people and to their communities, and of frustration at inaction

in Congress.

Congress did, on a bipartisan basis, enact HOEPA, which has helped, but needs

to be improved. However, Congress has not done anything about the vacuum (and

the uncertainty) left by preemption. Some Federal regulatory agencies have made

the problem even worse since then, through broad (arguably overbroad) interpretations of Federal law. For example, the 1996 expansive reading of the Alternative

Mortgage Transactions Parity Act (AMTPA) to preempt State laws on prepayment

penalties has contributed to the problems we are talking about today. Over a year

ago, the OTS asked whether that Act and interpretations under it had contributed

to the problem, and 45 States submitted comments saying ‘‘yes.’’ But nothing has

come of that.37 In the meantime, regulators in Virginia and Illinois have been sued

by industry trade associations on grounds that AMTPA preempts their rules.38

What More Needs To Be Done?

It is simply not the case that existing laws are adequate. In an imperfect market,

there must be ground rules. These are some suggestions.

Federal Reserve Board: HOEPA Regulation

Thirty-one States submitted comments to the Federal Reserve Board urging it to

adopt the HOEPA rules as proposed, without being weakened in any respect. Our

comments emphasized the importance of including single-premium credit insurance

among the trigger fees. (A copy of the comments is submitted as Appendix A.)

Other Legislative Recommendations

In addition to closing the enforcement and substantive loopholes created by mandatory arbitration and preemption, HOEPA could be improved in light of the lessons

we have learned from almost 6 years of experience with it. Some of the suggested

reforms include:

• Improve the ‘‘asset-based lending’’ prohibition. Since this is the key issue in predatory lending, it is vital that it be effectual and enforceable. As it stands, it is

neither. The ‘‘pattern and practice’’ requirement should be eliminated from the

provision prohibiting making unaffordable loans.39 The concept of ‘‘suitability,’’

borrowed from the securities field, might be incorporated.

• Prohibiting the financing of single-premium credit insurance in HOEPA loans, as

HUD and the FRB have recommended.

• Remove the Federal preemption hurdle to State enforcement of laws prohibiting

prepayment penalties, or, at a minimum, prohibit prepayment penalties in

HOEPA loans. The current HOEPA provision on prepayment penalties, as a practical matter, is so convoluted as to be virtually unenforceable.

• Improve the balloon payment provisions. While we no longer see 1 and 2 year balloons, we now see 15 and 20 year balloons, whose sole purpose is to enable the

lender or broker to low-ball the cost by selling on ‘‘low monthly payments.’’ And

without prepayment penalties, there is no real reason for balloon loans: if a consumer is planning on selling in 5 years, they can prepay the loan in any event.

• Limit the amount of upfront fees and points which can be financed.

My colleagues and other State and local officials are seeing more and more of the

hardship and havoc that results from these practices. We are committed to trying

to address them as best we can within the limits of our jurisdiction and our resources. Federal preemption is part of what is limiting our ability to respond. Congress has a signal role here, for this is a national problem.

I would like to offer my continuing assistance to this Committee, and I know that

my colleagues will, as well.

Thank you for giving me this opportunity to share my views with you.

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ORIGINAL PREPARED STATEMENT OF CHARLES W. CALOMIRIS

PAUL M. MONTRONE PROFESSOR OF FINANCE AND ECONOMICS

GRADUATE SCHOOL OF BUSINESS, COLUMBIA UNIVERSITY, NEW YORK, NEW YORK

JULY 26, 2001

Mr. Chairman, it is a pleasure and an honor to address you today on the important topic of predatory lending.

Predatory lending is a real problem. It is, however, a problem that needs to be

addressed thoughtfully and deliberately, with a hard head as well as a soft heart.

There is no doubt that people have been hurt by the predatory practices of some

creditors, but we must make sure that the cure is not worse than the disease. Unfortunately, many of the proposed or enacted municipal, State, and Federal statutory responses to predatory lending would have adverse consequences that are

worse than the problems they seek to redress. Many of these initiatives would reduce the supply of credit to low-income homeowners, raise their cost of credit, and

restrict the menu of beneficial choices available to borrowers.

Fortunately, there is a growing consensus in favor of a balanced approach to the

problem. That consensus is reflected in the viewpoints expressed by a wide variety

of individuals and organizations, including Robert Litan of the Brookings Institution, Fed Governor Edward Gramlich, most of the recommendations of last year’s

HUD-Treasury Report, the voluntary standards set by the American Financial Services Association (AFSA), the recent predatory lending statute passed by the State

of Pennsylvania, and the recommendations and practices of many subprime mortgage lenders (including, most notably, Household). In my comments, I will describe

and defend that balanced approach, and offer some specific recommendations for

Congress and for financial regulators.

To summarize my recommendations at the outset, I believe that an appropriate

response to predatory practices should occur in two stages: First, there should be

an immediate regulatory response to strengthen enforcement of existing laws, enhance disclosure rules and provide counseling services, amend existing regulation,

and limit or ban some practices. I believe that these initiatives, described in detail

below, will address all of the serious problems associated with predatory lending.

In other areas—especially the regulation of prepayment penalties and balloon

payments—any regulatory change should await a better understanding of the extent

of remaining predatory problems that result from these features, and the best ways

to address them through appropriate regulations. The Fed is currently pursuing the

first systematic scientific evaluation of these areas, as part of its clear intent to expand its role as the primary regulator of subprime lending, given its authority

under HOEPA. The Fed has the regulatory authority and the expertise necessary

to find the right balance between preventing abuse and permitting beneficial contractual flexibility.

Congress, and other legislative bodies, should not rush to judgment ahead of the

facts and before the Fed has had a chance to address these more complex problems,

and in so doing, end up throwing away the proverbial baby of subprime lending

along with the bathwater of predatory practices.

I think the main role Congress should play at this time is to rein in actions by

States and municipalities that seek to avoid established Federal preemption by effectively setting mortgage usury ceilings under the guise of consumer protection

rules. Immediate Congressional action to dismantle these new undesirable barriers

to individuals’ access to mortgage credit would ensure that consumers throughout

the country retain their basic contractual rights to borrow in the subprime market.

My detailed comments divide into four parts: (1) a background discussion of

subprime lending, (2) an attempt to define predatory practices, (3) a point-by-point

evaluation of proposed or enacted remedies for predatory practices, and (4) a concluding section.

Subprime Lending, the Democratization of Finance, and

Financial Innovation

The problems that fall under the rubric of predatory lending are only possible

today because of the beneficial ‘‘democratization’’ of consumer credit markets, and

mortgage markets in particular, that has occurred over the past decade. Predatory

practices are part and parcel of the increasing complexity of mortgage contracts in

the high-risk (subprime) mortgage area. That greater contractual complexity has

two parts: (1) the increased reliance on risk pricing using Fair, Isaac & Co. (FICO)

scores rather than the rationing of credit via yes or no lending decisions, and (2)

the use of points, insurance, and prepayment penalties to limit the risks lenders and

borrowers bear and the costs borrowers pay.

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These practices make economic sense and can bring great benefits to consumers.

Most importantly, these market innovations allow mortgage lenders to gauge, price,

and control risk better than before, and thus allow them to tolerate greater gradations of risk among borrowers.

According to last year’s HUD-Treasury report, subprime mortgage originations

have skyrocketed since the early 1990’s, increasing by tenfold since 1993. The dollar

volume of subprime mortgages was less than 5 percent of all mortgage originations

in 1994, but by 1998 had risen to 12.5 percent. As Fed Governor Edward Gramlich

(2000) has noted, between 1993 and 1998, mortgages extended to Hispanic-Americans and African-Americans increased the most, by 78 and 95 percent, respectively,

largely due to the growth in subprime mortgage lending.

Subprime loans are extended primarily by nondepository institutions. The new

market in consumer credit, and subprime credit in particular, is highly competitive

and involves a wide range of intermediaries. Research by economists at the Federal

Reserve Board indicates that the reliance on nondepository intermediaries reflects

a greater tolerance for lending risk by intermediaries that do not have to subject

their loan portfolios to examination by Government supervisors (Carey et al. 1998).

Subprime lending is risky. The reason that so many low-income and minority borrowers rely on the subprime market is that, on average, these are riskier groups

of borrowers. It is worth bearing in mind that default risk varies tremendously in

the mortgage market. The probability of default for the highest risk class of

subprime mortgage borrowers is roughly 23 percent, which is more than one thousand times the default risk of the lowest risk class of prime mortgage borrowers.

When default risk is this great, in order for lenders to participate in the market,

they must be compensated with unusually high interest rates. For example, even

if a lender were risk-neutral (indifferent to the variance of payoffs from a bundle

of loans) a lender bearing a 20 percent risk of default, and expecting to lose 50 percent on a foreclosed loan (net of foreclosure costs) should charge at least the relevant Treasury rate (given the maturity of the loan) plus 10 percent. On second

trust mortgages, loan losses may be as high as 100 percent. In that case, the riskneutral default premium would be 20 percent. Added to these risk-neutral premia

would be a risk premium to compensate for the high variance of returns on risky

loans (to the extent that default risk is nondiversifiable), as well as premia to pay

for the costs of gathering information about borrowers, and the costs of maintaining

lending facilities and staff. These premia would be charged either in the form of

higher interest rates or the present value equivalent of points paid in advance.

Default risk, however, is not the only risk that lenders bear. Indeed, prepayment

risk is of a similar order of magnitude in the mortgage market. To understand prepayment risk, consider a 15 year amortized subprime mortgage loan of $50,000 with

a 10 percent interest rate over the Treasury rate, zero points and no prepayment

penalty. If the Treasury rate falls, say by 1 percent, assume that the borrower will

choose to refinance the mortgage without penalty, and assume that this decline in

the Treasury rate actually happens 1 year after the mortgage is originated.

If the interest rate on the mortgage was set with the expectation that the loan

would last for 15 years, and if the cost of originating and servicing the loan was

spread over that length of time, then the prepayment of the loan will result in a

loss to the lender. An additional loss to the lender results from the reduction in the

value of its net worth as the result of losing the revenue from the mortgage when

it is prepaid (if the lender’s cost of funds does not decline by the same degree as

its return on assets after the prepayment).

In the competitive mortgage market, lenders will have to protect against this loss

in one of several ways: First, lenders could charge a prepayment fee to discourage

prepayment, and thus limit the losses that prepayment would entail. Second, the

lender could ‘‘frontload’’ the cost of the mortgage by charging points and reducing

the interest rate on the loan. This is a commitment device that reduces the incentive of the borrower to refinance when interest rates fall, since the cost of a new

mortgage (points and interest) would have to compete against a lower annual interest cost from the original loan. A third possibility would be avoiding prepayment

penalties and points and simply charging a higher interest rate on the mortgage to

compensate for prepayment risk.

In a competitive mortgage market, the present value of the cost to the borrower

of these three alternatives is equivalent. If all three alternatives were available,

each borrower would decide which of these three alternatives was most desirable,

based on the borrower’s risk preferences.

The first two alternatives amount to the decision to lock in a lower cost of funds

rather than begin with a higher cost of funds and hope that the cost will decline

as the result of prepayment. In essence, the first two choices amount to buying an

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insurance policy compared to the third, where the borrower instead prefers to retain

the option to prepay (effectively ‘‘betting’’ that interest rates will fall).

If regulation were to limit prepayment penalties, by this logic, those wishing to

lock in low mortgage costs would choose a mortgage that frontloads costs through

points as an alternative to choosing a mortgage with a prepayment penalty.

Loan maturity is another important choice for the borrower. The borrower who

wishes to bet on declining interest rates can avoid much of the cost of the third alternative mentioned above (that is, paying the prepayment risk premium) by keeping the mortgage maturity short-term (for example, by agreeing to a balloon payment of principal in, say, 3 years). Doing so can substantially reduce the annual cost

of the mortgage.

In the subprime market, where borrowers’ creditworthiness is also highly subject

to change, prepayment risk results from improvements in borrower riskiness as well

as changes in U.S. Treasury interest rates. The choice of either points, prepayment

penalties, or neither amounts to choosing, as before, whether to lock in a lower overall cost of mortgage finance rather than betting on the possibility of an improvement. Similarly, retaining a prepayment option, or choosing a balloon mortgage, allows the individual to ‘‘bet’’ on an improvement in his creditworthiness.

Borrowers in the subprime market are subject to significant risk that they could

lose their homes as the result of death, disability, or job loss of the household’s

breadwinner(s). Some households will want to insure against this eventuality with

credit insurance. Credit insurance comes in two main forms: monthly insurance

(which is paid as a premium each month), or ‘‘single-premium’’ insurance, which is

paid for the life of the mortgage in a single lump sum at the time of origination,

and typically is financed as part of the mortgage. Because single-premium insurance

commits the borrower to the full length of time of the mortgage (and because there

is the possibility that the borrowers’ risk of unemployment, death, or disability will

decline after origination), the monthly cost of single-premium insurance is much

lower than the cost of monthly insurance. Borrowers who want the option to be able

to cancel their insurance policy (for example, to take advantage of a decline in their

risk of unemployment) pay for that valuable option in the form of a higher premium

per month on monthly insurance. According to Assurant Group (a major provider

of credit insurance to the mortgage market), the monthly cost for monthly credit insurance on 5 year mortgages, on average, is about 50 percent more expensive than

the monthly cost of single-premium credit insurance.

Economists recognize that substantial points, prepayment penalties, short mortgage maturities, and credit insurance have arisen in the subprime market, in large

part, because these contractual features offer preferred means of reducing overall

costs and risks to consumers. Default and prepayment risks are higher in the

subprime market, and therefore, mortgages are more expensive and mortgage contracts are more complex. Clearly, there would be substantial costs borne by many

borrowers from limiting the interest rates or overall charges on subprime mortgages, or from prohibiting borrowers from choosing their preferred combination of

rates, points, penalties, and insurance. As Fed Governor Edward Gramlich writes:

‘‘. . . some [predatory lending practices] are more subtle, involving misuse of practices that can improve credit market efficiency most of the time.

For example, the freedom for loan rates to rise above former usury ceilings

is mostly desirable, in matching relatively risky borrowers with appropriate

lenders. . . . Most of the time balloon payments make it possible for young

homeowners to buy their first house and match payments with their rising

income stream. . . . Most of the time the ability to refinance mortgages permits borrowers to take advantage of lower mortgage rates. . . . Often mortgage credit insurance is desirable. . . .’’ (Gramlich 2000, p. 2)

Any attempts to regulate the subprime market should take into account the potential costs of regulatory prohibitions. As I will argue in more detail in section 3

below, many new laws and statutory proposals are imbalanced in that they fail to

take into account the costs from reducing access to complex, high-cost mortgages.

Predatory Practices

So much for the ‘‘baby’’; now let me turn to the ‘‘bathwater.’’ The use of high and

multiple charges, and the many dimensions of mortgage contracts, I have argued,

hold great promise for consumers, but with that greater complexity also comes

greater opportunity for fraud and for mistakes by consumers who may not fully understand the contractual costs and benefits they are being offered.

That is the essential dilemma. The goal of policymakers should be to define and

address predatory practices without undermining the opportunities offered by

subprime lending.

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According to the HUD-Treasury report, predatory practices in the subprime mortgage market fall into four categories: (1) ‘‘loan flipping’’ (enticing borrowers to refinance excessively, sometimes when it is not in their interest to do so, and charging

high refinancing fees that strip borrower home equity), (2) excessive fees and ‘‘packing’’ (charging excessive amounts of fees to borrowers, allegedly because borrowers

fail to understand the nature of the charges, or lack knowledge of what would constitute a fair price), (3) lending without regard to the borrower’s ability to repay

(that is, lending with the intent of forcing a borrower into foreclosure in order to

seize the borrower’s home), and (4) outright fraud.

It is worth pausing for a moment to note that, with the exception of fraud (which

is already illegal) these problems are defined by (often subjective) judgments about

the outcomes for borrowers (excessive refinancing, excessive fees, excessive risk of

default), not by clearly definable actions by lenders that can be easily prohibited

without causing collateral harm in the mortgage market.

For example, with regard to loan flipping, it may not be easy to define in an exhaustive way the combinations of changes to a mortgage contract that make a borrower better off. There are clear cases of purely adverse change (for example, acrossthe-board increases in rates and fees with no compensating changes in the contract),

and there are clear cases of improvement, but there are also gray areas in which

a mix of changes occurs, and where a judgment as to whether the position of the

borrower has improved or deteriorated depends on an evaluation of the probabilities

of future contingencies and a knowledge of borrower preferences.

Similarly, whether fees are excessive can often be very difficult to gauge, since

the sizes of the fees vary with the creditworthiness of the borrower and with the

intent of the contract. For example, points are often used as a commitment device

to limit prepayment risk.

And what is the maximum ‘‘acceptable’’ level of default risk on a mortgage, which

would constitute evidence that a mortgage had been unreasonably offered because

of the borrower’s inability to repay?

Many alleged predatory problems revolve around questions of fair disclosure and

fraud prevention. These can be addressed to a great degree by ensuring accurate

and complete disclosure of facts (making sure that the borrower is aware of the true

APR, and making sure that legally mandated procedures under RESPA, TILA, and

HOEPA are followed by the lender). In section 3, I will discuss a variety of proposals

for strengthening disclosure rules and protections against fraud.

But the critics of predatory lending argue that inadequate disclosure and outright

fraud are not the only ways in which borrowers may be fooled unfairly by lenders.

For some elderly people, or people who are mentally incapacitated, predatory lending may simply constitute taking advantage of those who are mentally incapable of

representing themselves when signing loan contracts. And for others, lack of familiarity with financial language or concepts may make it hard for them to judge what

they are agreeing to.

Of course, this problem arises in markets all the time. When consumers purchase

automobiles, those who cannot calculate present values of cashflows (when comparing various financing alternatives) may be duped into paying more for a car. And

when renting a car, less savvy consumers may pay more than they should for gasoline or collision insurance. In a market economy, we rely on the time-honored common law principle of caveat emptor because on balance we believe that market solutions are better than Government planning, and markets cannot function if those

who make choices in markets are able to reverse those choices after the fact whenever they please.

But consumer advocates rightly point out that, given the importance of the mortgage decision, a misstep by an uninformed or mentally incapacitated consumer in

the mortgage market can be a life changing disaster. That concern explains why

well-intentioned would-be reformers have turned their attentions to proposals to

regulate mortgage products. But those proposed remedies often are excessive. Reformers advocate what amount to price controls, and prohibitions of contractual features that they deem to be onerous or unnecessary.

Some of these advocates of reform, however, seem to lack a basic understanding

of the functioning of financial markets and the pricing of financial instruments. In

their zeal to save borrowers from harming themselves they run the risk of causing

more harm to borrowers than predatory lenders.

Other reformers seem to understand that their proposals will reduce the availability of subprime credit to the general population, but they do not care. Indeed,

one gets the impression that some paternalistic community groups dislike subprime

lending and feel entitled to place limits on the decisionmaking authority even of

mentally competent individuals. Other critics of predatory lending may have more

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sinister motives related to the kickbacks they receive for contractually agreeing to

stop criticizing particular subprime lenders.

Whatever the motives of these advocates, it is easy to show that many of the extreme proposals for changing the regulation of the subprime mortgage market are

misguided and would harm many consumers by limiting their access to credit on

the most favorable terms available. There are better ways to target the legitimate

problems of abuse.

Evaluating Proposed Reforms

Let me now turn to an analysis of each of the proposed remedies for predatory

lending, which I divide into three groups: (1) those that are sensible and that should

be enacted by Fed regulation, (2) those that are possibly sensible, but which might

do more harm than good, and thus require more empirical study before deciding

whether and how to implement them, and (3) those that are not sensible, and which

would obviously do more harm than good.

SENSIBLE REFORMS THAT SHOULD BE IMPLEMENTED IMMEDIATELY BY THE FED

Under HOEPA, the Fed is entitled to regulate subprime mortgages that either

have interest rates far in excess of Treasury rates (the Fed currently uses a 10 percent spread trigger, but can vary that spread between 8 percent and 12 percent) or

that have total fees and points greater than either 8 percent or $451. HOEPA already specifies some contractual limits on these loans (for example, prepayment

penalties are only permissible for the first 5 years of the loan, and only when the

borrowers’ income is greater than 50 percent of the loan payment). It is my understanding that the Fed currently has broad authority to establish additional regulatory guidelines for these loans, and is currently considering a variety of measures.

Following is a list of measures that I regard as desirable.

Disclosure and Counseling

Disclosure requirements always add to consumers’ loan costs, but in my judgment,

some additional disclosure requirements would be appropriate for the loans regulated under HOEPA. I would recommend a mandatory disclosure statement like the

one proposed in section 3(a) of Senate bill S. 2415 (April 12, 2000), which alerts borrowers to the risks of subprime mortgage borrowing. It is also desirable to make

counseling available to potential borrowers on HOEPA loans, and to require lenders

to disclose that such counseling is available (as proposed in the HUD-Treasury report). The HUD-Treasury report also recommends amendments to RESPA and TILA

that would facilitate comparison shopping and make timely information about the

costs of credit and settlement easier for consumers to understand and more reliable.

I also favor the HUD-Treasury suggestions of imposing an accuracy standard on

permissible violations from the Good Faith Estimate required under RESPA, requiring lenders to disclose credit scores to borrowers (I note that these scores have since

been made available by Fair Isaac Co. to borrowers via the Internet), and expanding

penalties on lenders for inadequate or inaccurate disclosures. The use of ‘‘testers’’

to verify disclosure practices would likely prove very effective as an enforcement tool

to ensure that lenders do not target some classes of individuals with inadequate disclosure. I also agree with the suggested requirement that lenders notify borrowers

of their intent to foreclose far enough in advance that borrowers have the opportunity to arrange alternative financing (a feature of the new Pennsylvania statute)

as a means of discouraging unnecessary foreclosure. Finally, I would recommend

that, for HOEPA loans where borrowers’ monthly payments exceed 50 percent of

their monthly income, the lender should be required to make an additional disclosure that informs the borrower of the estimated high probability (using a recognized

model, like that of Fair Isaac Co.) that the borrower may lose his or her home because of inadequate ability to pay debt service.

Credit History Reporting

It is alleged that some lenders withhold favorable information about customers in

order to keep information about improvements in customer creditworthiness private,

and thus limit competition. It is appropriate to require lenders not to selectively report information to credit bureaus.

Single-Premium Insurance

Roughly one in four households do not have any life insurance, according to

Household (2001). Clearly, credit insurance can be of enormous value to subprime

borrowers, and single-premium insurance can be a desirable means for reducing the

risk of losing one’s home at low cost. To prevent abuse of this product, there should

be a mandatory requirement that lenders that offer single-premium insurance (1)

must give borrowers a choice between single-premium and monthly premium credit

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insurance, (2) must clearly disclose that credit insurance is optional and that the

other terms of the mortgage are not related to whether the borrower chooses credit

insurance, and (3) must allow borrowers to cancel their single-premium insurance

and receive a full refund of the payment within a reasonable time after closing (say,

within 30 days, as in the Pennsylvania statute).

Limits on Flipping

Several new laws and proposals, including a proposed rule by the Federal Reserve

Board, would limit refinancing to address the problem of loan flipping. The Fed rule

would prohibit refinancing of a HOEPA loan by the lender or its affiliate within the

first 12 months unless that refinancing is ‘‘in the borrower’s interest.’’ This is a reasonable idea so long as there is a clear and reasonable safe harbor in the rule for

lenders that establishes criteria under which it will be presumed that the refinancing was in the borrower’s interest. For example, if a refinancing either (a) provides substantial new money or debt consolidation, (b) reduces monthly payments

by a minimum amount, or (c) reduces the duration of the loan, then any one of those

features should protect the lender from any claim that the refinancing was not in

the borrower’s interest.

Limits on Refinancing of Subsidized Government or Not-for-Profit Loans

It has been alleged that some lenders have tricked borrowers into refinancing

heavily subsidized Government or not-for-profit loans at market (or above market)

rates. Lenders that refinance such loans should face very strict tests for demonstrating that the refinancing was in the interest of the borrower.

Prohibition of Some Contractual Features

Some mortgage structures add little real value to the menu of consumers’ options,

and are especially prone to abuse. In my judgment, the Federal Reserve Board has

properly identified payable-on-demand clauses or call provisions as an example of

such contractual features that should be prohibited.

Require Lenders To Offer Loans With and Without Prepayment Penalties

Rather than regulate prepayment penalties further as some have proposed, I

would recommend requiring that HOEPA lenders offer mortgages both with and

without prepayment penalties, so that the price of the prepayment option would be

clear to consumers. Then consumers could make an informed decision whether to

pay for the option to prepay.

PROPOSALS THAT REQUIRE FURTHER STUDY

In addition to the aforementioned reforms, many other potentially beneficial, but

also potentially costly, reforms have been proposed and should be studied to determine whether they are necessary over and above the reforms listed above, and

whether on balance they would do more good than harm. The list of potentially beneficial reforms that are worthy of careful scrutiny includes:

(1) A limit on balloons (for example, requiring a minimum of a certain period

of time between origination and the balloon payment) is worth exploring—although many of the proposed limits on balloons do not seem reasonable; for example both the Pennsylvania statute’s 10 year limit and the HUD-Treasury report’s proposed 15 year limit, seem to me far too long; but shorter-term limits

on balloons (say, a 3 or 5 year minimum duration) may be desirable.

(2) The establishment of new rules on mortgage brokers’ behavior (as proposed in the HUD-Treasury report) may be worthwhile, as a means of ensuring

that mortgage brokerage is not employed to circumvent effective compliance;

and

(3) It may be desirable, as the Fed has proposed, to lower the HOEPA interest

rate threshold from 10 percent to 8 percent. The main drawback of lowering the

trigger point for HOEPA, which has been noted by researchers at the Fed, and

by Robert Litan, is the potential chilling effect that reporting requirements may

have on the supply of credit in the subprime market. (I note in passing that

I do not agree with the proposal to include all fees into the HOEPA fee trigger;

fees that are optional, and not conditions for granting the mortgage—like credit

insurance—should be excluded from the calculation.)

PROPOSALS THAT SHOULD BE REJECTED

Usury Laws

Under the rubric of bad ideas, I will focus on one in particular: price controls. It

is a matter of elementary economics that limits on prices restrict supply. Among the

ideas that should be rejected out of hand are proposals to impose Government price

controls—on interest rates, points, and fees—for subprime mortgages.

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Because of legal limits on local authorities to impose usury ceilings (due to Federal preemption) States and municipalities intent on discouraging high-cost mortgage lending have pursued an alternative ‘‘stealth’’ approach to usury laws. The

technique is to impose unworkable risks on subprime lenders that charge rates or

fees in excess of Government specified levels and thereby drive high-interest rate

lenders from the market.

Additionally, some price control proposals are put forward by community groups

like ACORN in the form of ‘‘suggested’’ voluntary agreements between community

groups and lenders.

Several cities and States have passed, or are currently debating, stealth usury

laws for subprime lending. For example, the city of Dayton, Ohio this month passed

a draconian antipredatory lending law. This law places lenders at risk if they make

high-interest loans that are ‘‘less favorable to the borrower than could otherwise

have been obtained in similar transactions by like consumers within the City of

Dayton,’’ and lenders may not charge fees and/or costs that ‘‘exceed the fees and/

or costs available in similar transactions by like consumers in the City of Dayton

by more than 20 percent.’’ In my opinion, it would be imprudent for a lender to make a loan in Dayton governed by this statute. Indeed, I believe that the statute’s intent must be to eliminate

high-interest loans, which is why I describe it as a stealth usury law. Immediately

upon the passage of the Dayton law, Bank One announced that it was withdrawing

from origination of loans that were subject to the statute. No doubt others will exit,

as well.

The recent 131 page antipredatory lending law passed in the District of Columbia

is similarly unworkable. Lenders are subject to substantial penalties if they are

deemed to have lent at an interest rate ‘‘substantially greater than the home borrower otherwise would have qualified for, at that lender or at another lender, had

the lender based the annual percentage rate upon the home borrowers’ credit scores

as provided by nationally recognized credit reporting agencies,’’ or if loan costs are

‘‘unconscionable,’’ or if loan discount points are ‘‘not reasonably consistent with established industry customs and practices.’’

The District law is fundamentally flawed in several respects. First, it essentially

requires lenders to charge no more than the rate indicated by the customer’s credit

score. That is an improper use of credit scores. Credit scores are not perfect indicators of risk; they are used as one of many—and sometimes not the primary—means

of judging whether and on what terms to make a loan. Second, the DC law places

the ridiculous burden on the lender of making sure, prior to lending, that his customer could not find a better deal from his competitors. Finally, the vague wording

makes the legal risks of subprime lending so great that no banker would want to

engage in it.

As Donald Lampe points out, massive withdrawal from the subprime lending market occurred in response to the overly zealous initiative against predatory lending

by the State of North Carolina. To quote from Lampe’s (2001) summary of the North

Carolina experience:

‘‘Virtually all residential mortgage lenders doing business in North Carolina have elected not to make ‘‘high-cost home loans’’ that are subject to

N.C.G.S. 24–1.1E. Instead, lenders seek to avoid the ‘‘thresholds’’ established by the law.’’ (p. 4)

Michael Staten of the Credit Research Center of Georgetown University has compiled a new database on subprime lending that permits one to track the chilling

effect of the North Carolina law on subprime lending in the State. The sample coverage of the database nationwide includes 39 percent of all subprime mortgage loans

made by HMDA-reporting institutions in 1998.

Staten’s statistical research (reproduced with permission in an appendix to this

testimony) compares changes in mortgage originations in North Carolina with those

in South Carolina and Virginia, before and after the passage of the North Carolina

law (which was passed in July 1999 and phased in through early 2000). South Carolina and Virginia are included in these tables as controls to allow for changes over

time in mortgage originations in the Upper South that were not specific to North

Carolina.

As shown in the appendix, Staten finds that originations of subprime mortgage

loans (especially first-lien loans) in North Carolina plummeted after passage of the

1999 law, both absolutely and relatively to its neighbors, and that the decline was

almost exclusively in the supply of loans available to low- and moderate-income borrowers (those most dependent on high-cost credit). For borrowers in the low-income

group (with annual incomes less than $25,000) originations were cut in half; for

those in the next income class (with annual incomes between $25,000 and $49,000)

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originations were cut by roughly a third. The response to the North Carolina law

provides clear evidence of the chilling effect of antipredatory laws on the supply of

subprime mortgage loans to low-income borrowers.

Robert Litan (2001) had anticipated this result. He wrote that:

‘‘. . . statutory measures at the State and local level at this point run a

significant risk of unintentionally cutting off the flow of funds to creditworthy borrowers. This is a very real threat and one that should be seriously considered by policymakers at all levels of government, especially in

light of the multiple, successful efforts that Federal law in particular

has made to increase lending in recent years to minorities and low-income

borrowers.

‘‘The more prudent course is for policymakers at all levels of government

to wait for more data to be collected and reported by the Federal Reserve

so that enforcement officials can better target practices that may be unlawful under existing statutes. In the meantime, Congress should provide the

Federal agencies charged with enforcing existing statutes with sufficient resources to carry out their mandates, as well as to support ongoing counseling efforts to educate vulnerable consumers about the alternatives open

to them in the credit market and the dangers of signing mortgages with unduly onerous terms.’’ (p. 2)

The history of the last two decades teaches that usury laws are highly counterproductive. Limits on the ability of States to regulate consumer lenders headquartered outside their State were undermined by the 1978 Marquette National

Bank case (see DeMuth, 1986). In 1982, the Federal Government further expanded

consumers’ access to credit by preempting State restrictions on mortgage lending by

mortgage lenders headquartered within the State (the Alternative Mortgage Transaction Parity Act of 1982).

These measures were crucial contributors to the democratization of consumer finance, and particularly, mortgage finance in recent years. The Marquette case

opened a flood of competition in credit card lending, which led the way to establishing a deep market in consumer credit receivables and the new techniques for

credit scoring—innovations which have increased the supply and reduced the cost

of consumer credit.

The 1982 Parity Act expanded the range of competition in consumer mortgage finance preempting State prohibitions on alternative mortgages originated by both depository and nondepository institutions. In particular, as I understand this law, it

effectively preempts State usury laws as applied to subprime mortgages. Because

mortgage lending relies on real estate as security, it can be provided more inexpensively than credit card loans or other unsecured consumer credit (Calomiris and

Mason, 1998). Thus the 1982 Act provided an important benefit to consumers over

and above the beneficial undermining of State usury laws after the Marquette case.

But the new stealth usury laws of North Carolina, Dayton, and Washington DC,

and similar proposals elsewhere, pose a new threat. If Congress fails to restore the

preemption principle in the subprime mortgage market established in 1982, then

lenders will be driven out of the high-risk end of the market, and therefore, many

consumers will be driven out of the mortgage market and into higher-cost, less desirable credit markets (credit cards, pawn shops, and worse).

That is not progress. Congress should do everything in its power to amend the

Parity Act to clearly define stealth usury laws as usury laws, not consumer protection laws, and thus prevent any further damage to individuals’ access to credit from

these pernicious State and city initiatives.

Other Prohibitions

I have already argued against further regulatory or statutory limits on prepayment penalties, or prohibition of single-premium credit insurance, in favor of alternative approaches to the abuses that sometimes accompany these features.

I am also opposed to the many proposals that would prevent borrowers from

agreeing to mandatory binding arbitration to resolve loan disputes. Individuals

should be able to choose. If an individual wishes to commit to binding arbitration,

that commitment reduces the costs to lenders of originating mortgages, and in the

competitive mortgage market, that cost is passed on to consumers. Requiring consumers not to commit to binding arbitration is only good for America’s trial lawyers.

Conclusion

For the most part, predatory lending practices can be addressed by focusing efforts on better enforcing laws against fraud, improving disclosure rules, offering

Government-financed counseling, and placing a few well thought out limits on credit

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industry practices. The Fed already has the authority and the expertise to formulate

those rules and is in the process of doing so, based on a new data collection effort

that will permit an informed and balanced approach to regulating subprime lending.

The main role of Congress, in my view, should be to monitor the Fed’s rulemaking

as it evolves, make sure that the Fed has the statutory authority that it needs to

set appropriate regulations, and amend the 1982 Parity Act to reestablish Federal

preemption and thus defend consumers against the ill-conceived usury laws that are

now spreading throughout the country.

Members of Congress, and especially Members of this Committee, also should

speak out in defense of honest subprime lenders, of which there are many. The possible passage of State and city usury statutes is not the only threat to the supply

of subprime loans. There is also the possibility that bad publicity, orchestrated by

community groups, itself could force some lenders to exit the market.

Some community organizations have been waging a smear campaign against

subprime lenders. To the extent that zealous community groups, whether out of

noble or selfish intent, succeed in smearing subprime lenders as a group, the public

relations consequences will have a chilling effect on the supply of subprime credit.

The first casualty will be the truth. The second casualty will be access to credit for

the poor.

References

Calomiris, Charles W., and Joseph R. Mason (1998). High Loan-To-Value Mortgage Lending. Washington: AEI Press.

Carey, Mark, Mitch Post, and Steven A. Sharpe (1998). ‘‘Does Corporate Lending

by Banks and Finance Companies Differ? Evidence on Specialization in Private

Debt Contracting.’’ Journal of Finance 53 (June), 845–78.

DeMuth, Christopher C. (1986). ‘‘The Case Against Credit Car Interest Rate Regulation.’’ Yale Journal on Regulation 3 (Spring), 201–41.

Gramlich, Edward M. (2000). ‘‘Remarks by Governor Edward M. Gramlich at the

Federal Reserve Bank of Philadelphia Community and Consumer Affairs Department Conference on Predatory Lending.’’ December 6.

Household International Inc. (2001). ‘‘News Release: Household International to

Discontinue Sale of Single Premium Credit Insurance on All Real Estate Secured

Loans.’’ July 11.

Lampe, Donald C. (2001). ‘‘Update on State and Local Anti-Predatory Lending

Laws and Regulations: The North Carolina Experience.’’ American Conference Institute, Predatory Lending Seminar, San Francisco, June 27–28.

Litan, Robert E. (2001). ‘‘A Prudent Approach To Preventing ‘Predatory’ Lending.’’

Working Paper, The Brookings Institution, 2001.

U.S. Department of Housing and Urban Development and U.S. Department of the

Treasury (2000). Curbing Predatory Home Mortgage Lending: A Joint Report. June.

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REVISED PREPARED STATEMENT OF CHARLES W. CALOMIRIS

PAUL M. MONTRONE PROFESSOR OF FINANCE AND ECONOMICS

GRADUATE SCHOOL OF BUSINESS, COLUMBIA UNIVERSITY, NEW YORK, NEW YORK

JULY 27, 2001

Mr. Chairman, it is a pleasure and an honor to address you today on the important topic of predatory lending.

Predatory lending is a real problem. It is, however, a problem that needs to be

addressed thoughtfully and deliberately, with a hard head as well as a soft heart.

There is no doubt that people have been hurt by the predatory practices of some

creditors, but we must make sure that the cure is not worse than the disease. Unfortunately, many of the proposed or enacted municipal, State, and Federal statutory responses to predatory lending would have adverse consequences that are

worse than the problems they seek to redress. Many of these initiatives would reduce the supply of credit to low-income homeowners, raise their cost of credit, and

restrict the menu of beneficial choices available to borrowers.

Fortunately, there is a growing consensus in favor of a balanced approach to the

problem. That consensus is reflected in the viewpoints expressed by a wide variety

of individuals and organizations, including Robert Litan of the Brookings Institution, Fed Governor Edward Gramlich, most of the recommendations of last year’s

HUD-Treasury Report, the voluntary standards set by the American Financial Services Association (AFSA), the recent predatory lending statute passed by the State

of Pennsylvania, and the recommendations and practices of many subprime mortgage lenders (including, most notably, Household). In my comments, I will describe

and defend that balanced approach, and offer some specific recommendations for

Congress and for financial regulators.

To summarize my recommendations at the outset, I believe that an appropriate

response to predatory practices should occur in two stages: First, there should be

an immediate regulatory response to strengthen enforcement of existing laws, enhance disclosure rules and provide counseling services, amend existing regulation,

and limit or ban some practices. I believe that these initiatives, described in detail

below, will address all of the serious problems associated with predatory lending.

In other areas—especially the regulation of prepayment penalties and balloon

payments—any regulatory change should await a better understanding of the extent

of remaining predatory problems that result from these features, and the best ways

to address them through appropriate regulations. The Fed is currently pursuing the

first systematic scientific evaluation of these areas, as part of its clear intent to expand its role as the primary regulator of subprime lending, given its authority

under HOEPA. The Fed has the regulatory authority and the expertise necessary

to find the right balance between preventing abuse and permitting beneficial contractual flexibility.

Congress, and other legislative bodies, should not rush to judgment ahead of the

facts and before the Fed has had a chance to address these more complex problems,

and in so doing, end up throwing away the proverbial baby of subprime lending

along with the bathwater of predatory practices.

I think the main role Congress should play at this time is to rein in actions by

States and municipalities that seek to avoid established Federal preemption by effectively setting mortgage usury ceilings under the guise of consumer protection

rules. Immediate Congressional action to dismantle these new undesirable barriers

to individuals’ access to mortgage credit would ensure that consumers throughout

the country retain their basic contractual rights to borrow in the subprime market.

My detailed comments divide into four parts: (1) a background discussion of

subprime lending, (2) an attempt to define predatory practices, (3) a point-by-point

evaluation of proposed or enacted remedies for predatory practices, and (4) a concluding section.

Subprime Lending, the Democratization of Finance, and

Financial Innovation

The problems that fall under the rubric of predatory lending are only possible

today because of the beneficial ‘‘democratization’’ of consumer credit markets, and

mortgage markets in particular, that has occurred over the past decade. Predatory

practices are part and parcel of the increasing complexity of mortgage contracts in

the high-risk (subprime) mortgage area. That greater contractual complexity has

two parts: (1) the increased reliance on risk pricing using Fair Isaac Co. (FICO)

scores rather than the rationing of credit via yes or no lending decisions, and (2)

the use of points, insurance, and prepayment penalties to limit the risks lenders and

borrowers bear and the costs borrowers pay.

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These practices make economic sense and can bring great benefits to consumers.

Most importantly, these market innovations allow mortgage lenders to gauge, price,

and control risk better than before, and thus allow them to tolerate greater gradations of risk among borrowers.

According to last year’s HUD-Treasury report, subprime mortgage originations

have skyrocketed since the early 1990’s, increasing by tenfold since 1993. The dollar

volume of subprime mortgages was less than 5 percent of all mortgage originations

in 1994, but by 1998 had risen to 12.5 percent. As Fed Governor Edward Gramlich

(2000) has noted, between 1993 and 1998, mortgages extended to Hispanic-Americans and African-Americans increased the most, by 78 and 95 percent, respectively,

largely due to the growth in subprime mortgage lending.

Subprime loans are extended primarily by nondepository institutions. The new

market in consumer credit, and subprime credit in particular, is highly competitive

and involves a wide range of intermediaries. Research by economists at the Federal

Reserve Board indicates that the reliance on nondepository intermediaries reflects

a greater tolerance for lending risk by intermediaries that do not have to subject

their loan portfolios to examination by Government supervisors (Carey et al. 1998).

Subprime lending is risky. The reason that so many low-income and minority borrowers rely on the subprime market is that, on average, these are riskier groups

of borrowers. It is worth bearing in mind that default risk varies tremendously in

the mortgage market. According to Frank Raiter of Standard & Poor’s, the probability of default (over the lifetime of the mortgage, which is typically 3 to 5 years)

for the highest risk class of subprime mortgage borrowers is roughly 23 percent,

which is more than one thousand times the default risk of the lowest risk class of

prime mortgage borrowers. There is variation in default risk within the highest risk

class, as well, so that some subprime mortgages have even higher risk of default.

When default risk is this great, in order for lenders to participate in the market,

they must be compensated with unusually high interest rates. Consider an extreme

case. For example, even if a lender were risk-neutral (indifferent to the variance of

payoffs from a bundle of loans) a lender bearing a 20 percent risk of default (on average, in each year of the mortgage), and expecting to lose 50 percent on a foreclosed

loan (net of foreclosure costs) should charge at least the relevant Treasury rate

(given the maturity of the loan) plus 10 percent. On second-trust mortgages, loan

losses may be as high as 100 percent. In that case, the risk-neutral default premium

would be 20 percent. Added to these risk-neutral premia would be a risk premium

to compensate for the high variance of returns on risky loans (to the extent that

default risk is nondiversifiable), as well as premia to pay for the costs of gathering

information about borrowers, and the costs of maintaining lending facilities and

staff. These premia would be charged either in the form of higher interest rates or

the present value equivalent of points paid in advance.

Default risk, however, is not the only risk that lenders bear. Indeed, prepayment

risk is of a similar order of magnitude in the mortgage market. To understand prepayment risk, consider a 15 year amortized subprime mortgage loan of $50,000 with

a 10 percent interest rate over the Treasury rate, zero points and no prepayment

penalty. If the Treasury rate falls, say by 1 percent, assume that the borrower will

choose to refinance the mortgage without penalty, and assume that this decline in

the Treasury rate actually happens 1 year after the mortgage is originated.

If the interest rate on the mortgage was set with the expectation that the loan

would last for 15 years, and if the cost of originating and servicing the loan was

spread over that length of time, then the prepayment of the loan will result in a

loss to the lender. An additional loss to the lender results from the reduction in the

value of its net worth as the result of losing the revenue from the mortgage when

it is prepaid (if the lender’s cost of funds does not decline by the same degree as

its return on assets after the prepayment).

In the competitive mortgage market, lenders will have to protect against this loss

in one of several ways: First, lenders could charge a prepayment fee to discourage

prepayment, and thus limit the losses that prepayment would entail. Second, the

lender could ‘‘frontload’’ the cost of the mortgage by charging points and reducing

the interest rate on the loan. This is a commitment device that reduces the incentive of the borrower to refinance when interest rates fall, since the cost of a new

mortgage (points and interest) would have to compete against a lower annual interest cost from the original loan. A third possibility would be avoiding prepayment

penalties and points and simply charging a higher interest rate on the mortgage to

compensate for prepayment risk.

In a competitive mortgage market, the present value of the cost to the borrower

of these three alternatives is equivalent. If all three alternatives were available,

each borrower would decide which of these three alternatives was most desirable,

based on the borrower’s risk preferences.

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The first two alternatives amount to the decision to lock in a lower cost of funds

rather than begin with a higher cost of funds and hope that the cost will decline

as the result of prepayment. In essence, the first two choices amount to buying an

insurance policy compared to the third, where the borrower instead prefers to retain

the option to prepay (effectively ‘‘betting’’ that interest rates will fall).

If regulation were to limit prepayment penalties, by this logic, those wishing to

lock in low mortgage costs would choose a mortgage that frontloads costs through

points as an alternative to choosing a mortgage with a prepayment penalty.

Loan maturity is another important choice for the borrower. The borrower who

wishes to ‘‘bet’’ on declining interest rates can avoid much of the cost of the third

alternative mentioned above (that is, paying the prepayment risk premium) by

keeping the mortgage maturity short-term (for example, by agreeing to a balloon

payment of principal in, say, 3 years). Doing so can substantially reduce the annual

cost of the mortgage.

In the subprime market, where borrowers’ creditworthiness is also highly subject

to change, prepayment risk results from improvements in borrower riskiness as well

as changes in U.S. Treasury interest rates. The choice of either points, prepayment

penalties, or neither amounts to choosing, as before, whether to lock in a lower overall cost of mortgage finance rather than betting on the possibility of an improvement. Similarly, retaining a prepayment option, or choosing a balloon mortgage, allows the individual to ‘‘bet’’ on an improvement in his creditworthiness.

Borrowers in the subprime market are subject to significant risk that they could

lose their homes as the result of death, disability, or job loss of the household’s breadwinner(s), which might make them unable to make their mortgage payments.

Some households will want to insure against this eventuality with credit insurance.

Credit insurance comes in two main forms: monthly insurance (which is paid as a

premium each month), or ‘‘single-premium’’ insurance, which is paid for the life of

the mortgage in a single lump sum at the time of origination, and typically is financed as part of the mortgage.

Much has been said and written recently about single-premium, insurance. Single-premium insurance, it is often alleged, is a means unscrupulous lenders employ

to trick borrowers into overpaying for coverage. The reason for that claim is that,

in present value terms, single-premium insurance is more expensive for borrowers

than monthly premium insurance.

For example, using data provided to me by Assurant Group (a major provider of

credit insurance to the mortgage market), a typical single-premium policy for a 12

percent APR mortgage would have a monthly payment today of approximately $22

per month for 30 years. That policy provides coverage, however, for only the first

5 years. Its costs are amortized, however, over the entire 30 year period. A comparable 5 year average monthly cost for monthly insurance would be roughly $33,

but that higher monthly payment would end after 5 years. Clearly, monthly insurance is much cheaper on a present value basis.

Defenders of single-premium insurance argue that it is sold because insurers are

unwilling to supply monthly insurance in many cases because its price (which is

regulated at the State level) is set too low to be profitable for issuers. Defenders

also argue that single-premium insurance has some benefits that customers appreciate which would make them prefer it, even at current prices, even if both singlepremium and monthly insurance were available. The former argument seems to

have some merit, although I have not been able to assemble evidence to prove or

disprove it. The latter argument I find hard to believe, although I do not have evidence to refute it.

In any case, while I am in favor of regulating single-premium insurance to prevent abuse (as discussed below in section 3), I am not in favor of prohibiting it, for

two reasons. First, it may be that, as defenders argue, under current State price

controls, it is the only economically feasible alternative. In that case, prohibiting it,

without also changing State price limits, would reduce the supply of credit insurance available to consumers.

Second, if it were possible to deregulate the pricing of credit insurance, to allow

the market to set prices for both kinds of insurance, and if reasonable objections

to current practices of selling credit insurance could be addressed, then some consumers would prefer single-premium coverage over monthly coverage. The reason is

that the market price (in present value) of single-premium coverage would probably

be lower than that of monthly coverage. Because single-premium insurance commits

the borrower to the full length of time of the mortgage (and because there is the

possibility that the borrowers’ risk of unemployment, death, or disability will decline

after origination), if prices were set by a competitive market, single-premium insurance would be less expensive (in present value terms) because buyers of monthly

insurance are also purchasing an implicit option. Borrowers who want the option

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to be able to cancel their insurance policy (for example, to take advantage of a decline in their risk of unemployment, or upon repaying their mortgage) would prefer

monthly insurance and would pay for that valuable option in the form of a higher

premium per month on monthly insurance.

So, while I recognize that under current rules, single-premium insurance is priced

above monthly insurance, that does not imply that buyers of single-premium insurance have been cheated, or that it should be prohibited. If we can find a way for

lenders to offer both kinds of insurance in a way that enhances consumer choice,

and avoids defrauding borrowers, theory suggests that this would be desirable.

In short, economists recognize that substantial points, prepayment penalties,

short mortgage maturities, and credit insurance have arisen in the subprime market, in large part, because these contractual features offer preferred means of reducing overall costs and risks to consumers. Default and prepayment risks are higher

in the subprime market, and therefore, mortgages are more expensive and mortgage

contracts are more complex. Clearly, there would be substantial costs borne by

many borrowers from limiting the interest rates or overall charges on subprime

mortgages, or from prohibiting borrowers from choosing their preferred combination

of rates, points, penalties, and insurance. As Fed Governor Edward Gramlich writes:

‘‘. . . some [predatory lending practices] are more subtle, involving misuse of practices that can improve credit market efficiency most of the time.

For example, the freedom for loan rates to rise above former usury ceilings

is mostly desirable, in matching relatively risky borrowers with appropriate

lenders. . . . Most of the time balloon payments make it possible for young

homeowners to buy their first house and match payments with their rising

income stream. . . . Most of the time the ability to refinance mortgages permits borrowers to take advantage of lower mortgage rates. . . . Often mortgage credit insurance is desirable. . . .’’ (Gramlich 2000, p. 2)

Any attempts to regulate the subprime market should take into account the potential costs of regulatory prohibitions. As I will argue in more detail in section 3

below, many new laws and statutory proposals are imbalanced in that they fail to

take into account the costs from reducing access to complex, high-cost mortgages.

Predatory Practices

So much for the ‘‘baby’’; now let me turn to the ‘‘bathwater.’’ The use of high and

multiple charges, and the many dimensions of mortgage contracts, I have argued,

hold great promise for consumers, but with that greater complexity also comes

greater opportunity for fraud and for mistakes by consumers who may not fully understand the contractual costs and benefits they are being offered.

That is the essential dilemma. The goal of policy makers should be to define and

address predatory practices without undermining the opportunities offered by

subprime lending.

According to the HUD-Treasury report, predatory practices in the subprime mortgage market fall into four categories: (1) ‘‘loan flipping’’ (enticing borrowers to refinance excessively, sometimes when it is not in their interest to do so, and charging

high refinancing fees that strip borrower home equity), (2) excessive fees and ‘‘packing’’ (charging excessive amounts of fees to borrowers, allegedly because borrowers

fail to understand the nature of the charges, or lack knowledge of what would constitute a fair price), (3) lending without regard to the borrower’s ability to repay

(that is, lending with the intent of forcing a borrower into foreclosure in order to

seize the borrower’s home), and (4) outright fraud.

It is worth pausing for a moment to note that, with the exception of fraud (which

is already illegal) these problems are defined by (often subjective) judgments about

the outcomes for borrowers (excessive refinancing, excessive fees, excessive risk of

default), not by clearly definable actions by lenders that can be easily prohibited

without causing collateral harm in the mortgage market.

For example, with regard to loan flipping, it may not be easy to define in an exhaustive way the combinations of changes to a mortgage contract that make a borrower better off. There are clear cases of purely adverse change (for example, acrossthe-board increases in rates and fees with no compensating changes in the contract),

and there are clear cases of improvement, but there are also gray areas in which

a mix of changes occurs, and where a judgment as to whether the position of the

borrower has improved or deteriorated depends on an evaluation of the probabilities

of future contingencies and a knowledge of borrower preferences.

Similarly, whether fees are excessive can often be very difficult to gauge, since

the sizes of the fees vary with the creditworthiness of the borrower and with the

intent of the contract. For example, points are often used as a commitment device

to limit prepayment risk.

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And what is the maximum ‘‘acceptable’’ level of default risk on a mortgage, which

would constitute evidence that a mortgage had been unreasonably offered because

of the borrower’s inability to repay?

Many alleged predatory problems revolve around questions of fair disclosure and

fraud prevention. These can be addressed to a great degree by ensuring accurate

and complete disclosure of facts (making sure that the borrower is aware of the true

APR, and making sure that legally mandated procedures under RESPA, TILA, and

HOEPA are followed by the lender). In section 3, I will discuss a variety of proposals

for strengthening disclosure rules and protections against fraud.

But the critics of predatory lending argue that inadequate disclosure and outright

fraud are not the only ways in which borrowers may be fooled unfairly by lenders.

For some elderly people, or people who are mentally incapacitated, predatory lending may simply constitute taking advantage of those who are mentally incapable of

representing themselves when signing loan contracts. And for others, lack of familiarity with financial language or concepts may make it hard for them to judge what

they are agreeing to.

Of course, this problem arises in markets all the time. When consumers purchase

automobiles, those who cannot calculate present values of cashflows (when comparing various financing alternatives) may be duped into paying more for a car. And

when renting a car, less savvy consumers may pay more than they should for gasoline or collision insurance. In a market economy, we rely on the time-honored common law principle of caveat emptor because on balance we believe that market solutions are better than Government planning, and markets cannot function if those

who make choices in markets are able to reverse those choices after the fact whenever they please.

But consumer advocates rightly point out that, given the importance of the mortgage decision, a misstep by an uninformed or mentally incapacitated consumer in

the mortgage market can be a life changing disaster. That concern explains why

well-intentioned would-be reformers have turned their attentions to proposals to

regulate mortgage products. But those proposed remedies often are excessive. Reformers advocate what amount to price controls, and prohibitions of contractual features that they deem to be onerous or unnecessary.

Some of these advocates of reform, however, seem to lack a basic understanding

of the functioning of financial markets and the pricing of financial instruments. In

their zeal to save borrowers from harming themselves they run the risk of causing

more harm to borrowers than predatory lenders.

Other reformers seem to understand that their proposals will reduce the availability of subprime credit to the general population, but they do not care. Indeed,

one gets the impression that some paternalistic community groups dislike subprime

lending and feel entitled to place limits on the decisionmaking authority even of

mentally competent individuals. Other critics of predatory lending may have more

sinister motives related to the kickbacks they receive for contractually agreeing to

stop criticizing particular subprime lenders.

Whatever the motives of these advocates, it is easy to show that many of the extreme proposals for changing the regulation of the subprime mortgage market are

misguided and would harm many consumers by limiting their access to credit on

the most favorable terms available. There are better ways to target the legitimate

problems of abuse.

Evaluating Proposed Reforms

Let me now turn to an analysis of each of the proposed remedies for predatory

lending, which I divide into three groups: (1) those that are sensible and that should

be enacted by Fed regulation, (2) those that are possibly sensible, but which might

do more harm than good, and thus require more empirical study before deciding

whether and how to implement them, and (3) those that are not sensible, and which

would obviously do more harm than good.

SENSIBLE REFORMS THAT SHOULD BE IMPLEMENTED IMMEDIATELY BY THE FED

Under HOEPA, the Fed is entitled to regulate subprime mortgages that either

have interest rates far in excess of Treasury rates (the Fed currently uses a 10 percent spread trigger, but can vary that spread between 8 percent and 12 percent) or

that have total fees and points greater than either 8 percent or $451. HOEPA already specifies some contractual limits on these loans (for example, prepayment

penalties are only permissible for the first 5 years of the loan, and only when the

borrowers’ income is greater than 50 percent of the loan payment). It is my understanding that the Fed currently has broad authority to establish additional regulatory guidelines for these loans, and is currently considering a variety of measures.

Following is a list of measures that I regard as desirable.

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Disclosure and Counseling

Disclosure requirements always add to consumers’ loan costs, but in my judgment,

some additional disclosure requirements would be appropriate for the loans regulated under HOEPA. I would recommend a mandatory disclosure statement like the

one proposed in section 3(a) of Senate bill 2415 (April 12, 2000), which alerts borrowers to the risks of subprime mortgage borrowing. It is also desirable to make

counseling available to potential borrowers on HOEPA loans, and to require lenders

to disclose that such counseling is available (as proposed in the HUD-Treasury report). The HUD-Treasury report also recommends reasonable amendments to

RESPA and TILA that would facilitate comparison shopping and make timely information about the costs of credit and settlement easier for consumers to understand

and more reliable. I also favor the HUD-Treasury suggestions of imposing an accuracy standard on permissible deviations from the Good Faith Estimate required

under RESPA, requiring lenders to disclose credit scores to borrowers (I note that

these scores have since been made available by Fair Isaac Co. to borrowers via the

Internet), and expanding penalties on lenders for inadequate or inaccurate disclosures. The use of ‘‘testers’’ to verify disclosure practices would likely prove very effective as an enforcement tool to ensure that lenders do not target some classes of

individuals with inadequate disclosure. I also agree with the suggested requirement

that lenders notify borrowers of their intent to foreclose far enough in advance that

borrowers have the opportunity to arrange alternative financing (a feature of the

new Pennsylvania statute) as a means of discouraging unnecessary foreclosure. Finally, I would recommend that, for HOEPA loans where borrowers’ monthly payments exceed 50 percent of their monthly income, the lender should be required to

make an additional disclosure that informs the borrower of the estimated high probability (using a recognized model, like that of Fair Isaac Co.) that the borrower may

lose his or her home because of inadequate ability to pay debt service.

Credit History Reporting

It is alleged that some lenders withhold favorable information about customers in

order to keep information about improvements in customer creditworthiness private,

and thus limit competition. It is appropriate to require lenders not to selectively report information to credit bureaus.

Single-Premium Insurance

Roughly one in four households do not have any life insurance, according to the

Life and Health Insurance Foundation (1998). Clearly, credit insurance can be of

enormous value to subprime borrowers, and single-premium insurance may be, as

its defenders claim, a desirable means for reducing the risk of losing one’s home at

low cost. To prevent abuse of this product, however, there should be a mandatory

requirement that lenders that offer single-premium insurance must do three things.

(1) Lenders, when computing the equivalent monthly payment on single-premium

insurance in their disclosure statement, should be required to fully amortize the cost

of the insurance over the period of coverage (typically 5 years) rather than over a

30 year period. That will avoid confusion on the part of borrowers about the effective cost of the insurance product. (2) Lenders should clearly disclose that credit insurance is optional and that the other terms of the mortgage are not related to

whether the borrower chooses credit insurance. (3) Lenders should allow borrowers

to cancel their single-premium insurance and receive a full refund of the payment

within a reasonable time after closing (say, within 30 days, as in the Pennsylvania

statute).

Limits on Flipping

Several new laws and proposals, including a proposed rule by the Federal Reserve

Board, would limit refinancing to address the problem of loan flipping. The Fed rule

would prohibit refinancing of a HOEPA loan by the lender or its affiliate within the

first 12 months unless that refinancing is ‘‘in the borrower’s interest.’’ This is a reasonable idea so long as there is a clear and reasonable safe harbor in the rule for

lenders that establishes criteria under which it will be presumed that the refinancing was in the borrower’s interest. For example, if a refinancing either (a) provides substantial new money or debt consolidation, (b) reduces monthly payments

by a minimum amount, or (c) reduces the duration of the loan, then any one of those

features should protect the lender from any claim that the refinancing was not in

the borrower’s interest.

Limits on Refinancing of Subsidized Government or Not-for-Profit Loans

It has been alleged that some lenders have tricked borrowers into refinancing

heavily subsidized Government or not-for-profit loans at market (or above market)

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rates. Lenders that refinance such loans should face very strict tests for demonstrating that the refinancing was in the interest of the borrower.

Prohibition of Some Contractual Features

Some mortgage structures add little real value to the menu of consumers’ options,

and are especially prone to abuse. In my judgment, the Federal Reserve Board has

properly identified payable-on-demand clauses or call provisions as an example of

such contractual features that should be prohibited.

Require Lenders To Offer Loans With and Without Prepayment Penalties

Rather than regulate prepayment penalties further as some have proposed, I

would recommend requiring that HOEPA lenders offer mortgages both with and

without prepayment penalties, so that the price of the prepayment option would be

clear to consumers. Then consumers could make an informed decision whether to

pay for the option to prepay.

PROPOSALS THAT REQUIRE FURTHER STUDY

In addition to the aforementioned reforms, many other potentially beneficial, but

also potentially costly, reforms have been proposed and should be studied to determine whether they are necessary over and above the reforms listed above, and

whether on balance they would do more good than harm. The list of potentially beneficial reforms that are worthy of careful scrutiny includes:

(1) A limit on balloons (for example, requiring a minimum of a certain period

of time between origination and the balloon payment) is worth exploring—although many of the proposed limits on balloons do not seem reasonable; for example both the Pennsylvania statute’s 10 year limit and the HUD-Treasury report’s proposed 15 year limit, seem to me far too long; but shorter-term limits

on balloons (say, a 3 or 5 year minimum duration) may be desirable.

(2) The establishment of new rules on mortgage brokers’ behavior (as proposed in the HUD-Treasury report) may be worthwhile, as a means of ensuring

that mortgage brokerage is not employed to circumvent effective compliance;

and

(3) It may be desirable, as the Fed has proposed, to lower the HOEPA interest

rate threshold from 10 percent to 8 percent. The main drawback of lowering the

trigger point for HOEPA, which has been noted by researchers at the Fed, and

by Robert Litan, is the potential chilling effect that reporting requirements may

have on the supply of credit in the subprime market. (I note in passing that

I do not agree with the proposal to include all fees into the HOEPA fee trigger;

fees that are optional, and not conditions for granting the mortgage—like credit

insurance—should be excluded from the calculation.)

PROPOSALS THAT SHOULD BE REJECTED

Usury Laws

Under the rubric of bad ideas, I will focus on one in particular: price controls. It

is a matter of elementary economics that limits on prices restrict supply. Among the

ideas that should be rejected out of hand are proposals to impose Government price

controls—on interest rates, points, and fees—for subprime mortgages.

Because of legal limits on local authorities to impose usury ceilings (due to Federal preemption) States and municipalities intent on discouraging high-cost mortgage lending have pursued an alternative ‘‘stealth’’ approach to usury laws. The

technique is to impose unworkable risks on subprime lenders that charge rates or

fees in excess of Government specified levels and thereby drive high-interest rate

lenders from the market.

Additionally, some price control proposals are put forward by community groups

like ACORN in the form of ‘‘suggested’’ voluntary agreements between community

groups and lenders.

Several cities and States have passed, or are currently debating, stealth usury

laws for subprime lending. For example, the city of Dayton, Ohio this month passed

a draconian antipredatory lending law. This law places lenders at risk if they make

high-interest loans that are ‘‘less favorable to the borrower than could otherwise

have been obtained in similar transactions by like consumers within the City of

Dayton,’’ and lenders may not charge fees and/or costs that ‘‘exceed the fees and/

or costs available in similar transactions by like consumers in the City of Dayton

by more than 20 percent.’’

In my opinion, it would be imprudent for a lender to make a loan in Dayton governed by this statute. Indeed, I believe that the statute’s intent must be to eliminate

high-interest loans, which is why I describe it as a stealth usury law. Immediately

upon the passage of the Dayton law, Bank One announced that it was withdrawing

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from origination of loans that were subject to the statute. No doubt others will exit,

as well.

The recent 131 page antipredatory lending law passed in the District of Columbia

is similarly unworkable. Lenders are subject to substantial penalties if they are

deemed to have lent at an interest rate ‘‘substantially greater than the home borrower otherwise would have qualified for, at that lender or at another lender, had

the lender based the annual percentage rate upon the home borrowers’ credit scores

as provided by nationally recognized credit reporting agencies,’’ or if loan costs are

‘‘unconscionable,’’ or if loan discount points are ‘‘not reasonably consistent with established industry customs and practices.’’

The District law is fundamentally flawed in several respects. First, it essentially

requires lenders to charge no more than the rate indicated by the customer’s credit

score. That is an improper use of credit scores. Credit scores are not perfect indicators of risk; they are used as one of many—and sometimes not the primary—means

of judging whether and on what terms to make a loan. Second, the DC law places

the ridiculous burden on the lender of making sure, prior to lending, that his customer could not find a better deal from his competitors. Finally, the vague wording

makes the legal risks of subprime lending so great that no banker would want to

engage in it.

As Donald Lampe points out, massive withdrawal from the subprime lending market occurred in response to the overly zealous initiative against predatory lending

by the State of North Carolina. To quote from Lampe’s (2001) summary of the North

Carolina experience:

‘‘Virtually all residential mortgage lenders doing business in North Carolina have elected not to make ‘‘high-cost home loans’’ that are subject to

N.C.G.S. 24–1.1E. Instead, lenders seek to avoid the ‘‘thresholds’’ established by the law.’’ (p. 4)

Michael Staten of the Credit Research Center of Georgetown University has compiled a new database on subprime lending that permits one to track the chilling

effect of the North Carolina law on subprime lending in the State. The sample coverage of the database nationwide includes 39 percent of all subprime mortgage loans

made by HMDA-reporting institutions in 1998.

Staten’s statistical research (reproduced with permission in an appendix to this

testimony) compares changes in mortgage originations in North Carolina with those

in South Carolina and Virginia, before and after the passage of the North Carolina

law (which was passed in July 1999 and phased in through early 2000). South Carolina and Virginia are included in these tables as controls to allow for changes over

time in mortgage originations in the Upper South that were not specific to North

Carolina.

As shown in the appendix, Staten finds that originations of subprime mortgage

loans (especially first-lien loans) in North Carolina plummeted after passage of the

1999 law, both absolutely and relatively to its neighbors, and that the decline was

almost exclusively in the supply of loans available to low- and moderate-income borrowers (those most dependent on high-cost credit). For borrowers in the low-income

group (with annual incomes less than $25,000) originations were cut in half; for

those in the next income class (with annual incomes between $25,000 and $49,000)

originations were cut by roughly a third. The response to the North Carolina law

provides clear evidence of the chilling effect of antipredatory laws on the supply of

subprime mortgage loans to low-income borrowers.

Robert Litan (2001) had anticipated this result. He wrote that:

‘‘. . . statutory measures at the State and local level at this point run a

significant risk of unintentionally cutting off the flow of funds to creditworthy borrowers. This is a very real threat and one that should be seriously considered by policymakers at all levels of government, especially in

light of the multiple, successful efforts that Federal law in particular

has made to increase lending in recent years to minorities and low-income

borrowers.

‘‘The more prudent course is for policymakers at all levels of government

to wait for more data to be collected and reported by the Federal Reserve

so that enforcement officials can better target practices that may be unlawful under existing statutes. In the meantime, Congress should provide the

Federal agencies charged with enforcing existing statutes with sufficient resources to carry out their mandates, as well as to support ongoing counseling efforts to educate vulnerable consumers about the alternatives open

to them in the credit market and the dangers of signing mortgages with unduly onerous terms.’’ (p. 2)

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The history of the last two decades teaches that usury laws are highly counterproductive. Limits on the ability of States to regulate consumer lenders headquartered outside their State were undermined by the 1978 Marquette National

Bank case (see DeMuth, 1986). In 1982, the Federal Government further expanded

consumers’ access to credit by preempting State restrictions on mortgage lending by

mortgage lenders headquartered within the State (the Alternative Mortgage Transaction Parity Act of 1982).

These measures were crucial contributors to the democratization of consumer finance, and particularly, mortgage finance in recent years. The Marquette case

opened a flood of competition in credit card lending, which led the way to establishing a deep market in consumer credit receivables and the new techniques for

credit scoring—innovations which have increased the supply and reduced the cost

of consumer credit.

The 1982 Parity Act expanded the range of competition in consumer mortgage finance preempting State prohibitions on alternative mortgages originated by both depository and nondepository institutions. In particular, as I understand this law, it

effectively preempts State usury laws as applied to subprime mortgages. Because

mortgage lending relies on real estate as security, it can be provided more inexpensively than credit card loans or other unsecured consumer credit (Calomiris and

Mason, 1998). Thus the 1982 Act provided an important benefit to consumers over

and above the beneficial undermining of State usury laws after the Marquette case.

But the new stealth usury laws of North Carolina, Dayton, and Washington DC,

and similar proposals elsewhere, pose a new threat. If Congress fails to restore the

preemption principle in the subprime mortgage market established in 1982, then

lenders will be driven out of the high-risk end of the market, and therefore, many

consumers will be driven out of the mortgage market and into higher-cost, less desirable credit markets (credit cards, pawn shops, and worse).

That is not progress. Congress should do everything in its power to amend the

Parity Act to clearly define stealth usury laws as usury laws, not consumer protection laws, and thus prevent any further damage to individuals’ access to credit from

these pernicious State and city initiatives.

Other Prohibitions

I have already argued against further regulatory or statutory limits on prepayment penalties, or prohibition of single-premium credit insurance, in favor of alternative approaches to the abuses that sometimes accompany these features.

I am also opposed to the many proposals that would prevent borrowers from

agreeing to mandatory binding arbitration to resolve loan disputes. Individuals

should be able to choose. If an individual wishes to commit to binding arbitration,

that commitment reduces the costs to lenders of originating mortgages, and in the

competitive mortgage market, that cost saving is passed on to consumers. Requiring consumers not to commit to binding arbitration is only good for America’s trial

lawyers.

Conclusion

For the most part, predatory lending practices can be addressed by focusing efforts on better enforcing laws against fraud, improving disclosure rules, offering

Government-financed counseling, and placing a few well thought out limits on credit

industry practices. The Fed already has the authority and the expertise to formulate

those rules and is in the process of doing so, based on a new data collection effort

that will permit an informed and balanced approach to regulating subprime lending.

The main role of Congress, in my view, should be to monitor the Fed’s rulemaking

as it evolves, make sure that the Fed has the statutory authority that it needs to

set appropriate regulations, and amend the 1982 Parity Act to reestablish Federal

preemption and thus defend consumers against the ill-conceived usury laws that are

now spreading throughout the country.

Members of Congress, and especially Members of this Committee, also should

speak out in defense of honest subprime lenders, of which there are many. The possible passage of State and city usury statutes is not the only threat to the supply

of subprime loans. There is also the possibility that bad publicity, orchestrated by

community groups, itself could force some lenders to exit the market.

Some community organizations have been waging a smear campaign against

subprime lenders. To the extent that zealous community groups, whether out of

noble or selfish intent, succeed in smearing subprime lenders as a group, the public

relations consequences will have a chilling effect on the supply of subprime credit.

The first casualty will be the truth. The second casualty will be access to credit for

the poor.

110

References

Calomiris, Charles W., and Joseph R. Mason (1998). High Loan-To-Value Mortgage Lending. Washington: AEI Press.

Carey, Mark, Mitch Post, and Steven A. Sharpe (1998). ‘‘Does Corporate Lending

by Banks and Finance Companies Differ? Evidence on Specialization in Private

Debt Contracting.’’ Journal of Finance 53 (June), 845–78.

DeMuth, Christopher C. (1986). ‘‘The Case Against Credit Car Interest Rate Regulation.’’ Yale Journal on Regulation 3 (Spring), 201–41.

Gramlich, Edward M. (2000). ‘‘Remarks by Governor Edward M. Gramlich at the

Federal Reserve Bank of Philadelphia Community and Consumer Affairs Department Conference on Predatory Lending.’’ December 6.

Lampe, Donald C. (2001). ‘‘Update on State and Local Anti-Predatory Lending

Laws and Regulations: The North Carolina Experience.’’ American Conference Institute, Predatory Lending Seminar, San Francisco, June 27–28.

Life and Health Insurance Foundation (1998). America’s Financial Security

Survey.

Litan, Robert E. (2001). ‘‘A Prudent Approach To Preventing ‘Predatory’ Lending.’’

Working Paper, The Brookings Institution, 2001.

U.S. Department of Housing and Urban Development and U.S. Department of the

Treasury (2000). Curbing Predatory Home Mortgage Lending: A Joint Report. June.

111

112

113

114

115

116

117

118

119

120

1See an example loan document at www.responsiblelending.org/hud1.pdf. Note that the borrower in this case needed $53,755.22 to pay off other debts. But total loan amount was

$76,230.12, a difference of over $20,000. Five thousand dollars was dispersed to borrower. The

bulk of the rest of the fees are a $4,063 origination fee and an $11,630 upfront credit insurance

premium. The loan also includes a $63,777.71 balloon payment due at the end of the 15 year

term. This is not an atypical case. Abusive lenders often obtain a list of homeowners in lowermiddle class neighborhoods and target those with high equity, low-income and credit blemishes.

The sales pitch focuses on lowering monthly payments by consolidating debts, getting cash for

a vacation, or other needs. The unwitting borrower signs the loan, not realizing it is packed with

credit insurance premiums, high origination fees, hidden balloons (that allow the lender to

charge high fees AND show a lower monthly payment), and/or prepayment penalties that lock

the borrower into the loan. And then, if there is more equity left, the same lender or broker

or another lender will come and offer to refinance the loan again (or ‘‘flip it’’) and charge high

fees once more. 2See http://www.responsiblelending.org/PL%20Issue%20-%20Habitat%20FAQ.htm 3See Joint HUD/Treasury Report, pp. 12–49; Panels I to III at May 24, 2000 House Banking

Committee Hearings: http://www.house.gov/banking/52400toc.htm; Unequal Burden: Income

and Racial Disparities in Subprime Lending in America, Department of Housing and Urban Development, April 12, 2000; National Training and Information Center, Preying on Neighborhoods: Subprime Mortgage Lenders and Chicagoland Foreclosure (September 21, 1999); Daniel

Immergluck & Marti Wiles, Two Steps Back: The Dual Mortgage Market, Predatory Lending,

and the Undoing of Community Development (The Woodstock Institute, 1999). See also New

York Times Special Report by Diana Henriques with Lowell Bergman: MORTGAGED LIVES:

A SPECIAL REPORT: Profiting From Fine Print With Wall Street’s Help, March 15, 2000, Section 1, page 1 (companion piece ran on ABC’s 20/20 the same night).

PREPARED STATEMENT OF MARTIN EAKES

PRESIDENT AND CEO, SELF-HELP ORGANIZATION, DURHAM, NORTH CAROLINA

JULY 26, 2001

Mr. Chairman and Members of the Committee, thank you for holding this important hearing to examine the problem of predatory mortgage lending and thank you

for providing Self-Help and the Coalition for Responsible Lending the opportunity

to testify before you today.

Introduction

Fundamentally, I am a lender. Self-Help (www.self-help.org), the organization for

which I serve as President, consists of a credit union and a nonprofit loan fund. SelfHelp is a 20 year old community development financial institution that creates ownership opportunities for low-wealth families through home and small business lending. We have provided $1.6 billion dollars of financing to help 23,000 low-wealth

borrowers buy homes, build businesses, and strengthen community resources. SelfHelp believes that homeownership represents the best possible opportunity for families to build wealth and economic security and take their first steps into the middle

class. Accumulating equity in their homes is the primary way most families earn

the wealth to send children to college, pay for emergencies, and pass wealth on to

future generations, as well as develop a real stake in society. Some would call us

a subprime lender. We have had significant experience making home loans available

to families who fall outside of conventional guidelines because of credit blemishes

or other problems, and our loan loss rate is well under 0.5 percent each year. SelfHelp’s assets are $800 million.

I am also spokesperson for the Coalition for Responsible Lending (CRL). CRL

(www.responsiblelending.org) is an organization representing over three million people through 80 organizations, as well as the CEO’s of 120 financial institutions. CRL

was formed in response to the large number of abusive home loans that a number

of lenders and housing groups witnessed North Carolina. We found that the combination of the explosive growth in subprime lending, the paucity of regulation of

the industry and the lack of financial sophistication for large numbers of subprime

borrowers have created an environment ripe for abuse.

We discovered that too many families in our State—over 50,000—have been victimized by abusive lenders, losing their homes or a large portion of the wealth they

spent a lifetime building. Some lenders, we found, target elderly and other vulnerable consumers (often poor or uneducated) and use an array of practices to strip the

equity from their homes.1 We even found that abusive lenders ‘‘flipped’’ over 10 percent of Habitat for Humanity borrowers from their zero percent first mortgages

to high interest and high cost subprime loans.2 The problem is not anecdotal; it is

closer to an epidemic.3

The North Carolina Law

The standard industry response at the national level has been to fight against

stronger rules and for tighter enforcement of existing laws. We found that those

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4 ‘‘National Adult Literacy Survey,’’ National Center for Education Statistics, 1992. These

Level 1 individuals cannot read ‘‘well enough to fill out an application, read a food label, or read

a simple story to a child.’’ See http://www.nifl.gov/nifl/faqs.html#literacy.

calls rang hollow: people’s hard-earned equity was being stolen and their homes

being lost through practices that complied with the law. These practices were entirely legal. Since Federal law was insufficient, as a second-best solution we decided

to try to amend North Carolina’s mortgage lending law to prohibit predatory lending

practices.

Thus, in 1999, CRL spearheaded an effort that helped enact the North Carolina

predatory lending law. The bill was the result of a collaborative effort supported by

associations representing the State’s large banks, community banks, mortgage bankers, credit unions, mortgage brokers, realtors, the NAACP, and consumer, community development, and housing groups. There were two principles we all agreed

upon from the beginning. First, we would not rely on disclosures. In the blizzard

of paper that constitutes a home loan closing, even lawyers can lose track of what

they are signing. In addition, 22 percent of the adult American population is functionally illiterate, unable to fill out an application.4 In our experience, disclosures

often do more harm than good, because unscrupulous lenders use them as a shield

for abuse. Second, we would not ration credit by attempting to cap interest rates.

We believe in risk-based pricing; in fact, Self-Help has engaged in it for 17 years.

Loans with higher risk should bear an appropriately higher interest rate in order

to compensate lenders for this risk. We believe, however, that the risk should primarily be paid for through higher interest rates rather than fees, because a subsequent lender can always refinance a borrower out of a loan with an excessive rate

(barring a prepayment penalty). Fees, on the other hand, must be paid in full once

agreed to; there is nothing a responsible lender can do to help a borrower whose

prior loan financed exorbitant fees.

The bill we supported utilized market principles and common sense rather than

credit rationing or other extreme measures, it enjoyed widespread support within

the North Carolina banking industry and the State’s credit unions. Some would say

that if the State’s credit unions and banks could come to agreement over the bill,

it had to be a good idea. Consumer groups did just that. They saw the bill as a credible response to the predatory lending that was harming our communities. As a result of the support of all major groups, the bill passed both chambers almost unanimously in July 1999.

Some say that it is impossible to define predatory lending. I disagree. The North

Carolina bill did just that, in the same way that statutes attack any problem: by

setting parameters for what is acceptable, that encourage certain actions while discouraging others. The practices that the North Carolina law discourages are exactly

the abusive lending practices that we find most harmful to borrowers. Please see

the Coalition for Responsible Lending Issue Paper entitled Quantifying the Economic Cost of Predatory Lending that is included in the appendix for a discussion

of the cost that predatory lending practices imposes on hundreds of thousands of

borrowers across the country.

Abusive Lending Practices

• Financing single-premium credit insurance on home loans. • Charging fees, direct and indirect, over 3–5 percent of the loan amount. • Levying back end prepayment penalties on subprime loans, which serve as anticompetitive tools to keep responsible lenders from remedying abusive situations. • ‘‘Flipping’’ borrowers through repeated fee-loaded refinancings. • ‘‘Steering’’ borrowers into loans with higher-rates than those for which they

qualified. • Permitting mortgage broker abuses, including broker kickbacks. • Requiring mandatory arbitration clauses in any home loans.

I would like to briefly discuss these abusive practices and how the North Carolina

law has defined and attempted to correct them.

Financing Single-Premium Credit Insurance On Home Loans

One type of credit insurance, credit life, is paid by the borrower to repay the

lender should the borrower die. The product can be useful when paid for on a

monthly basis. When it is paid for upfront, however, it does nothing more than strip

equity from homeowners. This is why the mortgage industry is disavowing singlepremium credit insurance (SPCI) in the face of heavy criticism.

Fannie Mae and Freddie Mac, U.S. Departments of Treasury and Housing and

Urban Development, bills introduced in the Senate and House Banking Committees,

and the Federal Home Loan Bank of Atlanta have all condemned the practice for

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5See http://www.freddiemac.com/news/archives2000/predatory.htm and http://

www.fanniemae.com/news/speeches/speech—116.html; Joint HUD/Treasury Report, page 91;

H.R. 4250 (Rep. LaFalce/S. 2415 (Senator Sarbanes), Sec. 2(b)(3); Federal Home Loan Bank of

Atlanta BankTalk, Nov. 27, 2000. 6See ‘‘Equicredit to Stop Selling Single-Premium Credit Life,’’ Inside B&C Lending, April 2,

2001, p. 3 (Bank of America); Erick Bergquist, ‘‘Gloom Turns to Optimism in the Subprime Business,’’ American Banker, May 15, 2001, p. 10 (Chase); ‘‘First Union and Wachovia Announce

Community Commitment for the New Wachovia,’’ May 24, 2001; statements by officers of

Ameriquest and Option One; Jathon Sapsford, ‘‘Citigroup Will Halt Home-Loan Product Criticized by Some as Predatory Lending,’’ Wall Street Journal (6/29/01); Anitha Reddy, ‘‘Household

Alters Loan Policy,’’ The Washington Post (7/12/2001). 7 According to the 1990 census, median net worth for African-American families was $4,400

compared to $44,000 for white families. Home equity is the primary factor in this disparity.

all home loans.5 In addition, Bank of America, Chase, First Union, Wachovia,

Ameriquest, Option One, Citigroup, Household, and just this week, American General, have all decided not to offer SPCI on their subprime loans.6 The Federal Reserve has proposed to count SPCI in determining what loans are ‘‘high cost,’’ which

will further disfavor the practice. Conseco Finance, formerly Greentree, seems to be

the last large lender continuing to defend it. Conventional loans almost never include, much less finance, credit insurance. The North Carolina law prohibited the

practice for all home loans.

Charging Fees Greater Than 3–5 Percent of the Loan Amount

Points and fees (as defined by HOEPA) that exceed this amount (not including

third party fees like appraisals or attorney fees) take more equity from borrowers

than the cost or risk of subprime lending can justify. By contrast, conventional borrowers generally pay at most a 1 percent origination fee. Again, subprime lenders

can always increase the interest rate. The North Carolina law sets a fee threshold

for ‘‘high cost’’ loans at 5 percent. If a loan reaches this threshold, a number of protections come into place: the lender cannot finance any upfront fees or make a loan

without considering the consumer’s ability to repay; the loan may not be structured

as a balloon where the borrower owes a large lump sum at some point during the

term or permit negative amortization; and the borrower must receive housing counseling to make sure the loan makes sense for his or her situation.

Charging Prepayment Penalties On Subprime Loans

(defined by interest rates above conventional)

• Prepayment penalties trap borrowers in high-rate loans, which too often leads to

foreclosure and bankruptcy. The subprime sector serves an important role for borrowers who encounter temporary credit problems that keep them from receiving

lower-rate conventional loans. This sector should provide borrowers a bridge to

conventional financing as soon as the borrower is ready to make the transition.

Prepayment penalties prevent this from happening. Why should any borrower be

penalized for doing just what they are supposed to do—namely, pay off a debt? • Prepayment penalties are hidden, deferred fees that strip significant equity from

over half of subprime borrowers. Prepayment penalties of 5 percent are common. For a $150,000 loan, this fee is $7,500, more than the total net wealth built up

over a lifetime for the median African-American family.7 According to Lehman

Brothers’ prepayment assumptions, over half of subprime borrowers will be forced

to prepay their loans—and pay the 4 percent to 5 percent in penalties—during

the typical 5 year lock-out period. And borrowers in predominantly African-American neighborhoods are five times more likely to be subject to wealth-stripping

prepayment penalties than borrowers in white neighborhoods. Prepayment penalties are therefore merely deferred fees that investors fully expect to receive and

borrowers never expect to pay. • Borrower choice cannot explain the 80 percent penetration rate of prepayment penalties in subprime loans. Only 2 percent of conventional borrowers accept prepayment penalties in the competitive conventional market, while, according to Standard & Poor’s, 80 percent of subprime loans had prepayment penalties. The North Carolina law prohibited prepayment penalties on all loans of less than $150,000.

‘‘Flipping’’ Borrowers Through Repeated Fee-Loaded Refinancings

One of the worst practices is for lenders to refinance subprime loans over and

over, taking out home equity wealth in the form of high fees each time, without providing significant borrower benefit. Some lenders originate balloon or adjustable

rate mortgages only to inform the borrowers of this fact soon after closing to convince them to get a new loan that will pay off the entire balance at a fixed rate.

Others require borrowers to refinance in order to catch up if the loan goes delinquent. The North Carolina law prohibits refinancings that do not provide the borVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00132 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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8See Victoria Nugent, Arbitration Clauses that Require Individuals to Pay Excessive Fees are

Unconscionable, The Consumer Advocate 8, 9–10 (September/October 1999). 9Paul D. Carrington and Paul H. Haagen, Contract and Jurisdiction, 1996 Sup. Ct. Rev. 331,

346–9 (1996). 10See John Vail, Defeating Mandatory Arbitration Clauses, Trial 70 (January 2000).

rower with a net tangible benefit, considering all of the circumstances; this standard

is similar to the ‘‘suitability’’ standard applicable to the securities industry.

Mortgage Broker Abuses, Including Broker Kickbacks

Brokers originate over half of all mortgage loans and a relatively small number

of brokers are responsible for a large percentage of predatory loans. Lenders should

identify—and avoid—these brokers through comprehensive due diligence. In addition, lenders should refuse to pay kickbacks (yield-spread premiums) to brokers.

These are fees lenders rebate to brokers in exchange for placing a borrower in a

higher interest rate than that for which the borrower qualifies. These lender kickbacks violate fair lending principles since they provide brokers with a direct economic incentive to steer borrowers into costly loans. While we decided to focus on

lenders and not brokers in the bill, we are working in collaboration with the brokers’ association in North Carolina on a mortgage broker licensing bill this session to

crack down on abusive brokers.

‘‘Steering’’ Borrowers Into Higher Cost Loans

Than That for Which They Qualify

As Fannie Mae and Freddie Mac have shown, subprime lenders charge borrowers

with prime credit who meet conventional underwriting standards higher rates than

justified by the risk incurred. This is particularly troubling for lenders with prime

affiliates—the very same ‘‘A’’ borrower who would receive the lender’s lowest-rate

loan from its prime affiliate pays substantially more from the subprime affiliate.

HUD has shown that steering has a racial impact since borrowers in African-American neighborhoods are about five times more likely to get a loan from a subprime

lender—and therefore pay extra—than borrowers in white neighborhoods. A minority borrower with the same credit profile as a white borrower simply should not pay

more for the same loan. Therefore, lenders should either offer ‘‘A’’ borrowers loans

with ‘‘A’’ rates, or refer such borrowers to an affiliated or outside lender that offers

these rates. This is not a problem we were able to address in the North Carolina

bill.

Imposing Mandatory Arbitration Clauses in Home Loans

Increasingly, lenders are placing predispute, mandatory binding arbitration

clauses in their loan contracts. While many lenders’ mantra has been the need to

enforce current laws, many of these same lenders are making this goal impossible

by denying borrowers the right to have their grievances heard. These clauses burden consumers because they increase the costs of disputing unfair and deceptive

trade practices, limit available remedies, and prevent consumers from having their

day in court. Mandatory arbitration imposes high costs on consumers in terms of

filing fees and the costs of arbitration proceedings.8 Arbitration also limits the availability of counsel, cuts off traditional procedural protections such as rules of discovery and evidence, slows dispute resolution, and restricts judicial review.9 Lenders

benefit unfairly from arbitration as repeat players, and in some cases, have used

the mandatory arbitration clause to designate an arbiter within the industry, producing biased decisions. Further, lenders are able to use arbitration to handle disputes in secret, avoiding open and public trials which would expose unfair lending

practices to the public at large.10

Lenders have used mandatory arbitration to close the courtroom door for millions

of consumers and have forced borrowers to waive their constitutional right to a civil

jury trial. This situation has only been made worse as many mandatory arbitration

clauses have been expanded to also contain provisions that waive the consumers’ right to participate in class action suits against the lender, making it more difficult

for smaller claims to prevail. For these reasons, mandatory arbitration clauses are

unfair to consumers who do not know what they are giving up or do not have a

choice but to sign adhesion contracts. If an informed consumer thinks that arbitration is a helpful step in resolving a dispute with a lender, the consumer and lender should be permitted to agree to arbitration at that time. Because the Federal

Arbitration Act preempts State regulation of mandatory arbitration clauses, we

were unable to get any language prohibiting mandatory arbitration in the North

Carolina bill.

And what are the results of North Carolina’s law? The only significant data to

date about the law’s effects are comforting. The Residential Funding Corp., the NaVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00133 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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11 59 Fed Reg. 61,832, 61,834 (December 2, 1994).

tion’s largest issuer of subprime mortgage securities, reported that North Carolina’s

share of subprime mortgages issued nationwide actually increased in 2000. And we

have publicly and repeatedly challenged lenders to show us a single responsible loan

made impossible under the law. No one has accepted our challenge to date.

Congress Should Address the Weaknesses in Federal Law

That the North Carolina Law Identified

The fact that so many people went to so much trouble to help enact North Carolina’s law is an indictment of current Federal law. While mortgage lending in our

State conforms to reasonable rules, balancing consumer protections and lenders’

need to make a profit, families in the rest of the country have no such protection.

Ideally, therefore, Congress should pass a Federal statute that would address the

seven predatory lending practices identified above in ways similar to what we accomplished in North Carolina.

The major Federal law designed to protect consumers against predatory home

mortgage lending is the Home Ownership and Equity Protection Act of 1994.

HOEPA has manifestly failed to stem the explosion of harmful lending abuses that

has accompanied the recent subprime lending boom. Strengthening the law is important to protect homeowners from abuse. I recommend for the Committee’s consideration two excellent HOEPA bills: legislation introduced last session by Chairman

Sarbanes and Senator Schumer.

Looking at our definition of abusive lending practices, while I would go a bit further, the bill Chairman Sarbanes introduced is very strong. Specifically, it prohibits

the financing of single-premium credit insurance, reduces the HOEPA points and

fees trigger to 5 percent from the current 8 percent, imposes significant limits on

prepayment penalties for high cost loans, disfavors broker kickbacks by including

them in the definition of points and fees, and prohibits mandatory arbitration for

HOEPA loans.

The Federal Reserve Board Should Promptly Issue

Strong Predatory Lending Regulations

It is important that regulators take advantage of the authority that current laws

have provided them to address predatory lending. The Federal Reserve Board (the

‘‘Board’’) is the regulatory agency with by far the most existing authority to address

predatory lending practices. In December of last year, the Board proposed substantial regulations on HOEPA and the Home Mortgage Disclosure Act (HMDA). While

modest, the Board’s proposed HOEPA and HMDA changes are a very constructive

step forward.

HOEPA Regulation Proposal

The proposed HOEPA regulations would broaden the scope of loans subject to its

protections by, most significantly, including single-premium credit insurance and

similar products in its fee-based trigger, as well as by reducing its rate-based trigger

by 2 percentage points. In addition, the Board suggested a modest flipping prohibition that would restrict creditors from engaging in repeated refinancing of their own

HOEPA loans over a short time period when the transactions are not in the borrower’s interest and similarly restrict refinancing subsidized-rate nonprofit and Governmental loans.

The Board’s HOEPA proposal to include SPCI would be an extraordinarily important move against predatory lending. In 1994, the Board stated that ‘‘The legislative

history [of HOEPA] includes credit insurance premiums as an example of fees that

could be included, if evidence showed that the premiums were being used to circumvent the statute.’’ 11 It has become clear in the seven succeeding years that unscrupulous lenders have indeed used the exclusion of credit insurance from ‘‘points

and fees’’ to circumvent the application of HOEPA to loans that really are ‘‘high

cost’’. Financed credit insurance alone exceeds the HOEPA limits in many cases—

up to 20 percent of the loan amount—yet the borrowers do not qualify for HOEPA

protections.

The Board should address this evasion, as proposed, by including these fees in the

definition of ‘‘points and fees’’. Since including SPCI in a loan in most cases will

make it a HOEPA loan, and HOEPA imposes certain duties on lenders and has a

stigma attached, lenders will have the incentive to provide credit insurance on a

monthly basis, a form that does not strip borrower equity. This is exactly what has

happened in North Carolina: lenders have uniformly switched from SPCI to monthly

outstanding basis (except for CUNA Mutual, which has always done almost excluVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00134 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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sively monthly outstanding balance credit insurance), and borrowers have benefited

enormously.

The Board’s proposal to reduce the APR trigger is welcome also, since at present

only 2 percent of subprime loans are estimated to meet the very high HOEPA triggers. Finally, the restriction on refinancing subsidized loans would benefit thousands of borrowers and avoid what we experienced in North Carolina, where Habitat for Humanity borrowers were flipped from zero percent loans to 12 percent and

14 percent loans.

HMDA Regulation Proposal

The Board’s proposed changes to HMDA would enhance the public’s understanding of the home mortgage market generally, and the subprime market in particular, as well as to further fair lending analysis. At the same time, the Board has

attempted to minimize the increase in data collection and reporting burden. Most

significantly, the Board would require lenders to report the annual percentage rate

of the loan. The lender also would have to report whether the loan is subject to

HOEPA and whether the loan involves a manufactured home. In addition, it would

require reporting by additional nondepository lenders by adding a dollar-volume

threshold of $50 million to the current loan-percentage test.

The Board’s proposal to require lenders to report the APR on loans is crucial. It

is currently impossible to obtain any pricing data on loans and therefore to determine which loans are subprime and which are not, or to draw any conclusions about

the cost of credit that borrowers undertake. The most important fair lending issues

today are no longer the denial of credit, but the terms of credit. Providing the APR

is a good start in providing information on terms. Requiring additional nondepository lenders to report is also important; Household Finance, the Nation’s second

largest subprime lender, does not currently report HMDA information because of a

quirk in the rule that the Board rightly proposes to fix.

Because these proposed changes would significantly help in the battle to combat

predatory lending, I would urge the Board not to backtrack on any of these suggestions and to finalize these regulations as soon as possible.

Notwithstanding our support for these proposals, I believe that each should be

strengthened. For HOEPA, first, the Board should count authorized prepayment penalties in the new loan in the points and fees threshold. When a borrower pays a

5 percent prepayment penalty on the back end, that 5 percent is stripped directly

out of the family’s accumulated home equity wealth exactly the same as if it were

a fee that was financed on the front end. This fee should therefore also be counted

in determining which loans are high cost. Some mortgage industry representatives

will argue that a prepayment penalty should not be counted because it is a contingent fee. When 50 percent of borrowers actually pay the fee, it is hardly a speculative contingency. If the contingent nature of an authorized prepayment penalty is

persuasive to the Board, however, then the Board at minimum should include the

authorized prepayment penalty discounted by the frequency with which it is paid.

Second, the Board should hold the initial purchaser of a brokered loan responsible

for the broker’s actions, so the marketplace will self-police equity-stripping practices

by mortgage brokers. When these activities occur, borrowers are often left with no

remedy because many brokers are thinly capitalized and transitory, leaving no assets for the borrower to recover against. The borrower generally cannot recover

against the lender who benefited from the broker’s actions because the broker is

considered an independent contractor under the law. In addition, many times the

holder-in-due-course doctrine prevents the borrower from raising these defenses

against the note holder, even in a foreclosure action.

The Board should address the problem of brokers by making the original lender

funding the loan responsible for the broker’s acts and omissions, for all loans. To

accomplish this goal, the Board should prohibit a lender from funding a loan where

the broker violates State or Federal law in arranging the loan unless the lender exercised reasonable supervision over the broker transaction. In addition, the Board

should prohibit lenders from funding a loan arranged by a broker who is not certified or licensed under State law.

For HMDA, the Board should replace the HOEPA yes-no field with ‘‘points and

fees.’’ Loan pricing is the most important issue in understanding the fairness of

mortgage markets. Although in the popular mind, abusive lending is primarily associated with high interest rates, the primary issue is actually the high fee total

charged to borrowers. Lenders should use the HOEPA definition of ‘‘points and

fees,’’ since lenders already count these fees to determine whether the loan is subject to HOEPA. HOEPA also provides the most comprehensive, and therefore descriptive, catalogue of charges available. It is a very simple calculation. Reporting

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12See OTS comments of the National Association of Attorneys General at http://

www.ots.treas.gov/docs/48197.pdf.

states the true cost of fees since the APR amortizes fees over the original term of

the loan, and almost all loans are paid off well before the term expires.

At A Minimum, Weak Federal Law Should Not Preempt

State Consumer Protections

Little is as frustrating or disheartening than to observe specific predatory lending

abuses happening to real people; work successfully to get a State law or regulation

passed to address the problem; and then find that Federal law has been interpreted

to preempt this State consumer protection. Congress has not acted in a substantial

manner against predatory lending practices since it enacted HOEPA in 1994. Since

then, however, subprime lending has increased 1,000 percent, and abusive lending

is up commensurately. Rather than acting as a sword in the fight against abusive

practices, Federal law has functioned instead as a shield, enabling the continuation

of abusive lending at the expense of entire neighborhoods.

I already discussed the problem of mandatory arbitration restrictions being preempted by the Federal Arbitration Act. The FAA was originally enacted in 1925 to

overturn a common law rule that prevented enforcement of agreements to arbitrate

between commercial entities. Ironically, it was intended to lower the costs of dispute

resolution within the business community, but today is used to raise the costs of

vindicating consumer rights. The States are unable to respond to this problem, because the Supreme Court has held that State laws that impose any restrictions specific to arbitration clauses are incompatible with the FAA. Preemption even applies

to basic disclosure requirements such as a Montana law that required notice of an

arbitration requirement to be ‘‘typed in underlined capital letters on the first page

of the contract’’ in order to make the agreement enforceable.

The States are unable to protect their consumers from mandatory arbitration as

long as the FAA preempts even requiring disclosure of arbitration clauses. We propose the prohibition of mandatory arbitration clauses in consumer loan contracts

and amending the FAA to allow State regulation of consumer arbitration agreements. Of course, these changes would not affect the ability of consumers to voluntarily agree to submit a dispute with a lender to arbitration after the dispute had

occurred. These changes would only protect consumers from signing away their

rights before they knew the consequences.

A second important example is the Alternative Mortgage Transaction Parity Act

(the Parity Act). Passed during the high interest rate crisis of the early 1980’s, the

Parity Act enabled State depository institutions and ‘‘other housing creditors’’ (unregulated finance companies) to make adjustable rate mortgages without complying

with State laws prohibiting such mortgages. For 13 years, this Federal preemption

did not pose a significant problem to consumers. However, in 1996, the OTS ‘‘reex- amined’’ the purposes of the Parity Act and ‘‘reevaluated’’ its regulations. This ‘‘reinterpretation’’ occurred 10 years after States lost the ability to opt-out of the law. At

that time, the OTS concluded the Parity Act required it to extend Federal preemption to restrictions on prepayment penalties and late fees.

Since this novel interpretation, predatory lending by unregulated finance companies has exploded, based in part on these companies’ ability to avoid compliance

with State laws, especially those State laws limiting prepayment penalties. In fact,

the Illinois Association of Mortgage Brokers has filed suit asserting that the Parity

Act preempts the State of Illinois’ predatory lending regulations in their entirety for

all alternative mortgages, including even the common sense requirement that lenders verify borrower ability to repay the loan. The OTS’s definition of ‘‘alternative

mortgage’’ is so loose, that nearly any loan could be made to fall under this category.

CRL estimates that up to 460,000 families across the country have $1.2 billion

stripped from their home equity each year directly as a result of the Parity Act.

Forty-six State Attorneys General, both Republican and Democrat, have urged the

Office of Thrift Supervision (OTS) to reduce the scope of Parity Act preemption,12

but without Congressional action, OTS feels constrained to act. The best solution

to the legacy of problems caused by the Parity Act is simply to repeal the legislation.

It serves no good purpose anymore, and many unregulated nondepository institutions are taking advantage of Federal preemption in ways that are abusive to borrowers without any corresponding regulatory obligations. If the Parity Act were

repealed, finance companies would not be able to use the Federal law to avoid

meaningful regulation by States. A less preferable, although still extremely helpful,

solution would be to simply delete reference to finance companies in the Act. This

would still allow State-chartered depository institutions to piggyback on the preemption authority that Federally chartered institutions have. At a minimum, given that

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the Act’s broad effect goes far beyond what was understood when it was enacted,

Congress should reopen the opt-out period for States that did not initially opt-out

(only six States did).

Finally, although it does not involve mortgage lending, we have been active in

North Carolina attempting to reform payday lending. This relatively new industry

has grown, rapidly to 10,000 outlets and provides desperate borrowers with a twoweek loan, often at 500 percent annualized interest rates, secured by a deferred

check. However, with such a short term, borrowers invariably lack the time to solve

the problems that led them to take such a high fee loan in the first place. They

therefore get stuck paying a $45 fee every 2 weeks just to keep same $255 loan outstanding; in fact, 90 percent of total payday loans come from customers caught on

flipping treadmill (five or more payday loans per year). Reforming this industry is

made much more difficult by the payday lenders engaging in a ‘‘rent a charter’’ partnership arrangement to enable them to take advantage of the Federal preemption

of usury limits available to regulated depository institutions. For example, Eagle

National Bank (1 percent of payday fee) claims preemption on behalf of its ‘‘agent’’

Dollar Financial (99 percent of payday fee).

Conclusion

Fundamentally, I am a lender. Attempting to make loans to borrowers stuck in

predatory loans taught me what lender practices were abusive. Finding out that

these practices were legal under Federal law made me angry. And so, on behalf of

thousands of borrowers who face losing their homes and all the wealth they accumulated through a lifetime of hard work, I would ask the following: pass the bill that

Chairman Sarbanes introduced last session, urge the Federal Reserve Board expeditiously to adopt the predatory lending rules it has proposed, and remove the obstacles placed on States in protecting their citizens by revising the Federal Arbitration

Act, the Parity Act, and laws potentially allowing payday lending ‘‘rent a charters.’’

If Congress could take these steps, then we will have come a long way to making

sure that family home equity wealth is protected.

Thank you for the opportunity to testify before this Committee today. I am happy

to answer any questions and to work with the Committee in the future.

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STATEMENT OF ELIZABETH C. GOODELL, COUNSEL

COMMUNITY LEGAL SERVICES OF PHILADELPHIA, INC., PHILADELPHIA, PENNSYLVANIA

ON BEHALF OF LEROY WILLIAMS

JULY 26, 2001

The interest (note) rates on Mr. Williams’ loans were as follows: EquiCredit, 9.65

percent. New Jersey Mortgage, 14.5 percent. Option One, 11.25 percent. We do not

know the APR’s for the loans from EquiCredit and New Jersey Mortgage, but the

APR for the Option One loan is 13.136 percent.

We do not know, if the loans from EquiCredit or New Jersey Mortgage were

HOEPA loans. Based on the TILA disclosures for the Option One loan, the fees, and

other prepaid finance charges totaled 7.469 percent of the amount financed, just

barely under the HOEPA fee trigger of 8.0 percent.

The transaction costs in the third loan (including prepaid finance charges and fees

that are not included in the finance charge) total approximately $2,700, or 8.3 percent of the principal balance of the loan. Although we do not have all the loan documents from the first two loans, if the transaction costs of the first and second loans

were similar to the costs of the third loan, Mr. Williams paid approximately $8,700

to lenders, brokers and title companies (including the prepayment penalty and interest paid on the second loan when the third tender refinanced it barely 3 months

after origination) in connection with the three loans, representing nearly 27 percent

of the $32,435 principal balance of the most recent loan.

Mr. Williams’ story is typical of low income homeowners with subprime loans in

several respects. First, once Mr. Williams had executed one high-cost loan, he became the victim of targeted marketing by other brokers and lenders of high-cost

subprime loans. We find that brokers and lenders research public records to identify

homeowners with mortgages originated by other subprime lenders and target such

homeowners, attempting to sell new loans within a relatively short period of time.

Like many low income homeowners with a succession of subprime, high-cost loans,

Mr. Williams was sought out by the lenders rather than seeking them.

Second, Mr. Williams was caught up in loans with complex terms he did not understand. Based on the loan documents, the second (New Jersey Mortgage) loan included a prepayment penalty and a balloon. Mr. Williams did not know about and

did not understand either of these terms. The third (Option One) loan includes a

prepayment penalty, a variable rate, and an arbitration provision. Again, Mr. Williams did not know about and did not understand these terms, although there is

some indication that the broker tried to explain the prepayment penalty.

It is a fiction that the market—or present statutes and regulations—adequately

protect homeowners when they are unsophisticated about consumer lending. Additional protections are needed to prevent what happened to Mr. Williams. A lower

HOEPA fee trigger which included the prepayment penalty might have discouraged

the third senseless and in fact harmful refinancing. Substantive prohibitions against

such blatantly inappropriate/no benefit refinancings would accomplish the same goal

directly, as would imposing a duty on mortgage brokers and lenders to avoid making

loans that are unsuitable, a duty already required of stockbrokers.

—————

STATEMENT OF DANIEL F. HEDGES, COUNSEL

MOUNTAIN STATE JUSTICE, INC., CHARELSTON, WEST VIRGINIA

ON BEHALF OF MARY PODELCO

JULY 26, 2001

In thirty years of representing low income consumers, I have always observed

some level of home improvement fraud (particularly in the decade of the 1970’s, to

a lesser extent in the 1980’s). In the last 5 to 7 years, however, there has been an

explosion of predatory home equity lending and flipping. Predatory practices on low

income consumers, and in particular, vulnerable consumers such as the elderly, illiterate working families and minorities, have become routine.

Current law provides no meaningful restriction on the kind of flipping that occurred in Ms. Podelco’s case and occurs in hundreds of other cases per year in my

State, which results in the skimming of equity from borrowers in their homes.

Meaningful prohibition of flipping calls for a simplified remedy (for example, the

prohibition of charging new fees and points). West Virginia had such a time limitation on refinancing by the same lender and charging new points and fees. The 2000

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enactment was repealed in 2001, after the new Banking Commissioner pushed for

the elimination of that restriction at the industry’s behest.

The opportunity for recurring closing points and fees financed in the loan and the

lender to be rewarded immediately for refinancing leads to disregard of whether or

not a borrower can repay. Ms. Podelco is typical of a frequent pattern of consistent

loan flipping with the last loan pushed off onto another lender who takes the loss.

Ms. Podelco provides one example of hundreds of West Virginians. On these loans

no laws are being broken but the flipping is so exploitive that it results in loss of

the individual’s equity in their home, and ultimately in many cases the loss of the

home, forcing the elderly or otherwise vulnerable citizens out of their residence.

A meaningful cap on fees and on financing points and fees would have a substantial impact upon these exploitive loans. I would urge the Committee to consider an

easy definition that limits high points and fees up front and provides other protections against exploitive equity based lending, a system that rewards the lender immediately on closing, no matter what the fees, regardless of whether the borrower

pays, and provides economic incentive for this type of conduct to continue unchecked.

A single definition of high points and fees is easily enforceable. Lowering the

HOEPA points and fee trigger to the greater of 4 percent of the loan amount or

$1,000 is a first step but it is still not low enough to prevent the abuses. The proposed legislation will be helpful in (1) prohibiting balloon mortgages, (2) creating additional protections in home improvement loans, (3) expanding the TILA rescission

as a remedy for violations of all HOEPA prohibitions, (4) prohibiting the sale of

lump sum credit insurance and other life and health insurance in conjunction with

these loans, and (5) limiting mandatory arbitration.

Virtually all of the subprime balloon mortgages observed in my State are very

exploitive to the consumer. The fact of such balloon payment predestines foreclosure

for the consumer in many cases.

Mandatory arbitration clauses are now used by the majority of home equity lenders and they are increasing daily as the technique to deny consumers any meaningful opportunity to contest the loss of their home. Arbitrators selected by the creditors now decide whether a consumer gets to keep his home. Notwithstanding the

fact that there are many exploitive abuses, the arbitrator designated by the lender

in the loan agreement now decides the merits of all claims. Practically speaking,

this means that the consumer loses, and arbitration rules provide that the practices

of the lender are kept confidential.

In the subprime mortgage context, that is, outside of conventional loans, there is

an urgency to address the following exploitive lending practices:

(1) Prohibition of mandatory arbitration clauses in all subprime loans.

(2) Prohibition of subprime balloon payment loans. Low income borrowers

generally cannot meet these loans and the lender cannot expect them to make

a balloon payment. Such loans assure (a) the loss of a home or (b) require refinancing on usually very exploitive terms if the borrower can even get the loan.

(3) Excessive interest rates, not justified by any additional risk, are frequent

for the vulnerable consumer groups. The risk is covered by the real property

security.

(4) Broker kickbacks should be prohibited. They are a very anticompetitive

practice and in the subprime market result primarily in increasing the cost.

(5) Home solicitation scams have been with us for many years but as a means

for skimming the equity from unsophisticated consumers, home equity lenders

are now more frequently using them as a solicitation tool.

(6) Altered and falsified loan applications are now becoming commonplace in

the subprime market. These are altered after signature by fudging the income

of the prospective borrower or by alteration of the proposed loan amount. The

impact is a level of payments that the consumer cannot make.

(7) Credit insurance packing (by consumer finance companies) into regular,

nonhome secured consumer loans and flipping them into home equity secured

loans is commonplace. Consumer finance loans with five insurance policies are

common to a greater extent than home equity loans with credit life insurance.

(8) Excessive loan points and broker fees are primary incentives to abuses.

Conventional mortgages with 1–11⁄2 percent broker fees are standard, while the

lack of sophistication of vulnerable groups leads to broker compensation of 3 to

7 percent. These are very discriminatory to unsophisticated consumers given

the similarity in the work performed.

(9) Excessive loan to value loans. One hundred twenty five percent to 200 percent of actual market value loans are not uncommon for brokered loans given

the financial incentives to flip, and the lack of any concern for ability of the borrower to pay. The broker’s only concern is closing the loan for the fee.

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1Pub. L. 103–325, Title 1, Subtitle B (September 23, 1994). Our comments on the Federal Reserve’s proposed amendments are an appendix to this testimony.

STATEMENT OF AMERICA’S COMMUNITY BANKERS

JULY 26, 2001

America’s Community Bankers (ACB) is pleased to take this opportunity to submit a statement on predatory lending practices. ACB represents the Nation’s community banks of all charter types and sizes. ACB members pursue progressive,

entrepreneurial and service-oriented strategies in providing financial services to

benefit their customers and communities.

General

ACB members participate in many important programs and partnerships that

help average Americans become and remain homeowners. This commitment of

ACB’s members to homeownership is good for communities and is good for business.

In contrast, predatory lending practices undermine homeownership and damage

communities. ACB pledges to work with this Committee and other policymakers to

eliminate predatory lending practices in the most effective way and to enhance all

creditworthy borrowers’ access to sound loans. ACB also would appreciate the opportunity to provide the Committee with the views of our recently formed task force

on predatory lending when they are available.

Legislative and regulatory attempts to deal with predatory lending face serious

challenges. New laws and regulations could discourage certain types of lending by

inaccurately labeling loans as ‘‘predatory’’ or stigmatizing legitimate loan terms and

at the same time failing to stop predators from engaging in egregious practices. It

is essential to recognize the important difference between legitimate loan product

terms and predatory lending practices. Any loan term is subject to abuse if it is not

properly disclosed or if the loan officer falsifies documents.

An overly broad law or regulation could impose restrictions that would limit the

availability of credit while allowing predators to continue their deceptive practices.

Rather than imposing more regulations on heavily supervised institutions, ACB continues to recommend stronger supervision of unsupervised lenders. A combination

of vigorous enforcement of existing laws and regulations and enhanced opportunities

for homeownership education and counseling would be the best approach to the

problem.

The Board of Governors of Federal Reserve System (Federal Reserve) is considering amendments to its regulations implementing the Home Ownership and Equity

Protection Act of 1994 (HOEPA).1 The Office of Thrift Supervision and the FDIC

continue their review of regulations and policies. In addition, the new Administration—particularly the Department of the Treasury and the Department of Housing

and Urban Development (HUD)—have indicated that they will become engaged on

the topic. While this Committee’s hearings are timely and appropriate, Congress

will likely wish to review the Federal Reserve’s and the agencies’ final regulations

and receive the Administration’s views before moving on legislation.

One troubling development is the actions by various State and local governments

regarding predatory lending. They have considered—and in some cases passed—

overly broad legislation. The effect has already been to discourage lenders from

making subprime loans in some of these jurisdictions, cutting off credit to those who

need it most.

While regulation and improved supervision have important roles to play, the consumer is the first line of defense against abusive practices. Homeownership education and counseling cannot be overemphasized as a way to help borrowers avoid

becoming victims of predatory lenders. This is particularly true for borrowers with

little or no experience in homeownership and finance. ACB members currently provide counseling on their own or in combination with other institutions or community

groups. ACB will continue to work with the American Homeowner Education and

Counseling Institute as a founding member to provide more education and counseling. Lenders, community groups, and public agencies should work to expand

these programs.

Equal Enforcement Is Essential

Most proposed legislation and regulations would, in theory, apply to almost all

mortgage lenders. Indeed, many nondepository institution lenders assert they must

adhere to the same regulations that insured depository institutions must follow.

However, many of the firms most commonly associated with predatory practices are

not Federally insured and are not subject to regular examination and rigorous suVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00164 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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2 Joint Report to the Congress Concerning Reform to the Truth in Lending Act and the Real

Estate Settlement Procedures Act, July 1998, p. 66. 3Letter of July 5, 2000 in response to OTS advanced notice of proposed rulemaking on responsible alternative mortgage lending. 4 12 U.S.C. 3801–3806.

pervision. Such firms are examined on a complaint-only basis. The joint report by

the Federal Reserve and the HUD issued in 1998 acknowledged these facts, stating:

Abusive mortgage loans are not generally a problem among financial institutions that are subject to regular examination by Federal and State

banking agencies. Abuses occur mainly with mortgage creditors and brokers

that are not subject to direct supervision.2

Abusive practices—for example, falsifying documents; hiding or obscuring disclosures; orally contradicting disclosures—are the essence of predatory lending. The

proper remedy for these abuses is to ensure that loan originators do not violate laws

against fraud and deceptive practices and properly disclose loan terms. If existing

and new regulations are effectively applied only to Federally supervised depository

institutions, they will fail to deal with the problem. ACB is concerned that the current focus on abusive lending practices could lead to overly broad regulations. By

unduly tightening restrictions on subprime lending, there is a risk of discouraging

insured depository institutions from making responsible subprime loans, which

would effectively open the door even wider to unregulated predators.

To avoid this, the focus of regulatory efforts should be on enhancing systems to

detect and deter deception and fraud without restricting the availability of credit.

Borrowers should enjoy the same consumer protections, regardless of the institutions they patronize, and the institutions that offer similar products should operate

under the same rules. Therefore, ACB strongly encourages increased supervision of

non-Federally insured lenders.

ACB recommends that Congress provide the Federal Trade Commission (FTC)

with adequate resources to enforce the laws under its jurisdiction, particularly with

respect to unsupervised lenders. The Federal banking agencies should work with the

States and the FTC to ensure that Federal regulations apply in practice, as well

as in theory, to all lenders, including State-licensed, nondepository lenders.3 The application of the standards and enforcement of these regulations is particularly important because State-licensed lenders can choose to follow regulations issued by the

Office of Thrift Supervision under the Alternative Mortgage Transactions Parity

Act.4 Without adequate enforcement, there may be situations where State law is

preempted but Federal regulations are not enforced.

Subprime Lending vs. Predatory Practices

It is important that policymakers distinguish between subprime lending and predatory lending practices. These terms are often mistakenly used interchangeably.

Subprime lending provides financing to individuals with impaired credit or other

risk factors, though at somewhat higher rates or under stricter terms than are

available to more creditworthy borrowers. The rise of subprime lending has given

many previously underserved borrowers access to credit; before the expansion of

subprime lending, a consumer either qualified for a prime loan or was denied credit.

Subprime loans now offer a middle ground and have helped consumers achieve and

maintain home ownership at record levels.

A properly underwritten subprime mortgage benefits both the borrower and the

lender. To be considered properly underwritten, a subprime loan—indeed any loan—

must be priced appropriately. The best credit risk enjoys the lowest rate; those with

weaker credit histories are risk priced at higher rates for access to credit. By expanding the pool of eligible borrowers, lenders are able to add earning assets to

their books. However, subprime borrowers also add risk to the balance sheet. By

taking borrowers’ circumstances into account in pricing, lenders are properly compensated for the risks they take. Done right, subprime lending is good for an institution’s customers, community, stakeholders, and deposit insurance fund.

In contrast, true predatory lending benefits only the lender. All lending should

balance the interests of lenders and borrowers. In the case of loans made on an

abusive or predatory basis, the mortgage broker, home improvement contractor, or

lender receive excessive fees, while borrowers who cannot meet the terms of their

loans may diminish their equity, damage their credit ratings, and even risk the loss

of their home. To avoid foreclosure, borrowers must often carry ultra-high debt service until they can secure new financing. These predatory lenders charge far more

than what is required to fairly compensate for risk or lend to borrowers that are

unqualified. They do so to extract as much profit from the transaction as possible.

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5 ‘‘Curbing Predatory Home Mortgage Lending: A Joint Report’’ (June 20, 2000) p. 85. 6 Id at p. 87. 7Federal Reserve Governor Edward Gramlich described the problem this way in his May 1,

2000 letter to Senate Banking Committee Chairman Phil Gramm. The Governor wrote:

‘‘HOEPA’s triggers may bring subprime loans not associated with unfair or abusive lending

within the acts’s coverage. Similarly, abusive practices may occur in transactions that fall below

the HOEPA triggers.’’ In a similar letter sent on May 5 to Chairman Gramm, Comptroller of

the Currency John D. Hawke, Jr. summed up the problem this way: ‘‘I am concerned that attempting to define this term [predatory lending] risks either over- or under-inclusiveness.’’

Adjusting the HOEPA Triggers

The Federal Reserve has authority under HOEPA to adjust the annual percentage

rate (APR) trigger from 10 to 8 percentage points over the comparable treasury

rates. The Federal Reserve may also include additional fees in to the points and fees

trigger.

Adjusting the APR Trigger

There are many descriptions of predatory lending practices, but they cannot easily

be translated into a clear statutory or regulatory definition of predatory lending.

Rather than attempting to define the term, HOEPA draws a line between high-cost

loans—which require special disclosures and restrictions—and all other loans. This

bright line has the advantage of clarity, but HOEPA does not encompass all loans

that might be predatory. That is probably an impossible goal, but ACB members believe that the current APR threshold of 10 percent over comparable Treasuries could

be lowered to 8 percent without restricting the subprime market.

According to last year’s report on predatory lending practices by HUD and the

Treasury, only 0.7 percent of subprime loans originated from July through September of 1999 met the current HOEPA APR threshold.5 By lowering the threshold

from 10 to 8 percent, HUD and Treasury estimated that 5 percent of subprime loans

would be covered.6 ACB recommended that the Federal Reserve take this step under

its current HOEPA authority.

Lowering the threshold to 8 percent would cover a larger universe of transactions

and provide additional protection to consumers. Doing so will not, however, solve

the problem. Some lenders may try to avoid the HOEPA trigger by shifting the coupon rate and the upfront fees by small amounts. In any event, predatory lenders

may not bring the HOEPA disclosures to the borrowers’ attention or may tell the

borrower the disclosures are irrelevant. As pointed out above, rules without enforcement are no solution.

In addition, we caution against lowering the thresholds too far, as proposed in

some legislation. That could unfairly label legitimate subprime loans as predatory

and impose additional burdens on legitimate subprime lenders.7 Imposing additional

disclosures; restrictions on terms; and reduced access to the secondary market

would be harmful, but still not effectively deal with the predatory lending problem.

Regulators have suggested that they will not consider HOEPA loans for purposes

of Community Reinvestment Act compliance, a step ACB supports. The secondary

mortgage market, at least as far as the Government-sponsored enterprises are concerned, will not now accept HOEPA loans. These are helpful steps under the current

HOEPA limits, but could be perversely damaging if the current trigger values are

decreased too far. Such a chain of events could force more borrowers away from regulated lenders to the unregulated.

Points and Fees Trigger

In general, ACB opposes adding additional items to the points and fees trigger.

We recommend applying the HOEPA definition to a substantial number of additional loans by reducing the APR trigger. That change, when coupled by the increased reluctance of lenders to make any HOEPA loans and investors to buy such

loans, would have a substantial effect. Policymakers risk overreaching if they also

bring more loans under HOEPA through the points and fees mechanism. If Congress or the Federal Reserve believe it is necessary to add items to the points and

fees trigger, ACB believes it should apply only to cases where the refinancing takes

place within a relatively short period, such as 12 months or less.

Prepayment Penalties

ACB opposes including prepayment fees in the points and fees trigger for HOEPA

loans as proposed by the Federal Reserve. Prepayment penalties are a common option the borrower can accept in exchange for other consideration, such as a lower

interest rate. This earlier transaction has no direct relationship to the new loan.

ACB understands the concern with the abusive practice known as ‘‘loan flipping’’

that is used to increase opportunities for predatory loan arrangers to impose inapVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00166 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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8Governor Gramlich described the problem with new rules this way before the House Banking

Committee on May 24, 2000: ‘‘Frankly, the value of rules prohibiting such practices is uncertain,

given the nature of predatory practices. Some occur even though they are already illegal, and

others are harmful only in certain circumstances. The best solution in many cases may simply

be stricter enforcement of current laws.’’

propriate costs and fees at closing. However, the suggestion that a new rule be imposed runs the risk of bringing legitimate loans and lenders into the HOEPA ambit.

ACB recommends that policymakers attack these abuses directly, through better enforcement and consumer education and counseling. This is a better approach than

unfairly stigmatizing legitimate transactions.

Points

As with prepayment penalties on the original loan, ACB believes that points paid

on that loan have no relationship to the points and fees—and hence the HOEPA

trigger—on a new loan. The proposed addition to the points and fees trigger is another way to discourage loan flipping by predatory lenders. Again, ACB urges policymakers to attack this problem directly.

Scope of Restriction on Certain Acts or Practices

In its request for comment last year, the Federal Reserve sought comment on several approaches to deal with predatory lending practices and asks whether they

should apply to:

• All mortgage transactions;

• To refinancings only; or

• To HOEPA loans only.

The current anecdotal information does not implicate the vast majority of mortgage transactions or refinancings. Therefore, ACB recommended that any new restrictions apply only to HOEPA-covered refinancings to avoid limiting the availability of legitimate subprime loans.

Specific Terms and Conditions

During the debate on this issue, a number of specific proposals have been advanced to attempt to prevent predatory lending practices. ACB is concerned that

certain rates and terms might be defined as ‘‘predatory,’’ even though in most circumstances they would be appropriate. Whether a particular term is predatory generally depends on the facts and circumstances of the particular transaction. Blanket

restrictions on loan terms that have a legitimate role in the marketplace is not the

right solution.8

These are ACB’s comments on some of these specific issues:

Unaffordable Loans

One practice used by predatory lenders is to make a loan to an individual that

he or she is clearly in no position to repay, based on the stated amortization schedule. ACB opposes such a practice where the borrower does not understand the terms

of the loan and has no other means to repay. However, there may be some situations where both the lender and the borrower understand at the outset that the borrower lacks the capacity to amortize the loan from ordinary sources but structures

the loan to accommodate repayment from an extraordinary source. One common example is a ‘‘bridge loan’’ where repayment will come from the sale of the borrower’s

current residence. ACB urges that policymakers avoid imposing legislation or regulation that might interfere with these kinds of accommodating transactions.

Federally insured banks and savings associations must already demonstrate that

their loans are made according to sound underwriting guidelines. They have a good

record of making loans that borrowers can repay. If other lenders adhered to similar

good business practice, this aspect of the predatory lending issue would be substantially mitigated.

There are some indications that the capital markets are already pulling away

from predatory lenders because of losses due to foreclosures and increased public

and regulatory scrutiny. While many predatory loans may remain on the books and

reports suggest that borrowers are continuing to suffer from predatory practices,

capital market discipline is likely to become increasingly effective. Therefore, it is

important that policymakers not overreact and impose rules that discourage mainstream lenders from providing credit to underserved areas and populations.

Limits on Refinancing

Another predatory technique involves frequent refinancings, sometimes within a

brief period. One of the most egregious examples involves refinancing low-cost loans

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on community development housing and simply replacing them with much higherrate loans. Such practices are completely inappropriate.

Yet additional regulation to protect consumers is not the answer. First, refinancing a loan at a higher rate is not, by itself, a predatory practice. For example,

a borrower may wish to convert a substantial amount of equity into cash, resulting

in a higher loan-to-value ratio and risk profile for the new transaction. Alternatively, that borrower may find that market rates may have simply risen since the

original loan was made. While repeated refinancings at higher rates may well be

a common predatory practice, a borrower and a lender may find it mutually agreeable to restructure their business relationship. A well-informed consumer who

chooses and can afford the obligation should not have that option foreclosed.

Second, repeated refinancing is generally just one aspect of a broader predatory lending scheme that involves deceiving the borrower, falsifying loan papers,

and ‘‘packing’’ the loan with hidden fees. Without these illegal practices, there would

be little point in repeated refinancing. Thus, a special rule on refinancing is not

necessary.

Some have suggested language that would permit refinancing at higher rates if

there is a tangible net benefit to the borrower. This is an intensely fact-based standard that—if imposed by law—could create an unprecedented burden on institutions,

for example to analyze and document the ‘‘tangible net benefit’’ for every loan. ACB

opposes this standard as both unnecessary and overly burdensome.

Balloon Payments

Balloon payment provisions can be used by predatory lenders to force a refinancing or even foreclosure. However, it is important to recognize that balloon payments can serve legitimate purposes. A balloon provision would make sense for a

borrower who wishes to pay the loan on a long-term schedule, but fully expects to

refinance or repay the loan before the date the balloon payment is due. For example,

a borrower may have a fixed-rate, fully amortizing loan (no balloon) coupled with

a line of credit with interest-only payments until a date certain when the loan must

be paid in full. Properly used balloon transactions give borrowers the benefits of

short-term interest rates and long-term amortization of the loan debt. A borrower

who is fully informed by the lender and who understands his or her obligations can

avoid foreclosure by a planned sale of the property, refinancing the balloon transaction, seeking an extension before the final due date, or taking some other action.

These positive features depend on an informed borrower who understands the implications of a balloon payment. Based on the anecdotal information provided during

last year’s HUD-Treasury forums, it appears that some victims of predatory lending

practices have not understood this particular loan term. As indicated below in the

discussion of improved disclosures, ACB believes that it should be determined why

this is the case and steps taken to correct the problem, rather than imposing unnecessary and disruptive restrictions.

Prepayment Penalties

Unreasonable prepayment penalties can make it extremely difficult for a borrower

to replace a loan made on an abusive or predatory basis. In other instances, prepayment penalties which are typically in effect only a few years—are appropriate and

beneficial to borrower and lender alike. They decrease the likelihood that a borrower

will pay off a loan quickly (decreasing anticipated income to investors) or compensate the investor for lost income if the borrower does decide to prepay the loan.

What is the benefit to the borrower? Investors are willing to accept a loan with

a lower interest rate, with the protection of a prepayment penalty. This is an especially good option for borrowers who expect to remain in their homes for a longer

period. It is also important to emphasize that these clauses may discourage the refinance option for only a limited time and may not be binding at all if the borrower

seeks to sell the home. In some cases, borrowers prefer loans without prepayment

penalties and lenders do not include them. This is an appropriate market response.

Some have proposed limiting prepayment penalties to cases where the borrower

receives a benefit, such as lower upfront costs or lower interest rates. This is similar

to the ‘‘tangible net benefit’’ test discussed above in connection with limits on refinancing. However expressed, ACB believes that it would be extremely difficult for

an institution to reliably measure and demonstrate compliance with such a requirement across an entire loan portfolio, especially in periods of high mortgage interest

rates. Each case would depend on particular facts and circumstances, requiring an

economic analysis of each situation.

Regulatory evaluation could even turn on the subjective intent of the borrower.

For example, a borrower who had no intention, at the time of closing, of selling the

home soon might later decide for any number of reasons to sell his or her house

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9 65 Fed. Reg. 42892 (July 12, 2000).

and prepay the mortgage. He or she would have received a lower interest rate or

fewer points in exchange for a prepayment penalty that he or she never expected

to incur. However, what might have looked like a good bargain at closing could turn

out to be relatively costly just a short time later simply because the borrower chose

a different course.

ACB believes that this is another case where informed consumer consent, rather

than a difficult to enforce standard makes the most sense.

Negative Amortization

Some loans have payment schedules that are so low that interest is added to the

principal, rather than being paid as it accrues. This can be harmful if too much interest is added to the loan’s principal and the loan terms do not provide a way to

reverse the process. However, like a prepayment penalty, the possibility of negative

amortization can help borrowers. For example, some lenders offer fixed-payment,

adjustable rate loans that—depending on prevailing interest rates—could result in

some negative amortization. These loans are sometimes made to ease the debt service requirement for a defined and often limited period. The interest rate on these

loans is capped, the possibility of negative amortization is fully disclosed, and the

negative amortization potential is itself capped. Sometimes the negative amortization is provided to assist the borrower in a time of financial stress or in times of

unusually high short-term interest rates.

Misrepresentations Regarding Borrower’s Qualifications

Some have suggested a rule that would prohibit lenders from misleading consumers into thinking that they do not qualify for a lower cost loan. In a request

for comment last year, the Federal Reserve indicates that, ‘‘Such a practice generally would be illegal under State laws. . . .’’ 9 ACB believes that State authorities

should enforce these laws with respect to lenders they regulate. It is unlikely that

Federally insured depository institutions are engaged in these practices and, if they

are, the existing examination process would correct them.

Reporting Borrowers’ Payment History

One important potential benefit of responsible subprime lending is that it can give

those borrowers with credit blemishes a chance to qualify for prime loans. ACB

strongly supports the reporting of all loan performance data and is opposed to the

reported practice by some lenders of choosing not to report positive performance for

fear their customers will be targeted by competitors for refinancing. If a lender does

not report positive credit experience, the credit report is no longer accurate and the

benefit of an improved credit report is lost. Lenders that report data must report

all data and not subjectively choose what to report. This is an instance where consumers benefit from appropriate disclosure of their financial information.

Referral to Credit Counseling Services

ACB strongly supports homeownership education and counseling and our members have no objection to telling borrowers that counseling is available. In fact,

many of our members offer counseling or participate in joint programs. And, as indicated above, ACB is a founding member of the American Homeowner Education

and Counseling Institute. However, we are reluctant to endorse mandatory counseling for all high-cost loans, as some have suggested—particularly if a substantially

higher number of loans are covered by a new definition. Mandatory counseling could

create perverse incentives and give rise to meaningless counseling programs. Consumer representatives told the HUD-Treasury joint task force that they were

concerned that counseling certifications could become yet another document that

predatory lenders would routinely falsify. And, they indicated that if the mandatory

counseling actually took place, it could be used as a shield against later claims that

the loan was predatory or otherwise improper.

Nevertheless, ACB believes that counseling can be a real benefit to borrowers,

especially those with little or no experience in homeownership and finance. Counseling gives potential victims of predatory lenders tools to avoid an inappropriate

transaction.

Mandatory Arbitration

Arbitration agreements have been criticized when included in some HOEPA loans

or loans deemed ‘‘predatory.’’ However, arbitration can be a simple, fast, more affordable alternative to foreclosure litigation. Attorneys who represent homeowners

victimized by predatory lenders often complain that they lack the time and resources to pursue claims in court. Fair and properly structured arbitration arrangeVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00169 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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10 Regulation Z, Appendix G–10(A) & (B) & H–2. 11 15 U.S.C. 1639(a).

ments could help them. Of course, they must be fully and properly disclosed. In

legitimate agreements, consumers retain all of their substantive legal rights. And,

the record shows that there is no inherent bias against consumers in arbitration

proceedings.

HOEPA Disclosures

In addition to increasing the number of loans considered high-cost, some have

suggested increasing the disclosures that must be made for these loans. ACB believes that requiring substantial additional disclosures would provide little benefit.

The HUD-Treasury forums presented convincing evidence that the existing

disclosures are sometimes ineffective, and more elaborate disclosures might even

give predators more opportunities to confuse consumers. Rather, ACB recommends

that the Federal Reserve and other policymakers thoroughly study why the existing

disclosure regime is ineffective and what alternatives might work. Those efforts

should concentrate on simpler, ‘‘plain English’’ disclosures that focus consumer

attention on relevant information. Regulators also should work to ensure that disclosures are provided in a timely way, particularly by institutions that are not regularly supervised.

One approach might be adapted from the Truth in Lending Act (TILA) tables required for mortgage loans and the requirement that credit card solicitations include

a special table (sometimes known as the ‘‘Schumer box’’) that highlights key

terms.10 For a loan (as opposed to credit sale) the highlighted terms are:

• Annual percentage rate • Finance charge • Amount financed • Total of payments • Payment number, amount, due dates

The form also includes information on credit insurance, security interest, filing

fees late charges, and prepayment penalties.

For credit cards, these terms are:

• Annual percentage rate

• Variable rate (if any)

• Method of computing the balance for purchases

• Annual fees

• Minimum finance charge

• Transaction fee for purchases

• Transaction fee for cash advances and fees for paying late or exceeding the credit

limit

These special disclosure boxes provide consumers with conspicuous disclosures of

the key terms, though do not substitute for the full TILA disclosures.

In contrast, the special HOEPA disclosures—provided 3 days before closing—are

limited to APR, monthly payment, and statutorily prescribed language that states,

‘‘You are not required to complete this agreement . . .’’ and ‘‘. . . you could lose

your home . . .’’.11 These disclosures do not address the predatory practices used

to strip equity from borrowers’ homes.

ACB suggests that policymakers carefully study why the current HOEPA disclosure system may be inadequate and determine how it could be improved. As things

now stand, in some situations borrowers do not understand the disclosures or lenders do not provide the disclosures or discourage their use.

If the problem is lack of borrower understanding, the disclosures should be improved and lenders should make greater efforts to educate and counsel consumers.

If the problem is with the lenders, ACB urges greater enforcement.

Certainly, disclosures should be written using plain language. But in addition,

ACB recommends that Congress direct the agencies to work with lenders to field

test the entire disclosure system. Such a review may reveal that even disclosures

drafted in plain language are not fully understood by consumers. ACB cautions

against overloading consumers with too much detail. ACB members’ ‘‘field tests’’—

conducted at loan closings every day—demonstrate that many consumers do not understand the current disclosures.

Open End Home Equity Lines

Some have raised concern that lenders could use open-end credit lines to evade

HOEPA and, if so, whether such structuring should be prohibited. ACB does not

have any evidence that HOEPA is being evaded in this fashion. In addition, ACB

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members generally do not offer open-end mortgage loans; secured lines of credit are

generally offered for a specified term, for example, 5 or 10 years, to give the lender

an opportunity to review and restructure the agreement. In any case, ACB believes

it would be very difficult to distinguish between legitimate lines of credit and ‘‘evasions,’’ because whether a particular loan was an evasion would depend on the lenders state of mind.

Community Outreach and Consumer Education

The Committee should be aware of a wide variety of community outreach activities and consumer education efforts already underway. As indicated above, ACB is

a founding member of the American Homeowner Education and Counseling Institute (AHECI), a nonprofit organization, which supports national standards for organizations and individuals that provide education and counseling services. This organization is the creation of a diverse group of mortgage industry stakeholders who

realized that existing educational programs or counseling services had neither uniform content or value. The effort also recognized the need to determine and measure

the qualifications and standards of conduct of those who deliver these services.

AHECI has established minimum standards for educational program content and

duration; these standards have been widely circulated and well received by the industry. AHECI certification of instructors and program approval will provide borrowers and lenders of a degree of assurance as to the quality and utility of locally

offered programs never before available, once the certification/approval process is in

place.

ACB also participated with other associations in the creation of a brochure designed to help consumers understand the terms of their loans before they commit

in writing. This brochure defines key loan terms and includes a worksheet to help

consumers compare their monthly spending plans before and after taking out a new

mortgage loan. It also helps consumers compare all the terms of various mortgages.

Finally, the brochure lists key rights available to protect against predatory lenders,

such as the right to cancel a refinancing within three business days of a closing.

A copy of this brochure is included with this statement. (Brochure held in Senate

Banking Committee files.)

Whether through formal counseling programs or in the normal loan underwriting

process, ACB member institutions work to ensure that borrowers understand their

responsibilities and will be able to fulfill them.

Despite these efforts, supervised mortgage lenders have a difficult time competing

with the aggressive marketing tactics of some lenders and brokers. The economics

faced by the different types of lenders may go a long way toward explaining the

problem. Simply put, a predatory lender that charges rates and fees substantially

above prime can afford to devote substantial resources to marketing. This may include print, broadcast, and even ‘‘house calls’’ by loan sales people. Prime or nearprime lenders may have a better product, but their profit on a given loan is too

small to support a similarly aggressive sales campaign.

Because of this imbalance in the market and because of the important public policy goal of blunting predatory lending practices, ACB believes that the Government

agencies have a role in consumer information and education. The FDIC recently

launched a financial literacy program with the Department of Labor. The OTS and

the Comptroller of the Currency also have financial literacy programs. Federal Reserve Banks provide training sites for education and counseling services. Government agencies could—through public service announcements and the like—urge consumers to seek out education and counseling and encourage lenders to offer or recommend those services. In addition, ACB strongly supports funding for HUD’s home

ownership education and counseling programs.

Mortgage Lending Reform

Some assert that simplifying the application and settlement rules could go a long

way toward solving the predatory lending problem. ACB supports simplification efforts, but we also recognize they are not a panacea for predatory lending. Industry

and policymakers have tried repeatedly to streamline this process, but no matter

how successful they are, making the biggest purchase and taking on the biggest financial obligation in your life is inherently complicated. But as indicated above,

solid education and counseling can help borrowers learn enough about the process

to understand whether or not they are being fairly treated.

Conclusion

In conclusion, we would like to emphasize the following points:

• Policy makers should avoid imposing over-inclusive legislation or regulations that

unfairly label legitimate loans as predatory or stigmatize legitimate loan terms;

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• Many firms associated with predatory practices are not subject to regular examination and rigorous supervision, and the Federal financial supervisory agencies

should work with the FTC and the States to help ensure that new and existing

rules are effectively and equally applied to all mortgage lenders;

• Unless all lenders are subject to the same rigorous enforcement, new rules only

will increase the burden on institutions that are now heavily supervised while

failing to solve the predatory lending problem;

• Existing disclosures should be made clearer—and validate these improvements

through field testing—rather than adding lengthy new disclosures.

• Education and counseling can be an effective way to prevent predatory lending.

ACB and its members pledge to increase access to high-quality homeownership

education and counseling.

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STATEMENT OF GALE CINCOTTA

EXECUTIVE DIRECTOR, NATIONAL TRAINING & INFORMATION CENTER

NATIONAL CHAIRPERSON, NATIONAL PEOPLE’S ACTION

JULY 25, 2001

I want to thank Chairman Sarbanes and other Members of the Senate Banking

Committee for holding hearings on predatory lending. My name is Gale Cincotta

and I serve as Executive Director of the National Training & Information Center

(NTIC) as well as the Chairperson of National People’s Action (NPA). In these positions, I remain committed to stomping out this scourge. We hope that these hearings will lead to Federal legislation which would protect homeowners from the

deceptive and equity-stripping practices used by predatory lenders.

NTIC is a 30 year old training and resource center for grassroots community organizations across the country. NPA is a coalition of 302 community groups from 38

States who organize locally and coalesce nationally around issues of mutual concern

that require national action.

We are proud that Chicago was the first city to pass an antipredatory lending ordinance that required financial institutions with city deposits or contracts to swearoff predatory lending practices. We are also proud that Illinois passed strong

antipredatory lending regulations in April (see http://www.obre.state.il.us/predatory/predrules.htm for details and attached articles).

Documenting the Problem

Both of these victories came after NTIC spent 2 years organizing at the local and

State levels to address predatory lending. We argued for reform by getting homeowners and advocates directly involved in the fight.

We also documented that subprime lenders are the source of an explosion of foreclosures in the Chicago area—subprime lenders went from initiating 163 foreclosures in 1993 to filing 4,796 in 1999 (see attached maps). Similarly, the share

of foreclosures by subprime lenders grew from 2.6 percent in 1993 to 36.5 percent

in 1999 for the same seven county metropolitan area.

The countless stories associated with the foreclosure dots on the maps reveal a

dozen or so predatory practices that pushed the borrower into bankruptcy and foreclosure. While this foreclosure data does not exist in most cities, the stories do. A

dozen local organizations across the midwest, southwest, and northeast have been

organizing homeowners ripped-off by predatory lenders. The stories are similar and

the effects are devastating: elderly and other borrowers are left homeless, the equity

wealth and credit records of entire families is ruined, and communities are left with

abandoned buildings. (See attached articles).

The roots of these problems—predatory lending—must be pulled up. We have

begun the process in one State, Illinois, and are willing to work in 30 more.

However, we are pleased that you are using your leadership powers to move Federal

legislation.

The organizations affiliated with NTIC and NPA who are working on this issue

have all achieved intermediate success. (See attached ‘‘NPA’s National and Local Accomplishments on Predatory Lending’’). All agree, however, that ultimately the solution is strong Federal legislation that is strictly enforced. The money to be made

through predatory lending will last as long as Americans have equity in their

homes.

Predatory Lending Policy Recommendations

NTIC and affiliated organizations have found that effective legislation should contain the following elements:

1. Sets the annual percentage rate (APR) triggers at T-bill plus 4 percent

points and fee triggers at 3 percent of the total loan amount to capture the full

range of loans likely to contain predatory loan terms. Predatory lending is most

often found in refinance and equity loans that carry higher-than-normal interest

rates and fees. Currently, the Home Ownership Equity Protection Act (HOEPA)

captures only a tiny percentage of the subprime loans. Predatory lenders have

learned to originate loans that fly under the radar of HOEPA’s annual percentage rate and fee triggers; in fact, only loans with close to a 16 percent interest

rate are subject to restrictions on predatory terms under HOEPA. However, borrowers with interest rates of even 10 percent are being successfully targeted

with predatory loans that steal equity out from under the homeowner. Similarly, HOEPA applies too high of a fee trigger to loans. While Freddie Mac has

determined that banks charge a prime rate customer 1–2 percent points of the

loan amount in fees, predatory lenders often charge borrowers 5–20 percent in

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financed fees. These come in the form of inflated origination & broker fees, as

well any number of ‘‘junk fees.’’

2. Prohibits Steering: Charging high, subprime interest rates (9–25 percent)

on borrower’s who have good enough credit to qualify for prime-rate loans (7–

9 percent).

3. Prohibits lending without ability to repay: Making a loan based on the equity that the borrower has in the home, without regard to the borrower’s ability

to repay the loan.

4. Prohibits single-premium credit insurance packing: Including overpriced insurance such as credit life, disability, and unemployment insurance. The lender

finances the insurance as part of the loan, instead of charging periodic premiums outside of the loan.

5. Prohibits Loan Flipping: Frequent, unnecessary refinancings of a loan with

no benefit to the borrower.

6. Prohibits fees in excess of 3 percent of the total loan amount: While Freddie

Mac has determined that banks charge a prime-rate customer 1–2 percent

points of the loan amount in fees, predatory lenders often charge borrowers 5–

20 percent in financed fees. These come in the form of inflated origination and

broker fees, as well any number of ‘‘junk fees.’’

7. Prohibit Prepayment Penalties: Huge fees charged when a borrower pays

off the loan early or refinances into another loan. Prepayment penalties are designed to lock borrowers into high-interest loans, thereby undermining our free

market economy by taking away a borrower’s right to choose the best product

available to them at a given time.

8. Prohibit Balloon Loan: A loan that includes an unreasonably high payment

due at the end of or during the loan’s term. The balloon payment is often hidden and almost the size of the original loan. These loans are structured to force

foreclosure or refinancing.

9. Prohibit Adjustable Rate Mortgages (ARM’s): ARM’s by predatory lenders

are usually indexed so that they only adjust up, increasing a borrower’s interest

rate a full point every 6 months. As a result, a borrower’s monthly payment increases twice a year even though they likely were told that the adjustable rate

mortgage would fluctuate with the economy.

10. Requires lenders to escrow for property insurance and tax premiums: Many

predatory lenders artificially reduce a borrower’s monthly payments by not

charging them the full amount necessary to pay for property taxes and insurance premiums out of an escrow account. As a result, homeowners who have

never had to worry about saving for separate property tax and insurance payments are hit with bills potentially as big as their mortgage payments twice a

year.

11. Prohibits Home Improvement Scams: A home improvement contractor arranges the mortgage loan for repairs, often charging the borrower for incomplete or shoddy work.

12. Prohibits Bait & Switch: A lender offers one set of loan terms when

the borrower applies, but pressures the borrower to accept worse terms at the

closing.

Other Efforts To Combat Predatory Lending

While the Congress begins to debate the legislative remedy to this issue, we will

continue to pursue four distinct strategies to combat predatory lending:

Compelling and Supporting Increased Enforcement Through

the Federal Trade Commission (FTC), State Banking Departments,

and Attorneys General

In March 2001, Assistant to the Director of Consumer Protection, Ron Isaac, represented the FTC at the NPA Conference. At the conference, Mr. Isaac committed

the FTC to participating in predatory lending hearings in seven cities over within

12 months. Mr. Isaac committed to attending himself (or sending a representative

of equal authority from the national FTC office), asking a regional representative

to also attend, and to attending the NPA Conference in 2002. At the hearings, local

organizations will expose predatory lenders through personal testimony and statistical supporting evidence. NTIC and NPA also recognize that the FTC has sweeping

powers under Section 5 of the FTC Act to write regulations that would guard

against ‘‘unfair practices.’’ We will be asking the FTC to use these powers to regulate against predatory lending practices.

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Targeting Citigroup’s CitiFinancial/Associates, Nationally, and

Other Problem Lenders, Locally, for Lending Reform

Pressure from NPA and other groups has forced Citigroup to discontinue one of

its most profitable and abusive lending practices—the sale of single-premium credit

insurance. But while celebrating the conglomerate’s decision, NPA demands that

Citigroup take additional steps toward lending reform.

NPA leaders in Chicago, Cincinnati, Cleveland, Des Moines, central Illinois, Indianapolis, Pittsburgh, Syracuse, Wichita, and other cities say that Citigroup must

cap fees at 3 percent, eliminate terms that lock borrowers into predatory loans, and

allow borrowers their American right to sue predatory lenders in court.

Furthermore, Citigroup must review and restructure the predatory loans made by

The Associates and CitiFinancial which tens of thousands of homeowners are currently struggling to repay. Many of these homeowners will ultimately end up in

bankruptcy and foreclosure unless Citigroup repairs the loans so that borrowers are

able to repay their loans and remain in their homes.

Finally, NPA calls on Citigroup to offer affordable, prime-rate loans throughout

the 48 States where they operate. Currently, most borrowers can only get high-interest loans through CitiFinancial branches, even if they have good credit and qualify for a prime-rate loan. This Citigroup policy creates a discriminatory loan system

where most borrowers pay too much for mortgage credit.

Pursuing Increased Protection in States Where Local Groups Are

Positioned—Through Either State-Level Legislation or Regulation

Several States are at or nearing the point where they are poised to push for legislative or regulatory protection from predatory lending as was accomplished in

Illinois in 2001.

Working With Responsible Lenders To Develop Lending Products

That Provide an Alternative to the Quick-cash Predatory Loans

Under the Predatory Lending Intervention and Prevention Project, NTIC, and affiliated NPA organizations joined Fannie Mae and several lenders in Chicago last

November to kick-off a pilot product that refinances borrowers out of predatory

loans and into loans that they can afford to repay. Similarly, some groups such as

the Northwest Neighborhood Federation in Chicago are pursuing banks to develop

their own loan products to provide borrowers alternatives to the quick-cash promises

of predatory loans. We are currently expanding this pilot to central Illinois, Cincinnati, Cleveland, and Des Moines.

While these are all important ways to stop predatory lending, everyone would

agree that thorough, strong Federal regulation is the most effective way to protect

borrowers.

Please let me know how I, NTIC, and NPA can help the Banking Committee on

this issue in the future.

Please See the Attachments That Follow

1. Maps of ‘‘Foreclosures Started by Subprime Lenders in Chicago, 1993 and 1999’’

2. Maps of ‘‘Foreclosures Started by Subprime Lenders in Chicagoland, 1993 and

1999’’

3. Selected articles

4. ‘‘NPA’s National and Local Accomplishments on Predatory Lending’’

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STATEMENT OF ALLEN J. FISHBEIN

GENERAL COUNSEL, CENTER FOR COMMUNITY CHANGE, WASHINGTON, DC

JULY 26, 2001

My name is Allen J. Fishbein, and I am General Counsel of the Center for Community Change and I also Codirect the Center’s Neighborhood Revitalization

Project. Mr. Chairman and Members of the Committee, I want to commend you for

holding this hearing on the problems associated with predatory mortgage lending

and thank you for the opportunity to provide testimony on behalf of my organization

on this important topic.

Prior to rejoining the Center in December of last year, I served for almost 2 years

as the Senior Advisor to the Assistant Secretary for Housing at the U.S. Department of Housing & Urban Development. My duties at HUD included helping to direct the activities of National Task Force on Predatory Lending, which the Department established in conjunction with the Treasury Department.

The Center for Community Change (www.communitychange.org) is a national,

nonprofit organization that provides training and technical assistance of many kinds

to locally based community organizations serving low income and predominately minority communities across the country. For the last 25 years, the Center’s Neighborhood Revitalization Project has advised hundreds of local organizations on strategies

and ways of developing innovative public/private partnerships aimed at increasing

the flow of mortgage credit and other financial services to the residents of these underserved areas.

The rapid rise in predatory lending has been a disturbing part of the growth in

the subprime mortgage market. It threatens to quickly reverse much of the progress

made in recent years to expand homeownership to underserved households and communities. At a time when a record number of Americans own their own home for

too many families the proliferation of abusive lending practices has turned the

dream of homeownership into a nightmare. Abusive practices in the subprime segment of the mortgage lending market have been stripping borrowers of home equity

they spend a lifetime building and threatens thousands of families with foreclosure,

destabilizing urban and rural neighborhoods and communities that are just beginning to reap success from the recent economic expansion. Further, predatory lending

disproportionately victimizes vulnerable populations, such as the elderly, womenheaded households and minority homeowners. The predators selectively market

their high-cost loans to unsuspecting borrowers, saddling these families with expensive debt, when in many cases, they qualify for less costly loans.

Given the nature and prevalence of this problem, a comprehensive approach is required, involving all levels of government, the mortgage and real estate industries,

together with community and consumer organizations. This was the approach recommended last year by the Treasury Department and HUD and we think this approach makes the most sense.

To be sure, increased consumer awareness about predatory lending practices must

be part of the mix and there is much that industry and nonprofit organizations are

doing and can do to improve the financial literacy, especially for at-risk homeowners. Expanded enforcement is needed as well.

However, efforts to increase financial literacy among consumers and incremental

increases in enforcement, in and of themselves, will not be sufficient to curb the

growing problem of predatory lending. Existing consumer protections must also be

strengthened, since existing laws are simply inadequate to prevent much of the

abuse that is occurring. Further, better mortgage loan data collection by the Federal

Government is necessary to provide regulators and the public with more comprehensive and consistent information about those areas most susceptible to predatory

lending activity. And there is much more to be done by those who purchase or

securitize high-cost subprime loans to ensure that, knowingly or unknowingly, they

do not support the activities of predatory loan originators.

Later in my testimony I discuss our recommendations for the additional Federal

action that is needed to combat the problem.

What Is Predatory Mortgage Lending?

The term ‘‘predatory lending’’ is a short hand term that is commonly used to encompass a wide range of lending abuses. The local community organizations, housing counseling agencies, and legal aid attorneys we work with report a steep rise

over the past few years in the incidence of these abusive practices. Disturbingly,

while home mortgage lending is regulated by the States and at the Federal level,

local groups working on this issue find that many of the most abusive practices by

predators are technically permissible under current law.

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Predatory lending generally occurs in the subprime market, where most borrowers

use the collateral in their homes for debt consolidation or other consumer credit purposes. Most borrowers in this market have limited access to the mainstream financial sector, yet some would likely qualify for prime loans. While predatory lending

can occur in the prime market, it is ordinarily deterred in that market by competition among lenders, greater homogeneity in loan terms and greater financial information among borrowers. In addition, most prime lenders are banks, thrifts, or

credit unions, which are subject to more extensive Federal and State oversight and

supervision, unlike most subprime lenders.

The predatory lending market works quite differently than the mainstream mortgage market. It usually starts with a telephone call, a mailing, or a door-to-door solicitation during which time unscrupulous lenders or brokers attempt to persuade

a borrower to use home equity for a loan. High-pressure sales techniques, deception,

and outright fraud are often used to help ‘‘close the deal.’’ According to a recent

AARP survey over three quarters of seniors who own homes receive these types of

solicitations, while many takeout loans relying solely on these overtures, without

taking the necessary time to shop around to find the best possible loan deal for

themselves.

Some would have this Committee believe that the term predatory lending is not

well defined and therefore, cannot be used as a basis for enacting stronger regulation. A broad consensus emerged last year among a diverse range of institutions,

including Federal and State regulators and the Government Sponsored Housing Enterprises (GSE’s) about the common elements associated with predatory lending.

Testimony from victims and others at the public forums sponsored by Treasury and

HUD, and by the Federal Reserve Board, also illustrated the all too-frequent abuses

in the subprime lending market.

The joint report issued last year by the Treasury Department and HUD, Curbing

Predatory Home Mortgage Lending (June, 2000), catalogued the key features commonly associated with predatory loans. These include the following:

• Lending without regard to a borrower’s ability to repay. Instead of establishing the borrower’s ability to pay, predators underwrite the property and charge

very high origination and other fees that are not related to the risk posed by the

borrower. • Packing. Single-premium credit life insurance policies and other fees are ‘‘packed’’ into loans but not disclosed to borrowers in advance. The financing of these products and fees increases the loan balance, stripping equity from the home. • Loan flipping. The predators pressure borrowers into repeated refinancings over

short time periods. With each successive refinancing the borrower is asked to pay

more high fees, thus stripping further equity. • Prepayment penalties. Excessive prepayment penalties ensure that the loan cannot be paid off early without paying significant fees, trapping borrowers into to

high-cost mortgages. • Balloon payments. Predatory loans may have low monthly payments at first, but

the loan is structured so that a large lump sum payment is due within a few

years. • Mandatory arbitration. Mandatory arbitration clauses to resolve disputes are usually required as a condition for receiving a loan. Such clauses reduce the legal

rights and remedies available to victims of predatory lending.

The report concluded that practices such as these, alone or in combination, are

abusive or make the borrower more vulnerable to abusive practices in connection

with high-cost loans.

What Are the Reasons for the Growth in Predatory Lending?

The Nation’s economic success has caused home values to rise. Consequently,

Americans have found greater equity in their homes, which has fostered an enormous expansion in consumer credit, as many homeowners have refinanced their

mortgages to consolidate their debts or pay-off other loans. The growth in the

subprime lending over the last several years may have benefited many credit-impaired borrowers. Subprime lenders have allowed these borrowers to access credit

that they perhaps could not otherwise obtain in the prime credit market. Nationally,

subprime mortgage refinancings rose from 100,000 in 1993 to almost one million in

1998, a ten-fold increase in just 6 years.

However, studies by HUD, the Chicago-based Woodstock Institute, and others

have demonstrated that subprime lending is disproportionately concentrated in low

income and minority communities. Mainstream lenders active in white and upperincome neighborhoods were much less active in low income and minority neighborhoods effectively leaving these neighborhoods to unregulated subprime lenders. Certainly, not all predatory practices are confined to the subprime market. However,

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as the Treasury-HUD report concluded, subprime lending has proven to be fertile

ground for predatory practices.

According to HUD statistics, subprime lenders are three times more likely in low

income neighborhoods than in upper-income neighborhoods and five times more

likely in predominately African American neighborhoods than in white neighborhoods. Moreover, subprime lending is twice as prevalent in high-income African

American neighborhoods as it is in the low income white communities (See, HUD’s

report Unequal Burden: Income and Racial Disparities in Subprime Lending in

America, April 2000).

The Effects of Predatory Lending

The dramatic growth in foreclosure actions in some neighborhoods that has accompanied the growth in subprime lending over the last several years suggest the

damaging effects of lending abuses. In fact, foreclosure rates for subprime loans provide the most concrete evidence that many subprime borrowers are entering into

mortgage loans that they simply cannot afford. And the most compelling evidence

that subprime lending has become a fertile ground for predatory practices is the current, disproportionate percentage of subprime loan foreclosures in low income and

minority neighborhoods.

HUD and others have documented the wave of foreclosures now coming out of the

subprime market in recent research studies. Studies of subprime foreclosures in

Chicago (by the National Training and Information Center), Atlanta and Boston (by

Abt Associates) and Baltimore (by HUD), as well as other research, reinforce raises

serious concerns about the impact of subprime loans on low income and minority

neighborhoods in urban areas. These findings provide recent evidence that predatory lending can potentially have devastating effects for individual families and

their neighborhoods.

Additional Federal Action Is Needed To Combat Predatory Lending

Predatory lending has received considerable attention in the news media, largely

because of the efforts of national and local community and consumer organization,

some of who have provided testimony to this Committee on this subject. In addition,

growing concerns about abuses in the subprime market have led States and increasingly, localities to mount their own legislative and regulatory efforts to curb predatory lending.

Some industry groups have complained about and lobbied against the adoption of

State and local antipredatory laws. They say they fear being subjected to growing

set of local, and possibly, conflicting standards. However, in our opinion, these local

legislative efforts will continue and expand in the absence of decisive action being

taken at the Federal level.

We believe that the Federal Government can make a significant dent in the problem of predatory lending by taking action in five key areas (similar recommendations were endorsed by the Treasury-HUD report):

Strengthening the Home Ownership and Equity Protection Act (HOEPA)

and the Fair Lending Laws

A key recommendation in the Treasury-HUD report was that HOEPA needs to

be strengthened (HOEPA is the key Federal protection for borrowers of certain highcost loans by requiring lenders to provide additional disclosures and by restricting

certain terms and conditions that may be offered for such loans). We agree that

Congress needs to take this action.

As witnesses before this Committee in connection with these hearings have testified, the ‘‘dirty, rotten secret’’ of predatory lending is that many of the worst abuses

are not necessarily illegal under existing consumer protections. This means that

beefed-up enforcement of the existing laws alone will not curb the problem.

Currently, HOEPA is a useful, but limited tool. For one thing, it covers very few

high-cost loans (about 1 percent). It does not cover home purchase or home equity

and home improvement loans that are structured as open-end credit lines. Moreover, the statute currently does not cover some critical abusive practices associated

with high-cost lending and the civil remedies that are provided need to be enhanced.

We are pleased that the Federal Reserve Board is contemplating using the administrative discretion it has under HOEPA to revise and expand some limited aspects

of the regulations governing the implementation of this statute. For example, the

Board is proposing to adjust the existing interest rate trigger to bring additional

loans under HOEPA. The proposal also would expand the Act’s coverage to include

most loans in which credit life or similar products are paid by the borrower at or

before closing.

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But the Board has yet to act on its proposal and even if these changes were eventually adopted, the vast majority of high-cost loan borrowers (95 percent or more,

according to most estimates) still would not be covered by HOEPA’s protections.

Consequently, we support the type of legislation that was introduced last year in

the Senate by Chairman Sarbanes and in the House of Representatives by Representative LaFalce (and reintroduced in the House again this year, as H.R. 1051,

by Mr. LaFalce). We also commend Senator Schumer for legislation he offered last

year. Passage of this type of legislation would help to curb what appear to be the

key elements of abusive mortgage lending. We are pleased, Mr. Chairman, that you

have indicated your intention to reintroduce your bill and your strong desire to have

a bill reported out of Committee.

The proposed legislation extends HOEPA protections to a greater number of highcost mortgage transactions, restricts additional abusive practices in connection with

high-cost lending, and strengthens consumer rights and legal remedies. Moreover,

the proposed legislation balances curbs that are need to deter the abusive lending

without cutting off the legitimate access to credit that helps families of modest

means to move up the economic ladder.

Also, since predatory mortgage lending appears, in many respects, to be a fair

lending problem, legislation is needed to make the Equal Credit Opportunity Act

(ECOA) a more effective tool in this area. In particular, ECOA should be amended

to explicitly prohibit ‘‘reverse redlining’’ (that is, the discriminatory steering of inferior loan products to neighborhoods disinvested by prime lenders). Tougher penalties

for those lenders who persist in engaging in these practices are also needed. Representative LaFalce has introduced legislation in the House of Representatives that

addresses both of these points (H.R. 1053). Mr. Chairman, we urge you to introduce

similar legislation in the Senate.

Providing Additional Federal Funding of Home Mortgage Counseling

Virtually everyone associated with mortgage lending, both industry and consumer

and community organizations alike, agree that understanding the terms of a home

loan and taking the time to shop around for the best available loans are critical

steps that borrowers must take to avoid being victimized by predatory lenders. This

is especially true for borrowers in the subprime mortgage market since a substantial

number of these may qualify for less expensive, prime mortgages.

The borrowers who have access to qualified premortgage loan counseling are less

likely to enter into loans they cannot afford. Current law requires certain categories

of these borrowers, such as recipients of HUD’s Home Equity Conversion Mortgage

program (HECM) to receive preloan counseling. However, a substantial gap in qualified counseling exists, especially for those homeowners most vulnerable to being victimized by predatory lenders.

Congress should require lenders to recommend certified housing counseling to all

high-cost loan applicants. Additional Federal funding should be provided to increase

the availability premortgage loan counselors. These funds should be targeted to borrowers and communities most susceptible to predatory lending.

Encouraging the Expansion of Prime Lending In Underserved Communities

The lack of competition from prime lenders in low income and minority neighborhoods increases the chances that borrowers in these communities are paying more

for credit than they should. According to HUD research, higher income AfricanAmerican borrowers rely more heavily on the subprime market than low income,

white borrowers which suggests that a portion of subprime lending occurs with borrowers whose credit would qualify them for lower cost prime loans. There is also

evidence that the higher interest rates charges by subprime lenders cannot be fully

explained solely as the function of the additional risk they bear (for example, Fannie

Mae has estimated that one-half and Freddie Mac has estimated that 10 to 35 percent of subprime borrowers could qualify for lower cost loans). Thus, a greater presence by mainstream lenders could possibly reduce the high interest and fees currently being paid by the residents of underserved areas.

One of the problems that may contribute to the misclassification of borrowers is

that by and large financial institutions do not have adequate processes in place to

refer-up borrowers who qualify for prime credit from their subprime affiliates to

mainstream banks and thrifts. Expanding the universe of prime borrowers would

help to curb predatory lending.

Accordingly, Congress should urge the Federal banking regulators to use authority under the Community Reinvestment Act and other laws to ‘‘promote’’ borrowers

from the subprime to the prime market, while penalizing lenders who make predatory loans. Moreover, the Federal Reserve Board should utilize the authority it has

under the Gramm–Leach–Bliley Financial Modernization Act to conduct examinaVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00186 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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tions of subprime lenders that are subsidiaries of bank holding companies where it

believes that such entities are violating HOEPA or otherwise engaging in predatory

lending.

Improving Loan Data on Subprime Lending

Despite the explosive growth in subprime mortgage lending over the past several

years, there is no consistent, comprehensive source of data on where those loans are

being made geographically, by which lenders, and to what types of borrowers. In

truth, the data collection requirements of the Federal Government have failed to

keep up with these trends.

Virtually all of the research to date is based on a list of subprime lenders compiled, on his own initiative, by an enterprising researcher at HUD. The Federal Reserve Board, HUD, and other Governmental agencies, as well as lenders, academics

use this list, and anyone else interested in the field. Lenders on the list are classified as subprime if they identify themselves as such. All loans reported by those

lenders are counted as subprime, and no loans reported by lenders that do not identify themselves as subprime are counted. Further, HUD is under no mandate to

compile this list, and should it cease to do this, there would be virtually no future

information available about where and to whom they are going. This is the best information available on subprime lender, and nobody thinks that it serves the need

adequately.

The Federal Reserve Board has proposed to amend the Home Mortgage Disclosure

Act regulations (with which this information about subprime lenders is combined).

The Fed’s proposal would, among other things, collect and disclose information on

the annual percentage rates of loans reported, and indicate whether a particular

loan was classified as a HOEPA loan. The proposal would also revise the rules to

ensure that some large, nondepository subprime lenders, not currently covered

under HDMA, would be required to submit annual reports on their loan activities.

Unfortunately, the Fed has yet to finalize these rules.

Accordingly, Congress should adopt legislation requiring more systematic reporting by lenders under HMDA on their subprime lending activities. In addition to revising ECOA, the LaFalce bill (H.R. 1053) I referenced previously amends HMDA

to require reporting on subprime lending. It also provides HUD with the necessary

authority to impose civil money penalties to enforce compliance with HMDA by nondepository lenders, similar to the authority banking regulators have for banks and

thrifts. The lack of reporting by many nonbank financial institutions has hindered

the ability of regulators to track lenders that may engage in abusive lending. Providing HUD with the necessary statutory authority in this area also would establish

a more level playing field between depository and nondepository mortgage lenders.

We believe that similar legislation should be introduced in the Senate as well.

The Federal Government Should Take Steps to Prevent the Secondary Market

From Supporting Predatory Lending

Ultimately predatory lending could not occur but for the funding that is provided

by the secondary market to finance these loans. The rapid rise in subprime lending

that has occurred in recent years was possible because many of these loans were

purchased in the secondary market either whole or through mortgage-backed securities (about 35 percent of subprime loans by dollar volume in 1999 was securitized).

While the secondary market to some extent has been part of the problem connected with predatory lending, it can become an important part of the solution. The

refusal by the secondary market to purchase or securitize loans with abusive features, or to conduct business with lenders that originate such loans could curtail

their liquidity and thus, reduce their profitability.

Last year, Fannie Mae and Freddie Mac, the two Government sponsored housing

enterprises, pledged not to buy loans with predatory features. HUD acted further

to discourage the GSE’s from purchasing predatory loans, when it also elected to

disallow the GSE’s from receiving credit toward fulfillment of their affordable housing goals for the purchase of loans with predatory features. The GSE’s pledges and

the provisions in the Affordable Housing Goals rule must be monitored to ensure

that the two enterprises are living up to their commitments.

However, the GSE’s constitute a relatively small share of the subprime market

and unfortunately, other secondary market players have been less willing to adopt

similar corporate policies against predatory lending. HOEPA provides that purchasers or assignees of mortgages covered by that statute are liable for violations

unless ordinary due diligence would not reveal them as such. Similarly, Section 805

of the Fair Housing Act makes the secondary market potentially liable for financing

discriminatory loans.

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Consequently, the secondary market institutions appear to have taken at least

some notice of their potential legal liability for the purchase of high-cost loans involving HOEPA violations. However, because HOEPA loans represents such a small

share of the highcost loan market and discrimination claims are difficult to prove,

these developments have not yet resulted in across the board vigilance and screening by the secondary market that makes an impact by constricting the funding pipeline for predatory lenders.

Expanding HOEPA coverage to a greater share of the market and clarifying that

parent companies are liable for the sins of their subprime affiliates (a provision contained in the Sarbanes and LaFalce bills) could encourage loan purchasers to develop the necessary due diligence to filter out abusive loans from their business activities. Expanding liability in this area is critical given the recent influx of many

of the Nation’s largest financial institutions into the subprime market. Unfortunately, some of the subprime lenders acquired by these giant entities are being sued

or otherwise have been exposed for their connection to predatory lending practices.

Establishing that parent companies and officers of lenders, or subsequent holders

of loans by contractors, or liable for the predatory practices of originators would encourage these mega-financial institutions to develop the necessary internal controls

to deter abusive loan practices.

We urge this Committee and the Congress to move decisively in the areas we

have identified. It will take such comprehensive action by the Federal Government

to curb the predatory lending problem.

Thank you Mr. Chairman for the opportunity to provide our views on this subject.

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1Founded in 1974, NHEMA serves as the principal trade association for home equity lenders.

Our current membership of approximately 250 companies employs tens of thousands of people

throughout the Nation and underwrites most of the subprime consumer mortgage loans. 2Federal Reserve Board Governor Gramlich recognized many of these points in a recent

speech at the Board’s Community Affairs Research Conference: ‘‘Studies of urban metropolitan

data submitted under the Home Mortgage Disclosure Act (HMDA) have shown that lower-income and minority consumers, who have traditionally had difficulty in getting mortgage credit,

have been taking out loans at record levels in recent years. Specifically, conventional home-purchase mortgage lending to low income borrowers nearly doubled between 1993 and 1999. . . .

Much of this increased lending can be attributed to the development of the subprime mortgage

market. Again using HMDA data, we see a thirteen-fold increase in the number of subprime

home equity loans and a sixteen-fold increase in the number of subprime loans to purchase

homes. The rapid growth in subprime lending has expanded homeownership opportunities and

provided credit to consumers who have difficulty in meeting the underwriting criteria of prime

lenders because of blemished credit histories or other aspects of their profiles. As a result, more

Americans now own a home, are building wealth, and are realizing cherished goals. . . . However, this attractive picture of expanded credit access is marred by those very troubling reports

of abusive and unscrupulous credit practices, predatory lending practices, that can strip homeowners of the equity in their homes and ultimately even result in foreclosure. . . . Though we

have held discussions on the different categories of subprime loans, the credit profiles of vulnerable borrowers, and the marketing and underwriting tactics that predatory lenders employ,

we find that the absence of hard data inhibits a full understanding of the predatory lending

problem. Exactly what are the most egregious lending practices? How prevalent are they? How

can they be stopped? Absent the available data and the analysis and relationships they reveal, rulemakers and policymakers are challenged to ensure that their actions do not have unintended consequences. We are mindful that expansive regulatory action intended to deter

predatory practices may discourage legitimate lenders from providing loans and restrict the access to credit that we have worked so hard to expand. . . .’’

STATEMENT OF JEFFREY ZELTZER

EXECUTIVE DIRECTOR, NATIONAL HOME EQUITY MORTGAGE ASSOCIATION

JULY 26, 2001

Chairman Sarbanes and Committee Members, I am Jeffrey Zeltzer, the Executive

Director of The National Home Equity Mortgage Association (‘‘NHEMA’’).1 I appreciate the opportunity to provide NHEMA’s views on how to stop inappropriate mortgage lending practices that many now call ‘‘predatory lending.’’ NHEMA abhors abusive lending and wants it stopped. We advocate a multitrack strategy for stopping

these abuses: (1) tougher enforcement of existing laws; (2) voluntary industry selfpolicing by such things as adopting ‘‘Best Lending Practices’’ Guidelines; (3) greatly

enhanced consumer education programs; (4) broad-based reform and simplification

of RESPA and TILA requirements; and (5) targeted legislative reforms where appropriate to address specific abusive practices. Subsequently, we will comment further

on each of these areas.

Subprime consumer mortgage lenders are performing an extremely important

service by making affordable credit available on reasonable terms to millions of

Americans who otherwise could not easily meet their credit needs. Before the

subprime market became well established over the past decade, consumers in many

underserved markets often found it difficult, if not impossible to obtain credit.

Today, virtually every American has the opportunity to obtain mortgage credit at

fair and reasonable prices. We are very proud that our industry has played a key

role in democratizing the mortgage credit markets and in helping so many consumers. We also are deeply troubled both by the continued existence of abusive

lending practices in the subprime marketplace and by the unintended adverse consequences that are likely to arise if corrective measures are not drafted with extreme care.2 NHEMA is committed to helping eradicate such lending abuses that

are harming too many of our borrowers and undermining our industry’s reputation.

We commend Chairman Sarbanes and the Committee for focusing attention on this

problem, and we pledge to work constructively with you to help stop the abuses.

Although there is little quantitative data to document the prevalence of such problems, we know that some abuses are occurring, and NHEMA believes that they

must be stopped. None of our borrowers should be preyed upon and risk losing their

homes by even a few unscrupulous mortgage brokers, lenders, and home improvement contractors. Having devoted a great deal of time and resources to addressing

these concerns, we are convinced that there is no single, simple ‘‘silver bullet’’ solution to prevent abusive or improper practices that some parties are perpetrating on

unsuspecting and often unsophisticated borrowers. Before discussing our five part

strategy for preventing mortgage lending abuses, we want to first share some general information and observations that we believe will be helpful to the Committee’s

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understanding of the predatory lending issue and the subprime segment of the

mortgage market.

Background

What is ‘‘Predatory Lending?’’ While there is no precise definition of the term ‘‘predatory lending,’’ it is generally recognized as a term that encompasses a variety

of practices by home improvement contractors and mortgage brokers and lenders

that are abusive, grossly unfair, deceptive, and often fraudulent. These practices include such things as unreasonably high charges for interest rates, sales commissions

(points) and closing costs, imposing loan terms that are unfair in particular situations, and outright fraudulent misrepresentations. In recent years, the label ‘‘predatory’’ has been used in recognition of the fact that some of the perpetrators literally

prey upon the elderly, the less affluent, and more vulnerable homeowners, including

in some cases, minorities. ‘‘Subprime Lending’’ vs. ‘‘Predatory Lending’’ While abusive practices do in fact

occur to some extent in all types of consumer credit transactions, including the socalled ‘‘prime’’ or ‘‘conventional’’ mortgage market, it appears some abuses are concentrated more heavily in the subprime market segment. Regrettably, this occurrence has undoubtedly caused some people to confuse ‘‘subprime’’ and ‘‘predatory’’ lending. It is critically important that Congress fully understand that subprime

mortgage lending should not be equated with ‘‘predatory.’’ Subprime loans are a

wholly legitimate and an absolutely vital segment of the broader mortgage market.

Between 10 percent to 15 percent of all U.S. mortgages fall within the subprime category. Roughly 50 percent of subprime loans are originated through mortgage brokers, with the remainder coming from retail sales by lenders.

‘‘Subprime’’ is the term that generally is used to refer to loan products that are

offered to borrowers who do not qualify for what are called ‘‘prime’’ or conventional

products. Prime mortgage borrowers have more pristine, ‘‘A’’ grade credit, are considered less risky and accordingly qualify for the lowest available rates. Borrowers

whose qualifications are below the ‘‘prime’’ requirements are usually referred to as

‘‘subprime’’ and have to pay somewhat higher rates as they are viewed as being

higher credit risks. Most subprime mortgage loans are made to people who have

varying degrees of credit impairments. We want to emphasize, however, that many

borrowers with ‘‘A’’ grade credit do not automatically qualify for prime mortgage

rates because credit is not the only factor considered in underwriting a loan. Other

issues, such as the amount of equity that the borrower has to invest in the property

(the ‘‘loan-to-value ratio’’), nonconforming property types, one’s employment status

or the lack of adequate loan documentation often prevent borrowers from qualifying

for a prime mortgage product.

Unlike the relatively limited number of prime loan products, there are a wide variety of subprime products and rates, which reflect the more customized, risk-based

pricing underwriting of the subprime market segment. Lenders in the subprime

market usually offer mortgages in categories broadly described as ‘‘A-minus,’’ ‘‘B,’’

‘‘C,’’ and ‘‘D.’’ (Many lenders have numerous subcategories with graduated prices

within each of these general categories.) The majority of subprime loans, roughly

60–65 percent, fall into the ‘‘A-minus’’ range and have interest rates only moderately higher than prime loans. Another 20–25 percent qualify as ‘‘B,’’ which have

a few more credit impairments and slightly higher rates to reflect more risk. The

remaining 10–20 percent tend to be mostly ‘‘C’’ grade loans, which have substantially more credit defects, and a small percentage of ‘‘D’’ loans, which present the

highest credit risks.

It is important to understand that while subprime borrowers present higher risks,

and accordingly must be charged higher rates to reflect those risks, they still generally are good customers who remain current in their mortgage payments. They do,

however, require a higher level of loan servicing work to help keep them on track,

and this also entails higher costs to the lenders, which must be reflected in loan

pricing.

Who are the subprime borrowers? Many media stories relating to abuses in the

subprime market have left people with a misimpression that most subprime borrowers are elderly, minorities, very poor, and likely to be unable to repay their

loans, and therefore are destined to lose their homes in foreclosure. In fact, the typical subprime customer is totally different from this stereotype. The overwhelming

majority of subprime borrowers are white, not minorities. They are mostly in their

40’s, with only a small percentage over 65 years old. And, their incomes typically

range between $50,000 and $60,000 per year. Most repay in a timely manner, and

the foreclosure rate is only somewhat higher than that for prime loans. The

subprime borrower’s profile is basically that of a ‘‘prime’’ borrower, and it is one’s

credit record, not age or race, that is the main distinguishing factor. NHEMA comVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00243 Fmt 6633 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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3Governor Gramlich, in a speech to the Fair Housing Council of New York, aptly pointed out

how wholly legitimate terms and practices can be misused: ‘‘. . . The harder analytical issue

involves abuses of practices that do improve credit market efficiency most of the time. . . .

Mortgage provisions that are generally desirable, but complicated, are abused. For these generally desirable provisions to work properly, both lenders and borrowers must fully understand

them. Presumably lenders do, but often borrowers do not. As a consequence, provisions that

work well most of the time end up being abused and hurting vulnerable people enormously some

of the time.’’

missioned a study last year by SMR Research, which is one of the Nation’s leading

independent mortgage market research and analysis firms, to review subprime lending. SMR’s report, which we are providing to the Committee’s staff, offers additional

details regarding our market segment and customer characteristics.

Protecting Borrowers’ Access to Credit

In sharp contrast to legitimate subprime or prime lending, some unethical loan

originators do engage knowingly in abusive lending practices and many of these

abuses are now often lumped together in the term ‘‘predatory lending.’’ These abusive practices include a variety of improper marketing practices and inappropriate

loan terms. Sometimes it is quite easy to identify predatory lending, but it often is

much more difficult to determine whether abuses are occurring. Moreover, a number

of the loan terms being attacked are not per se improper, but can sometimes be used

improperly.3

To illustrate this point, we want to highlight several loan terms typically help

consumers and are not per se abusive, yet many consumer advocates now often seem

to be alleging these terms are inherently predatory:

• Prepayment Fees—Many subprime loans contain terms that impose a prepayment

fee or penalty if the borrower pays off the loan before the end of the agreed upon

loan period. Some critics are strongly attacking prepayment fees as predatory and

unfair, and some legislators have proposed prohibiting such fees. Are prepayment

fees abusive? Most of the time, absolutely not. Prepayment fee clauses actually

provide a major benefit to most consumers because they allow the borrower to get

a significantly lower rate on the loan than they would get without the clause. Prepayment provisions are very important in keeping rates lower and helping make

more credit available in the subprime market. Loans are priced based on the assumption that they will remain outstanding for some projected time period. If a

loan is paid off earlier, the lenders or secondary market investors who may buy

the loan cannot recover the upfront costs unless they address this issue in the

terms of the loan. Instead of charging a higher interest rate or higher initial fees,

lenders know it is usually fairer and better for the borrower to have an early payment fee to protect against losing these upfront costs. On the other hand, it is

certainly possible to have an abusive prepayment clause that imposes too much

of a penalty and/or that applies for too long a time. The point here is that most

of the time the consumer benefits and the provision is not abusive. Sometimes,

however, this otherwise wholly legitimate provision can be applied in an abusive

manner. Again, the challenge for all of us is to find ways to prevent the abusive

application of such provisions without denying the consumer the benefit of the

provision, which applies in most cases. With regard to prepayment provisions, this

benefit can be easily accomplished (for example, requiring that the borrower be

given an option of a product with and without the fee and limiting the fee amount

and the time it is applicable).

• Arbitration Clauses—Some parties contend that loan terms that require disputes

between the lender and borrower to be arbitrated are inherently oppressive and

abusive. We strongly disagree with such a general characterization of arbitration

clauses. Yes, it is certainly possible to structure a clause so that it is unfair. For

example, if a national lender operating in California required that the arbitration

always be conducted at the lender’s headquarters in New York, we think this is

obviously unfair (and a court would probably not enforce such a loan clause). On

the other hand, appropriately structured arbitration generally is recognized by

courts as an acceptable, fair alternative dispute resolution procedure that frequently can benefit all parties. Arbitration allows disputes to be resolved much

more quickly and with less expense than litigation. Arbitration clauses that meet

certain safeguards, such as restricting venue to where the property is located and

compliance with the rules set forth by a nationally recognized arbitration organization, should not be deemed inherently abusive.

In addition to preserving such loan terms that are legitimate, NHEMA wishes to

emphasize that attacks on certain lending practices are unjustified. In particular,

some consumer advocates criticize the financing of points and fees by subprime

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lenders. We strongly believe that their criticisms are not valid. Most subprime borrowers do not have extra cash readily available to pay closing costs, so they voluntarily elect to finance them in connection with the loan. Prime borrowers often do

the same thing. Subprime borrowers should not be discriminated against and should

be allowed to continue to finance such costs. Why should they be forced to borrow

money from other sources, typically at higher, unsecured rates, to pay such necessary costs? In many cases, it could prove very difficult, if not impossible, to obtain

the funds needed to pay such costs.

Legislators and regulatory officials have a difficult task in balancing the competing and often conflicting considerations that arise in this area. While wanting

abuses stopped, NHEMA cannot overemphasize the importance of moving very carefully and deliberately in addressing the abuses because there is a great danger that

new restrictions would limit terms or practices that are generally helpful and desirable for most consumers.

NHEMA believes that this Committee can make a tremendous contribution by

demonstrating how thoughtful legislators can sort through the complexities involved

and develop truly workable provisions to the extent that additional legislation is

needed as part of the overall solution.

How Best Can Abusive Lending Problems Be Addressed?

Although NHEMA does not believe that abusive or predatory practices are pervasive in the subprime mortgage sector, and we know that some alleged problems are

not necessarily real abuses, we recognize that there are legitimate areas of concern.

For example, ‘‘loan flipping,’’ which involves repeated refinancing of a mortgage in

a relatively brief period of time with little or no real economic benefit to the borrower, does occur to some degree, and it should be stopped. Likewise, far too many

borrowers are victims of home improvement lending scams. Others are required to

pay excessive loan origination fees to mortgage brokers or loan officers. Industry,

regulators and legislators must work together to find effective ways to stop such

abuses. In doing so, however, we must be very careful not to overreact and adopt

inappropriate restrictions that raise the cost of subprime mortgage credit, or curtail

credit availability to those who need it.

As mentioned earlier in our testimony, NHEMA believes that a multitrack strategy must be taken to deal with these questions:

(1) Greater Enforcement of Existing Laws and Regulations—A substantial

portion of predatory lending abuses involve fraud and deception that are clearly

already illegal. In many cases it also appears that some unscrupulous mortgage

brokers and lenders are disregarding current laws such as the Real Estate Settlement Procedures Act (RESPA), the Home Ownership Equity Protection Act

(HOEPA), the Equal Credit Opportunity Act (ECOA), and the Federal Trade

Commission Act, which prohibits unfair and deceptive practices. First, and foremost, we feel that these laws, and related regulations, need to be enforced more

vigorously. Many abuses could be handled quite effectively by better enforcement. The FTC has already brought a number of enforcement actions involving

most of the recognized predatory lending practices under the existing HOEPA

and the FTC Act, and has obtained a handful of settlements. Obviously, the

FTC already has broad authority in this area. We hope that the FTC will do

much more to enforce these current laws to curtail abuses. In addition, the Federal Reserve Board (FRB) is now in the process of issuing enhanced HOEPA

regulations. NHEMA has provided information and comments to these and

other regulatory bodies and will continue to work with regulators to help control

abuses. NHEMA urges this Committee and the Congress generally to support

making whatever additional appropriations are reasonably necessary to help

Federal agencies enforce the current laws and regulations more effectively. In

addition, we encourage the agencies to request additional funds if they need

them. It also is very important to remember that States have various laws and

regulations that apply to many of the questionable practices. State regulatory

officials and State legislators need to consider how existing State laws and regulations can be better enforced to prevent abusive lending practices.

(2) Consumer Education—Helping Consumers to ‘‘BorrowSmart’’—Obviously,

a key element of the problem is that some borrowers, especially lower-income,

less-educated people, do not understand their mortgage loan terms. NHEMA’s

number one priority is supporting the consumer’s right of free and fair access

to affordably priced credit. That priority is served by NHEMA’s support of consumer education initiatives. Educated consumers are good borrowers. They

know how to avoid unethical and abusive lending practices. They know how to

get the loan terms that work best for them. And they know how to manage their

money wisely and avoid running up new debt after taking out a home equity

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4 Additional information concerning our BorrowSmart program and educational materials is

contained in Appendix A. Held in Senate Banking Committee files. 5 Appendix B to this testimony contains a copy of NHEMA’s Code of Ethics and our various

industry Guidelines. Held in Senate Banking Committee files.

loan. To educate consumers, NHEMA created and supports the BorrowSmart

Public Education Foundation,4 a separate organization, which is undertaking a

number of education initiatives:

BorrowSmart.org. This website will show consumers how the home equity

lending process works, offer tips for avoiding abusive practices, provide borrowers with resources they can turn to if they think they have been a victim of fraud of misrepresentation, educate borrowers about their rights and

responsibilities and offer other valuable information.

Consumer Education Materials and Cooperation with Consumer

Groups—NHEMA has produced consumer brochures for distribution by our

member institutions to inform and educate borrowers about the loan process, and the importance of smart money management. We have distributed

CD-ROM’s with consumer education materials to all our members so they

can easily reproduce and distribute them to their customers. NHEMA also

has worked to build education partnerships with consumer groups. For example, we have published a joint brochure with the Consumer Federation

of America about the importance of keeping credit card debt in check after

taking out a home equity loan to consolidate debt. The BorrowSmart Foundation is now taking over producing such educational materials and in

working cooperatively with consumer groups.

In addition, NHEMA conferences, seminars, and publications encourage association members to keep borrowers educated and informed. Our goal is to keep

home equity loans available as a financial resource for all homeowners, while

ensuring that every borrower understands how to use that resource wisely and

effectively.

(3) Voluntary Actions—NHEMA has recognized that there is much that industry can do voluntarily to help raise industry standards and ensure that

subprime mortgage lenders follow proper practices. We have taken a proactive

posture in this area. In 1998, NHEMA adopted a new, enhanced Code of Ethics

to which our members subscribe. We also have adopted new Home Improvement

Lending Guidelines (1998) and Credit Reporting Guidelines (2000). Last year,

we adopted a particularly significant measure—new comprehensive Fair Lending and Best Practices Guidelines. These guidelines were the product of months

of study and analysis, and reflect input from a broad cross-section of our membership. We believe that these guidelines will be very helpful in improving overall industry lending standards and practices. The guidelines provide a useful

baseline of what generally should be considered to be appropriate lending practices and procedures.5

(4) Comprehensive Legislative & Regulatory Reforms—NHEMA was an active

participant in the so-called Mortgage Reform Working Group (MRWG), which

began in the spring of 1997 and continued to 1999. This group came together

at the urging of key Congressional leaders who wanted industry and consumer

groups to try to reach consensus on how the mortgage lending process might

be reformed. Participants spent literally thousands of hours considering how

mortgage lending might be improved. MRWG participants included basically all

relevant national trade organizations and many consumer groups. Representatives from HUD, the FTC, and FRB participated in many of the sessions. Most

MRWG participants agreed that there were various problems with the present

statutory and regulatory structure as it applies to both prime and subprime

mortgage lending. One of the biggest problems identified was that current laws

and regulations are overly complex and often very confusing for both borrowers

and lenders. This makes it very difficult for many consumers to understand

what is occurring and to make proper shopping comparisons. It also poses a

host of compliance burdens and uncertainties for lenders and mortgage brokers.

A number of the participants, including NHEMA, put forth various reform concepts for discussion by the group, but no consensus was reached, and the process essentially ended without any resolution of the issues. Part of the reason

that legislative reforms could not be agreed upon was, and is, that these are

complex and difficult issues. For example, as noted earlier in my testimony,

many of the loan terms that some parties object to are not necessarily abusive,

and it is difficult to craft restrictions that do not do more harm than good. In

any case, NHEMA believes that comprehensive reforms of current RESPA and

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6 NHEMA’s 1997 comprehensive outline of proposed legislative reforms is attached as Appendix C. Held in Senate Banking Committee files. 7 NHEMA’s staff developed and widely circulated a working draft of a possible model targeted

legislative proposal in 1999, a copy of which is attached as Appendix D. Held in Senate Banking

Committee files.

TILA mortgage lending provisions should be seriously considered by Congress,

and especially by this Committee. We are certain that changes can be made to

encourage more informed comparison-shopping for home equity loans. Moreover,

we believe that Federal regulators can use their existing authorities to make

significant improvements. In addition to the FRB’s ongoing work regarding

additional HOEPA regulations, we want to point out that HUD has authority

to simplify and clarify many relevant policies and regulatory provisions. We

urge this Committee to encourage HUD officials to utilize such authority, particularly as it relates to reducing some of RESPA’s burdensome and confusing

provisions.

(5) Carefully Crafted Legislation Targeted At Specific Abuses—NHEMA originally proposed new legislative safeguards to protect against particular abuses,

such as loan flipping, as a part of its 1997 comprehensive legislative reform proposals.6 We subsequently recognized that it might be easier to address many

of these concerns in a narrower bill focused on particular practices.7 NHEMA

has long said that new legislative safeguards appear to be merited in some

cases. On the other hand, we have long voiced serious concern that many of the

proposals put forward by legislators have been overly broad and would prohibit

or unduly restrict perfectly legitimate lending practices while attempting to

limit perceived abuses. The old saying that ‘‘the devil is in the details’’ is perhaps no place so appropriate as in the context of legislation intended to protect

against predatory mortgage lending practices. We implore this Committee to be

certain that any legislative proposals you may ultimately put forth have been

carefully vetted to ensure that they are clear and do not have the unintended

effect of curtailing legitimate lending practices instead of being targeted to stop

only the abusive ones.

Ten Key Issues for the Committee’s Consideration

Given our ongoing efforts to stop abusive lending practices and our knowledge of

the subprime marketplace, we believe it is helpful to highlight 10 key questions and

considerations that Congress may wish to explore as you grapple with predatory

lending concerns:

(1) What loans should be made subject to special protections? The present

regulatory approach contained in the so-called HOEPA provisions of the Truth

In Lending Act, essentially targets only the most costly loans made to higher

risk borrowers. Under HOEPA, loans that have a rate that is more than 10 percent over a comparable Treasury bill rate, or that have certain loan fees and

closing costs that exceed 8 percent of the loan amount or a minimum dollar

amount, are subject to special protections. These enhanced safeguards include

special disclosures and some specific substantive restrictions (for example, no

balloons less than 5 years in duration). Typically, most legislative proposals

to address predatory lending, including that put forth earlier by Chairman Sarbanes, have proposed lowering the levels of both the rate and the point/fee triggers. In addition, proposals generally would change the definition of what items

must be included in calculating the point/fee trigger amount. The effect of this

computational change is to cause a dramatic increase in the number of loans

that hit this second trigger level. NHEMA recognizes that Congress might conclude that some modest trigger reductions may be appropriate. However, we see

no justification for sweeping in essentially all subprime loans (and many prime

ones) as is frequently suggested in legislative proposals. Many lenders will not

make HOEPA loans, which unfortunately have developed a very negative stigma, due to the very real reputational and legal risks involved. We fear that any

significant expansion HOEPA’s coverage will result in many lenders withdrawing from offering covered products and this will have a very negative impact on credit costs and availability. Moreover, we believe that abuses tend to

be concentrated primarily in the highest risk grades which is where legislation

should be targeted.

(2) How might ‘‘loan flipping’’ be prevented? Without question, ‘‘loan flipping,’’

which involves the frequent refinancing of a mortgage loan with the borrower

receiving no meaningful benefit and typically having to pay significant refinancing fees, is one area where abuse does exist and where existing laws do

not appear adequate to prevent it. Various approaches have been proposed to

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remedy this problem. Most suggestions have tended to apply special safeguards

when a loan is refinanced within 12 months or some other relatively brief time

period. The suggested restrictions include, for example: prohibiting or limiting

the amount of sales commissions (points) that can be charged; requiring that

the borrower receive a benefit from the refinancing; or allowing points to be

charged only to the extent they reflect new money actually advanced to the borrower. NHEMA feels that when considering this issue, legislators need to recognize that many borrowers’ views of what constitutes a benefit to them differs

from what some of the industry’s critics believe. Thus, most borrowers who obtain a loan for debt consolidation purposes consider it to be a very real and

often critically important benefit to be able to lower their monthly payment

even if they will have to pay more money over a longer period of time. Another

important point to note is that some of the tests that have been proposed (that

is, requiring a ‘‘net tangible benefit’’) are hopelessly vague and certain to foster

costly litigation. Legislators therefore need to develop simple, clear tests in any

new provisions.

(3) How should a provision be crafted to ensure a borrower’s repayment ability is properly considered before a loan is made? Lenders normally carefully review a borrower’s credit record and economic situation to ensure that the borrower can repay the loan. In some instances, however, lenders may make the

loan more on the basis of the value of the collateral property than on the borrower’s ability to repay without reference to the underlying asset. Such asset

based lending can lead to loan flipping and may eventually end in the borrower’s losing his or her home in foreclosure. HOEPA currently contains a provision that prohibits lenders from engaging in a pattern and practice of lending

without proper regard for repayment ability. If the Committee revises present

law by removing the pattern and practice requirement, we urge that it do so

in a simple and straightforward manner. Traditionally, many lenders have employed a 55 percent debt to income test, but if any such test is embodied in statute, it is important to make it clear that no presumption of a violation arises

merely because such a test is not met. We also do not believe that it is necessary to try to employ some complex formula regarding residual income as

some have suggested.

(4) How should single-premium credit insurance be treated? Some lenders

have offered customers various credit insurance products that are sold on a single-premium basis where the cost is typically assessed at the time of loan closing and this cost is financed along with other closing costs. While those who

sell such credit insurance generally have defended it as a valuable, fairly priced

product, many consumer advocates strongly attack such single-premium products. Recently several major lenders have announced that they are ceasing to

offer such single pay products. Some have suggested that the continued sale of

single-premium insurance should be allowed, provided certain safeguards are

met such as: requiring that the borrower be offered a choice of a monthly pay

policy instead of a single pay product; requiring additional special disclosure notices relating to the product; and giving the borrower a right to cancel with a

full refund for some period of time and thereafter the right to cancel with a refund based on an actuarial accounting method. Many companies believe that if

additional restrictions are adopted they should, at a minimum, allow for the

sale on credit insurance on a monthly pay basis.

(5) How might safeguards be crafted to ensure certain legitimate loan terms

are not misused? Many predatory lending proposals would prohibit or severely

restrict certain loan terms. Some of these terms, such as prepayment penalties,

are not necessarily unfair or inappropriate. Quite to the contrary, some such

terms are most often beneficial to the borrower. Therefore, it is critically important that any new limitations on loan terms be drafted so that legitimate

uses of the terms are not prohibited. For example, prepayment penalties can

be structured so that the borrower must be given a choice of a loan product with

and without a penalty, and the amount of the penalty and the length of

time it can apply also can be limited. By applying such balanced and carefully

drafted provisions, the consumer can generally gain the significant benefit of

lower rates by accepting a penalty provision, while the lender can be protected

against loss of expected revenue on which the loan pricing is based. Certain

other terms, like balloon payments, could be addressed with similar carefully

crafted safeguards. Balloon mortgage payments usually are very helpful for consumers who need lower initial monthly payments for a period of time and who

reasonably expect to have higher income to meet higher obligations later. A balloon provision allows many first-time homebuyers to acquire their home. There

is nothing inherently wrong with using a balloon payment. On the other hand,

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8 Although this list is limited as a matter of priority and convenience to 10 items, certain other

issues merit the Committee’s consideration. For example, industry today typically already reports mortgage payment history data to credit bureaus. NHEMA thus supports requiring lenders to provide such data periodically to the major national consumer reporting agencies. We also

have no problem with providing for a modest increase in penalties for violations of an amended

HOEPA, but believe provisions should be added to allow lenders to correct unintentional errors.

Another concern that the Committee might consider is the question of liability of secondary market participants. It is extremely difficult, and usually practically impossible, for secondary market participants to know if an abuse has occurred unless it happens to be evident on the face

of the loan documents, which is rarely the case. An additional issue relates to the degree to

which brokers’ roles and compensation should be disclosed, and whether better licensing requirements are needed.

an abusive mortgage originator can structure a mortgage with a balloon payment that some consumers can never expect to be able to meet. This could force

the borrower to refinance one or more times, having the equity stripped out of

his or her home, and ultimately being forced to sell the home, or face foreclosure. By contrast, still others, such as call provisions or accelerating interest

upon default, might be appropriately prohibited outright.

(6) Should restrictions be imposed on subprime borrowers’ rights to finance

loan closing costs? Mortgage loan closing costs are usually substantial, amounting to several thousand dollars, and many borrowers, especially those in the

subprime segment, do not have extra cash readily available to pay such costs.

Borrowers therefore generally finance the closing costs and the amount of such

costs are rolled into the loan and paid off over an extended period of time. Some

parties who have sought to curtail subprime lending have proposed denying consumers’ the right to finance their closing costs. NHEMA strongly objects to this

unwarranted restriction. Subprime borrowers would be seriously harmed by

such discriminatory treatment. Borrowers would have to obtain money to pay

closing costs by borrowing from more expensive unsecured sources, or in some

cases could not obtain the funds needed to close the loan.

(7) Are more special disclosures needed? Some have suggested adding to the

disclosures that currently apply to HOEPA loans. NHEMA basically has no objection to enhancing some present disclosures. However, we do have concerns

about continuing to flood the consumer with confusing, lengthy notices that

most parties do not read, and would not understand if they did. Again, care

must be taken in crafting any further notices (for example, special foreclosure warnings) to ensure that they are clear, simple, and actually helpful to

borrowers.

(8) Can home improvement lending scams be prevented? It is well recognized

that a great amount of the abuse in the subprime marketplace comes from

home improvement lending scams. Vulnerable borrowers are suckered into loan

transactions relating to home repairs and other improvements that are never

made, or if made are not completed properly. HOEPA requires that home improvement loan disbursements must be made by checks that are payable to both

the borrower and the contractor, or at the borrower’s option to a third party escrow agent. NHEMA has also issued voluntary guidelines in this area. We urge

the Committee to investigate whether there may be other viable restrictions

that should be applied to prevent abuses in the home improvement area.

(9) Should customers be forced to submit to mandatory credit counseling?

Some parties argue that all subprime customers should be required to submit

to counseling sessions with a professional credit counselor. Although NHEMA

strongly supports making counselors available to all customers and encouraging

borrowers voluntarily to consider meeting both with a counselor, we do not support mandatory counseling in the case of all subprime loans. Mandatory counseling clearly is not necessary for most customers, and many would find it offensive to have to submit to counseling. Moreover, in many areas there is a serious

shortage of qualified counselors, so such a requirement would unduly delay the

loan process.

(10) What must be done to achieve more uniform nationwide rules against

abusive practices? 8 Last, but certainly not least, is the issue of Federal preemption. For most of NHEMA’s members, the single biggest concern over predatory

lending legislation arises because of the dozens of differing proposals that are

constantly being put forth at the State and local levels. This year, we already

have differing bills in thirty-odd jurisdictions. We believe that it is critical that

Congress recognize that in today’s nationwide credit markets, a uniform Federal

standard is needed for addressing predatory lending concerns. Compliance with

scores of differing State and local rules in this area is impractical and unduly

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burdensome. Federal preemption of differing State and local predatory lending

measures is badly needed.

Mr. Chairman, these are difficult and complex issues. NHEMA trusts that this

Committee and your House counterpart will give them very careful consideration,

and we want to continue working in good faith with you to explore further how to

stop abusive lending and related concerns. During this process, we encourage everyone to remember that the democratization of the credit markets that subprime

mortgage lenders have helped achieve would be seriously undercut by most of the

pending legislative proposals which are well-intended, but which have serious, unintended adverse consequences for needy borrowers. Ultimately, we hope that agreement can be reached on a package of reforms that will include workable provisions

targeted to prevent particular abuses, together with some simplification and streamlining of current disclosure requirements and preemption of conflicting State and

local laws.

Thank you for this opportunity to present NHEMA’s views.

(241)

PREDATORY MORTGAGE LENDING:

THE PROBLEM, IMPACT, AND RESPONSES

FRIDAY, JULY 27, 2001

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC.

The Committee met at 10:08 a.m., in room SD–538 of the Dirksen Senate Office Building, Senator Paul S. Sarbanes (Chairman of

the Committee) presiding.

OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

Chairman SARBANES. The Committee will come to order.

Today is the Senate Banking, Housing, and Urban Affairs Committee’s second day of hearings on predatory lending—the problem,

impact and responses.

Yesterday, we heard some very eloquent statements of the problem from four Americans who worked all their lives to attain the

dream of homeownership, to build up a little wealth, only to have

it slowly, piece by piece, loan by loan, taken away from them.

These people were targeted by unscrupulous lenders, often elderly

homeowners who have a lot of equity in their homes.

In the case of one lady from West Virginia, Ms. Podelco, she actually took the proceeds of the insurance policy on her husband’s

life, $19,000, and paid off the mortgage on her home. She had the

home free and clear, in a way a prudent thing to do, although I

guess a lot of smart financial people would have said, no, you

should have kept the mortgage and invested the money.

But that is, I believe, a standard way of thinking for lower income people. They get their home, it is free and clear, it is theirs.

There is nothing owed on it, and then they started approaching her

and soliciting her. She had some debts and she wanted to do some

improvements on the home. She took out a loan. Then they came

along, they refinanced that loan, and then they refinanced that

loan. And every time they did it, they packed in the fees and the

charges and everything. Her loan obligation rose and, in the end,

in just a few years, she lost her home. That is what we are trying

to get at. She was refinanced six times in about a 2 years period.

What struck me about these four stories were that many of the

practices that harmed the witnesses are legal under existing law.

There have also been abuses that are not legal and, of course, I

strongly support action by regulators to use their authority under

existing law to expand protections against predatory lending. I support stronger enforcement of current protections by the Federal

242

Trade Commission and others. I applaud campaigns to increase financial literacy.

I want to particularly acknowledge Senator Corzine’s leadership

in this effort. Chairman Greenspan actually gave a speech just on

this issue, and I am hopeful that we will be able to help to put together with the industry, and with the regulators, and with people

sitting at this table and others, a good program of financial literacy. I do not think that this alone is the solution to this problem.

I also encourage and welcome industry’s effort to establish best

practices. There have been a number of important developments in

that regard, and we certainly encourage others to follow along.

I think those who take the position that stronger regulatory and/

or more aggressive enforcement of existing laws will be adequate,

have a special burden to carry, particularly in light of yesterday’s

testimony, to make sure that regulatory and enforcement tools are

adequate to the job.

At a minimum, at the very beginning, I think they should be

supporting the Federal Reserve Board’s proposed regulation on

HOEPA, as Ameriquest, who was here yesterday, has done, and

now as some other financial institutions have undertaken to do. We

need to support the Fed’s effort to gather additional information

through an expanded HMDA, and the regulatory enforcement and

enforcement agencies, such as the FTC, the Treasury, and HUD, in

their recommendations for more effective enforcement.

But, as I said, I do not think stronger enforcement, literacy campaigns, best practices alone are enough. Too many of the practices

that we heard about in yesterday’s testimony, while extremely

harmful and abusive, are legal. And while we must pursue aggressively financial education, we need to recognize that takes time to

be effective, and thousands of people are being hurt every day.

I would like to quote what Fed Governor Roger Ferguson said in

his confirmation hearing, ‘‘Legislation, careful regulation, and education are all components of the response to these emerging consumer concerns.’’ I subscribe to that view.

Before turning to my colleagues who have joined us for their

opening statements, and to the witnesses, I just want to take a moment to explain the arrangements here this morning. First of all,

we had far more requests to testify than we really could accommodate. A number of groups and organizations and companies asked

to come in—the Center for Community Change, the Neighborhood

Assistance Corporation of America, the National People’s Action,

Neighborhood Housing Services, the National Neighborhood Housing Network, the Greenlining Institute, America’s Community

Bankers, Assurant Credit Insurance Company, Consumer Bankers

Association, Consumer Credit Insurance Association, the Realtors,

and so forth.

We obviously could not accommodate everyone. I believe that is

apparent by the current crowded witness table. We have offered to

include statements from all of these groups who wish to submit

them in the record, as well as other organizations. As we continue

to explore and examine this issue, we may have other opportunities

for people to come in and actually appear and to testify. I want to

explain to our witnesses, we had considered doing two panels. But

it is a Friday. Members have a lot of pressure on them at the end

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of the week, including the necessity to get back to their States. We

decided that we would just put everyone at the table at the same

time. We have tried to mix you up a bit so you get to know people

maybe you have not met before.

[Laughter.]

We will encourage some dialogue at the table as a consequence.

You have submitted very thoughtful statements. We appreciate

that. The full statements will be included in the record. If each person could take about 5 minutes to summarize and make their

major points, we will go through the panel and then we will have

a question period. Often what happens, there are a fair number of

people around for the first panel. And by the time you get to the

second panel, a lot of people have left.

If we do it this way, I hope it will work out. I know it is somewhat crowded at the witness table and I apologize to you for that,

but I believe this will work out.

With that, I am going to yield to Senator Miller for any opening

statement he may have.

COMMENT OF SENATOR ZELL MILLER

Senator MILLER. I do not have an opening statement, Mr. Chairman but, again, I thank you for holding these hearings and again,

welcome to these witnesses.

We look forward to your testimony.

Chairman SARBANES. Thank you. Senator Stabenow.

COMMENTS OF SENATOR DEBBIE STABENOW

Senator STABENOW. Well, thank you, Mr. Chairman. And again,

thank you for holding this important hearing. I think yesterday

was a very important and moving opportunity to hear from witnesses directly about their experiences.

I will submit a full statement for the record. I just want to welcome all of the panelists. I see a lot of familiar faces. I want to particularly recognize Tess Canja, who hails from my hometown in

Lansing, Michigan. Before she was the esteemed head of the

AARP, we actually started together—I will not say the date—in

working on issues related to seniors and an effort to save a nursing

home in Lansing, Michigan, which got me into politics.

We now both find ourselves here in Washington focusing again

on seniors and important issues. So welcome, Tess. And to all of

the esteemed panelists, I look forward to hearing from all of you

about what I think is an incredibly important topic, and I hope

that we will have the opportunity to move in a way that makes

sense to really address these issues.

Chairman SARBANES. Well, we will consider giving Ms. Canja a

couple of extra minutes so that she can tell us about Senator

Stabenow in her earlier years, yes.

[Laughter.]

Senator STABENOW. That is all right, Mr. Chairman.

[Laughter.]

Senator CORZINE. You ought to put her under oath on that.

[Laughter.]

Chairman SARBANES. Senator Corzine.

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STATEMENT OF SENATOR JON S. CORZINE

Senator CORZINE. Senator Sarbanes, Mr. Chairman, you know

how strongly I feel about this issue. The literacy initiatives are one

step, and enforcement certainly is. And as you talked about, some

element of legislative action I think is necessary.

The stories we heard yesterday, which we must acknowledge are

anecdotal, I think are indicative of a serious market problem that

we have. And it is something that I hope we can try to cut down

to the key elements so that we can be as precise as possible.

It is a difficult issue to define, but it is clearly a problem. And

I thank all of the witnesses here. We should have sold admission

and we would have had all of our budget taken care of for years.

[Laughter.]

Thank you all very much for being here.

Chairman SARBANES. I will introduce the panelists one by one

as we turn to you to speak, instead of taking the time to introduce

everyone right at the outset.

Our first panelist will be Wade Henderson, who is the Executive

Director of the Leadership Conference on Civil Rights, the Nation’s

oldest, largest, and most diverse coalition of organizations committed to the protection of civil rights in the United States.

The Leadership Conference on Civil Rights has played an active

role in increasing awareness of predatory lending practices and its

impact on the civil rights community.

We have interacted with Mr. Henderson on many issues that are

on the agenda of this Committee and we always appreciate his very

positive and constructive contributions.

Wade, we would be happy to hear from you.

STATEMENT OF WADE HENDERSON

EXECUTIVE DIRECTOR, LEADERSHIP CONFERENCE

ON CIVIL RIGHTS

Mr. HENDERSON. Well, thank you, Mr. Chairman, and good

morning to the Members of the Committee. I am pleased to appear

before you today on behalf of the Leadership Conference to discuss

this very pressing issue of predatory mortgage lending in America.

Some may wonder why the issue of predatory lending raises civil

rights issues. But I think the answer is quite clear. Shelter, of

course, is a basic human need—and homeownership is a basic key

to financial viability. While more Americans own their homes today

than at any time in our history, minorities and others who historically have been underserved by the lending industry still suffer

from a significant homeownership gap.

Unequal homeownership rates cause disparities in wealth, since

renters have significantly less wealth than homeowners at the

same income level. To address wealth disparities in the United

States and to make opportunities more widespread, it is clear that

homeownership rates of minority and low income families must

rise. Increasing homeownership opportunities for these populations

is, therefore, central to the civil rights agenda of this country.

Increasingly, however, hard-earned wealth accumulated through

owning a home is at significant risk for many Americans. The past

several years have witnessed a dramatic rise in harmful home

equity lending practices that stripped equity from families homes

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and wealth from their communities. These predatory lending practices include a broad range of strategies that can target and disproportionately affect vulnerable populations, particularly minority

and low income borrowers, female single-headed households, and

the elderly. These practices too often lead minority families to foreclosure and leave minority neighborhoods in ruin.

Today, predatory lending is one of the greatest threats to families working to achieve financial security. These tactics call for an

immediate response to weed out those who engage in or facilitate

predatory practices, while allowing legitimate, responsible lenders

to continue to provide necessary credit.

As the Committee is aware, however, subprime lending is not

synonymous with predatory lending. And I would ask each of you

to remain mindful of the need for legitimate subprime lending in

the market.

Some have suggested, for example, that subprime lending is unnecessary. They contend that if an individual does not have good

credit, then the individual should not borrow more money. But as

we all know, life is never that simple. Even hard working, good

people can have impaired credit, and even individuals with impaired credit have financial needs. They should not be doomed to

a financial caste system, one that both stigmatizes and permanently defines their financial status as less than ideal.

Until a decade ago, consumers with blemishes on their credit

record faced little hope of finding a new mortgage or refinancing

an existing one at a reasonable rate. And therefore, without legitimate subprime loans, those experiencing temporary financial difficulties could lose their homes and even sink further into red ink

or even bankruptcy.

Moreover, too many communities continue to be left behind despite the record economic boom. Many communities were redlined

when the Nation’s leading financial institutions either ignored or

abandoned inner city and rural neighborhoods. And regrettably, as

I mentioned earlier, predators began filling that void—the payday

loan sharks, the check-cashing outlets, and the infamous finance

companies.

Clearly, there is a need for better access to credit at reasonable

rates and legitimate subprime lending serves this market. I feel

strongly that legitimate subprime lending must continue, and

therefore, we hope that we will not go back to the days when inner

city residents had to flee from finance companies and others who

preyed on them.

At the outset, I want to recognize that many persons and organizations have really helped to advance this debate. Yesterday, you

heard from Martin Eakes of Self-Help, who is one of the leaders in

this effort. Maude Hurd, the President of ACORN and her colleagues, have done a tremendous job. The Nation Community Reinvestment Coalition and others have helped to promote the idea of

best practices and encourage the industry to sit at the table. But

in truth, they need help. It is simply not enough.

Recent investigations by Federal and State regulatory enforcement agencies, as you stated, Mr. Chairman, document that lending abuses are both widespread and increasing in number. You

mentioned the Federal Trade Commission and the good work they

246

have done. We should also acknowledge the States attorneys general who have taken out after these practices and tried to address

them in a significant way, and we encourage the regulators to do

more than they have done.

You have talked about the important work of the Fed. You talked

about the need for additional data under HMDA. All of those

things are necessary. But even if we got all of that, they would still

be insufficient.

Over 30 State and local efforts are currently pending and as

many as a dozen or more have recently been enacted to address

these problems. In my testimony, I list nine States and local jurisdictions that have addressed these issues and I lay out the kinds

of steps that they have taken which I think are significant, but,

again, inadequate.

Notwithstanding that States have tried to fill the void, we believe that more is needed and that the truth is State legislation

under the current scheme is primarily inadequate.

First, State legislation may not be sufficiently comprehensive to

reach the full range of objectionable practices. And you mentioned

that some of them are still legal on the books today.

For example, while some State and local initiatives impose restrictions on single-premium credit life insurance, others do not.

This, of course, leaves gaps in protection even for citizens in some

States that have enacted legislation.

Second, while measures have been enacted in some States, the

majority of States have not enacted predatory lending legislation.

And for this reason, the Leadership Conference supports the enactment of comprehensive Federal legislation, of the sort, Mr. Chairman, that you have introduced here in the Senate.

The Predatory Lending Consumer Protection Act is the standard

that we think is necessary. We strongly support it and we urge its

swift enactment. Now one last point.

We have made efforts to address these issues on a voluntary

basis. We know that the industry is deeply concerned about the

problems of predatory lending and they want to disassociate themselves from practices that would mark them as predatory.

So for those good lenders, we have made efforts to work with

them voluntarily and believing that there may have been an opportunity for voluntary responses to these issues, several national

leaders within the prime and subprime lending industry, also with

the secondary market, join civil rights and housing and community

advocates and attempted under the auspices of the Leadership

Conference to synthesize a common set of best practices and selfpolicies guidelines.

We achieved a lot of consensus on many issues. However, the

truth is, in the end, we failed to get consensus on some of the most

difficult issues which are now being discussed and being addressed

today, like credit life insurance.

And one of the reasons that we failed to get that consensus is

because many in the industry believe they could be insulated politically from any mandatory compliance with Federal legislation.

They were not fearful that the Congress would enact a bill of a

comprehensive nature and therefore, they were unwilling to grapple with their own practices, even though they knew they were

247

questionable and created hardship on many communities. As a result, our view is that only Federal legislation will be sufficient.

I am going to end my testimony where I began—why subprime

lending? Why is its evil twin, predatory lending, a civil rights

issue? The answer can be found in America’s ongoing search for

equal opportunity. After many years of difficult and sometimes

bloody struggle, our Nation and the first generation of America’s

civil rights movement ended segregation. But our work is far from

over. Today’s struggle involves equal opportunity for all and making that a reality. Predatory lending is a cancer on the financial

health of our communities and it must be stopped.

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you very much. You made reference

to the State attorneys general and I should just note that we had

Tom Miller, the Attorney General for the State of Iowa, here with

us yesterday. He heads up the attorney general’s special task force

on predatory lending and gave some very strong testimony.

Two-thirds of the States’ attorneys general have interceded with

the Federal Reserve in support of the regulation which the Federal

Reserve now has under consideration with respect to this issue.

Next, we will hear from Ms. Judy Kennedy, the President of the

National Association of Affordable Housing Lenders.

I ought to note that over the past 11 years, the NAAHL has

worked quite successfully to infuse private capital investment into

low- and moderate-income communities by pioneering a number of

innovative community investment practices.

Ms. Kennedy, we are pleased to have you here.

STATEMENT OF JUDITH A. KENNEDY

PRESIDENT, NATIONAL ASSOCIATION OF

AFFORDABLE HOUSING LENDERS

Ms. KENNEDY. Thank you, Senator. I am delighted to be here.

As you pointed out, NAAHL’s members are a cross-section of the

pioneers of community investment—banks, loan consortia, financial

intermediaries, pension funds, foundations, local and national nonprofit providers, public agencies, and allied professionals.

In 1999, we held a conference in Chicago where Gail Cincada and

others informed us about predators’ activities in that city. We came

to the conclusion then that if NAAHL is not part of the solution

to predatory lending, we will be part of the problem. It is clear that

while we are committed to increasing the flow of capital into underserved communities, we must be equally concerned about access to

capital on appropriate terms.

So in March of this year, we sponsored a symposium that

brought together experts on this issue—regulators, researchers, advocates, for-profit and nonprofit lenders, and secondary market

participants. We are issuing today that report and I hope you have

it before you—Juntos Podemos, Together We Can.

Our goal was to accelerate progress in stopping the victimization.

As the Mayor of Chicago succinctly puts it, ‘‘It is all down the drain

if we cannot stabilize the communities that were stable until these

foreclosures started to happen.’’

Our findings are as follows, first, you can profile predatory lending. It is clear.

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Second, more needs to be done at the Federal level. More, of

course, is being done this year, in part, thanks to your attention,

Senator Sarbanes. But as Elizabeth McCaul, the New York State

Banking Commissioner, and you have emphasized, it is critical to

balance the need for credit with the need to end abuses. NAAHL

members have a history of tailoring credit to the unique needs of

low income households in underserved communities. But as the

Federal Reserve has pointed out, a significant amount of mortgage

lending is not covered by a Federal framework. For example, Governor Gramlich reported that only about 30 percent of all subprime

loans are made by depository institutions that have periodic exams.

Some estimate that as low as 15 percent of originators of subprime

loans have any reporting and examination. Even if the Fed were

to do periodic compliance exams of the subsidiaries of financial

holding companies, that would only increase the number to, at

best, 40 percent.

It is not surprising, then, that of the 21 completed Federal Trade

Commission investigations into fair lending and consumer compliance violations, none were Federally examined. If the Fed’s recent

proposal to expand reporting under the Home Mortgage Disclosure

Act to more lenders is adopted, it will still encompass only those

whose mortgage lending exceeds $50 million per year. Many of the

other proposed changes to HMDA that the Fed proposes which we

supported will simply make the playing field even less level by putting additional burdens and costs on the responsible lenders while

the worst lenders go unexamined.

To stop the predators, the symposium confirmed, we need to

close the bar doors on examination and reporting of mortgages in

America. A level playing field in enforcement and reporting is key.

Right now, the institutions that you talk about that have best practices in the subprime lending market do extensive due diligence of

their brokers to ensure fair lending practices. They maintain data

on those loans. They are rigorously examined by the bank regulatory agencies. But the majority of lenders in this market are not

subject to regulatory oversight, do not have the same level of compliance management, and often do not even file HMDA reports. In

a town with no sheriff, the bandits are in charge. Unscrupulous

brokers who are rejected by legitimate lenders simply go to others

who have no knowledge of the loan terms or reputation or compliance concerns about funding predatory loans.

Third, our symposium also confirmed that subprime lending is an

important source of home finance, and I think we agree on that.

Fourth, we heard that vigorous enforcement at all levels of Government works. We heard from people actively involved in combatting predatory lending on the State and local level and we think

all of this will help to eradicate predatory lending.

Fifth, consumer education is key. We know that many initiatives

in the last year, some as a result of your attention and some that

preceded that, are making a difference. But increased Federal resources for targeted counseling in neighborhoods vulnerable to

predators could greatly extend the efforts of the private sector. As

Martin Eakes points out, ‘‘. . . the Department of Education says

that 24 percent of adult Americans are illiterate.’’ But targeted

counseling could go a long way.

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Overall, our symposium confirmed once again that it is a complex

issue requiring a multifaceted solution. But as our closing speaker,

HUD Secretary Martinez, pointed out—juntos podemos—together,

we can.

As president of an organization whose members have spent their

careers trying to increase the flow of private capital into underserved communities, I say, together we must.

Chairman SARBANES. Thank you very much. I simply want to

note, I thought the symposium that you held out of which this report emanated was a very important contribution toward a deepening understanding of this issue.

Ms. KENNEDY. Thank you, Mr. Chairman.

Chairman SARBANES. I will now turn to Tess Canja, who is President of the Board of Directors of the American Association of Retired Persons, the AARP, which has for quite sometime now taken

a very strong campaign against predatory mortgage lending, which

disproportionately impacts seniors. Seniors are clearly, from some

of the statements that have been received from people who work

in the industry, a very heavily targeted group.

I might note that only yesterday, in Roll Call, the AARP, as part

of its campaign against predatory lending, had this ad—‘‘They

Didn’t Tell Me I Could Lose My Home.’’ And then it details here

being subjected to these pressure tactics and high-cost loans that

strip equity and then lead to foreclosure.

Ms. Canja, we would be happy to hear from you.

STATEMENT OF ESTHER ‘‘TESS’’ CANJA

PRESIDENT, AMERICAN ASSOCIATION OF RETIRED PERSONS

Ms. CANJA. Thank you, Senator, and good morning. Good morning to all of the Members of the Committee.

Thank you for showing that ad from Roll Call because we are involved in a very big educational campaign and that is exactly what

we are calling it—They Didn’t Tell Me I Would Lose My Home— which is exactly what happens with predatory lending.

AARP appreciates this opportunity to bring into greater focus

one of the most troubling forms of financial exploitation—namely,

making unjustifiable, high-cost home equity loans to older Americans. For most Americans, it takes time to accumulate home equity. For many, it is a working lifetime, so that equity become

highly correlated with age. The most abusive loans for older Americans are often refinancing loans and home modification loans because they target the equity value of the home. Equity in a home

is frequently the owner’s largest financial asset. Abusive lending is

particularly devastating when the older homeowner is living on a

modest or fixed income.

In AARP’s view, loans become predatory when they take advantage of a borrower’s inexperience, vulnerabilities, and/or lack of information; when they are priced at an interest rate and contain

fees that cannot be justified by credit risk; when they manipulate

a borrower to obtain a loan that the borrower cannot afford to

repay; and when they defraud the borrower.

Older homeowners are often targeted for mortgage refinancing

and home equity loans because they are more likely to live in older

homes in need of repair, are less likely to do the repairs themVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00259 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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selves, are likely to have substantial equity in their homes to draw

on, and they are likely to be living on a reduced or fixed income.

AARP’s efforts to address these problems are directed at improving credit market performance, not at limiting consumer access to

credit for those with a less-than-perfect credit history. We believe

that our, and other, consumer financial literacy campaigns are very

important. These public- and private-sector efforts aim to make

consumers their own first line of defense. However, while consumer

education and counseling programs are necessary, they certainly

are not enough.

AARP believes there is a need to strengthen and expand

HOEPA’s loan coverage. This upgrade will help to ensure that the

need for credit by subprime borrowers will be fulfilled more often

by loans that are subject to HOEPA’s protections against predatory

practices. In this context, AARP has urged the Federal Reserve

Board to issue the final HOEPA amendment as soon as possible.

Chairman Sarbanes, and Members of the Committee, the problems associated with abusive home-equity-related lending practices

are complex and to date, agreement on a comprehensive reform of

the more mortgage finance system to address these problems has

proven elusive. We are, therefore, encouraged by the Committee’s

continued efforts to call attention to predatory mortgage lending

and to establish effective deterrence. AARP is committed to working with this Committee, Congress, and the Bush Administration

to address the problems posed to the elderly by these devastating

lending practices.

We thank you, and I will try to answer any questions you may

have later.

Chairman SARBANES. Thank you very much. We appreciate your

testimony and we always appreciate working with AARP.

Our next witness will be John Courson, who is the President and

CEO of Central Pacific Mortgage Company in Folsom, California,

and the Vice President of the Mortgage Bankers Association of

America.

The Mortgage Bankers Association represents companies involved in real estate finance, including mortgage companies, mortgage brokers, and commercial banks. And this Committee deals

with a whole range of issues that encompass the concerns of the

Mortgage Bankers Association.

Mr. Courson, we are pleased to have you with us here today. We

look forward to hearing from you.

STATEMENT OF JOHN A. COURSON, VICE PRESIDENT

MORTGAGE BANKERS ASSOCIATION OF AMERICA

PRESIDENT AND CEO

CENTRAL PACIFIC MORTGAGE COMPANY

FOLSOM, CALIFORNIA

Mr. COURSON. Thank you. Good morning, Mr. Chairman, and

Members of the Committee. Let me begin by saying that the Mortgage Bankers Association and, indeed, all legitimate lenders, unequivocally oppose abusive and predatory lending practices. There

is no hiding from the fact, however, that certain rogue lenders continue to prey on our most vulnerable populations.

251

We all agree that a significant problem exists and we all share

in the responsibility to address the problem. In searching for answers, we should not focus on band-aids that merely cover up the

harms. Rather, we must work together to find lasting solutions

that will truly protect even the most vulnerable consumers.

I know from the outset that predatory lending is not a new problem. In fact, it has traditionally been referred to as mortgage fraud.

And I stress that those consumer laws that are currently on the

books—TILA, RESPA, HOEPA—are all aimed at curing problems

of fraud and abuses in lending. We must recognize that these laws

have existed for years and yet, predatory lending has managed to

survive. The fact that we are holding this hearing today should

wake us up to that reality.

MBA believes predatory lending is a problem that has a number

of sources. We believe there are three keys to effective and lasting

solutions. These are: enforcement, education and simplification.

First, MBA believes that a general lack of enforcement has done

much to create an environment for unscrupulous lenders to operate. Mortgage lending is among the most regulated of all activities.

It is subject to pervasive Federal and State regulation.

For these laws to be effective, they need to be enforced. We have

long held and reaffirm our belief here that predatory lenders gouge

the public through techniques that constitute outright fraud—concealment, forgery, deceptive practices, and nondisclosure. We would

note that these activities are against the law in every single State.

It is essential that we enforce these laws to the maximum extent

possible. Due to a current lack of enforcement, there are often no

consequences for those who engage in predatory lending and we

urge the allocation of additional resources for enforcement.

Second, we believe that consumer awareness and education are

among the most effective tools for combatting predatory lending

practices. Simply put, consumers who have an understanding of the

lending process and who are aware of counseling and other options

are far less likely to fall prey to unscrupulous lenders.

MBA is currently working on new programs designed to educate

consumers about the mortgage loan process. In particular, we are

developing interactive tools that will empower borrowers confronted with predatory lending practices. These tools will include

important information advice, provide typical warning signs of

predatory lending, and have direct links to State and Federal regulators that are able to assist possible victims of abusive lending.

And third, the complexity of the current mortgage process needs

to be addressed. We need to streamline and simplify the laws that

govern consumer disclosures and protections, RESPA and TILA.

Any consumer that has been through the mortgage process

knows how bewildering it is. No less than HUD Secretary Martinez, who is not only an attorney, but a housing attorney, has commented publicly that he was overwhelmed by the complexity of the

process that he went through when and his family bought a house

in Washington earlier this year.

Disclosures provided in the mortgage process are so cryptic and

so voluminous, that consumers do not understand what they read

or what they sign. This complexity is the very camouflage that alVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00261 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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lows unscrupulous operators to hide terms and conceal crucial information from unsuspecting consumers.

Partly because of his personal experience, Secretary Martinez

has made simplification and regulatory reform in this area a priority. I hope that Congress will also address this very important

piece of the predatory lending issue.

In summary, MBA believes that we must address predatory lending on three fronts—a commitment to full enforcement, robust education, and simplification of existing laws. Nothing short of that

will suffice.

Thank you for the opportunity to appear this morning and I look

forward to answering your questions.

Chairman SARBANES. Thank you very much, Mr. Courson. We

appreciate your coming.

We will now hear from Mr. Irv Ackelsberg, who is the managing

attorney at the Community Legal Services of Philadelphia. Mr.

Ackelsberg is recognized as one of the leading public interest lawyers in the country, and he has been involved, of course, in this

predatory lending issue.

He is testifying today not only on behalf of his own organization,

but also the National Consumer Law Center, Consumers Union,

Consumer Federation of America, National Association of Consumer Advocates, and U.S. Public Interest Research Group.

Mr. Ackelsberg, we would be happy to hear from you.

STATEMENT OF IRV ACKELSBERG

MANAGING ATTORNEY, COMMUNITY LEGAL SERVICES, INC.

TESTIFYING ON BEHALF OF

THE NATIONAL CONSUMER LAW CENTER

THE CONSUMER FEDERATION OF AMERICA

THE CONSUMER UNION

THE NATIONAL ASSOCIATION OF CONSUMER ADVOCTAES

U.S. PUBLIC INTEREST RESEARCH GROUP

Mr. ACKELSBERG. Chairman Sarbanes and Members of the Committee, thank you so much for this invitation. This is actually my

first time doing this, so I am really thrilled to be here.

Chairman SARBANES. We put you right in the middle, as it

turned out.

[Laughter.]

Mr. ACKELSBERG. Yes.

[Laughter.]

By way of personal introduction, I am a career legal services lawyer. I have spent my entire 25 years as a lawyer with Community

Legal Services of Philadelphia, primarily as a consumer law specialist. Because of the extremely high rate of homeownership

among low income communities in Philadelphia, most of the work

that I have done during the past 25 years has been associated with

protecting existing homeowners from loss of their homes.

The predatory lending crisis is so devastating and so widespread,

that we are currently using six lawyers who are working almost exclusively on defending predatory lending victims in Philadelphia

alone, and we cannot keep up with that demand. There is no question that we are expending more resources than any other legal

service program in the country on this problem, and we cannot

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keep up with it. We have just set up, with the cooperation of the

Philadelphia Bar Association, a special predatory lending panel by

which we will be training private lawyers and working with them

to teach them how to do this work.

I believe that our office has probably reviewed more of these

transactions than any other law firm in the country and it is from

the hundreds of stories of victims that I draw most of my experience. But I should also add that I have deposed countless loan officers, brokers, title clerks, and I was the principal trial counsel in

the first reported case under HOEPA, called Newton v. United

Companies Financial.

I also, by the way, served on the official creditors committee in

the United Companies Lending Chapter 11 proceeding. I believe

that I am uniquely qualified to speak to you about the nature of

the problem and the legislation needed to remedy the problem.

First, just to supplement the written testimony on the foreclosure

explosion that was referred to in the written testimony, just a few

bits of data from Philadelphia.

Pennsylvania has a State emergency mortgage assistance program that offers financial help to qualified homeowners facing foreclosures. These are all foreclosures other than FHA’s.

In data obtained from the State agency that administers this program, we found that in the year 2000, it received 740 applications

for help from borrowers facing foreclosure in Philadelphia. Of those

740 requests for help, 164, or 22 percent, involved threats of foreclosure from a single lender, EquiCredit, the subprime subsidiary

of Bank of America, which at the moment, according to what we

are seeing pouring into the office, is the biggest problem.

Just this week, we looked at the sheriff’s sale listings for the

month of August. Every month, there is a list of the sales. There

is a monthly sale in Philadelphia. Forty houses are being sold just

by EquiCredit in the City of Philadelphia in August. The undisputed explosion in foreclosure is indeed a reflection of the predatory lending crisis. All across our country, we have senior citizens,

our mothers, our grandmothers, who are anxious about their credit

card debt and bashful about talking about their finances. They are

lonely, and they are good, trusting people, all of which combine to

make them sitting ducks for a veritable parade of low-life lenders,

brokers, and contractors who are seeking to extract what often is

the only wealth that they have—their home.

There is a veritable gold rush going on in our neighborhoods and

the gold that is being mined is home equity. This bleeding of

wealth is not simply the result of market forces. As we describe in

our written testimony, there have been critical Federal policies that

have fueled the gold rush, particularly the first lien usury deregulation of the 1980’s and the changes in the tax code that limited

interest payment deductions to only home equity interest.

There are also Federal policies that have undermined the ability

of lawyers to defend victims, most notably the Federal Arbitration

Act, which has been interpreted by the courts to basically allow

wholesale waiver of borrower’s access to the courts, and I might

add, the restrictions in legal services, which have basically made

the work that I do virtually impossible for Legal Services CorporaVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00263 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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tion-funded programs. And for that reason, we had to give up our

funding from the Legal Services Corporation to do this work.

The existing HOEPA triggers are too high, particularly the

points and fees trigger currently at 8 points. This allows the predators to make costly loans just under those triggers. Indeed, we are

seeing 7 point loans, 7.9 points. We even saw one last week that

had exactly 8.0 of points.

But there is an upside to that fact. These loans used to have 10

to 15 points. That means that the basic structure of HOEPA is

sound. It is doing good work. It is already functioned to nudge

down the cost of credit. Remember that the same lenders who are

warning you today that if you bring down the triggers, credit will

dry up, said the same thing 7 years ago, that if you enacted

HOEPA, there will be no credit.

Subprime credit did not disappear. It just got less costly, and it

needs to get less costly still. I hope within the questioning period

I will have the opportunity to discuss some of the very specific aspects of S. 2415 which we believe will be very helpful to those of

us who are trying to save houses. And in summation, I would just

say, and I apologize if the words seem inappropriately too strong,

but these words come from 25 years of experience.

I believe that predatory lending is the housing finance equivalent

of the crack cocaine crisis. It is poison sucking the life out of our

communities. And it is hard to fight because people are making so

much money. But we need Government to join the fight with zeal

and with smarts. S. 2415 has our unconditional support.

Thank you.

Chairman SARBANES. Thank you very much, sir.

We are being joined this morning by Senator Crapo. Mike, do you

have an opening statement?

COMMENT OF SENATOR MIKE CRAPO

Senator CRAPO. Thank you, Mr. Chairman. I do not have an

opening statement and in fact, I have to leave in just a few minutes for a live interview. I hope to get back. I have read about half

of the testimony already and will read that which I am not able

to hear. But I appreciate your holding this hearing. I look forward

to working with you on the legitimate problems that are identified

and finding solutions that can work for everybody.

Chairman SARBANES. Thank you very much.

We will now hear from Neill Fendly, who is the immediate Past

President of the National Association of Mortgage Brokers, NAMB.

The NAMB provides education, certification, industry representation, and publications for the mortgage broker industry.

Mr. Fendly, we appreciate your being here with us this morning.

STATEMENT OF NEILL A. FENDLY, CMC

IMMEDIATE PAST PRESIDENT

NATIONAL ASSOCIATION OF MORTGAGE BROKERS

Mr. FENDLY. Thank you. Mr. Chairman and Members of the

Committee, I am the Immediate Past President of the National Association of Mortgage Brokers, referred to as NAMB. This is the

first time that NAMB has testified in the Senate. We are truly apVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00264 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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preciative of the opportunity to address you today on the subject

of abusive mortgage lending practices.

NAMB currently has over 12,000 members and 41 affiliated

State associations Nationwide. NAMB members subscribe to a

strict code of ethics and a set of best business practices that promote integrity, confidentiality and, above all, highest levels of professional service to the consumer.

I would like to focus this testimony on helping the Committee

understand the important and unique role of mortgage brokers in

the mortgage marketplace and offer the unique perspective of mortgage brokers in examining the problem of predatory lending.

Today, mortgage brokers originate more than 60 percent of all

residential mortgages in America. Mortgage brokers are critical to

ensuring that people in every part of our country have access to

mortgage credit. Almost anyone can usually find a mortgage broker

right in their community that gives them access to hundreds of

loan programs. Mortgage brokers are generally small business people who know their neighbors, build their businesses through referrals from satisfied customers, and succeed by becoming active

members of their communities.

The recent expansion in subprime lending has also relied heavily

on mortgage brokers. Mortgage brokers originate about half of all

subprime loans. Many mortgage brokers are specialists in finding

loans for people who have been turned down by other lenders.

Mortgage brokers often do an amazing amount of work on these

loans. I recently completed one such loan that took over 1 year

from start to finish. They work with borrowers to help them understand their credit problems, work out problems with other creditors, clean up their credit reports when possible, and review many

possible options for either purchasing a home or utilizing existing

home equity as a tool to improve their financial situation.

We know that mortgage credit is the least expensive source of

credit for those who may have made some mistakes or had some

misfortune in the past and now need money to improve their home,

finance their children’s education, or even start a business. They

need to have the widest possible range of choices when they are

buying a home or need a second mortgage, and today they do. It

is important that Congress be very careful to avoid measures that

will deny people choices they deserve and the tools they need to

manage and improve their financial situation.

One of the most important choices available to consumers is the

no- or low-cost loan which enables people to buy a home, refinance,

or obtain a home-equity loan with little or no cash required up

front for closing costs. These costs are financed through an adjustment to the interest rate. Both mortgage brokers and retail lenders

offer these popular loans. When a mortgage broker arranges a loan

like this, the broker is compensated from the lender from the proceeds of the loan. This kind of payment goes by many names, but

is often called a yield spread premium. These payments are perfectly legitimate and legal under Federal law, RESPA, so long as

they are reasonable fees and the broker is providing goods and

services and facilities to the lender. They must be fully disclosed

to borrowers on the good faith estimate and the HUD–1 settlement

statement, and are included in the interest rate. Retail lenders,

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however, are not required to disclose their comparable profit on a

loan that is subsequently sold in the secondary market as most

mortgages are today.

Despite the great popularity of this loan with consumers, today

it is under assault in the courts. Trial lawyers across America are

pursuing class action lawsuits claiming such payments to mortgage

brokers are illegal and abusive. This is despite Statement of Policy

1991–1, issued at the direction of Congress by the Department of

Housing and Urban Development in 1999, which clearly sets forth

the Department’s view that yield-spread premiums are not, per se,

illegal and must be judged on a case-by-case basis.

Recently, the 11th Circuit Court allowed a class action to be certified in one of these suits. This has resulted in a flood of new litigation against mortgage brokers and wholesale lenders and has

caused a great deal of uncertainty and anxiety in the mortgage industry. The cost of defending these class actions is staggering. The

potential liability could run over $1 billion. The prospect of a court

deciding that the prevalent method of compensation for over half

the mortgage loans in America is illegal is chilling, to say the least.

If these lawsuits succeed, the real losers will be tomorrow’s firsttime homebuyers, tomorrow’s working families, tomorrow’s entrepreneurs who will not be able to get a mortgage without paying

hundreds of dollars up front. Further down the road, many small

business men and women will not be able to stay in business as

mortgage brokers without being able to offer these no-cost loans. As

competition decreases, all potential mortgage borrowers will suffer

higher costs and fewer choices.

Mr. Chairman, this illustrates the unintended consequences that

can come from litigation, regulation, or legislation that singles out

one part of the mortgage industry, places blanket restrictions on

prohibitions of certain types of loans and products, or unreasonably

restricts interest rates and fees.

Virtually no loan terms are always abusive, and almost any loan

term that is offered in the market today can be beneficial to some

consumers. Whether a loan is abusive is a question that turns on

context and circumstances from case to case. This is why NAMB

and the mortgage industry have opposed legislation or regulation

that would impose new blanket restrictions or prohibition on loan

terms. We believe such measures will increase the cost of homeownership, restrict consumer choice, and reduce the availability of

credit, primarily to low- and moderate-income borrowers.

NAMB believes that the problem of predatory lending is a threefold problem: abusive practices by a small number of bad actors;

lack of consumer awareness about loan terms; and the complexity

of the mortgage process itself. We believe all three of these areas

must be addressed together and with equal forces if the problem

is to be solved without unintended consequences that I mentioned

earlier. The mortgage industry is working vigorously in all three

areas and NAMB wants to continue working with Congress to address all these areas, in particular, reform and simplification of the

mortgage loan process.

This part of the solution is one toward which NAMB has put a

tremendous amount of effort. This is a comprehensive overhaul of

the statutory framework governing mortgage lending. We cannot

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emphasize enough to this Committee how badly this framework

needs to be changed and how important this is to curtailing abusive lending.

The two major statutes governing mortgage lending have not

been substantially changed since they were enacted in 1968 and

1974. The disclosures required under these laws are confusing and

overlapping. The laws actually prevent consumers from being as

well informed as they could be and put consumers at a decided disadvantage in the mortgage process. As one of the borrowers at yesterday’s hearing so eloquently put it, ‘‘the problem is the lenders

know everything and the borrowers know nothing.’’ It is impossible

for consumers to effectively compare different types of mortgage

loan products.

NAMB has been engaged from the beginning in efforts to reform

the laws regulating mortgage originations and we remain committed to the goal of comprehensive mortgage reform and simplification. We urge this Committee in the strongest terms possible

to work with our industry on mortgage reform.

In conclusion, I want to reiterate that NAMB supports measures

by the industries and regulators to curb abusive practices, punish

those who do abuse consumers, and promote good lending practices.

We support legislation that would reform and simplify the mortgage process and believe this is the legislation that is most needed

to empower consumers. The problem of predatory lending can only

be solved through a three-pronged approach of enforcing existing

laws, targeting bad actors, educating consumers, and reforming

and simplifying the mortgage process. In considering any new legislation, we urge Congress to apply this fundamental principle: Expand consumer awareness and consumer power rather than restrict

consumer choice and product diversity. That should be the goal of

any new legislation affecting the mortgage process.

Thank you for this opportunity to express our views and we look

forward to working with the Committee in the future.

Chairman SARBANES. Thank you very much, sir.

We will now hear from David Berenbaum, the Senior Vice President, Program and Director of Civil Rights for the National Community Reinvestment Coalition.

For more than 10 years, the National Community Reinvestment

Coalition has been a leading force in promoting economic justice

and increasing fair access to credit, capital, and banking services

for traditionally underserved communities.

Mr. Berenbaum, we are pleased to have you with us.

STATEMENT OF DAVID BERENBAUM

SENIOR VICE PRESIDENT

PROGRAM AND DIRECTOR OF CIVIL RIGHTS

NATIONAL COMMUNITY REINVESTMENT COALITION

Mr. BERENBAUM. Thank you, Chairman Sarbanes, Members of

the Committee. We are extremely concerned about the prevalence

of predatory lending in our Nation. During the next 5 minutes, I

will try to synthesize the remarks included in our over 20 pages

of testimony and exhibits. We are clearly in a dual-lending marketplace. Let it be said and let it be heard that the continuation of

redlining is in our Nation.

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Despite popular belief, or the argument that in fact subprime

lending has ended redlining that is argued by some industry associations, in fact, it has put an entirely new face on the issue of redlining, a whole new cast on it.

Before, where overt discrimination occurred, overt consumer denial with regard to access to credit was commonplace, today, we are

dealing with a race tax. In fact, if you look at recent HUD-Treasury

studies, they report that African-Americans are five times more

likely to receive subprime loans than their white neighbors. Other

studies document the fact, studies by the GSE’s, that 30 to 50 percent of African-Americans who are currently receiving subprime

loans should have qualified and been afforded the opportunity to

receive prime paper.

This is a major failure. Picture yourself living in an urban community. You approach a retail lender operation. On the front window of that lender is an equal housing opportunity/equal lender

logo. You go in and in fact, they give you papers in compliance with

the Truth in Lending Act, in compliance with all other consumer

protections. And then they try to sell you a product that has four

points, fees, single-premium credit life, and that has a balloon note.

Now picture that individual going into a suburban location. In

fact, another division of the very same company. And you are told,

that you can get a prime note with one point, no single-premium

credit. And you have options, you have choices.

In fact, this is not, as was referenced, a rogue lender. It is an

example of many corporate lenders in our country right now, having subprime divisions that market themselves exclusively to urban

communities while their prime traditional lending banks covered

by CRA, in fact, are operating in predominantly white areas.

Included in our testimony, we have maps based on the Home

Mortgage Disclosure Act that look at, ‘‘minority census lending.’’ On the board here, we have a map from the Baltimore area. The

first map documents subprime lending. You can see the concentration of the dots. These are refinanced loans that were originated in

the subprime marketplace in 1999. You see the concentration in

the areas that have the darker shading which represent predominantly African-American and Latino areas. The next map looks at

prime lending. Look at the strong difference. Prime lending is happening throughout the Baltimore/Metropolitan Washington area.

I submit to you that the prime lending that is occurring in African-American communities is coming from responsible lenders that

are living up to their commitments under the Community Reinvestment Act and in partnership with community-based organizations.

Financial modernization, the changing nature of the mortgage

marketplace has prompted an atmosphere where many lenders are

not falling within compliance reviews, are not falling with existing

statutory reviews.

Best practices include the lender marketing their goods in both

the urban and suburban areas and where they have agreements.

I respectfully say, and I believe in best practices. I believe in financial literacy. NCRC has been a leader in doing ‘‘train the trainer’’

work with regard to financial literacy. We believe in all that.

But with all due respect, it is not simply rogue lenders like Cap

Cities Mortgage, right here in Washington, DC, who foreclosed on

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85 percent of their loans. It is a systemic problem with race at the

background of the issue that we need to address.

The consumer protection bills that have been introduced, in particular, the legislation that you, Chairman Sarbanes, are considering, are critical to address HOEPA. I hope during the questions

and answers, I can go into why these changes are necessary.

Best practices are not enough. These are ethical issues. The

mortgage practitioner who are stealing homes from seniors, from

African-Americans, from people who are not sophisticated borrowers, should lose their licenses.

The companies that are buying these products on the secondary

market need additional regulatory oversight. The market is changing. The law needs to be more than a band-aid. We need penicillin.

Chairman SARBANES. Thank you very much, Mr. Berenbaum.

Before I turn to our final three witnesses, we have been joined

by Senators Dodd and Carper.

I yield to either of them if they wish to make a statement.

COMMENT OF SENATOR CHRISTOPHER J. DODD

Senator DODD. Mr. Chairman, let us continue with the witnesses.

And when the chance comes around for questioning, I will use the

time then. But you have been sitting here for a long time.

Chairman SARBANES. Thank you, Senator Dodd.

Senator Carper.

COMMENT OF SENATOR THOMAS R. CARPER

Senator CARPER. I would simply echo the sentiments. And again,

to the witnesses, thank you for being with us today.

Chairman SARBANES. Our next witness is Mr. George Wallace.

Mr. Wallace is counsel for the American Financial Services Association. AFSA is a trade organization that represents a wide variety of financial services firms, including market-funded lenders and

credit insurance providers.

Mr. Wallace, we appreciate your coming today. We would be

happy to hear from you.

STATEMENT OF GEORGE J. WALLACE

COUNSEL, AMERICAN FINANCIAL SERVICES ASSOCIATION

Mr. WALLACE. Thank you, Mr. Chairman, and Members of the

Committee.

Chairman SARBANES. I think it might help a bit if you pull that

microphone closer to you.

Mr. WALLACE. Am I close enough now?

Chairman SARBANES. That is good, although you are leaning.

Mr. WALLACE. I would like to be heard.

Chairman SARBANES. We want you to be heard.

[Laughter.]

Mr. WALLACE. Some people might not want to hear me, but any

way——

Chairman SARBANES. No, no. We want to hear everybody and try

to address everyone.

Mr. WALLACE. I am a dissenter today. Today, I want to talk

about predatory lending, as everybody else is. Allegations of predatory lending, particularly in the subprime mortgage market, have

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received significant attention in recent months. Advocates of increased regulation have claimed that stepped up fraudulent or

predatory marketing practices have persuaded vulnerable consumers to mortgage their homes in unwise loan transactions. Some

consumer advocates have strongly urged that various loan products

and features common to the mortgage market are predatory and

should be outlawed.

Extensive new regulation of mortgage credit in the way advocates now urge would dramatically reduce loan revenue, increase

the risk and/or increase costs the lender must bear. And I speak

for people who have to produce the loans that those who wish to

make credit available to lower and moderate income people, we are

the ones who have to produce those loans and we are looking at

your suggestions and we are seeing that it is going to raise costs.

Initially, the resulting burdens will fall on lenders, in the long

term, the effects will most always be felt directly by working American families, either because of decreased loan availability, higher

credit prices, or less flexible loan administration.

The resulting reduced credit availability strikes at the very heart

of the efforts over the last quarter century by Congress, many

States, and the lending industry to make efficiently priced consumer credit available to working American families, including

minorities, single-parent families, and others who for so long were

unable to obtain credit.

Consumer advocacy have shared this goal. In testimony before

this Committee in 1993, Deepak Bhargava, then Legislative Director for ACORN, spoke of a credit famine in low- and moderateincome and minority communities in urban and rural areas, and

also about massive problems of credit access in many communities

around the country, particularly in minority and low-income areas.

Subprime lenders, spurred on by Congress, have been enormously successful in delivering efficiently priced consumer credit to

working American families, regardless of race, ethnicity, or background. Moreover, during the past 5 years, 96 percent of those who

have borrowed from AFSA members have used their subprime

mortgage loan credit, successfully, 85 percent without any significant delinquency.

Why would Government deny to these deserving Americans access to the benefits of credit that middle-class Americans enjoy?

The 96 percent of Americans who use credit extended by AFSA

members successfully are not asking for that interference. There

are some people who have been victims of fraudulent, deceptive, illegal, and unfair practices in the marketing of mortgage loans. In

fact, predatory lending is fundamentally the result of misleading

and fraudulent sales practices, as others have said today.

Some advocates have mistakenly focused on loan products and

features as the reason for these victims’ misfortune, and have

reached the faulty conclusion that if regulation just barred certain

loan features, the harm would be avoided.

Pursuing this mistaken reasoning, they have tried to label as

predatory highly regulated loan products and features, such as

credit insurance, prepayment penalties, balloon payments, arbitration, higher rates and fees. However, any legitimate consumer good

or service can be marketed fraudulently.

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Indeed, the scam artist prefers to use legitimate products like

loans as a cover because consumers want and need that product.

The illegality comes in the fraudulent marketing of the good or

service, not in the good or service itself. We urge the Congress not

to confuse the loan features that consumers want and need with

the fraudulent marketing practices that some isolated operators

have used to prey upon the unfortunate. If fraudulent and deceptive practices are the root of the problem, how should predatory

lending be addressed?

First, Congress should do no harm to the present system, which

has been extremely successful in delivering consumer credit to

America’s working families. Such proposals as forbidding such features as balloon payments, financed single-premium insurance, and

prepayment fees take away legitimate loan features useful to

America’s working families without addressing in the slightest way

the fraud underlying the predatory practices, and that is an important point to remember.

Second, consumer education should play a major role. AFSA has

been a leader in developing educational programs to help meet the

enormous need for greater financial literacy. As a founding member

of the Jump Start Coalition, a coalition of industry, Government

and private groups dedicated to increasing financial literacy, it has

for several years pushed strongly for increased efforts to educate

Americans about credit.

We urge Congress to support these and other efforts because

they hold the greatest promise to help over the long run. We particularly want to thank Senator Corzine for his efforts in obtaining

additional support for financial literacy efforts this year.

Third, industry self-regulation plays an important role. AFSA

has developed best practices which its member companies have voluntarily adopted. They strike a reasonable balance between limits

on controversial loan terms and providing legitimate consumer benefits in appropriate circumstances. A copy of AFSA’s best practices

are attached to my written statement.

And finally, Government’s role is appropriately the vigorous enforcement of deceptive practices in civil rights laws. Any objective

analysis of these laws much reach the conclusion that they provide

some powerful tools to address both fraudulent sales practices and

discrimination.

Strong enforcement is appropriate because it addresses the real

problem—the fraudulent and discriminatory practices—without affecting the overall ability of lenders to make loans available to

working American families with less than perfect credit.

That is the appropriate policy balance between dealing with the

real misfortunes which some borrowers have experienced and the

continued availability of credit to working American families.

We urge Congress to encourage that an appropriate balance be

maintained. Thank you, Mr. Chairman, and Members of the Committee, for the opportunity to address you today and I look forward

to any questions you may have later on.

Chairman SARBANES. Well, thank you very much, sir. I also want

to thank you for your statement and for the attachment of the best

practices AFSA.

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Our next witness is Lee Williams, who is the President of the

Aviation Associates Credit Union in Wichita, Kansas, and is the

Chairperson of the Credit Union National Association’s State issues

subcommittee.

Ms. Williams, we would be happy to hear from you.

STATEMENT OF LEE WILLIAMS

CHAIRPERSON, STATE ISSUES SUBCOMMITTEE

CREDIT UNION NATIONAL ASSOCIATION, AND

PRESIDENT, AVIATION ASSOCIATES CREDIT UNION

WICHITA, KANSAS

Ms. WILLIAMS. Good morning, Mr. Chairman, Members of the

Committee. It is indeed a pleasure for me to be here and speak to

you on behalf of the Credit Union National Association, CUNA.

CUNA represents over 90 percent of the 10,500 State and Federal Credit Unions Nationwide. And as Chair of CUNA’s State

issues subcommittee, I have had the privilege of carefully considering issues surrounding abusive practices of predatory lending and

appreciate this opportunity to present to you some of our findings.

America’s credit unions strive to help their 80 million members

create a better economic future for themselves and their families.

And with that in mind, the credit union system abhors the predatory lending practices being used by some mortgage brokers and

mortgage lenders across the country.

Predatory lending is a complex and difficult issue to resolve. My

committee, as well as this Committee, has come to that conclusion

by hearing testimony of individuals and looking at the current situation with predatory lending. Predatory lending’s primary targets

are subprime borrowers. These are consumers who do not qualify

for prime rate loans because of poor credit history or, in some

cases, simply a lack of credit history. This segment of the population is of particular interest to credit unions because, historically,

it is this population that has turned to us for our flexibility and our

wide range of credit options.

CUNA is concerned that the term predatory has become synonymous with subprime in the minds of some of our policymakers.

Consequently, legitimate subprime lending programs could suffer if

broad prohibitions on certain lending practices become law.

Credit unions urge policymakers to use a scalpel, not an elephant

gun, when drafting legislation to eliminate predatory lending practices. Subprime borrowers need to be served and credit unions do

not want to lose their ability to create flexible, subprime loan programs. A growing number of credit unions offer subprime loans to

members who do not qualify for a prime rate loan. Subprime loans

are offered to members with poor credit histories at rates above

prime to offset the higher risk of lending.

Credit union subprime loans are not predatory. They are a vital

tool that give borrowers with poor credit history the ability to build

and/or rebuild their credit history.

To illustrate some of the alternative subprime lending programs

offered by credit unions, CUNA created a task force last February.

The task force has recently completed a handbook called, ‘‘Subprime Doesn’t Have To Be Predatory—Credit Union Alternatives,’’

which is included in my attachment, as you have seen. The booklet

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provides a sample of credit union subprime loan programs that are

designed to help borrowers actually improve their credit.

There are many positive programs being developed in the

subprime lending market by credit unions to assist consumers of

all economic circumstances. Credit unions urge policymakers to

address the abuse of lending practices rather than complete prohibition of practices that, when used legitimately, would provide

flexibility and credit options to meet individual borrower’s needs.

America’s credit unions support elimination of lending practices

that are intentionally deceptive and disadvantageous to borrowers.

CUNA and credit unions across the country have been establishing

programs to help our members fight back against the effects of

high cost and predatory loans.

At Aviation Associations Credit Union, we recently initiated a

Take Control program. It provides resources for our members, allowing them to take control of their financial well-being and effectively deter the success of payday lenders and predatory mortgage

lenders in our community.

Let me give you an example of that. We have members with high

interest mortgage loans acquired from a mortgage broker that have

come into our credit union and asked us to refinance these loans

because they cannot make the payments. My initial response, being

member-owned, is to offer to refinance these loans and to reduce

the interest rates. But often, that is no solution. Typically, these

type of loans have been initially packed with so many fees, paid up

front and financed, that the loan-to-value ratio is often up to 125

percent. Neither my credit union, nor many other lenders, can refinance such a loan. Even in such a dire situation, our Take Control

program can improve the member’s financial circumstances. Our

program does this through member education.

With the help of an on-site consumer credit counselor available

twice a week at our credit union, members can learn how to pay

down loans faster, obtain lower fees and rates, and even in the grip

of predatory mortgage loans, learn how to build equity faster so the

credit union can at a later point refinance these mortgages.

This is only a band-aid on a serious injury. When the credit

union refinances for the member, the predatory lender wins. At

Aviation Associates, we believe our members must never fall victim

to predatory lending in the first place. That is why Take Control

also offers a significant component that includes education to teach

our members how to avoid predatory mortgages in the first place.

We are convinced education is a critical tool, although not the only

tool, needed for our members to obtain financial independence.

On a national level, CUNA developed mortgage lending standards and ethical guidelines to be adopted by credit unions across

the country. These guidelines were designed to help emphasize

credit unions’ concerns for consumers and further distinguish credit

unions as institutions that care more about people than money.

One of the most important programs CUNA is currently promoting to combat predatory lending practices is financial education

of our Nation’s youth. Credit unions believe that by educating our

young people in the area of personal finance, they will learn to

make sound financial decisions and choose not to use high cost or

predatory lenders.

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Through our partnership with the National Endowment for Financial Education and other efforts, we have reached over 130,000

students in over 5,000 schools.

Again, let me say that I am very pleased that you are holding

these hearings because I see the effects of predatory lending daily,

and it is not a pretty picture. Credit unions are eager to see the

abusive practice of predatory lending eliminated. Credit unions

have taken positive steps in that direction through our voluntary

efforts to educate our members and provide them with fair and

sound alternative products. It is our hope that we will have allies

in our efforts to assure all consumers have access to credit products

that do not unfairly take advantage of their circumstances.

I thank you for allowing me to be here today and I would answer

any questions.

Chairman SARBANES. Well, Ms. Williams, thank you very much

for the statement on behalf of CUNA.

If you had been here yesterday, I think you would have appreciated and the Members of the Committee were very careful to recognize—and as the witnesses this morning have said right from the

beginning with Wade Henderson—that there is a role to be played

in the legitimate subprime market. We are trying to get at those

people who are abusing that market with these predatory practices.

I was looking at this pamphlet that you told us about and I note

that you very clearly try to draw that distinction. And that is one

of the things that we are about here today, is to ascertain that line

and then knock out what is on the wrong side of that line.

Our last witness this morning is Mike Shea, who is the Executive Director of ACORN Housing.

For over 25 years, ACORN has worked to increase homeownership and community development in low-income and minority communities. The organization has worked successfully with many

lenders to develop loan products that provide fair and affordable

access to credit for individuals traditionally shut out of the economic mainstream.

Mr. Shea, we are pleased to have you with us today. We look forward to hearing from you.

STATEMENT OF MIKE SHEA

EXECUTIVE DIRECTOR, ACORN HOUSING

Mr. SHEA. Thank you, Mr. Chairman, Members of the Committee. I appreciate the opportunity to appear. I work in many of

your States and it is a pleasure to be able to share my insights on

predatory lending. I have been Executive Director of the ACORN

Housing Corporation since 1986, when the organization was formed

to create low-income homeownership opportunities.

We learned early on that to create homeownership in distressed

neighborhoods, you have to do two things. First of all, you have to

bring private capital back into those communities. FHA lending

and Government subsidies on their own will not do the trick. And

second, you have to provide consumer education and prepurchase

mortgage counseling to potential homeowners so that people living

in those communities will actually apply and qualify for loans.

To educate community residents about the home-buying process

and how to qualify for a loan, we operate mortgage counseling cenVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00274 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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ters in 27 cities around the country. I am proud to say that our

lender partnerships along with our mortgage counseling and financial literacy efforts have produced home loans for 36,000 first-time

home-buyers.

Last month, our largest banking partner, Bank of America,

announcedthe amount of home mortgages that have been originated through our partnership with them has reached the $10 billion mark. It is our experience that subprime lenders have not

played a major role in the creation of homeownership in this country. The recent increases in homeownership that we have seen in

the 1990’s was not because of subprime lending.

Of the 36,000 ACORN clients who have become homeowners,

only about 1,100 purchased their homes with loans from subprime

lenders. And our experience is not atypical according to the 1999

Home Mortgage Disclosure Act data which reported that just 6.6

percent of all home mortgage loans in the United States were originated by subprime lenders, while 82 percent of all first-lien

subprime loans are refinances.

In many of the communities that we work, the benefits that families have gained from homeownership are under attack. Increasingly, we find that as soon as one of our clients moves into their

new home, they are bombarded with offers from subprime lenders

to refinance their mortgage or take out additional debt, receiving

three or four letters a week and regular phone calls.

Now, we know that you have heard these numbers before, but it

is worth repeating, that half of all refinanced loans in communities

of color are made by subprime lenders. When you consider that

number in combination with the observations from Fannie Mae and

Freddie Mac, that between 30 to 50 percent of borrowers in

subprime loans could have qualified for ‘‘A’’ loans, you are clearly

talking about a massive drain of equity from these communities,

the communities that can least afford it.

At a bare minimum, these numbers indicate that huge numbers

of borrowers are paying interest rates 2 to 3 percent higher than

they would if they had an ‘‘A’’ loan. Consider, for example, that for

a $100,000 mortgage with a 30 year term, a person with a 101⁄2

percent interest rate will pay $65,000 more over the life of the loan

than a person with an 8 percent rate. Fannie Mae Chairman and

CEO, Frank Raines, recently put it best, and I would like to quote

him, ‘‘The central question is whether all consumers are enjoying

their basic right to the lowest-cost mortgage for which they can

qualify.’’ Answering this is critical if we are to close the homeownership gaps facing many groups in America.

Predatory lending is everywhere. Over the July 4th weekend, I

visited my mother in Benzig County, Michigan. And as Senator

Stabenow can say, Benzig County is a very conservative, rural

county in Northern Michigan. When I told her what I was doing,

she immediately told me of two of her elderly friends, staunch Republicans from the day they were born, how they had been victimized by predatory lending.

Paul Satriano yesterday testified, and his testimony received extensive coverage in Minnesota. As a result, our office in the Twin

Cities has received phone calls from throughout the States of Minnesota, Wisconsin, South Dakota, and even the upper peninsula of

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Michigan, two people called who were victimized by predatory

loans and looking for ways to get out.

We have to get rid of all the tricks and hidden practices that

make it impossible for consumers to know what kind of loan they

are getting into. What you have now is a situation where it is difficult for even my best loan counselors to understand all of the

damaging bells and whistles embedded in many subprime loans.

That should not be how getting a home loan works. It is not

what happens in the ‘‘A’’ market, but that is what is happening

every day in the subprime market. We need a strong, clear set of

rules that will allow homeowners to navigate the subprime market

with some basic assurances of safety.

We often hear the argument that predatory lending can be eliminated with more education and financial literacy. We certainly support financial literacy efforts. In fact, I would venture that ACORN

Housing, working together with many of our bank lending partners, has delivered more information to homebuyers about these

issues than anyone. Last year alone, nearly 100,000 people attended our bank fairs, workshops, and other events. We held a

bank fair recently in Detroit where 3,000 people came.

And Fannie Mae’s latest national housing survey found that consumer literacy efforts have already lowered the information barriers to buying a home, with nearly 60 percent of Americans now

feeling comfortable with the terminology and process of buying a

home. In spite of this increased financial literacy, we see that predatory lending continues to rise.

Part of what we have learned from this experience of providing

financial literacy and education is the limits of the approach. First,

there is the question of resources. Until we are ready to spend the

$1,500 to $2,000 per originated loan that many predators can

spend, we will always be playing catch-up.

And second, no advertisement, bus billboard or even workbook is

going to compete with a one-on-one sales pitch of a very good salesman who knows more about the process and about the products

than the borrower.

We have also heard the argument that all that is needed is better enforcement of existing laws. We see a lot of borrowers in

heart-breaking situations and we have tried to use current law to

help protect them. This year, we have helped 40 clients in 10

States file grievances with State regulators, and that has not

worked.

HOEPA covers only a tiny fraction of loans and it mostly requires disclosures. As long as the right piece of paper was slipped

somewhere into the pile, there is often little the borrower can do.

Fraud and deceit are against the law, but they are extremely difficult to prove. It usually turns into a matter of he-said/she-said,

and when the lender knows more about the transaction and has

the paperwork, and has the lawyers, the borrower loses. And when

we hear certain industry groups suggest that the solution is better

enforcement of current law, we wonder how they expect that to

happen if they routinely include in their loan documents mandatory arbitration clauses which severely limit a consumer’s right to

seek relief in court.

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What we need are some basis rules covering a broader group of

high-cost loans that create a level playing field where a borrower

in the subprime market, like a consumer in the ‘‘A’’ market, has

a set of understandable options to choose between.

Buying or refinancing a home is a lot more like buying medicine

than like buying a tube of toothpaste. We do not expect every patient to read the New England Journal of Medicine and evaluate

for themselves which drugs are safe and which are not. Instead,

Congress and the FDA establishes rules about what is too dangerous to be sold, within those rules, patients and their doctors still

can choose what is best for them. In our view, Congress and the

Federal Reserve need to make rules about subprime loans in the

same way.

Chairman SARBANES. Mr. Shea, we are going to have to draw to

a close.

Mr. SHEA. Thank you. I would like to just make one more point.

There is a lot of comments by the industry about unavailable data.

I would just like to say that Jesus did not need an economic study

to convince him of the need to drive the money changers from the

temple. He had a moral compass. He knew what was right and

wrong, and he had the courage to act on those beliefs.

Thank you.

Chairman SARBANES. Thank you very much, Mr. Shea.

We will go to questions. A number of my colleagues have been

here for a while and I want to at least get them started.

Senator Dodd wanted to make a very quick comment.

Senator DODD. Just while my other colleagues are here. Mr.

Chairman, thank you for these hearings and thank our witnesses,

too. It has been tremendously helpful. We are going to be constrained in time. Our desire here is to make subprime lending

more available for people. We do not look to cut that. There are

many lenders out there who are doing a very good job, particularly

some who have reacted already. As you have just point out,

CitiCorp and others have been very helpful.

I thank them for what they are doing, and we are talking about

those who engage in predatory practices. Not all subprime lending

is a predatory practice, and I think it is important that we state

that here.

But to be as emphatic as you, Mr. Chairman that we are determined as a Committee here, I am convinced the Republicans as

well as the Democrats, should do everything we can to stop that.

I thank all our witnesses for their your help.

Thank you, Mr. Chairman.

Chairman SARBANES. We have been joined by Senator Santorum.

COMMENT OF SENATOR RICK SANTORUM

Senator SANTORUM. Thank you, Mr. Chairman. I know people

have been here longer than me. I just want to associate myself

with the remarks of Senator Dodd that I beileve we do have some

bad actors out there in the area. But I want to also reiterate the

importance of subprime lending and having money available for

those who do not have the kind of credit rating that otherwise can

succeed. I think we are interested in engaging in something that

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is constructive to deal with this issue and I look forward to working

with you.

Chairman SARBANES. We do not intend to throw the baby out

with the bathwater. But we do intend to throw the bathwater out.

[Laughter.]

The dirty bathwater out, I should say.

[Laughter.]

Debbie, why don’t I recognize you for as long as we can go before

we have to leave for a vote. I will say to the panel, we will have

to recess briefly and go for this vote, and then we will return and

continue the question period.

Senator STABENOW. Thank you, Mr. Chairman. I appreciate that

and would note that I will not be able to come back because I have

to preside at noon. I actually have numerous questions. We will not

be able to address all of them. And possibly, we can follow up in

writing with the panelists. I appreciate all of your comments.

We have heard and have to address complex issues. We have

issues that we heard yesterday of loan flipping and issues on mandatory arbitration, disclosures, prepayment penalties, the definition

of what is a high-cost loan, the whole question of regulation, and

the effective ways of promoting financial education. There is a lot

of different issues that we need to address. I would simply ask Mr.

Courson, Mr. Fendly, and Mr. Wallace, whom I will ask first.

You mentioned consumer education being the primary focus. Yesterday, a constituent of mine was here, Carol Mackey, who spoke

about the fact that she was given a good-faith estimate in writing

several days before the loan closure, and that in fact, when she got

there, the interest rate was higher, the payments were higher.

The information she was given on the good-faith estimate was

not accurate. So, she was attempting to be educated as a consumer.

She is a bright woman. And found herself, when she dug through

all the papers, that in fact it was different.

So, I would ask how you feel——

Chairman SARBANES. When she dug through them afterwards,

when she went back.

Senator STABENOW. After she settled.

Chairman SARBANES. She really was not in the position to do so

at the closing.

Senator STABENOW. That is correct, Mr. Chairman.

She came into the closing with information that she assumed

was accurate based on the good-faith estimate, found after she got

home and sorted through—and as someone who closed on a home

not that long ago and considers myself reasonably intelligent and

as a Member of the Banking Committee, I found myself going

through pages and pages and pages and trying to make sure that

there was not something there that I had not seen before and so

on, and know how complicated it was.

I appreciate the issues of simplicity. I think we do have to address that and want to work with you on how we might simplify

this process. I certainly agree that it is extremely complicated and

difficult to sort through, even when you are very conscientious.

But when we are talking about consumer education and someone

has been given information, and later, it was found to be different

in the final analysis, how would you correct that through consumer

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education? Or do you believe, in fact, that it is appropriate to require that the good-faith estimate be a formal estimate so that it

has to be the same 3 days before as it is on the day that you close?

Mr. Wallace.

Mr. WALLACE. Well, I was not here yesterday and I did not hear

Mrs. Mackey’s statement. But as you describe it, the good-faith estimate is, in fact, an estimate. It has to be given within 3 days of

application. Then there is a HUD–1 Statement which does have to

be accurate. So, you are describing what appears to be a violation.

Likewise, the Truth in Lending Statement has to be accurate. If

it was inaccurate, that would be a violation of Truth in Lending.

We do have a legal system already in place which would appear to

address the concerns that you are raising.

Senator STABENOW. If I might just say, though, the documents

that you are referring to are given on the day of the closing.

Would you support having those documents given to consumers

several days in advance in straightforward, simple terms, so that

people know exactly what the costs are, the interest rate, the

points, the fees, et cetera?

Mr. WALLACE. The difficulty with that is it produces a certain degree of inflexibility with regard to borrowers. Borrowers often wish

to move straight to the closing. I have been involved in this for 35

years. People have suggested this for many years, and it might be

nice to do that. And then you start to work out the practicalities

of it and it starts to tie the borrower’s hands.

I think in the end what we are trying to do is to develop a regulatory system which deals both with the problems of communicating to people, educating them so that they understand when

they are communicated to, and working out a system which can be

consistently applied and appropriately managed by creditors without interfering too much with the borrower’s flexibility. I believe

the objection to your mechanism is, and other people have raised

it, is that it starts to interfere with the borrower’s flexibility.

That is a policy trade-off that, in the end, one has to deal with.

Senator STABENOW. I appreciate that. Well, let me just say knowing 3 days in advance what you are walking into is not an unreasonable request, and if we are focusing on consumer education, I

think we need to make sure that that education and information

is accurate.

Mr. Courson, would you like to respond? I know you have spoken

in your testimony about early price guarantees.

Chairman SARBANES. Well, I think——

Mr. COURSON. I am sorry, Senator?

Chairman SARBANES. I think if I do not move my colleagues out

of here, we are going to miss this vote.

Could you give a brief——

Mr. COURSON. Thirty second answer.

Senator STABENOW. Could you give us a 30 second answer?

Mr. COURSON. Yes. Part of the reform that we are advocating,

simplification, is taking the front-end system, the good-faith estimate, which really has no limits in terms of how it can change the

closing.

Chairman SARBANES. There is no liability for a misstatement on

the estimate.

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Mr. COURSON. That is correct.

Chairman SARBANES. Contrary to what I think Mr. Wallace said,

that it was illegal. As I understand it, there is no legal penalty for

that. Is that correct?

Mr. COURSON. Correct.

Mr. WALLACE. Are you speaking about the HUD–1 or the Truth

in Lending?

Chairman SARBANES. No. I am talking about good-faith estimate.

Mr. WALLACE. I was speaking about the Truth in Lending. Truth

in Lending, there is clearly liability.

Chairman SARBANES. All right. But when do you provide that?

Mr. WALLACE. The Truth in Lending is what tells her——

Chairman SARBANES. When do you provide that?

Mr. WALLACE. You have to provide that 3 days after application

on an estimated basis, and then at closing.

Chairman SARBANES. And is the estimate—are you liable for a

misstatement on the estimate?

Mr. WALLACE. On the HUD—— Chairman SARBANES. On the estimate.

Mr. WALLACE. On the estimate, the answer is, at this point, no.

Chairman SARBANES. All right.

Mr. COURSON. Our reform plan envisions, at the time of the application, as opposed to the good-faith and the TILA that someone

gets today, they would get one simple disclosure. That disclosure

would include really what the customer wants to know. How much

cash do I have to bring to closing and what are my payments? Of

course, it would have other disclosures on there.

One of the things that we are advocating is that the closing costs

that would be included on that disclosure would be guaranteed.

And so, the consumer at three different times through the transaction would see the same disclosure with more specificity as they

go through from application to credit approval to closing, with more

information completed. But the closing cost guarantee itself would

not be a violatation. It would stay. If it did change, it would be a

violation.

I heard Mrs. Mackey’s testimony yesterday. And it is the fallacy

of the system of not giving the certainty to the consumer up front,

and then, in fact, when you get to the closing, those guaranteed

closing costs must remain the same. That is part of what we have

in our reform proposal and in working with Secretary Martinez.

Chairman SARBANES. I believe we need to recess, otherwise we

are going to miss the vote.

Senator STABENOW. Thank you very much.

Chairman SARBANES. I certainly will return. We will recess and

return after the vote.

[Recess.]

Chairman SARBANES. Let me bring the Committee back into session. The hearing will come to order and we will resume.

Mr. Wallace.

Mr. WALLACE. I wanted to correct my earlier remarks. I thought

that Senator Stabenow was asking a question about conventional

mortgage loans. I believe she was asking a question about HOEPA

loans. Several people have pointed out to me, in a HOEPA loan,

there is a requirement, 3 days before closing, to give an accurate

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statement. If it is inaccurate, there are civil penalties. There are

enforcement provisions that work quite strongly, and you cannot

change the good-faith estimate between the closing and the giving

of it 3 days in advance.

Indeed, this has been an issue that borrowers have raised because they not only have 3 days advanced disclosure that I just described, but also the 3 day recision period. So, it takes them 6 days

to get their money. So, I just wanted to correct my remarks, sir.

Chairman SARBANES. The correction will be noted. Ms. Mackey

did not have a HOEPA loan. One of the problems here is that a

lot of these loans are not HOEPA loans. That is one of the reasons

that the Fed is now addressing what the HOEPA limits are in an

effort to include within them more of these loans that are now falling outside of it.

Senator Corzine.

Senator CORZINE. Yes. It was a terrific presentation by all of you

and I appreciate the discussion.

I just wanted to make sure that I heard this properly from Mr.

Courson. The Mortgage Bankers Association believes this is a problem and a pervasive problem. And that is something that we can

count on, your objective view, as we go about debating this as we

go forward?

Mr. COURSON. You certainly can, Senator. We have been involved

in this debate as one piece of an effort to really reform and simplify

the entire mortgage process for over 5 years, and you have our

commitment.

Senator CORZINE. I think sometimes there is a debate about

whether this is just an anecdotal situation here or there and we

fine four people here, or 10 people there.

But my observation, our studies would lead me to believe that

this is actually a very pervasive issue and needs addressing. And

I believe it is informative that one of the foremost associations underscores that.

I have this curiosity, and I will let anyone respond. But don’t

most ‘‘A’’-lenders have lawyers with them at times of closing on

mortgages, pretty simple conventional mortgages?

Does anyone want to address that?

Mr. SHEA. Senator, of the 36,000 families that have gotten home

loans first to buy a home from our program, we estimate about 25

percent use lawyers at closings.

Senator CORZINE. That is in the subprime market, though.

Mr. SHEA. That is in the prime market.

Senator CORZINE. That is in the prime.

Mr. SHEA. In the prime market, there is enough protections and

it is easy to understand what you are getting into ahead of time

where you oftentimes do not need a lawyer. We advise people to

seek legal counsel and we work with them ahead of time to review

the documents. The subprime market, very few people use lawyers.

Mr. BERENBAUM. Could I respond to that on a different level?

The issue of RESPA was addressed. I have to say that the National Community Reinvestment Coalition strongly supports the

consumer actions that have been filed in court. Who is empowered

in a mortgage settlement or a mortgage closing situation? Who has

the power?

272

The consumer, as has been stated generally, does not understand

the action, where fees are going. Disclosure is very important, and

part of the problem of predatory lending are the relationships between the players.

In fact, often a realtor may be working in concert with a

subprime lender who is a predator. And even the settlement agent

may be part of that process. We have even seen where whole separate corporations are bidding on the foreclosure ultimately that are

related to this little group of conspirators. And that is why in the

Capital Cities case, in fact, there is a claim trying to stretch and

use existing law, arguing racketeering.

Senator CORZINE. Sounds like racketeering to me if there is a

conspiracy of people working together.

In the ‘‘A’’ market, there is a lot of uniformity, conformity. I

think Freddie Mac and Fannie Mae have asked for conformity so

that the secondary mortgage market can actually work. Is there

room for some improvement in standardization in subprime lending

that would allow for that simplicity that is talked about? I understand the need for flexibility, but sometimes flexibility is camouflaged for some of the practices we have talked about.

Does anybody want to comment why and whether we ought to

get to more standardization? It certainly would provide more liquidity to the ultimate lender.

Mr. ACKELSBERG. Well, Senator, if I could speak to that.

I believe the first thing you need to do if you want standardization is actually have the rates and the fees available to the public

to know ahead of time. You have to understand that everything we

talk about in this market is different than your conceptions of what

mortgage lending is about.

Number one is, if you start with the assumption that when you

are in the market, you go to the newspaper on Sunday and in the

real estate or financial section, they list all the mortgages, the

prices, the points, and the rates, that does not exist in subprime.

Just yesterday, I deposed an area manager of one of the lenders

that has been mentioned as a responsible lender within the

subprime field. And I said, by the way, can I open the paper and

see what your rates are this week? And he says, oh, no, you cannot

do that. I said, why is that? Well, subprime lenders do not do that.

Nothing is really the way that we assume it. Brokers that we assume are representing lenders are not representing lenders. They

are representing themselves. In fact, they are being rewarded for

upselling their own customers.

Applications that we assume are being signed at sometime early

on in the process are routinely signed at the closing. You are signing an application at the same time you are signing the mortgage.

And that is done every day. I do not think I have seen a transaction where the application was signed prior to the closing. Everything about this market is different than the notions that we come

to the table with, having bought houses ourselves, for example.

Senator CORZINE. But are there lessons to be learned from the ‘‘A’’ market that we ought to be applying to the subprime market,

since it works efficiently and relatively securely for the consumer?

Mr. WALLACE. Senator, one of the things to remember is that

Fannie Mae and Freddie Mac have withdrawn from the HOEPA

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market entirely. Thus, whatever encouragement they could give to

standardization does not occur. And if the HOEPA thresholds are

lower, presumably they will continue to withdraw from the HOEPA

market. They are concerned about risks. They are concerned about

the additional liability, I guess, with regard to that kind of paper.

But there is something which you could address perhaps with regard to the secondary market, particularly the Government-financed entities not being interested in dealing with subprime

paper.

Chairman SARBANES. I understand, though, that 70 percent of

the subprime market is what are called ‘‘A’’-minus loans. And

therefore there is a real opportunity, which I gather some institutions are now undertaking to upgrade people into ‘‘A’’ loans. That

seems to me a very worthwhile endeavor. And it also seems to me

that we need to consider carefully what measures or how you can

encourage just graduating people up.

And I am told that there are a fair number of people who are

getting subprime loans who really could get prime loans. But it is

not happening. Is that correct?

I am sorry, John. I did not mean to interrupt your questioning.

Senator CORZINE. No, no, no. I believe it is going in the same direction here.

Mr. BERENBAUM. There is no question. And what we are dealing

with is a blend of civil rights issues, Fair Housing Act issues, as

well as consumer issues, whether they be fraud or issues relevant

to the subprime market.

There is a new player in town, though. And I would agree with

any thought that, in fact, the entry of Fannie Mae and Freddie Mac

into the ‘‘A’’-minus market has been corrected. It absolutely has

been. We wish it would have been sooner. Who is the new player

in town? It is Wall Street. Who is funding the growth? It is private

investors? Who is specializing?

We heard about specialty lenders. Well, these specialty lenders

better start developing prime paper because right now, I believe

under existing law, they are facing civil rights liability if they do

not give an American the loan they are qualified for. And that is

what is happening here. The greed factor, as has been mentioned,

is playing a role in our financial transactions today.

And yesterday, there were references made to in the old times

or in the days when we did things by hand. We are still doing

things by hand. There are decisions being made by executives

today with underwriting practices and points and how to use credit

in a way that is greedy, manipulative, and not covered by law.

And these working-the-law situations are creating the scams.

There are responsible subprime lenders and then there are ones

who are making mistakes because they are not thinking through

their decisions, and then there are predators.

Senator CORZINE. Mr. Fendly, where do you think the regulatory

world should actually meet the mortgage broker?

We know the Federal Reserve, the FDIC, and others review the

balance sheets and practices of the banking industry. Our thrift industry has a regulator where the public meets creditor. Where

would you think, and how would that best be applied in the mortgage brokering business?

274

Mr. FENDLY. Well, obviously, we should have the same standards

applied to us as any other lender would or any other originator

would. The only problem is that an awful lot of mortgage brokers

are extraordinarily small business people. The majority of them

employ less than five people. And I do not think a financial

yardstick is what you want to use to analyze their credibility in the

marketplace.

When I was talking about mortgage reform and people were talking about the good-faith estimate, that is part of the whole process

and should apply across the board to all lenders, all originators, so

that people have concise information. The system now encourages

fraud and it actually is an uneven playing field for honest businessmen who cannot compete against false good-faith estimates that

are changed at closing. That is what we are looking for, is clarity,

bright lines, and accountability.

Chairman SARBANES. That is an interesting point because it

seems to me that if we find ways of eliminating these bad practices, it is to the benefit of the responsible people in the industry.

And it seems to me that the responsible people, instead of resisting this effort, ought to be supporting it. I know they are concerned

about how the line is drawn because they are concerned whether

it will impinge upon the legitimate activities.

But assuming the line can be drawn properly, they ought to be

supporting it because it will knock out what I guess is potentially

an unfair competitive advantage which the bad actor is able to exploit. I just throw that out there as an observation. Go ahead, Jon.

I am sorry.

Senator CORZINE. Again, who challenges it? State banking regulators? Is that who is looking at most of the mortgage brokers?

Or is there anyone who looks at their practices? Or is it just voluntary?

Mr. FENDLY. It depends on what kind of business that they do.

Most of them have State regulators.

In my particular State, you are audited every 2 to 3 years on all

fronts. If you have an entity that is an FHA correspondent, they

have to provide a HUD-approved audited financial statement each

year. Those individuals that are very small, they are just dealing

with their own State regulatory agencies.

Senator CORZINE. And do many of them have audits on their

practices, their business and market practices?

Mr. FENDLY. Yes, they do.

Mr. ACKELSBERG. Senator Corzine, I actually would have to disagree with that. Just to use my experience from Pennsylvania, it

has been said by many people there that in Pennsylvania, it is

easier to get a broker’s license than a fishing license. The only difference is that there actually is enforcement from the Fish and

Game Commission to make sure that the laws are being enforced.

In our experience, in that one State, as a practical matter, no enforcement. And we sent lots of complaints. They did finally manage, as I understand, to pull the license of someone who had plead

guilty to stealing from 16 of his customers. But to the others, for

example, the ones where we had a fraud judgment unpaid, that did

not seem to rise to the level of regulatory interest.

Senator CORZINE. Mr. Courson.

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Mr. COURSON. Senator, I believe that is one of the points that we

made.

I would agree. Where is the enforcement? Because it is besmirching our industry, my company, and other lenders like me, if we do

not get the enforcement.

And so, I think what the gentleman just said is exactly correct.

We have to have the enforcement. If we have the licensing out

there and do not enforce it, then there is no reason to have it.

It is very disheartening in our business to find the bad actors

who even have actions taken against them, showing up in other

companies under other names and other venues, propounding the

same practices for which they were eliminated from a different

venue. It makes no sense. We have to have that enforcement level.

Senator CORZINE. I do not mean to—please. Go ahead.

Ms. WILLIAMS. I just wanted to add a comment.

Earlier you had made mention of ‘‘A’’-minus borrowers and opportunities there.

Some credit unions have programs in place now where if the borrower, an ‘‘A’’-minus or ‘‘B’’-minus, pays the mortgage as agreed for

1 year, then the rate could be adjusted. That may be something

that could be beneficial. It not only encourages the consumer to get

on a good plan of making payments on time, but it also offers them

long-term relief for paying more for that mortgage.

Now I have had instances where my members have actually said

they were told they could get a 12 percent first mortgage now. If

they paid as agreed for a year, that mortgage rate could be decreased. Only to find out after a year that their mortgage had been

sold to another company and all bets were off.

So that may be a good option to consider, a way to have an option for a consumer to actually pay at a subprime rate temporarily,

for a limited amount of time, and then have that rate decreased

without a lot of penalties attached to having that done.

Chairman SARBANES. Jon, we were so engrossed here, I do not

think we noticed it, but there is another vote on. I am going to

have to again recess the hearing in order to vote. I am sure the

panel appreciates, we have no control over this process. Actually,

those lights and bells go off, Pavlov should have done his experiments here in the Congress.

[Laughter.]

We will return very promptly and then we will try to draw it to

a close because I know that people have conflicting engagements.

We will stand in recess.

[Recess.]

Chairman SARBANES. The hearing will resume. And I am hopeful

that we will have enough time here to complete. I do not want to

hold up the panel unduly.

Mr. Ackelsberg, I want to put a question to you off of something

that Mr. Shea said, where he said, the recent increases in homeownership are not from subprime lenders.

Now you have some very interesting material in the opening part

of your statement, which, of course, because of the truncated time,

you did not present orally. But we should to just touch on that a

little bit because lots of assertions are made about this subprime

market and what it permits or what it allows that we would regard

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as desirable. And of course, we regard homeownership as desirable

in every instance in which it really can be warranted. Could you

just touch on some of that?

Mr. ACKELSBERG. Yes. As we mentioned in the written testimony, you have homeownership increasing by 2 percent during a

period of time that, for example, foreclosures are——

Chairman SARBANES. What is that period of time?

Mr. ACKELSBERG.I believe the table is 1980 to 1999,

Chairman SARBANES. What?

Mr. ACKELSBERG. The period of 1980 to 1999.

Chairman SARBANES. Okay. And it is during that period, of

course, more in the 1990’s, when the amount of subprime lending

increased at a very rapid rate. Is that correct?

Mr. ACKELSBERG. Absolutely, Senator. We attribute that to a

number of factors, one being, as I mentioned in my testimony, the

Federal policy favoring first-lien mortgage lending, the deregulation of usury for first-lien mortgage lending, basically encouraging

lenders to turn—the typical example that we see is someone, for

example, wants $5,000 to fix their kitchen. And what instead they

get is a $30,000 loan that pays off all their debt, which they did

not need being paid off at all. And it is precisely the Federal preemption of usury—the Federal deregulation of State usury laws for

first-lien lending that has made that possible.

The other thing I would say, as I mentioned, is the change in the

tax laws to favor home equity lending. And finally, the market

forces of Wall Street securitizations which have really made this a

very profitable enterprise.

Chairman SARBANES. This Figure 1 you have in your statement.

Mr. ACKELSBERG. Yes. It is data from the Mortgage Bankers Association.

Chairman SARBANES. Where you say the sources are the Mortgage Bankers Association.

You should show Mr. Courson this, too.

[Laughter.]

Chairman SARBANES. Is the figure from the Mortgage Bankers

or—yes. Is the chart or just the numbers that enabled you to make

up the chart?

Mr. ACKELSBERG. No, it is the numbers. Actually, I am not entirely sure. Senator, my understanding is that it is just the numbers that were then put into this chart.

Chairman SARBANES. The graphic form. All right. Now, let me

run through these. You say over this period, there was a 2 percent

growth in the homeownership rate. Is that correct?

Mr. ACKELSBERG. Yes.

Chairman SARBANES. Then there was a 29 percent growth in

mortgages per home. What do you mean by that?

Mr. ACKELSBERG. Well, as it has become more and more attractive in the market for people to use their homes when they are borrowing money, what you have is more and more people doing that.

For example, many people—and I would say primarily in the ‘‘A’’-

borrower kind of universe—we will have a mortgage and then we

will also have a home equity credit line. So, it has become very

common for people basically to use their homes to access credit.

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Chairman SARBANES. And then you have foreclosures per mortgage. That growth was 120 percent.

Mr. ACKELSBERG. Yes.

Chairman SARBANES. What is the significance of that?

Mr. ACKELSBERG. Well, I would also, particularly in the 1990’s,

add an additional overlay, which is these have basically been good

times. You would expect in good times to see foreclosures going

down. In Philadelphia, we have seen foreclosures tripling during a

period where jobs were actually on the upswing. And we attribute

that to the radical change in the nature of mortgage lending, that

loans are being made in a fashion that they were never made

before.

Chairman SARBANES. And then foreclosures per home went up

184 percent over this period.

Mr. ACKELSBERG. That is correct.

Chairman SARBANES. Meaning, what?

Mr. ACKELSBERG. That is just the ratio. Basically, it is just another way of saying that the foreclosure rate has really exploded

during this period of time.

Chairman SARBANES. As I understand it, from this footnote, this

understates the problem because this says the data of mortgages

and foreclosure at the end of each period studied comes from 130

different lenders and is representatives of approximately one-half

of the mortgages in existence.

These numbers are actually grossly undercounted because the

foreclosures of mortgages made by finance companies are not

included in the statistics compiled by the Mortgage Bankers Association of America, which provides the raw data for the census statistics. Also, foreclosure statistics do not include homeowners who

simply turn their home over to the lender to avoid foreclosure. Actually, as bad as this sounds as we run through these figures, the

problem is actually worse than that.

Mr. ACKELSBERG. I would spin that another way. You could do

the same thing with default and delinquency numbers, Senator.

For example, I have looked at default and delinquency numbers,

which are very high for some of these lenders. I did a lot of litigation against United Companies Lending that had 15 percent default and delinquency rates. But that radically really underestimates the problem if you are comparing it to an ordinary lender

because you are looking at a portfolio that, on average, in that particular example was had loans 18 months old.

When you look at a subprime portfolio that is relatively unseasoned—that is the term, I believe—an unseasoned portfolio, and

you see rates that are—even if they are similar and they are far

higher than you see in the prime market, you are understating it

because you are not talking about a portfolio that has loans as

much as 20 years old or 30 years old in that portfolio. You are talking about loans that are 1 year, 2 years, 3 years, often at the most.

Chairman SARBANES. Yes. But aren’t some of these lenders, the

bad actors, they are making these loans with the purpose of foreclosing and getting the house and taking the equity?

Mr. ACKELSBERG. I think in some cases, that is true. I believe it

is more accurate to say that they do not really care one way or the

other. It is probably closer to the truth to say, they are making

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these loans with the intent of selling them very quickly. And the

more points that they can load into those loans, the more revenue

they can generate very quickly.

I think that what it is is basically, the loans are being originated

by lenders who have no accountability regarding the performance

of the loans. They do not really care one way or the other how the

loan performs, as long as there is a market out there to buy it from

them. And unfortunately, the market is booming, largely fueled, I

believe, by Wall Street securitization.

I am convinced that the ultimate consumer in this whole mess

is not Ms. Mackey, with her mortgage. The ultimate consumer is

my retirement fund, your retirement fund. It is the mutual funds

insurance companies that decided, for whatever reason, and that

these were good investments.

And they have been layered with layer upon layer of credit enhancements, so the investors really feel like they are not at risk

at all, whether it is the insurance on the securitization, whether it

is the subordinization structure built into the instrument.

It is very complicated. But in the end, you could look at it as a

very sophisticated laundering of money, where the ultimate consumer really has no responsibility for what is going on. In fact,

there are law review articles built on—one that I found very enlightening was called ‘‘The End of Liability.’’ This is all about structuring things so that no one is responsible for what they are doing.

Chairman SARBANES. Let me ask—and I really throw this open

to the panel. This is the joint report of the U.S. Department of the

Treasury and the U.S. Department of Housing and Urban Development, which was issued just about a year ago, entitled: ‘‘Curbing

Predatory Home Mortgage Lending.’’ I obviously found it a very interesting report and we intend to

make heavy use of it. In this report, they have a section discussing

mandatory arbitration. And this is what they say, and I would like

to get the reaction of the panel to this. In policy recommendations,

after they have a discussion of what is the problem, challenges for

reform, and so forth.

Prohibit mandatory arbitration for high-cost loans. The most vulnerable borrowers in the subprime market may be the least likely

to understand adequately the implications of agreeing to mandatory arbitration. Since they may also be the most likely borrowers

to default or be foreclosed upon, it is especially important that they

retain the rights afforded them under Federal fair lending and consumer protection laws.

In the high-cost loan market, the difference in bargaining power

between lenders and borrowers is particularly acute, making

predispute mandatory arbitration an unwise option for these consumers. And I would like to get people’s reaction to that.

Ms. CANJA. I will respond to that. In fact, AARP goes even farther. We do not believe that there should be mandatory arbitration

in any consumer protection laws because you cannot have a level

playing field. You have the very vulnerable people who do not have

the experience, they do not have the information. They certainly do

not have the resources.

All of those things are all centered on the other side. It certainly

is even more apparent and they are even more vulnerable in this

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very complex issue of mortgage lending. So, we definitely would

support that there should not be mandatory arbitration.

Chairman SARBANES. Yes.

Mr. HENDERSON. Mr. Chairman, the Leadership Conference on

Civil Rights, and I think I speak here for the vast majority of organizations in the civil rights community, would strongly support the

recommendation of the Treasury report in that regard.

Mandatory arbitration of the kind that we are discussing this

morning is a fundamental violation of the right of individuals to

protect their own interests by going to court when necessary to litigate issues like those that we are discussing today, particularly

where the unequal relationship and power between the consumer

and the lending institution is as stark as we see it here, and where

the regulatory scheme of protection that exists both at the Federal

level and at the State level, is inadequate to protect their interests.

What we are seeing with these loans is that you are forced into

an arbitration system. You are in an unequal bargaining position.

As a general matter, you do not fully understand the terms and

conditions of the loan, particularly in contrast with the lender. You

do not have adequate protections at the Federal level. You do not

have adequate protections at the State level. And now we are taking the courts away from you to protect fundamental rights. It is

an injustice. It needs to be corrected.

Mr. ACKELSBERG. I would also add that the one obvious way that

Congress, when it passes law, can see how the laws are functioning

is to read the cases that come out of the Federal courts.

You understand, I assume, that these are basically secret proceedings. There is no opinion. Nothing is public. And therefore,

there is really no accountability whatsoever for how the laws that

this body passes actually are getting enforced.

Mr. BERENBAUM. I would concur with the other consumer advocacy groups, and just add a slightly different wrinkle to it. We have

compliance arrangements and I have also served as a consultant to

many realtor and real estate companies. What I see is a growing

trend of realtors to bring matters forward where they are so concerned about predatory lending impacting on their ability to complete new sales transactions to consummate the deals, and they are

frustrated for everyone involved in the transaction—the buyer, the

seller, because they see prepayment terms or penalties. It impacts

on everyone. And they are frustrated because they see these

clauses in the mortgage papers.

Mr. SHEA. Mr. Chairman, if I could add to that. We have found

that with our clients who have mandatory arbitration clauses,

those serve as a tremendous chilling effect for those clients seeking

redress to right wrongs that they feel are in their loans. We found

many arbitration clauses, for example, that state that if you lose

the arbitration, you have to pay the cost.

Well, if you are a low income person, you are not willing to do

that. You are not willing to take that risk often because it could

mean the difference between paying the electric bill or not.

Chairman SARBANES. Mr. Wallace.

Mr. WALLACE. If I could speak, I am going to dissent. We found

that mandatory arbitration clauses are a substantial benefit to the

consumer. It provides a cheap, freely available remedy. What Mr.

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Ackelsberg did not point out is that you do get a remedy in the arbitration process. What we are talking about here is whether we

are going to have class actions or we are going to have a quick and

efficient remedy. The experience with class actions has been, unfortunately, one in which the trial bar is able to earn a fairly good

compensation. But in general, the remedies provided to individuals

are small.

Chairman SARBANES. But do you think—— Mr. WALLACE. Likewise, most of these cases are fraudulent cases,

cases involving fraud. In individual fraud cases, lawyers, individual

lawyers, if they are not Legal Aid, find it uneconomic to take the

case. In arbitration, a remedy is available. In a class action, you

cannot maintain a class action if it is based upon fraud.

So that arbitration provides an important remedy for the consumer. It should be available to consumers and restricting the

availability of it certainly raises operating costs and does not necessarily provide a good remedy.

Chairman SARBANES. Well, now, when you say it should be available to the consumer, put forward, as it were, on behalf of the consumer, what would be your reaction to having voluntary arbitration

clauses instead of mandatory, so that the consumer, if they made

the judgment that agreed with the rationale you have just laid out,

could choose to go to arbitration. But if the consumer did not, they

would not be precluded or denied their opportunity to go to court.

What I referenced were mandatory arbitration clauses.

Mr. WALLACE. Yes, and I was addressing mandatory arbitration

as well.

Chairman SARBANES. Oh, you were. Now why? On the rationale

you just gave me, why wouldn’t you be accepting of having voluntary arbitration clauses?

Mr. WALLACE. Well, the voluntary arbitration clause is no different from no arbitration clause at all. I can always in litigation

agree with the other litigant that I want to go into arbitration.

That is the effect of a voluntary arbitration clause. A mandatory

arbitration clause is binding on both parties. They should be fair.

AFSA’s standards require that they be fair. There was a question

raised about who pays. That needs to be fairly handled. But, nonetheless, they are an important way of providing the consumer a

remedy and they are also an important way of managing the very

high costs of class-action strike suits.

Chairman SARBANES. If you go to arbitration, as a consumer, and

lose, you should pay the cost of the arbitration?

Mr. WALLACE. That would be a possible way in which these

should be structured, yes, sir.

Chairman SARBANES. Well, that is the way it is structured now.

Mr. WALLACE. I am sorry. Maybe I did not hear you correctly.

Chairman SARBANES. Do you believe that if a consumer is

required with mandatory arbitration, goes to arbitration and loses,

that the cost of the arbitration should then be placed upon the consumer?

Mr. WALLACE. AFSA has standards on it. I do not quite remember what the standards are. But in any event, it seems to me that

that ought to be fairly administered. I am not prepared to answer

that one way or the other. I think it ought to be done fairly.

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Mr. ACKELSBERG. Senator, Mr. Wallace suggested that these are

reciprocal obligations taken on both parties.

In fact, most of the arbitration clauses out there say that the

lenders can use the courts to foreclose, whereas the borrowers have

no access to the courts to enforce their rights.

Chairman SARBANES. That is a very important point.

Mr. HENDERSON. Well, that was my point, Mr. Chairman. I think

Mr. Wallace, with all due respect, is being very disingenuous to

focus on the interests of consumers when, in fact, the relationship,

the unequal bargaining position between consumers and the lender

is of such a fundamental nature, that to structure a system that

effectively precludes the option of going to court, is to guarantee

that the consumer has virtually no protection.

We have established here this morning that the level of regulatory inspection and protection out here is deminimus. And the

truth is that State laws and local laws have proven to be woefully

inadequate.

And we now have the courts being cut off from consumers who

are the most vulnerable and most in need of them. And the idea

that trial lawyers are being bashed because they choose to represent individuals and to advance their interests, I think is patently unfair.

I really just want to take issue with the concept that forced,

mandatory arbitration is in the consumer’s interest. This is a situation where let the buyer beware governs the way in which the market operates. And it is not in the consumer’s interest to have that

kind of forced arbitration clause.

Chairman SARBANES. Is there anyone at the table who would object to the Fed, in changing the standards to determine a HOEPA

loan, so that it would actually reach more loans than are now being

reached?

That is under consideration now, as you know. Mr. Wallace made

reference to the protections that the people get from a HOEPA

loan. But the fact of the matter is that most of these loans that we

are talking about are not encompassed within the existing HOEPA

standards.

One way to start dealing with this problem, presumably, is to

change the standards so that more loans are caught by HOEPA

and therefore, gain the protections of HOEPA. And I would like to

get the reaction to that. First, is there anyone at the table who objects to that, moving in that direction?

Mr. COURSON. Senator, may I respond to that?

Chairman SARBANES. Sure.

Mr. COURSON. The Fed proposal has, as you are well aware,

many different facets to it, several different parts, most of which

actually the mortgage bankers, in our comments back and discussions with the Fed, certainly support.

In fact, I know there is an antiflipping provision in there. There

is a low-cost loan provision. We have had discussions with them on

the pattern and practice provision.

The one place where our comment back to the Fed did take issue

was, as I will refer to it, the dropping of the triggers or the change

of the points and fees test. And our concern was one that we voiced

in our testimony before, is one that many lenders, when HOEPA

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first was originated, made a decision that as part of their products

and loans that they would make available to consumers, not to

make HOEPA loans. That was a decision they made.

The concern is, as we drop the triggers, both rates and fees, that

there will be more lenders, or those same lenders will actually now

not serve another tranche of borrowers that they perhaps probably

today are serving. In addition to that, in the secondary market, and

we heard about the GSE’s being unavailable for HOEPA loans, as

we continue to drop those triggers, to that tranche of loans or additional borrowers, if you will, who will be eliminated from the GSE

programs.

We have some concerns about that. And we are concerned in that

we think that the triggers, per se, will not necessarily solve the

abusive practices, that is, the enforcement and the education we

have talked about that solves that issue. And we are concerned

that just moving the terms and conditions of a loan down, which

may, in fact, have the effects I have already discussed, will also not

eradicate the predatory practices we are trying to solve.

Mr. BERENBAUM. Senator Sarbanes, if I may, I would like to respectfully disagree with the earlier remarks. We think that the

points issue and other fees issues being addressed by the Fed do

not go far enough. And we think HUD’s recommendation in this

area should be supported.

Taking it a step further, we believe that the Home Mortgage Disclosure Act should be amended to capture these issues in the reporting, so that we will have indicators, a report card, so to speak,

on these subprime issues, which will actually aid the Fed in its current research on the issue.

The reality is, if you look at larger subprime lenders, responsible

lenders today, once you are in their pool of customers, you are part

of the territory that they, ‘‘farm’’, to use the industry language

itself. They will approach you for a home equity line of credit. They

will possibly suggest packing of various products. We need to capture these types of real estate guaranteed and unsecured properties

in this HOEPA threshold.

Chairman SARBANES. Mr. Wallace.

Mr. WALLACE. Yes, sir. In general, our view is that if you are trying to get at predatory lending, HOEPA is not the tool to do it.

That was what my testimony said and I want to reiterate that.

You have fraudulent practices out there. HOEPA does not address fraudulent practices. We said that in 1994. Experience has

proved that to be the case. You have fraud. That is the cause of

the predatory practices. That statute is not going to deal with it.

Now whether the Fed should drop the thresholds I think is a

question of credit availability. I think that some of the advocates

who are here today, perhaps, and at least some of the advocates

out in the background would just as soon not have credit so widely

available. There is a hostility toward it that is perhaps out there.

If that is the goal, well, then, drop the thresholds because that

is the effect that is going to have. We think that is a policy question. We think that is one that the Fed can probably make fairly

well because they can see the overall effects.

But we do caution that the basic effect of dropping HOEPA

thresholds is that the availability of capital for that type of loan

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in the past has become more difficult and we expect that to continue in the future.

Chairman SARBANES. Well, of course, at the extreme, and you

have to ascertain what the extreme is, even though you want to

make credit available and you want people to have the opportunity,

you may say, these terms for making credit available in the real

world are so abusive, that it is a mirage that is being made available. The person thinks he is getting credit made available, but the

next thing you know, it is all gone, and he is in the pit, so to speak.

You have to be careful about that because we all want people to

have access to credit. I was very struck by Mr. Henderson’s statement at the outset, which I thought was very careful to draw that

distinction.

But on the other hand, at some point, you can look at this thing

and say, you are packing in so many things and engaged in a whole

series of practices here, that this is not making credit available.

This is all a flim-flam to take this person to the cleaner’s, particularly when you are coming in and refinancing the home where

someone has built up to these senior citizens that Ms. Canja talked

about, built up their equities in their home, and so forth and so on.

I understand that a number of lenders, including some large

subprime lenders, actually are supporting reductions of the

HOEPA triggers as the Fed now wrestles with this problem. Does

anyone else want to add anything on that point?

Ms. CANJA. I will just add that we also support lowering those

triggers because there are so many people that just do not—you

saw yesterday, I think, that those are the cases that came within

the triggers, but there are so many that do not. And so, we support

lowering the trigger.

Mr. ACKELSBERG. Senator, as between the two triggers, the rate

trigger and the points and fees trigger, I would say the points and

fees trigger is by far the most important.

Now under the current legislation, while the Fed has the ability

to lower the rate trigger from 10 to 8, it does not have the ability

to lower the points and fees trigger. What it does have is the ability

to include more items within the definition of points and fees as

they are doing with credit life insurance.

But, again, I would reiterate what I said in my oral testimony,

that the proof is really in the pudding, in the empirical record since

Congress passed HOEPA, which is in fact, we are not seeing less

loans. We are seeing less costly loans, precisely as was said, because many lenders are just choosing not to make HOEPA loans

because they do not want to have the liability attached to it.

So while, theoretically, you might get to the point where you

could take the triggers so low, that you would in fact have an impact on credit, we are certainly far away from that.

When you have lenders making loans at seven points, I do not

think there is any economic argument to say that is connected to

any aspect of credit access or risk or anything else, other than

gouging.

Mr. BERENBAUM. Mr. Eakes’ testimony yesterday was extremely

probative of the North Carolina experience.

Chairman SARBANES. Yes, I was just going to refer to the North

Carolina case. Mr. Courson, let me ask you this question. You

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spoke earlier about you are considering an initiative where you

would guarantee the fees ahead of time.

You provide people with information about the fees and charges

and they would be told, guaranteed that is what they would be at

closing. Is that correct?

Mr. COURSON. Yes, sir.

Chairman SARBANES. Now, do you do the same thing for the interest rate?

Mr. COURSON. No sir. On the interest rate issue, it is a two-part

process.

Chairman SARBANES. Yes.

Mr. COURSON. At the time of the application, the closing costs

would, of course, be guaranteed, the lender’s cost of making that

loan.

The consumer has a couple of choices, as they do today, to deal

with an interest rate. Obviously, interest rates are a very dynamic

market. We spent a year arguing and discussing this back and

forth as to how you would deal with the interest rate.

Today, as we would under our proposal, a consumer can choose,

in fact, to select and, if you will, lock-in or guarantee an interest

rate that exists, or they can continue to float.

Our proposal would say, then, once credit is off the table—we

have an application. We have a guarantee of the closing costs. Once

the credit decision has been made, the lender now has approved

the loan, that is the point at which the customer, and now the

lender, knowing what they have in terms of risk, product, and so

on, can give to the customer the right to accept a guaranteed interest rate, in addition to the guaranteed closing costs, which would

be the same because, of course, those costs are fixed to the type of

loan, as opposed to the dynamic moving of the money markets.

There would be the second point in the process where the consumer would get the same disclosure they received initially, and

this time it would be completed in that it would guarantee an interest rate and points, if they choose to take it. Some may not

choose to take it at that point and continue to move with the market, and some of us think that we are smarter than the markets

out there, so we float.

But there would be that opportunity at the time of the credit approval for them to accept that guaranteed rate. And then that

would be the rate that would be guaranteed when the loan moved

on to the closing process.

Chairman SARBANES. Does anyone have any reaction to that,

anyone else at the table, about that process?

Mr. BERENBAUM. Again, if the consumer was afforded the choice,

the way the consumer should be, the way we all expect to be, that

would be fine. The reality is the consumer is not being afforded

that choice in our system right now, and there is a need for a correction.

Chairman SARBANES. Well, all of you have been very generous

with your time and we appreciate the statements. I think we

should draw this to a close. We have been here now for quite sometime. Let me ask this, though. Is there anyone at the table who

wanted to give an answer to a question that was not asked?

[Laughter.]

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Or get in that last response to something that someone else said.

I am going to give you this opportunity so you do not walk away

feeling frustrated from this hearing. Does anyone want to—yes, Mr.

Shea.

Mr. SHEA. Mr. Chairman, I would just like to make one final

point, and that has to do with the reliability of so-called risk-based

pricing. I think most people at this table would say that if you

could come up with a scheme that would adequately price a person’s real risk, that that would be legitimate.

The problem is we too often times see that there is various

schemes that are being used to judge a person’s risk and they vary

tremendously. I have a credit report here from one of our clients.

It is a triple-merge credit report. It contains three credit scores. Remember, currently, 620 to 660 is considered a prime ‘‘A’’ lender cutoff, from there and above.

This person has three credit scores on here, one from Fair Issacs

is a 505. D, very high risk. It is going to be a high interest rate

loan for this person for most lenders. The second one has a credit

score of 565 for the same person. The third one has a credit score

of 658 for the same person.

This is an inexact science we are dealing with. This is a client,

by the way, that made their home payments on time every month

for 2 years, and they still have this wide variety of credit scores.

So the subprime industry is an inexact world right now and people get caught up with it and they get trapped in it, which is why

many of the features that have been discussed here today, like arbitration clauses, prepayment payments that are lengthy, need to

be eliminated.

Chairman SARBANES. Thank you. Anyone else? Mr. Wallace.

Mr. WALLACE. Yes, sir. I just wanted to make one point. There

was a discussion between yourself and Mr. Berenbaum about North

Carolina. We have studied, and I believe it was mentioned yesterday, we have studied North Carolina. Our data ended 6 months

after the North Carolina legislation went in.

We found a very major decrease in subprime loan volume occurring amongst our members, very spectacular. Most lower-income

people, people below $50,000. I want to point that out to you. Mr.

Eakes, I understand, does not agree with that. I was not here yesterday. But I understand that he does not agree with that.

Chairman SARBANES. No. Mr. Eakes made the point that was

one of the objectives of the legislation. Namely, that, as I understand it, some 80 percent of these loans are for refinancing. Is that

correct?

Mr. WALLACE. I will take your word for it, sir.

Chairman SARBANES. All right. He said that one of the things

that they were trying to get at in passing the legislation was to decrease or reduce the amount of refinancing that was taking place

by low income people because it was perceived that was being used

to simply strip them of their equity in their home, which, of course,

was two of the very poignant examples that were presented to the

Committee yesterday.

It is a complicated relationship, and we need to analyze the figures very carefully. But they are subject to a different interpretaVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00295 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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tion and a different conclusion. And he was very forceful in making

that point.

Mr. WALLACE. I understand the point and we can all make value

judgments about the basic point.

But if the goal of legislation is to reduce credit availability, that

would be an enormous change in the policy of this country, which

has been to increase credit availability.

Chairman SARBANES. No, the goal is to prevent abusive practices.

That is the goal.

Mr. WALLACE. Yes.

Chairman SARBANES. And I do not accept that in order to get the

maximum credit availability, you are going to accept grossly abusive practices. The system ought to be able to do better than that.

I mean, America ought to have a better performance standard than

that, it seems to me.

Mr. WALLACE. Well, of course. And we all agree with that.

Mr. BERENBAUM. Senator Sarbanes, yesterday, the Home Mortgage Disclosure Act data for 2000 was issued. It is brand new raw

data that I am sure everyone at the table is analyzing.

But you should be aware that, unfortunately, last year, there

was a 16 percent drop across the board in both prime and subprime

lending, loan origination. I am afraid there are issues of our economy, as much as many other issues, impacting on this discussion.

Mr. WALLACE. This was actually compared to two adjacent States

and the effect did not occur in the other States.

There is one other point. I would like to commend ACORN in

their statement. They indicated that they are somewhat reluctant

to see local ordinances dealing with subprime issues and predatory

issues. We agree with that point of view.

Mr. SHEA. Whoa. That is taken way out of context.

[Laughter.]

You just got me on that.

Mr. WALLACE. I thought we all agreed together on that.

[Laughter.]

Chairman SARBANES. Why don’t you put it in context, Mr. Shea?

[Laughter.]

I think we understand the context.

Mr. SHEA. I think you do.

Chairman SARBANES. Let me say on that point because it is one

that runs through a number of issues, I understand the industry

argument that they operate nationwide and in 50 States and,

therefore, 50 different standards are difficult for them to meet and

present administrative problems. Therefore, they constantly are

referencing Federal preemption.

But it seems clear to me that if you start to entertain Federal

preemption, intimately interrelated with that question is the question of the substantive protections that would be provided under

the Federal standard.

The notion of preemption at an inadequate Federal standard I

find totally unacceptable. I think that needs to be understood upfront. You really have to address at the same time the question of

the standard and how adequately that deals with the problem and

protects the consumer.

287

Otherwise, it seems to me, there is no basis to deal the States

out of the picture. Now many of the States feel strongly that they

should not be dealt out of the picture in any event. And given that

we have a Federal system and the role of the States in our system,

that is not a minor question. That is a very important question

that would have to be looked at. But the notion that they should

be dealt out with a standard that is inadequate to deal with the

problem, is seems to me is a complete nonstarter. And I just

thought that I would lay that out as we draw the hearing to a

close.

Thank you all very much for coming. We really appreciate it.

The hearing is adjourned.

[Whereupon, at 1:15 p.m., the hearing was adjourned.]

[Prepared statements, responses to written questions, and additional material supplied for the record follow:]

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PREPARED STATEMENT OF SENATOR PAUL S. SARBANES

Today is the Committee’s second hearing on Predatory Lending: The Problem, Impact, and Responses. Yesterday, we heard some very eloquent statements of the

problem from four Americans who worked all their lives to attain the dream of

homeownership, to build a little wealth, only to have it slowly, bit-by-bit, loan-byloan, taken away from them.

These people were targeted by unscrupulous lenders because they were elderly

homeowners that had a lot of equity in their homes. In the case of one woman from

West Virginia, she owned her home free and clear, paid off her mortgage with the

proceeds of her husband’s life insurance policy, only to end up losing her home altogether because of a series of six or seven flips in the space of less than 2 years.

What struck me about these four stories was that many of the practices that

harmed these witnesses—the repeated flipping of the loans, the high points and fees

rolled into the loan, and the mandatory arbitration clauses that kept some of them

from effectively pursuing a legal remedy—are all legal.

Let me reiterate what I said yesterday. I support actions by regulators to utilize

their authority under existing law to expand protections against predatory lending.

I support stronger enforcement of current protections by the Federal Trade Commission and other regulators. I applaud campaigns to increase financial literacy and industry efforts to establish best practices. I know a number of witnesses at this

morning’s hearing will tell us about such efforts.

But those who take the position that stronger regulatory and/or more aggressive

enforcement of existing laws will be adequate have a special burden, particularly

in light of yesterday’s testimony, to make sure that regulatory and enforcement

tools are adequate to the job.

To that end, in my view, they should support the Federal Reserve Board’s proposed regulation on HOEPA, as Ameriquest has done. They should support the

Fed’s effort to gather additional information through an expanded HMDA.

And they should support the regulatory and enforcement agencies such as the

FTC, the Treasury, and HUD in their recommendations for more effective enforcement. I sincerely hope that today’s witnesses will take these positions.

But I want to be clear: neither stronger enforcement, nor literacy campaigns, nor

best practices are enough. Too many of the practices we heard about in yesterday’s testimony, while extremely harmful and abusive, are legal. And while we must aggressively pursue financial education, we must also recognize that education takes

time to be effective, and thousands of people are being hurt every day.

As I did yesterday, I want to recount what Fed Governor Roger Ferguson said in

his confirmation hearing: ‘‘legislation, careful regulation, and education are all components of the response to these emerging consumer concerns.’’ I ascribe to that

view.

Before turning to my colleagues and the witnesses, I want to take a moment to

explain that we have had far more requests to testify than we have openings, as

I think the tightly packed witness table makes abundantly clear.

We have offered to include statements from these and other organizations in the

record of today’s hearing.

—————

PREPARED STATEMENT OF SENATOR DEBBIE STABENOW

Mr. Chairman, I am glad to be back for a second day of hearings on the problem

of unscrupulous lending practices in the subprime market. Yesterday was a moving

and important opportunity to hear from victims of predatory lending. The story of

Carol Mackey from Michigan as well as the other hard working people on our panel

of predatory lending victims illustrates clearly why we need to act on this problem.

It is my sincere hope that something can be done to rectify the untenable situation these citizens find themselves in. I think that would be an important step by

key participants in this debate over predatory lending. Obviously, however, fixing

these four terrible lending situations will not address the problems that thousands

of other consumers have encountered while trying to get a loan, but it is a start.

Mr. Chairman, speaking of a positive step forward, I should take a moment to

note the decisions, over the last few weeks, by some of the major lenders. As many

of my colleagues on the Committee pointed out yesterday, the recent decision by

some companies to stop selling single-premium credit insurance was significant and

a positive step in the right direction.

I have had serious reservations about this product and fear that it is usually not

in the best interests of consumers. I am glad to see companies are responding to

these concerns; their actions are responsible and appreciated.

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Today, we are going to hear from an array of spokespeople representing the civil

rights community, consumer interests, seniors, low-income families, as well as some

representatives from the subprime industry. I welcome all of them to the discussion

we are having here and I know many of them have worked very hard on this issue

in different capacities for quite some time.

I am sure that their expertise and differing perspectives will be extremely helpful

to our Committee—especially because the issues before us are complex and different

parties have different ideas about how to stop predatory lending.

In the months ahead, we are going to have to grapple with such issues as loan

flipping, mandatory arbitration disclosures, prepayment penalties, the definition of

a ‘‘high-cost’’ loan, the role of regulation, and effective ways of promoting financial

education—to name just a few.

In the midst of this forthcoming discussion, working through the details and debating the policy merits of different proposals, I hope we keep in mind what this

entire discussion is about. I said it yesterday, and I will say it again today: this discussion is about homeownership and the right for people to build a secure future

for themselves and their families. And, as we heard so vividly yesterday, it is about

people like Carol Mackey, Mary Ann Podelco, Paul Satriano, and Leroy Williams.

Thank you, Mr. Chairman.

—————

PREPARED STATEMENT OF WADE HENDERSON

EXECUTIVE DIRECTOR, LEADERSHIP CONFERENCE ON CIVIL RIGHTS

JULY 27, 2001

Mr. Chairman and Members of the Committee, I am Wade Henderson, Executive

Director of the Leadership Conference on Civil Rights. I am pleased to appear before

you today on behalf of the Leadership Conference to discuss the very pressing issue

of predatory lending in America.

The Leadership Conference on Civil Rights (LCCR) is the Nation’s oldest and

most diverse coalition of civil rights organizations. Founded in 1950 by Arnold

Aronson, A. Philip Randolph, and Roy Wilkins, LCCR works in support of policies

that further the goal of equality under law. To that end, we promote the passage

of, and monitor the implementation of, the Nation’s landmark civil rights laws.

Today the LCCR consists of over 180 organizations representing persons of color,

women, children, organized labor, persons with disabilities, the elderly, gays and

lesbians, and major religious groups. It is a privilege to represent the civil rights

community in addressing the Committee today.

Predatory Lending Is A Civil Rights Issue

Some may wonder why the issue of predatory lending raises civil rights issues,

but I think the answer is quite clear.

Shelter, of course, is a basic human need—and homeownership is a basic key to

financial viability. While more Americans own their homes today than any time in

our history, minorities and others who historically have been underserved by the

lending industry still suffer from a significant homeownership gap.

The minority homeownership rate climbed to a record-high 48.8 percent in the

second quarter of 2001, Housing and Urban Development Secretary Mel Martinez

said yesterday. About 13.2 million minority families owned homes in this period, up

from 47.6 percent in the same quarter last year, HUD said. However, the rate for

minorities still lagged behind the overall homeownership rate in the second quarter

this year, which, at 67.7 percent, tied a high first set in the third quarter of 2000.

Nationally, 72.3 million American families owned their homes.

Unequal homeownership rates cause disparities in wealth since renters have significantly less wealth than homeowners at the same income level. To address wealth

disparities in the United States and make opportunities more widespread, it is clear

that homeownership rates of minority and low-income families must rise. Increasing

homeownership opportunities for these populations is, therefore, central to the civil

rights agenda of this country.

Increasingly, however, hard-earned wealth accumulated through owning a home

is at significant risk for many Americans. The past several years have witnessed

a dramatic rise in harmful home equity lending practices that strip equity from families’ homes and wealth from their communities. These predatory lending practices

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headed households and the elderly. These practices too often lead minority families

to foreclosure and minority neighborhoods to ruin.

Today, predatory lending is one of the greatest threats to families working to

achieve financial security. These tactics call for an immediate response to weed out

those who engage in or facilitate predatory practices, while allowing legitimate and

responsible lenders to continue to provide necessary credit.

As the Committee is aware, however, subprime lending is not synonymous with

predatory lending. Moreover, I would ask you to remain mindful of the need for legitimate ‘‘subprime’’ lending. We should be careful that it is not adversely impacted

by efforts directed at predators. The subprime lending market has rapidly grown from a $20 billion business in 1993 to a $150 billion business in 1998, and all indications are that it will continue

to expand. The enormous growth of subprime lending has created a valuable new

source of loans for credit strapped borrowers. Although these loans have helped

many in an underserved market, the outcome for an increasing number of consumers has been negative.

On a scale where ‘‘A’’ represents prime, or the best credit rating, the subprime

category ranges downward from ‘‘A’’-minus to ‘‘B,’’ ‘‘C,’’ and ‘‘D.’’ Borrowers pay more

for subprime mortgages in the form of higher interest rates and fees. Lenders claim

this higher consumer price tag is justified because the risk of default is greater than

for prime mortgages. Yet even with an increased risk, the industry continues to ring

up hefty profits and the number of lenders offering subprime products is growing.

Some have suggested that subprime lending is unnecessary. They contend that if

an individual does not have good credit then the individual should not borrow more

money. But as we all know, life is never that simple. Even hard working, good people can have impaired credit, and even individuals with impaired credit have financial needs. They should not be doomed to a financial caste system, one that both

stigmatizes and permanently defines their financial status as less than ‘‘A.’’

Until a decade ago, consumers with blemishes on their credit record faced little

hope of finding a new mortgage or refinancing an existing one at reasonable rates.

Without legitimate subprime loans, those experiencing temporary financial difficulties could lose their homes and even sink further into red ink or even bankruptcy.

Moreover, too many communities continue to be left behind despite the record economic boom. Many communities were ‘‘redlined,’’ when the Nation’s leading financial institutions either ignored or abandoned inner city and rural neighborhoods.

And, regrettably, as I discussed earlier, predators are filling that void—the payday

loan sharks; the check-cashing outlets; and the infamous finance companies.

Clearly there is a need for better access to credit at reasonable rates, and legitimate subprime lending serves this market. I feel strongly that legitimate subprime

lending must continue. I am concerned that if subprime lending is eliminated, we

will go back to the days when the only source of money available to many innercity residents was from finance companies, whose rates are often higher than even

predatory mortgage lenders. It was not long ago that these loan sharks walked

through neighborhoods on Fridays and Saturdays collecting their payments on a

weekly basis and raising havoc for many families. We do not want to see this again.

However, predatory lending is never acceptable, and it must be eradicated at all

costs.

Believing that there may have been an opportunity for a voluntary response to

the predatory lending crisis, several national leaders within the prime and subprime

lending industry, as well as the secondary market, came together last year with civil

rights, housing, and community advocates in an attempt to synthesize a common

set of ‘‘best practices’’ and self policing guidelines. Although the group achieved consensus on a number of the guidelines, several tough issues remained unresolved.

These points of controversy surrounded such issues as prepayment penalties, credit

life insurance, and loan terms and fees, which go to the very essence of the practice

by contributing to the equity stripping that can cause homeowners to lose the

wealth they spend a lifetime building. In the end, we failed to achieve a consensus

within our working group largely because industry representatives believed they

could be insulated politically from mandatory compliance of Federal legislation.

Given the industry’s general reluctance to grapple with these tough issues on a

voluntary basis, it seems clear that only a mandatory approach will result in a significant reduction in predatory lending practices.

Direct Action Has Led to Changes, But More Is Needed

At the outset, I think it is important to recognize that many persons and organizations have been actively combating predatory lending practices, and with some

success. I give credit to Maude Hurd and her colleagues at ACORN who have been

able to persuade certain lenders to eliminate products like single-premium credit life

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insurance. I think Martin Eakes of Self-Help, who testified before the Committee

yesterday, should also be recognized for his efforts in crafting a comprehensive legislative package in North Carolina, the first such measure among the States. These

groups, including the National Community Reinvestment Coalition and others you

have heard from in these hearings have forced real change. But they need help.

Recent investigations by Federal and State regulatory enforcement agencies, as

well as a series of lawsuits, indicate that lending abuses are both widespread and

increasing in number. LCCR is therefore pleased to see that regulators are increasingly targeting their efforts against predatory practices. For example, we note that

the Federal Trade Commission (FTC) has taken several actions aimed at predatory

actions. These include a lawsuit filed against First Alliance Mortgage that alleges

a series of deceptive marketing practices by the company, including a marketing

script designed to hide the trust cost of loans to the borrower.

More recently, the FTC filed a comprehensive complaint against the Associates

First Capital alleging violations of a variety of laws including the FTC Act, the

Truth in Lending Act, and the Equal Credit Opportunity Act. Among other things,

the suit claims that Associates made false payment savings claims, packed loans

with credit insurance, and engaged in unfair collection activities.

In addition to the activity at the Federal level, various States Attorneys General

have also been active in this area and I know the issue is of great concern to them.

Many have observed that certain practices cited as predatory are already prohibited by existing law. I agree, and therefore urge regulatory agencies to step up their

efforts to identify and take action against predatory practices. At a minimum, this

should include increased efforts to ensure lenders are fully in compliance with

HOEPA requirements, particularly the prohibition on lending without regard to repayment ability. In addition, we strongly support continued efforts to combat unfair

and deceptive acts and practices by predatory lenders.

State Legislation Has Addressed Some Practices

I think much can be learned from the actions of State legislators and regulatory

agencies. At last count, roughly 30 measures to address predatory lending have been

proposed and more than a dozen have been enacted. The first of these was the

North Carolina statute enacted in July 1999, that Martin Eakes has described to

the Committee. Following this statute, a number of other statutes, regulations and

ordinances have been adopted, several of which are summarized below.

Connecticut

Connecticut H.B. 6131 was signed into law in May 2001 and is effective on October 1, 2000. The new statute addresses a variety of predatory lending concerns by

prohibiting the following provisions in high-cost loan agreements: (i) balloon payments in mortgages with a term of less than 7 years, (ii) negative amortization, (iii)

a payment schedule that consolidates more than two periodic payments and pays

them in advance from the proceeds; (iv) an increase in the interest rate after default

or default charges that are more than 5 percent of the amount in default; (v) unfavorable interest rebate methods; (vi) certain prepayment penalties; (vii) mandatory

arbitration clauses or waivers of participation in a class action, and (viii) a call provision allowing the lender, in its sole discretion, to accelerate the indebtedness.

In addition to these prohibitions, the statute addresses certain lending practices

by prohibiting: (i) payment to a home improvement contractor from the proceeds of

the loan except under certain conditions; (ii) sale or assignment of the loan without

notice to the purchaser or assignee that the loan is subject to the Act; (iii) prepaid

finance charges (which may include charges on earlier loans by the same lender)

that exceed the greater of 5 percent of the principal amount of the loan or $2,000;

(iv) certain modification or renewal fees; (v) lending without regard to repayment

ability; (vi) advertising payment reductions without also disclosing that a loan may

increase the number of monthly debt payments and the aggregate amount paid by

the borrower over the term of the loan; (vii) recommending or encouraging default

on an existing loan prior; (viii) refinancings that do not provide a benefit to the borrower; (ix) making a loan with an interest rate that is unconscionable, and (x)

charging the borrower fees for services that are not actually performed or which are

not bona fide and reasonable.

City of Chicago

Chicago’s predatory lending ordinance was effective November 13, 2000. It requires an institution wishing to hold city funds to submit a pledge affirming that

neither it nor any of its affiliates is or will become a predatory lender, and provides

that institutions determined by Chicago Chief Financial Officer or City Comptroller

to be predatory lenders are prohibited from being designated as a depository for city

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funds and from being awarded city contracts. Cook County also has enacted an ordinance closely modeled to the one in Chicago.

Under the Chicago ordinance, a loan is predatory if its meets an APR or points

and fees threshold and contains any of the following: (i) fraudulent or deceptive

marketing and sales efforts to sell threshold loans (loan that meets the APR or

points and fees threshold to be predatory but does not contain one of the enumerated triggering criteria); (ii) certain prepayment penalties; (iii) certain balloon payments; (iv) loan flipping, that is the refinancing and charging of additional points,

charges or other costs within a 24 month period after the refinanced loan was made,

unless such refinancing results in a tangible net benefit to the borrower; (v) negative amortization; (vi) financing points and fees in excess of 6 percent of the loan

amount; (vii) financing single-premium credit life, credit disability, credit unemployment, or any other life or health insurance, without providing certain disclosures;

(viii) lending without due regard for repayment ability; (ix) payment by a lender to

a home improvement contractor from the loan proceeds, unless the payment instrument is payable to the borrower or jointly to the borrower and the contractor, or

a third-party escrow; (x) payments to home improvement contractors that have been

adjudged to have engaged in deceptive practices.

District of Columbia

The District of Columbia has amended its foreclosure law, effective August 31,

2001 or 60 days after the effective date of rules promulgated by the Mayor, to address predatory practices. In summary, the amendment prohibits: (i) making ‘‘home

loans’’ unless lenders ‘‘reasonably believe’’ the obligors have the ability to repay the

loan; (ii) financing single-premium credit insurance; (iii) refinancings that do not

have a reasonable, tangible net benefit to the borrower; (iv) recommending or encouraging default on any existing debt that is being refinanced; (v) making,

brokering, or arranging a ‘‘home loan’’ that is based on the inaccurate or improper

use of a borrower’s credit score and thereby results in a loan with higher fees or

interest rates than are usual and customary; (vi) charging unconscionable points,

fees, and finance charges on a ‘‘home loan’’; (vii) post-default interest; (viii) charging

fees for services not actually performed or, which are otherwise ‘‘unconscionable’’;

(ix) failing to provide certain disclosures; (ix) requiring waivers of the protections

of the Predatory Lending Law; (x) financing certain points and fees on certain

refinancings; and (xi) certain balloon payments.

Illinois

The State of Illinois has enacted a predatory lending law that was effective on

May 17, 2001. The Illinois law prohibits: (i) certain balloon payments; (ii) negative

amortization; (iii) disbursements directly to home improvement contractors; (iv) financing ‘‘points and fees,’’ in excess of 6 percent of the total loan amount; (v) charging points and fees on certain refinancings unless the refinancing results in a financial benefit to the borrower; (vi) loan amounts that exceed the value of the property

securing the loan plus reasonable closing costs; (vii) certain prepayment penalties;

(viii) accepting a fee or charge for a residential mortgage loan application unless

there is a reasonable likelihood that a loan commitment will be issued for such loan

for the amount, term, rate charges, or other conditions set forth in the loan application and applicable disclosures and documentation, and that the loan has a reasonable likelihood of being repaid by the applicant based on his/her ability to repay;

(ix) lending based on unverified income; (x) financing of single-premium credit life,

credit disability, credit unemployment, or any other credit life or health insurance;

and (xi) fraudulent or deceptive acts or practices in the making of a loan, including

deceptive marketing and sales efforts.

In addition, the statute requires lenders to: (i) provide notices regarding homeownership counseling and to forbear from foreclosure when certain counseling steps

have been taken; and (ii) report default and foreclosure data to regulators.

Massachusetts

Massachusetts adopted regulations that were effective on March 22, 2001. Those

regulations prohibit the following in high-cost loans: (i) certain balloon payments;

(ii) negative amortization; (iii) certain advance payments; (iv) post-default interest

rates; (v) unfavorable interest rebate calculations; (vi) certain prepayment penalties;

(vii) financing points and fees in an amount that exceeds 5 percent of the principal

amount of a loan, or of additional proceeds received by the borrower in connection

with the refinancing; (viii) charging points and fees on some refinancings; (ix) ‘‘packing’’ of certain insurance products or unrelated goods or services; (x) recommending

or encouraging default or further default on loans that are being refinanced; (xi) advertising payment savings without also noting that the ‘‘high-cost home loan’’ will

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gregate amount paid by a borrower over the term of the ‘‘high-cost home loan’’; (xii)

unconscionable rates and terms; (xiii) charging for services that are not actually performed, or which bear no reasonable relationship to the value of the services actually performed; (xiv) requiring a mandatory arbitration clause or waiver of participation in class actions that is oppressive, unfair, unconscionable, or substantially in

derogation of the rights of consumers; (xv) failing to report both favorable and unfavorable payment history of the borrower to a nationally recognized consumer credit

bureau at least annually if the creditor regularly reports information to a credit bureau; (xvi) single-premium credit insurance, including credit life, debt cancellation;

(xvii) call provisions; and (xviii) modification or deferral fees.

Massachusetts also requires credit counseling for any borrower 60 years of age or

more. The counseling must include instruction on high-cost home loans. Other borrowers must receive a notice that credit counseling is available.

New York

In June 2000, the New York State Banking Department adopted Part 41 of the

General Regulations of the Banking Board. This regulation, which was effective in

the fall of 2000, was designed to protect consumers and the equity they have invested in their homes by prohibiting abusive practices and requiring additional disclosures to consumers. Part 41 sets lower thresholds than the Federal HOEPA statute, covering loans where the APR is greater than 8 or 9 percentage points over

U.S. Treasury securities, depending on lien priority, or where the total points and

fees exceed either 5 percent of the loan amount.

The regulations prohibit lending without regard to repayment ability and establish a safe harbor for loans where the borrower’s total debt to income ratio does not

exceed 50 percent. The regulations address ‘‘flipping’’ by only allowing a lender to

charge points and fees if 2 years have passed since the last refinancing or on new

money that is advanced. The regulations also limit financing of points and fees to

a total of 5 percent and require reporting of borrower’s credit history. The regulations prohibit (i) ‘‘packing’’ of credit insurance or other products without the informed consent of the borrower; (ii) call provisions that allow lenders to unilaterally

terminate loans absent default, sale, or bankruptcy; (iii) negative amortization;

(iv) balloon payments within the first 7 years; and (v) oppressive mandatory arbitration clauses.

Finally, Part 41 requires additional disclosures to borrowers, including the statement ‘‘The loan which will be offered to you is not necessarily the least expensive

loan available to you and you are advised to shop around to determine comparative

interest rates, points, and other fees and charges.’’

Pennsylvania

Pennsylvania has recently enacted predatory lending legislation that prohibits a

variety of practices. These include: (i) fraudulent or deceptive acts or practices, including fraudulent or deceptive marketing and sales efforts; (ii) refinancings that do

not provide designated benefits to borrowers; (iii) certain balloon payments; (iv) call

provisions; (v) post-default interest rates; (vi) negative amortization; (vii) excessive

points and fees; (viii) certain advance payments; (ix) modification or deferral fees;

(x) certain prepayment penalties; (xi) certain arbitration clauses; (xii) modification

or deferral fees; (xiii) certain prepayment penalties; (xiv) lending without home loan

counseling; and (xv) lending without due regard to repayment ability.

Texas

Texas has enacted predatory lending prohibitions that are effective on September

1, 2001. Among other things, the Texas law prohibits: (i) certain refinancings that

do not result in a lower interest rate and a lower amount of points and fees than

the original loan or is a restructure to avoid foreclosure; (ii) certain credit insurance

products unless informed consent is obtained from the borrower; (iii) certain balloon

payments; (iv) negative amortization; (v) lending without regard to repayment ability; and (vi) certain prepayment penalties.

For certain home loans, the lender must also provide disclosures concerning the

availability of credit counseling.

Virginia

Virginia has enacted provisions that are effective July 1, 2001. These provisions

prohibit: (i) certain refinancings that do not result in any benefit to the borrower;

and (ii) recommending or encouraging a person to default on an existing loan or

other debt that is being refinanced.

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Federal Legislation Is Necessary

While LCCR commends State and local initiatives in this area, we believe they

are clearly not enough. First, State legislation may not be sufficiently comprehensive to reach the full range of objectionable practices. For example, while some State

and local initiatives impose restrictions on single-premium credit life insurance, others do not. This, of course, leaves gaps in protection even for citizens in some States

that have enacted legislation. Second, while measures have been enacted in some

States, the majority of States have not enacted predatory lending legislation. For

this reason, LCCR supports the enactment of Federal legislation, of the sort that

has been proposed by the Chairman, to fill these gaps.

The Predatory Lending Consumer Protection Act of 2001 contains key protections

against the types of abusive practices that have been so devastating to minority and

low-income homeowners. They include the following: (i) Restrictions on financing of

points and fees for HOEPA loans. The bill restricts a creditor from directly or indirectly financing any portion of the points, fees, or other charges greater than 3 percent of the total sum of the loan, or $600; (ii) Limitation on the payment of prepayment penalties for HOEPA loans. The bill prohibits the lender from imposing prepayment penalties after the initial 24 month period of the loan. During the first 24

months of a loan, prepayment penalties are limited to the difference in the amount

of closing costs and fees financed and 3 percent of the total loan amount; and (iii)

Limitation on single-premium credit insurance for HOEPA loans. The bill would

prohibit the up-front payment or financing of credit life, credit disability, or credit

unemployment insurance on a single-premium basis. However, borrowers are free

to purchase such insurance with the regular mortgage payment on a periodic basis,

provided that it is a separate transaction that can be canceled at any time.

The Leadership Conference strongly supports the Predatory Lending Consumer

Protection Act of 2001 and urges its swift enactment.

Conclusion

Let me finish where I began. ‘‘Why is subprime lending—why is predatory lending—a civil rights issue?’’ The answer can be found in America’s ongoing search for

equal opportunity. After many years of difficult and sometimes bloody struggle, our

Nation and the first generation of America’s civil rights movement ended legal segregation. However, our work is far from finished. Today’s struggle involves making

equal opportunity a reality for all. Predatory lending is a cancer on the financial

health of our communities. It must be stopped.

Thank you.

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PREPARED STATEMENT OF JUDITH A. KENNEDY

PRESIDENT, NATIONAL ASSOCIATION OF AFFORDABLE HOUSING LENDERS

JULY 27, 2001

Good morning. Thank you for the chance to appear before you today. My name

is Judith Kennedy. I am President of the National Association of Affordable Housing

Lenders, or NAAHL, the national association devoted to supporting private capital

investment in low- and moderate-income communities. NAAHL represents 200 organizations, including 85 insured depository institutions and more than 800 individuals. Formed more than 11 years ago, NAAHL’s members are the pioneering practitioners of community investment. They include banks, corporations, loan consortia,

financial intermediaries, pension funds, foundations, local and national nonprofits,

public agencies, and allied professionals.

Ever since NAAHL’s 1999 Chicago conference, where we heard about predators’

activities in that city, we have been convinced that if we are not part of the solution

to predatory lending, we are a part of the problem. It is clear that while we remain

committed to increasing the flow of capital into underserved communities, we must

be equally concerned about access to capital on appropriate terms.

In March, we sponsored a symposium that brought together experts on this issue:

regulators, researchers, advocates, for-profit and nonprofit lenders, and secondary

market participants. We were pleased to include as speakers, Martin Eakes of SelfHelp, who testified before you yesterday, and Margot Saunders of the National Consumer Law Center. NAAHL’s goal was to accelerate progress in stopping the victimization that strips equity from peoples’ homes and, all too often, triggers foreclosures. This victimization is not only wrong in itself, but as the Mayor of Chicago

succinctly put it: ‘‘It is all down the drain if we cannot stabilize the communities

that were stable until these foreclosures started to happen.’’

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1 Held in Senate Banking Committee files.

The symposium was very productive, and today we are releasing the summary of

these proceedings which is attached to my statement.1 Our findings are as follows.

First, a profile of predatory lending emerged. Loan flipping, home improvement

scams, asset-based and unaffordable mortgage loans, repetitive financings with no

borrower benefit, packing single-premium credit life insurance, and other products

into the loan amount, all of these can strip equity and trigger foreclosures.

Second, more needs to be done at the Federal level. More is, of course, being done,

and as New York State Banking Commissioner Elizabeth McCaul and Chairman

Sarbanes have both emphasized, it is critical to balance the need for credit with the

need to end abuses. NAAHL, like many others, has commented on the Federal Reserve’s proposals in this area. But as the Federal Reserve has pointed out, a significant amount of mortgage lending is not covered by a Federal framework. For example, Governor Gramlich reported that only about 30 percent of all subprime loans

are made by depository institutions that have periodic exams. Even if the Fed were

to do periodic compliance exams of the subsidiaries of financial holding companies,

that would only increase the percentage to about 40 percent.

It is not surprising, then, that of the 21 completed Federal Trade Commission investigations into fair lending and consumer compliance violations, 19 involved independent mortgage companies and two involved subsidiaries of financial holding

companies. None were Federally examined. If the Fed’s recent proposal to expand

reporting under the Home Mortgage Disclosure Act to more lenders is adopted, it

will encompass only those whose mortgage lending exceeds $50 million per year.

Many of the proposed changes to HMDA will only create a more uneven playing

field by putting additional burden and costs on responsible lenders while the worst

lenders go unexamined.

To stop the predators, we need to close the barn doors on examination and reporting. A level playing field in oversight and enforcement is key. Insured Depository

Institutions (IDI) engaging in the best practices in the subprime lending market

do extensive due diligence of their brokers to ensure fair lending practices. They

maintain data on their loans and are rigorously examined by the bank regulatory

agencies.

But the majority of lenders are not subject to the same regulatory oversight, do

not have the same level of compliance management, and often do not even file

HMDA reports. If they do file, there is very little oversight of their disclosure. In

a town with no sheriff, the bandits are in charge. Unscrupulous brokers who are

rejected by legitimate lenders, simply go to others who have no knowledge of the

loan terms, or reputational or compliance concerns about funding predatory loans.

Some States like New York are conducting vigorous exams of their licensed mortgage companies, but unfortunately many States lack sufficient resources. Some

States and municipalities believe that stricter laws and ordinances will solve the

problem of predatory practices. Many NAAHL members believe that the plethora of

local laws and ordinances may only drive out the responsible lenders who will

choose not to offer what may become ‘‘high-cost loans’’ under a crazy quilt of new

rate and fee restrictions.

Third, our symposium also confirmed that subprime lending is an important

source of home finance. For many consumers, subprime loans may be the only way

available to finance the American Dream—a home of their own. And many, many

programs exist, in both the private and public sectors, to help subprime borrowers

achieve prime borrower status—a worthy financial goal. Cutting off access to credit

on appropriate terms would not be constructive. As OTS Director Ellen Seidman has

warned, legislation must be very clear so as not to chill ‘‘the operation of the legitimate subprime market. The flow of responsibly delivered credit to underserved markets is critical to their survival and any legislative or enforcement solutions . . .

must proceed with this caution in mind.’’ Fourth, we also heard that vigorous enforcement, at all levels of Government,

works. We heard from people actively involved in combating predatory lending at

the city and State levels. Increased Government investigations, criminal prosecutions to the fullest extent of the law, and revocations of mortgage brokers’ licenses

all help to eradicate predatory lending. State bank supervisors coordinating across

State lines on a single company and its practices will also accelerate progress.

Fifth, consumer education is key. Our experts recommend that financial literacy

education must begin early, down to and including the high school level. The

NAAHL symposium also confirmed that both the public and private sectors, on all

levels, are undertaking consumer education and outreach campaigns, to stop predatory lending before it even happens, with good results. For example, New York residents can easily use State government information to shop for competitive mortgage

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1On January 31, 2001, the OCC, FRB, FDIC, and the OTS expanded the examination guidance for supervising subprime lending activities, limited to institutions under their respective

jurisdictions, which recognizes ‘‘. . . that some forms of subprime lending may be abusive or

predatory . . . designed to transfer wealth from the borrower to the lender/loan originator without commensurate exchange of value.’’ 2See attachment 1, ‘‘Homeownership Rates and Loan to Value (LTV), 1999.

rates. Chicago borrowers can call 1–866–SAVE–HOME to receive counseling and

legal assistance, funded by banks and city government. Lenders across the country

fund financial literacy programs to help borrowers with debt management, the implications of signing contracts, and tips on how to avoid stalkers who offer financing

on predatory terms.

Increased Federal resources for targeted counseling in neighborhoods that are vulnerable to predators could greatly extend these efforts. Education may not solve the

entire problem. As Martin Eakes points out, ‘‘the Department of Education says that

24 percent of adult Americans are illiterate.’’ But counseling can go a long way. As

Governor Gramlich proposed, ‘‘the best defense is if people really know what they

are doing.’’

Overall, our symposium confirmed once again that predatory lending is a complex

issue requiring a multifaceted solution. It takes a combination of responses from

both the public and private sectors, including a broader Federal framework establishing a level playing field for legitimate lenders, more vigorous enforcement of existing laws, and more resources devoted to consumer education to deal with it.

But, as our closing speaker, the Honorable Mel Martinez, Secretary of the Department of Housing and Urban Development put it, ‘‘juntos podemos’’: together we can.

As the President of an organization whose members have spent years trying to

increase the flow of private capital into underserved communities, I say, ‘‘together

we must.’’ Equity stripping, foreclosure triggering loans lead to family tragedies,

foreclosures, and destabilized neighborhoods. They must be stopped. We at NAAHL

commit to help you in any way we can.

—————

PREPARED STATEMENT OF ESTHER ‘‘TESS’’ CANJA

PRESIDENT, AMERICAN ASSOCIATION OF RETIRED PERSONS

JULY 27, 2001

Good morning, Chairman Sarbanes, Ranking Member Gramm, and Members of

the Senate Banking, Housing, and Urban Affairs Committee. My name is Esther

‘‘Tess’’ Canja. I live in Port Charlotte, Florida, and I serve as President of AARP.

AARP is actively engaged in efforts to protect consumer rights and interests. The

Association has been directly involved since the early 1990’s in researching issues,

litigating cases, and working with Federal and State regulatory agencies and legislative bodies to expose, hold accountable, and seek redress from those who are responsible for a wide range of exploitive financial practices.

AARP appreciates this opportunity to bring into greater focus one of the most

troubling forms of these exploitive financial practices—which is making unjustifiable

high-cost home equity loans to older Americans. For most Americans, home equity

accumulation is a factor of time (for many a ‘‘working lifetime’’), and therefore is

highly correlated with age. For older Americans, the most abusive loans are often

the refinancing and equity-based home modification loans because they target the

value of the home—frequently the owner’s largest financial asset. These forms of

abusive lending are particularly devastating when the older homeowner is living on

a modest or fixed income.

It has been AARP’s long-standing view that loans become predatory when they:

• take advantage of a borrower’s inexperience, vulnerabilities and/or lack of information;

• are priced at an interest rate and contain fees that cannot be justified by credit

risk;

• manipulate a borrower to obtain a loan that the borrower cannot afford to repay;

and/or defraud the borrower.1

The investment in homeownership among older Americans is substantial. For example, based on American Housing Survey data for 1999, the median mortgage

Loan to Value ratios (LTV’s) steadily decrease from 74.8 for those under 35 years

of age, to 31.7 for those age 65 and older.2 That is to say, the median homeowner’s

equity increases by more than two-and-one-half times by age 65 and older. The U.S.

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3Projections by the U.S. Census Bureau estimate that by the year 2020, the number of persons age 65 and older will grow to over 53 million—representing a 55 percent increase from

the 34 million estimated for 1998. Changes in the age distribution of the Nation’s older population are also occurring. Presently, the aging of the older population is driven by large increases

in the number of persons age 75 and older. 4 Attachment 2 provides an overview of AARP’s decade-long campaign against predatory lending practices through December 2000. 5 Attachment 3, which is an Executive Summary of the AARP-sponsored national survey of

housing and home modification issues, entitled: ‘‘Fixing to Stay,’’ May 2000.

6 HUD’s detailed study of almost 1 million—mostly refinancing—mortgages reported under

HMDA in 1998, entitled: ‘‘Unequal Burden: Income and Racial Disparities in Subprime Lending

Continued

Census reports that American homeownership averaged an all-time high of 67.4 percent for the year 2000.

What is it about older American homeowners that makes them particularly attractive to predatory lenders? 3 Older homeowners are often targeted for mortgage

refinancing and home equity loans because they are more likely to live in older

homes in need of repair, less likely to perform repairs themselves, and are likely

to have substantial equity in their homes to draw on. Many of them are nearing

or are in retirement, and therefore are more likely to be living—or are preparing

to live—on a reduced or fixed income. In this context, some of AARP’s most recent

research, litigation, and advocacy activities focus on abuses found in home repair

and modification loans.

With some obvious qualifications, this means that the longer a homeowner lives

in his/her home, building up equity as they pay down their mortgages, the greater

the risk that they will be subject to lenders seeking excessive financial advantage

through one of these loans. AARP has worked to educate its members as well as

the public-at-large about how consumers can better protect themselves against such

financial risks.4 We believe consumer education to be a necessary part of a multilevel approach.

AARP also recognizes that the damage done by predatory practices is not limited

to those who have lost, or are at risk of losing their home—as devastating as these

losses clearly are. It also includes those older Americans who need and desire access

to competitive, realistic risk-based home loans, but are reluctant or unwilling to pursue financial services and products due to their fear of potential exploitation. Ultimately, all forms of commerce—including financial services—are based on trust that

each party to a transaction has been treated fairly, and disagreements resolved equitably. Whenever it occurs, predatory home lending undercuts the very essence of

this basic tenet of commerce.

Consider these findings from an AARP-sponsored study, released in May 2000, entitled ‘‘Fixing to Stay’’.5 For Americans age 45 and over:

• more than 4-in-5 say they would like to stay in their current residence for as long

as possible; more than 9-in-10 age 65 or over feel this way; and

• almost 1-in-4 anticipates that they or someone else in their household will have

difficulty getting around their home in the next 5 years.

When asked why they have not modified their home, or have not modified as

much as they would have liked, respondents cited a number or reasons, including:

• not being able to do it themselves (37 percent);

• not being able to afford it (36 percent);

• not trusting home contractors (29 percent);

• not knowing how to find a good home contractor or company that modifies homes

(22 percent).

In most areas, the results of this national survey, when compared to its sample

of minority individuals (that is, African-Americans and Hispanics) were similar.

However, there were a few important differences:

• among those who have refinanced their home or taken out a mortgage against

their home, minorities are more likely to say they did so to obtain funds for home

maintenance or repairs (50 percent minorities versus 35 percent national sample);

• however, minorities are also more likely than the national sample to be very or

somewhat concerned about:

being able to afford home modifications that would enable them to remain at home (44 percent versus 30 percent);

finding reliable contractors or handymen (41 percent versus 28 percent);

finding information about home modifications (34 percent versus 21 percent).6

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in America,’’ found a disproportionate concentration of subprime loans in minority and low-income communities. 7 In April 2001, AARP launched a State-based campaign effort that, over the course of this

year, will focus on consumer education and advocacy efforts.

AARP’s efforts to address these problems—whether through the sentinel effects

of its litigation, its legislative, and regulatory advocacy, or its counseling and education programs—are directed at improving credit market performance, not limiting

consumer access to credit for those with a less-than-perfect credit history. AARP believes that our—and other—consumer financial literacy campaigns are an important

and necessary component of public and private sector efforts to make consumers

their own first line of defense.7 However, while consumer education and counseling

programs are necessary, they are not sufficient.

AARP submitted comments on March 9, 2001, supporting the Federal Reserve

Board’s (the Board) proposal to strengthen the Home Ownership and Equity Protection Act (HOEPA) regulations in an effort to reduce abusive lending practices targeted at the most vulnerable borrowers. In its comments on the proposed regulatory

amendments, AARP suggests that the Board use its current statutory authority to:

lower the annual percentage rate (APR) trigger, expand the definition of points and

fees, and prohibit certain unfair practices such as the use of ‘‘riders’’ to change the

terms of a consumer agreement.

In addition, the Board solicited proposals for making legislative changes that address predatory lending practices. AARP recommended three statutory amendments

to HOEPA that we believe are worthy of consideration by the Board for submission

to the Congress. We recommended:

• inclusion of all fees and points in the loan’s finance charges;

• inclusion of open-ended credit and purchase money loans within HOEPA’s coverage; and

• the elimination of the ‘‘pattern or practice’’ requirement for HOEPA protection;

that is, the borrower would only have to establish that a lender has made an

unaffordable loan under HOEPA—not that the lender has engaged in a pattern

or practice of such lending.

AARP agrees with the Board’s assessment of the beneficial impact of its proposed

amendment, that by expanding the coverage to an additional group of high-cost

loans it will ‘‘ensure that the need for credit by subprime borrowers will be fulfilled

more often by loans that are subject to HOEPA’s protections against predatory practices.’’ AARP believes that the Board should issue the final HOEPA amendment as

soon as prudently possible.

Chairman Sarbanes, and Members of the Committee, the problems associated

with abusive home equity-related lending practices are complex. To date, agreement

on a comprehensive reform of the mortgage finance system to address these problems has proven elusive. Therefore, we are encouraged by the Committee’s continued efforts to call attention to predatory mortgage lending and to establish effective

deterrents. AARP is committed to working with this Committee, the Congress, and

the Bush Administration to address the problems posed to the elderly by these devastating lending practices.

Thank you. I will try to answer any questions you may have.

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1MBA is the premier trade association representing the real estate finance industry.

Headquartered in Washington, DC, the association works to ensure the continued strength of

the Nation’s residential and commercial real estate markets, to expand homeownership prospects through increased affordability, and to extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters excellence and technical

know-how among real estate professionals through a wide range of educational programs and

technical publications. Its membership of approximately 3,100 companies includes all elements

of real estate finance: mortgage companies, mortgage brokers, commercial banks, thrifts, life insurance companies, and others in the mortgage lending field.

PREPARED STATEMENT OF JOHN A. COURSON

VICE PRESIDENT, MORTGAGE BANKERS ASSOCIATION OF AMERICA

PRESIDENT & CEO, CENTRAL PACIFIC MORTGAGE COMPANY, FOLSOM, CALIFORNIA

JULY 27, 2001

Good morning Mr. Chairman and Members of the Committee. My name is John

Courson, and I am President and CEO of Central Pacific Mortgage Company,

headquartered in Folsom, California. I am also Vice President of the Mortgage

Bankers Association of America (MBA),1 and it is in that capacity that I appear before you today. This morning I have been asked to testify before your Committee

to present MBA’s views on the very serious issue of predatory mortgage lending.

First, I want to thank you for inviting the MBA into this very important discussion on a very urgent matter. I commend the Committee’s leadership in calling for

these hearings, as we believe that a full understanding of the issues is the only responsible way to finding solutions to the scourge of abusive mortgage lending.

As Vice President of the trade association that represents the real estate finance

industry, and as President of a mortgage company, I am deeply troubled by the continuing reports of predatory and abusive lending practices that persist in our industry. It is imperative that you know, from the outset, where MBA stands on this

issue. We condemn these practices in the strongest possible terms. The MBA recognizes that this is a problem that is real, and one that carries real repercussions for

those communities that are affected. Although so-called predatory lending practices

are difficult to measure and quantify, there is no hiding from the fact that certain

rogue lenders and certain unscrupulous brokers continue to prey on our most vulnerable populations. Nor can we hide from our responsibility—as members of the

finance industry—to act in the face of this continuing problem.

For over 80 years, the MBA has stood for integrity and fairness in mortgage lending. Our members have helped millions of Americans achieve the dream of homeownership. In so doing, we have established a tradition of encouraging the highest

standards of responsible lending.

We, therefore, want to make clear that ending unfair lending practices is a major

priority for our association. We have devoted substantial amounts of attention and

time to this issue. We want to state in no uncertain terms that it is time to address

the problems of predatory lending head-on, and in a way that does not constrict the

flow of capital to credit-starved communities. Today, I will address the MBA’s views

on what needs to be accomplished to bring lasting and effective solutions to these

abuses.

‘‘Subprime’’ Lending

Before I do so, however, I think it is important to set forth some background on

the nature and recent growth of the so-called ‘‘subprime’’ lending, since most of the

reports of mortgage abuse appear to stem from this segment of the market. In general terms, that sector of the mortgage market that has become known as the

‘‘subprime market’’ serves customers that do not qualify for conventional, prime rate

loans. The reasons why such consumers do not qualify are varied, but generally,

these borrowers may have blemished credit records, or perhaps unproven credit or

income histories.

A further element of this market, and of subprime loans generally, is that they

tend to be more expensive in terms of fees and rates. This is so because they generally carry extensive due diligence costs and require hands-on servicing, and because they are inherently riskier than loans made in the prime market.

It is imperative to note that subprime lending has been extremely beneficial to

thousands of families in the last couple of years. Subprime lending has opened up

new markets and helped many consumers that would not have received needed

funds but for the special products available in this sector of the market. The

subprime market provides a legitimate and much needed source of credit for many

families. As the Department of the Treasury and the Department of Housing and

Urban Development acknowledged in a more recent report, ‘‘[b]y providing loans to

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2 U.S. Department of the Treasury and Department of Housing and Urban Development,

Curbing Predatory Home Mortgage lending: A Joint Report, June 2000 (HUD/Treasury Report). 3See Statement of John L. Bley, Director of Financial Institutions, State of Washington before

the Federal Reserve Hearing on Home Equity Lending (September 7, 2000). 4See, for example, HUD/Treasury Report, at p. 2.

5See Board Notice of Public Hearings and Request for Comments, at p. 3.

borrowers who do not meet the credit standards for borrowers in the prime market,

subprime lending provides an important service, enabling such borrowers to buy

new homes, improve their homes, or access the equity in their homes for other

purposes.’’ 2

Defining the Problem

It is unfortunate, however, that as the subprime market has expanded, the reports of predatory and abusive lending have apparently increased as well. We note

that the problem of abusive lending is not really new nor limited to the subprime

market alone. State regulators report that they have been dealing with these types

of issues for a long time, and that what was once called ‘‘mortgage fraud’’ is now

being dubbed ‘‘predatory lending.’’ 3 Regardless of the name, a major part of the

challenge that we face in finding solutions to this problem is that it has proven

quite difficult to answer the threshold question of how to define ‘‘predatory lending’’ or what constitutes ‘‘abuse’’ in the general context of mortgage lending. Surely we

can identify examples of practices that everyone would agree are ‘‘abusive,’’ but the

problem we face is that these examples could be both underinclusive and overinclusive, depending upon the full circumstances of the loan transaction. Thus, often

identified ‘‘predatory’’ practices could include the following: excessive fees and points

that are often financed as part of the loan; loan ‘‘flipping’’ or ‘‘churning,’’ in which

a loan is repeatedly refinanced in a way that degrades the owner’s equity in the

property; intentionally making a loan that exceeds the borrower’s ability to repay;

and overly aggressive sales techniques that deliberately mislead the borrower.

It is important to note that in every example noted, the full context of the transaction must be analyzed to properly assess whether an abuse has occurred. It is impossible, for example, to identify ‘‘excessive’’ fees without knowing the nature and

difficulty of the service provided in exchange for that fee. Nor can we recognize repeat refinances that are meant to strip equity without looking at the fee structure

of the transaction and the equity of the consumer. In order to determine that a consumer has been ‘‘deliberately misled,’’ we have to study the disclosures and the oral

representations made in the context of the specific transaction at hand. Since every

loan is unique and every transaction is tailored to specific needs and conditions, the

answer of whether mortgage abuse has occurred in any given situation is dependent

upon the totality of the circumstances of the borrower and the transaction. It is

daunting, therefore, to isolate the specific ‘‘bad acts’’ that are employed by unscrupulous lenders in a way that allows for appropriate regulation.

We also note that even those regulatory agencies with jurisdiction over mortgage

credit practices have not provided any clear guidance on the topic. Those agencies

that have attempted to provide a definition have uniformly avoided the real issue,

opting instead to provide either ‘‘categories’’ under which the abuses ‘‘tend to fall,’’ 4

or simply advancing descriptive examples and anecdotes of the more common abuses

that they may have observed in the market.5 Under either approach, the fundamental definitional issues are left unanswered. Sometimes the terms ‘‘predatory

lending’’ and ‘‘subprime lending’’ are used interchangeably. This confusion and lack

of adequate definitions at Federal and State levels, and the problem of lack of organized and coordinated data on predatory lending, is confirmed and described at

length in a recent report issued by the Senate Banking Committee staff to Chairman Gramm, released in August 2000.

Source of Problem

MBA believes that predatory lending is a problem that has various sources. As

we attempt to tackle this problem, it is necessary to isolate these sources, as they

must be addressed individually before we can be successful in crafting lasting solutions. In short, the MBA believes that the three fundamental sources that need

to be attacked jointly are the complexity of the laws, lack of education, and lack of

enforcement.

Complexity of Mortgage Laws/Process

First and foremost, we believe that a fundamental root problem leading to abusive

lending is the confusion created by the complexity of the mortgage process. Any consumer that has ever been through a settlement closing knows how confusing and

cumbersome the process can be. Mortgage disclosures are voluminous and often

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6See Board of Governors of the Federal Reserve System and Department of Housing and

Urban Development, Joint Report on the Real Estate Settlement Procedures Act and Truth in

Lending Act, July 17, 1998 (Appendix A). 7There are various examples noted by regulators. One of them consists of a dishonest lender that may reveal to consumers that they are borrowing $50,000 when, in effect, the total amount

borrowed is $60,000. This occurs because, under unique TILA rules, the ‘‘Amount Financed’’

number is derived by taking the amount of the note and subtracting ‘‘Prepaid Finance Charges.’’

These subtracted charges include the lender’s own loan origination fees and other fees. Under

this scenario, the unscrupulous lender can rely on the ‘‘Amount Financed’’ disclosure to mislead

the consumer into believing that they have a much smaller loan than they actually commit to

at the closing table.

cryptic, and consumers simply do not understand what they read nor what they

sign. In addition, the mandated forms lack reliable cost disclosures, making it difficult for prospective borrowers to ascertain true total closing costs and renders comparison shopping virtually impossible.

There are various confirmations of this core problem. In a recent report prepared

by the Federal Reserve Board and the Department of Housing and Urban Development, these Federal agencies ascertained that most consumers do not understand

the relation between the contract interest rate and the Annual Percentage Rate

(APR) listed in the Truth in Lending disclosures. The agencies explain that ‘‘the

[consumers’] belief was based on misconceptions about what the disclosures represent. For example, consumers believed the APR represents the interest rate . . .

and the amount financed represents the note amount. . . .’’ 6 These are fundamental

misunderstandings that can lead to very serious repercussions for unwary or unsophisticated shoppers. In fact, there are reports that these cryptic forms, and the

public’s misunderstanding of them, make the Federally required Truth in Lending

disclosures a very useful tool for predators to confuse and defraud consumers.7

We can name a myriad of other examples, but simply put, the complexity of the

current system is the camouflage that allows unscrupulous operators to hide altered

terms and conceal crucial information without fear of the consumer discovering or

even understanding the import of the masked or undisclosed items. In light of

this complexity, confounded borrowers often have no choice but to turn to the loan

officer for advice and explanation of the contents of the disclosures. In instances of

abusive lenders, the consumer’s reliance closes the loop of deception—the victims of

these scams are completely blinded to the realities and repercussions of the transaction. These problems are exacerbated ten-fold in instances of uneducated or illiterate consumers.

Lack of Consumer Awareness/Education

The complexity of the mortgage process leads directly to, and is intertwined with,

the second source of predatory lending—lack of consumer awareness and education.

It is a reality today that even well-educated consumers tend to lack basic understanding of the mortgage shopping and home buying processes. For example, the

borrower surveys conducted by the Federal Reserve Board revealed that over 20 percent of those surveyed contacted only one single source of credit. I already mentioned that consumers do not understand the meaning and importance of the APR

figure. Nor do mortgage shoppers entirely comprehend that the early Good Faith Estimate disclosures are not final. Often, homebuyers believe that ‘‘listing’’ real estate

agents carry fiduciary responsibilities vis-a ́-vis the purchaser. They generally do not.

Again, all these misperceptions have real repercussions in the market, and they all

stem from basic misunderstandings of the real estate and mortgage finance market.

Lack of Enforcement

The third problem creating a favorable environment for abusive lenders is the

general absence of real enforcement in this area. It is important to understand that

the mortgage lending industry is one of the most heavily regulated industries today.

Mortgage lending is subject to pervasive State regulation and must comply with a

wide array of Federal consumer protection laws including the Truth in Lending Act,

Real Estate Settlement Procedures Act, Fair Housing Act, Fair Credit Reporting

Act, Equal Credit Opportunity Act, Fair Credit Billing Act, Home Mortgage Disclosure Act, Federal Trade Commission Act, and Fair Debt Collection Practices Act.

Many of the ‘‘predatory’’ abuses reported today either violate current law or result

from lack of disclosures that violate current laws. We note that in practically all instances, these predatory loans also involve outright fraud and deception. We have

to set a new priority to aggressively enforce the multitude of existing laws.

MBA believes that these root causes must be addressed in order to fully erase the

pernicious lending practices that are occurring today. Any approach that does not

address these three basic prongs—simplification, education, and enforcement—will

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merely deal with the effects and not with the underlying causes of the problem.

Anything short of this full approach will fail to resolve the crisis.

Looking Ahead

I reiterate that there is general agreement that there is a problem with abusive

lending in many markets today. While there is some disagreement as to how to

eliminate these practices, I believe that the mortgage industry, policy makers, and

consumer representatives all share a sincere desire to end the abuses. I believe that

we are all gathered here today to engage in a serious dialogue as to what needs

to be done to advance real solutions to this problem.

Let me then address some steps we can all take to bring an end to this problem.

As I mentioned before, we all share in the responsibility to ensure that predatory

lending is eliminated.

Consumers

First, as outlined above, education of consumers is a most basic step in the struggle to push predators out of our neighborhoods. MBA believes that an educated consumer is the best prophylactic to predatory abuse.

Presently, MBA is assembling a workgroup to develop a series of resources aimed

specifically at consumers that believe that they are being victimized by predatory

lenders. The objectives of this initiative is to develop advice and materials that can

be accessed directly and immediately by consumers seeking protection from unfair

activities. To this end, the workgroup is developing a full list of legal rights and ethical norms that all consumers should expect from honest and reputable lenders. This

list will be made available to the general public and disseminated to Government

officials, consumer protection agencies, and consumer advocates to ensure that all

prospective borrowers fully understand their rights in the transaction.

In connection with this document, the workgroup will also develop a system

whereby affected consumers can obtain direct access to an enforcement agency or

other source of immediate assistance on items pertaining to their loan situation.

MBA believes that this direct access is crucial to protecting vulnerable borrowers.

Again, the goal under this system is to provide immediate help to those consumers

that feel they are being victimized by loan predators. This system would include a

method for identifying ‘‘warning signs’’ of possible abuses that would alert consumers that they may be dealing with less than honest operators. Once a consumer

identifies certain suspicious signs—that is, aggressive solicitations, unexplained

changes at the closing table, requests to leave line items blank on material forms—

then that consumer would be empowered to seek further immediate advice from a

trusted third party before completing the transaction. We note that there is

no system today that effectively delivers help and useful information that a victim

requires at the very point where the abuse is occurring. We are trying hard to

create a structure of support that works effectively and that can be implemented

immediately. We hope to report back to you very soon with good news on our

advancements.

Industry

The MBA has always been proactive in the fight against ‘‘predatory’’ lending

abuses. As lenders and brokers, we share a strong responsibility to fight predatory

abuses on various fronts. I will outline some of the examples of positive industry

activities that are making a difference in this endeavor.

First, our association was the first, and remains the only national trade association to sign a ‘‘fair lending/best practices’’ agreement with HUD. This agreement

was signed in 1994 and renewed in 1998. In this agreement, MBA committed to a

number of steps that will promote fair lending and assist the industry in reaching

underserved groups in our society.

Recently, MBA developed a set of ‘‘Best Practices’’ for our members. These Best

Practices encourage members to conduct their business according to the standards

contained therein and participate in periodic audits to test for compliance. These

guidelines are designed to ensure that all customers are given fair and equitable

treatment.

Further, MBA entered into a contractual relationship with the Mortgage Asset

Research Institute (MARI) to create a national database of companies and individuals that have been identified by law enforcement or regulatory bodies as having

engaged in illegal or improper behavior.

In 1998, MBA founded the Research Institute for Housing America (RIHA) and

currently funds its projects, which support research and other activities to help determine how discrimination occurs in home buying process, and to eliminate discrimination. RIHA projects also endeavor to develop useful research on meeting conVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00324 Fmt 6601 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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sumer demand for mortgage financing in underserved markets and to measure the

societal benefits and costs of homeownership.

As mentioned above, we believe that consumer awareness and education are

among the most effective tools available for combating predatory lending practices.

In this area, we think that industry participants can do much to develop educational

tools and programs that will enable consumers to make more informed choices. For

example, MBA is a founding and active member of the Board of the American

Homeowner Education and Counseling Institute (AHECI). The purpose of AHECI

is to provide training and certification to the homeownership counseling industry.

As a founding member of this organization, MBA provided $100,000 in startup

funds.

MBA has worked with the National Council on Economic Education (NCEE) over

the past several years to educate school children around the country in understanding the importance of good credit and the need for sound financial planning

and management skills, as well as how to go about purchasing and financing a

home. Recently, MBA partnered with NCEE with a donation of $130,000 to promote

a program that will educate high school youth and adult consumers on the perils

of abusive lending.

Last, MBA is currently engaged in discussions with lending organizations and

other groups to determine how to best provide useful and complete information and

education for homebuyers, with a special emphasis on subprime borrowers.

Government

MBA believes that there is much that Government can do to put an end to predatory lending abuses. First and foremost, MBA strongly believes that much more

must be done to enforce the laws that are currently on the books. In the past quarter century, both Federal and State Governments have put in place a far-reaching

body of laws designed to prevent abuse of consumers in credit transactions. Generally, there is a myriad of laws that exist in the different States that could effectively address the abuses that are occurring in the market today. These laws include

prohibitions against unfair and deceptive trade practices; prohibitions against discrimination and redlining in finance transactions; limitations on specific terms of

consumer and mortgage credit; limitations on insurance products; penalty provisions

for noncompliance; prohibitions of deception misrepresentation, nondisclosure and

concealment; and common law rules against fraud.

Before any additional laws are adopted, policymakers must realize that it does no

good to legislate against practices that are already illegal in all jurisdictions. More

laws will inevitably increase the complexity and costs of lending without a corresponding increase in consumer protection. Simply piling on more prohibitions will

not resolve a crisis that today is caused by actors that operate at the outer fringes

of the law. To be serious about solutions, we must pledge a full commitment to engage in serious enforcement of the laws.

MBA fully understands that enforcement actions are not an easy undertaking.

They require much time, careful examinations, documentation of disclosures and

documents, documentation of sales techniques, interviews with parties involved,

among other things. In the end, however, this is the most effective way to stamp

out these pernicious practices. To this end, MBA calls for increased funding of consumer protection agencies to accord them with all necessary resources so that we

may begin to, once and for all, clamp down on unscrupulous actors in earnest.

Second, MBA believes that, in order to fight predatory lending, it is absolutely essential to enact comprehensive reform of the current mortgage lending laws. As

mentioned above, predatory lending is in many ways a symptom of larger problems

that have evolved from complicated and outdated mortgage laws. Without broad

changes to existing laws and comprehensive reform of current cost disclosures, any

efforts to address predatory lending will merely deal with the effects and not with

the underlying causes of the problem. If the process remains confusing and perplexing, consumers will continue to be tricked and deceived. MBA has worked tirelessly to come up with a system that improves the consumer’s opportunities to shop

and allows for timely and effective disclosure of settlement costs and vital information to consumers.

Under MBA’s comprehensive reform package, lenders would be allowed to provide

mortgage applicants with an early price guarantee that permits consumers to effectively shop for mortgage products in the market. Under this plan, the closing cost

guarantee to be provided to consumers would include all the costs required by the

lender to close the loan, This guaranteed disclosure system would let consumers

know, early in the mortgage application process, the maximum settlement costs a

lender could charge. Under MBA’s plan, the cost guarantee would be binding and

enforceable.

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MBA’s reform proposal also seeks to streamline all current Federal loan disclosures so that they provide home shoppers with clearer and more concise information

without the confusion inherent in the current forms. We envision a system where

disclosures and educational materials, including advising consumers of the availability of counseling, would be provided to the consumer very early in the mortgage

application process, in effect. We believe that these educational materials must be

rewritten and restructured to make them more understandable and much friendlier

to consumers. For example, MBA believes that interactive resources or the use of

media other than booklets would go a long way in augmenting the accessibility and

the use of these materials. And, unlike the current RESPA materials, these materials would contain full and comprehensive advice regarding mortgage abuse, including possible sources of counseling.

We note also that by streamlining the current legal and regulatory landscape, we

also make it easier to identify abuses and prosecute unscrupulous players. If we

remove all the gray areas from the current process, and provide for clear penalties

and remedies that punish violators, we will make it easier to regulate, examine, and

enforce.

Last, and in connection with previous statements, MBA believes that Governmental agencies everywhere must do more to promote consumer awareness and education. To this end, we support expanded funding for the development of counseling

programs and counseling certification systems that assure that consumers receive

all information they need to protect themselves in this very complex transaction.

Conclusion

In summary, the MBA believes that the continuing search for solutions to this

problem must expand to comprehensively include all the underlying factors that

allow predatory lending to flourish. We can no longer afford to focus on Band-Aids

that merely cover up the harms. We must address predatory lending through direct

attacks on three fronts—a commitment to full enforcement, robust education, and

a simplification of existing laws. Nothing short of that will suffice.

Thank you for the opportunity to appear before the Committee. I look forward to

answering your questions.

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PREPARED STATEMENT OF NEILL A. FENDLY, CMC

IMMEDIATE PAST PRESIDENT, NATIONAL ASSOCIATION OF MORTGAGE BROKERS

JULY 27, 2001

Mr. Chairman and Members of the Committee, I am the Immediate Past President of the National Association of Mortgage Brokers (NAMB), the Nation’s largest

organization exclusively representing the interests of the mortgage brokerage industry. We appreciate the opportunity to address you today on the subject of abusive

mortgage lending practices.

NAMB currently has over 12,000 members and 41 affiliated State associations nationwide. NAMB provides education, certification, industry representation, and publications for the mortgage broker industry. NAMB members subscribe to a strict

code of ethics and a set of best business practices that promote integrity, confidentiality, and above all, the highest levels of professional service to the consumer.

In these hearings, the Committee will hear a number of individual stories as well

as comments from advocates about some egregious, and in our view inexcusable,

mortgage lending practices. You will also hear from others in the mortgage industry

about possible solutions, which NAMB supports and is actively involved in developing. My testimony today will briefly outline some of these. But I would like to

focus this testimony on helping the Committee understand the important and

unique role of mortgage brokers in the mortgage marketplace, and offer the unique

perspective of mortgage brokers in examining the problem of predatory lending.

Today, our Nation enjoys an all-time record rate of homeownership. While many

factors have contributed to this record of success, one of the principal factors has

been the rise of wholesale lending through mortgage brokers. Mortgage brokers

have brought consumers more choices and diversity in loan programs and products

than they can obtain from a branch office of even the largest national retail lender.

Brokers also offer consumers superior expertise and assistance in getting through

the tedious and complicated loan process, often finding loans for borrowers that may

have been turned down by other lenders. Meanwhile, mortgage brokers offer lenders

a far less expensive alternative for nationwide product distribution without huge investments in ‘‘brick and mortar.’’ In light of these realities, it is no surprise that

consumers have increasingly turned to mortgage brokers. Today, mortgage brokers

originate more than 60 percent of all residential mortgages in America. The rise of

the mortgage broker has been accompanied by a decline in mortgage interest rates

and closing costs, an increase in the homeownership rate, and an explosion in the

number of mortgage products available to consumers. These positive developments

are not mere coincidences. They would not have been possible without the advent

of wholesale lending through mortgage brokers.

Mortgage brokers now have an extremely important role in our economy. With the

collapse of the savings and loan industry in the 1980’s, followed by the rapid consolidation of mortgage banking firms in the 1990’s, today we find that in many communities, particularly in central cities and small towns, people might have a hard time

finding a retail bank branch or retail mortgage lending branch. But they can usually

find a mortgage broker right in their community that gives them access to hundreds

of loan programs. Mortgage brokers are generally small business people who know

their neighbors, build their businesses through referrals from satisfied customers,

and succeed by becoming active members of their communities.

The recent expansion in subprime lending, which has been noted by the Committee in these hearings and others, has also relied heavily on mortgage brokers.

Mortgage brokers originate about half of all subprime loans. Many mortgage brokers

are specialists in finding loans for people who have been turned down by other lenders. These are hard-working people who, for one reason or many reasons, do not fit

the profile that major lenders prefer for their customers. Each of them is unique.

Some lenders just do not want to be bothered with such customers that take a little

more time and effort to qualify. Some do not want to accept the risk of lending to

someone who may have had a bankruptcy, an uneven employment history, or a

problem with a previous creditor.

Mortgage brokers can usually find a loan for someone who has been turned down

by others. Most mortgage brokers who originate subprime loans do so primarily because they enjoy helping people. Certainly these loans can be profitable, and borrowers do pay higher rates and fees because of the increased risk, but subprime

loans are also time-consuming and often very difficult to arrange.

Mortgage brokers often do an amazing amount of work on these loans. They work

with borrowers, sometimes for weeks, to help them understand their credit problems, work out problems with other creditors, clean up their credit reports when

possible, and review many possible options for either purchasing a home or utilizing

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their existing home equity as a tool to improve their financial situation. The brokers

are rewarded with the knowledge that they have enabled a hard-working family to

buy its first home, avoid foreclosure, get out from under a crushing load of highrate credit card debt, finance their children’s education, pay delinquent taxes, repair

their homes, and help their parents pay off their mortgages and health care bills.

People of all income levels may end up in situations that leave them unable to

qualify for the lowest mortgage rates and fees. But they still need, and deserve to

have, access to mortgage credit. It is a lifeline for those who are drowning in debt,

facing a huge medical bill, trying to survive a layoff. It is the least expensive source

of credit for those who may have made some mistakes or had some misfortune in

the past and now need money to improve their home, finance their children’s education, or even start a business. They need to have the widest possible range of

choices when they are buying a home or need a second mortgage. And today they

do. It is important for them, and for others like them in the future, that Congress

be very careful to avoid measures that will rob them of choices they deserve and

the tools they need to manage and improve their financial situation.

One of the most important choices available to consumers with low-incomes, little

or no cash, and/or impaired credit is the ‘‘no- or low-cost’’ loan. Mortgage brokers

have originated thousands of loans for people who were able to buy a home, refinance, or obtain a home equity loan with little or no upfront closing costs or broker

fees. These costs are financed through an adjustment to the interest rate. Retail

lenders offer ‘‘no- or low-cost’’ loans at adjusted rates as well. When a mortgage

broker arranges a loan like this, the broker is compensated by the lender from the

proceeds of the loan. This kind of payment goes by many names, but is often called

a ‘‘yield spread premium.’’ These payments are perfectly legitimate and legal under

Federal law, the Real Estate Settlement Procedures Act, so long as they are reasonable fees and the broker is providing goods, services, and facilities to the lender.

These payments to mortgage brokers are also fully disclosed to borrowers on the

Good Faith Estimate and the HUD–1 Settlement Statement, and are included in the

interest rate. Retail lenders, however, are not required to disclose their profit on a

loan that is subsequently sold in the secondary market, as most mortgages are

today. This method of enabling consumers to obtain loans through mortgage brokers

with little or no upfront costs is now under assault in the courts. Despite Statement

of Policy 1999–1, issued at the direction of Congress by the Department of Housing

and Urban Development in 1999, which clearly set forth the Department’s view that

the legality of mortgage broker compensation must be judged on a case-by-case

basis, trial lawyers across America have continued to file and pursue class action

lawsuits claiming that all such payments are illegal and abusive.

Recently, the 11th Circuit agreed with the plaintiff in one of these suits and allowed a class action to be certified. Although at first glance this appears to be only

a procedural decision, it has resulted in a flood of new litigation against mortgage

brokers and wholesale lenders, and caused a great deal of uncertainty and anxiety

in the mortgage industry. The cost of defending these class actions is staggering.

The potential liability could run to over a billion dollars. The prospect of a court

deciding that the prevalent method of compensation for over half the mortgage loans

in America is illegal is chilling, to say the least.

If these lawsuits succeed, some lawyers will benefit at the expense of the mortgage industry. Their clients might get small refunds, or a few dollars off the cost

of their next loan. But the real losers will be tomorrow’s first time home buyers,

tomorrow’s working families, tomorrow’s entrepreneurs who will not be able to get

a mortgage without paying hundreds of dollars upfront. And, further down this

road, many small businessmen and women may not be able to stay in business as

mortgage brokers without being able to offer these ‘‘no-cost’’ loans. As competition

decreases, all potential mortgage borrowers will suffer higher costs and fewer

choices. This illustrates the unintended consequences that can come from litigation,

regulation, or legislation that singles out one part of the mortgage industry, places

blanket restrictions or prohibitions of certain types of loan terms or products, or

places unreasonable restrictions on interest rates and fees. We have ample reason

to believe that such measures will increase the cost of homeownership, restrict consumer choice, and reduce the availability of credit, primarily to low- and moderateincome consumers.

To further illustrate the problem with blanket restrictions on loan terms, consider

the balloon loan. A balloon term in a given loan could be abusive if the borrower

has not been advised that the loan contains such a feature and is not prepared for

the practical ramifications. Further, it may be that the borrower’s situation does not

make such a feature appropriate. Yet, very often, a balloon is a valuable tool to help

a borrower obtain a lower interest rate and lower monthly payments that are affordable. If the borrower’s circumstances are such that a refinance loan should be reaVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00351 Fmt 6601 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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sonably feasible at some time in the future, and possibly even at a lower interest

rate because the borrower has improved his or her credit standing in the meanwhile, then a balloon term can be a desirable feature. Many reputable, mainstream

lenders offer balloon loans to customers in all credit grades, and many borrowers

freely choose such loans, because they are good options in many cases.

The same is true for other loan terms or conditions frequently cited as abusive,

including negative amortization, prepayment penalties, financing of closing costs,

and even arbitration clauses. In certain circumstances, each of these may be abusive, but in the majority of cases they provide the consumer with a feature that fits

his or her unique circumstances, such as a reduced interest rate or lower monthly

payment. Virtually no loan terms are always abusive, and almost any loan term

that is offered in the market today can be beneficial to some consumers. Whether

a loan is abusive is a question that turns on context and circumstances, from case

to case. This is the primary reason why NAMB and the mortgage industry have opposed legislation or regulation that would impose new, blanket restrictions or prohibitions on loan terms. We believe such measures will increase the cost of homeownership, restrict consumer choice, and reduce the availability of credit, primarily

to low- and moderate-income consumers.

NAMB believes that the problem of predatory lending is a threefold problem of

abusive practices by a small number of bad actors; lack of consumer awareness

about loan terms; and the complexity of the mortgage process itself. We believe all

three of these areas must be addressed, together and with equal force, if the problem is to be solved without the unintended consequences mentioned earlier. The

mortgage industry is working vigorously in all three areas, and NAMB wants to

continue working with Congress to address all these areas—in particular, reform

and simplification of the mortgage process.

Addressing Abusive Practices

Those of us who are hard-working, reputable mortgage originators want nothing

more than to get the bad actors out of our industry. We do not like competing

against people who fraudulently promise deceptively low rates or costs and do not

disclose their fees, thereby making those of us who obey the law appear more expensive. We do not like the bad publicity our industry receives from media stories about

lenders or brokers who take advantage of senior citizens and poor people. We know

the long-term survival of our industry depends on having satisfied customers and

maintaining the trust people have in us as professionals, so we cannot afford to

have anyone making loans that hurt consumers and violate that trust.

All types of institutions have bad actors among their ranks. This is not an issue

that is confined to lenders, mortgage brokers, depository institutions, or independent companies. Bad actors are found among all of these types of entities. We

wish to emphasize in particular that mortgage brokers are not the only ones involved; we have observed that many have blurred the distinction between mortgage

brokers and various other types of companies.

A popular misconception is the belief that abusive lenders operate within existing

regulatory guidelines. Rather, most of them choose to ignore laws and regulations

that properly apply to them. There is a small minority of institutions that do not

obtain State licensure as required. Some ignore State consumer protection laws.

They do not observe the existing restrictions in the Federal HOEPA. They may even

violate basic disclosure rules under RESPA and TILA. In many cases they are committing outright fraud, which violates yet other State and Federal statutes. And, in

general, they do not join industry groups such as NAMB or the comparable organizations for their respective industries.

There are many tools at our disposal now to deal with these people and companies. Laws already exist at the Federal and State level that give regulators and

prosecutors the authority to revoke licenses, impose fines, and even pursue criminal

prosecution of lenders or brokers that commit fraud, charge unreasonable fees, and

otherwise violate HOEPA, RESPA, TILA, and other Federal statutes. The Federal

Trade Commission has brought enforcement actions under HOEPA. These enforcement actions do have a deterrent effect on others. The Department of Housing and

Urban Development is improving its own lender approval and enforcement policies

for FHA lending. Many States have toughened their licensing laws, usually with the

full support of our affiliated State mortgage broker associations.

The industry is also taking steps to address practices and behaviors in the market

that can be eliminated and thereby maintain trust in our industry. We note that

one of these, the sale of single-premium credit life insurance, has been dramatically

curtailed in recent weeks by the major companies involved with that product. In another example, a major subprime lender recently stopped using several hundred

mortgage originators that did not meet its standards of professional practice. NAMB

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supported this effort and continues to encourage wholesale lenders to use their

broker agreements to ensure sound origination practices. NAMB and other major

mortgage lending organizations have adopted Codes of Ethics and Best Business

Practices guidelines, and we all encourage consumers to make sure that their lender

or broker is a member of one of these national organizations.

Another unacceptable practice is loan flipping. NAMB supports reasonable measures that would stop this kind of abusive practice, but still allow people to refinance

their loans when they need to. For example, we support the proposal by the Federal

Reserve to limit the amount of fees that can be charged in a refinance of a HOEPA

loan by the existing lender to the new money financed. Some subprime lenders are

addressing this practice by discouraging frequent refinancing of their existing customers. One major subprime lender just this week announced new measures to ensure that refinances truly benefit the borrower. We think this is a great step that

other lenders should and will soon follow. Many of the consumer groups here today

are working with major lenders on these industry initiatives.

Consumer Education

The second part of addressing predatory lending is improving consumer awareness. An informed consumer is almost never a victim of a predatory loan. Every organization coming before the Committee today is involved in some way with consumer education. NAMB encourages its members to never originate a loan to an uninformed consumer. NAMB’s website includes extensive consumer information and

links to sites that provide consumers a wealth of information they can use to make

informed mortgage choices. The NAMB Mortgage 101 Center provides consumers

with information from one of the mortgage industry’s most popular and reliable online resources. The website provides consumers with information, in an unbiased

manner, about completing applications, the purpose of an appraisal, bankruptcy and

its alternatives, mortgage calculators, down payments, FHA loans, loan programs,

refinancing, relocation, second mortgages, VA loans and many other topics. This

website provides consumers with unbiased answers to many basic questions and

many more specific issues.

Fannie Mae, with its ‘‘Consumer Bill of Rights’’ campaign and Freddie Mac with

its ‘‘Don’t Borrow Trouble’’ campaign are putting millions of dollars into educating

people about how to choose a good mortgage loan and avoid being victims of predatory lending. AARP has launched a great education campaign aimed at seniors, who

are often the target of predatory lenders. NAMB supports these efforts.

It is also important for consumers to understand how to use credit, and the impact of their credit on their ability to obtain a mortgage at the lowest cost. There

are also industry efforts underway in this area, and we understand Senator Corzine

and others on this Committee are looking at ways to use Federal education programs and dollars to promote financial education in the public schools. NAMB supports the education of consumers in broader financial issues, such as managing

money, managing credit card debt, and other important issues. Ideally, these areas

should be taught routinely as part of the standard junior high school or high school

curricula in schools. NAMB has also dramatically increased educational programs

offered to its members, and revamped its certification program, to encourage all

mortgage brokers to be well informed about current laws, regulations, and ethical

business practices.

Comprehensive Mortgage Reform

The third part of the solution is one into which NAMB has put a tremendous

amount of effort. That is a comprehensive overhaul of the statutory framework governing mortgage lending. We cannot emphasize enough to this Committee how

badly this framework needs to be changed, and how important this is to curtailing

abusive lending.

The two major statutes governing mortgage lending were enacted in 1968 and

1974. The disclosures required under these laws are confusing and overlapping. The

laws actually prevent consumers from being as well informed as they could be, and

put consumers at a decided disadvantage in the mortgage process. For example, in

most cases the borrower does not know the exact amount of the closing costs until

he/she arrives at the closing, because the law requires only that costs be estimated

early in the process. The way the interest rate, terms, and monthly payments on

a mortgage are calculated and disclosed is confusing and makes it impossible for

consumers to effectively compare different types of mortgage products. Mortgage

brokers are required to itemize their profit on each loan, but retail lenders are not.

This is all terribly confusing to consumers. The entire process is much too complicated in a modern world of instant communications and one-click transactions.

Mortgage brokers are confronted every day with the frustrations of our customers

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about the many confusing, and largely useless, disclosures and paperwork. And we

know better than anyone that unscrupulous lenders take advantage of this complexity and confusion to deceive and mislead borrowers, hide onerous loan terms in

pages of fine print, and load up unnecessary fees at closing when the borrower feels

pressured and unable to walk away. Confused consumers, oftentimes desperate for

cash or credit, are more likely to simply rely on the word of an unscrupulous loan

officer and not question their loan terms, rates, or fees.

If the mortgage process were simplified, as we have proposed, consumers could

more effectively shop for loans. They could easily compare fixed-rate, adjustablerate, balloon loans, etc. They would have simple disclosures without a lot of fine

print that can hide deceptive fees or onerous loan terms. They would easily be able

to question and change terms and fees with which they do not agree, well before

closing. In addition, a simplified process would reduce costs for originators, and the

savings would be passed on to consumers. These changes would put the consumer

in a stronger position with more information, thereby drastically decreasing the opportunities for abusive lending.

NAMB has been engaged from the beginning in efforts to reform the laws regulating mortgage originations. We participated in the Negotiated Rulemaking convened by HUD in 1995, which sought to resolve the issues surrounding mortgage

broker compensation under RESPA. Following that effort, it became apparent to

NAMB that the entire statutory framework governing mortgage lending needed an

overhaul. In 1996, NAMB was the first major industry group to form an internal

task force on mortgage reform and begin developing a proposal for comprehensive

reform of RESPA and TILA. We participated in the Mortgage Reform Working

Group in 1997 and 1998, which sought to reach a consensus among industry and

consumer advocates on how to reform RESPA and TELA. And we participated in

the HUD-Treasury Department joint task force on predatory lending convened by

the previous Secretaries of HUD and Treasury, in which we continued to press the

case for comprehensive reform.

NAMB remains committed to the goal of comprehensive mortgage reform and simplification. We urge this Committee in the strongest terms to work with our industry on reform legislation. We ask the consumer advocates here to reengage with us

in developing a reform proposal. Without comprehensive statutory reform and simplification of the entire process, consumers will still be too confused and too vulnerable to deceptive disclosures and unnecessary fees at closing. Legislation that seeks

only to restrict or prohibit certain loan terms or pricing will only add to the complexity of the process and reduce the availability of credit.

Conclusion

In conclusion, I want to reiterate that NAMB supports measures by the industry

and regulators to curb abusive practices, punish those who do abuse consumers, and

promote good lending practices. We support legislation that would reform and simplify the mortgage process, and believe this is the legislation that is most needed

to empower consumers. We believe the problem of predatory lending can only be

solved through a three-pronged approach of enforcing existing laws and targeting

bad actors; educating consumers; and reforming and simplifying the mortgage process. In considering any new legislation, we urge Congress to apply this fundamental

principle: Expanding consumer awareness and consumer power, rather than restricting consumer choice and product diversity, should be the goal of any new legislation affecting the mortgage process.

Thank you for this opportunity to express our views. We look forward to working

with the Committee in the future.

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PREPARED STATEMENT OF DAVID BERENBAUM

SENIOR VICE PRESIDENT, PROGRAM AND DIRECTOR OF CIVIL RIGHTS

NATIONAL COMMUNITY REINVESTMENT COALITION

JULY 27, 2001

Good morning Chairman Sarbanes, Senator Gramm, and Members of the Committee. My name is David Berenbaum, and I am Senior Vice President—Program

and Director of Civil Rights of the National Community Reinvestment Coalition

(NCRC). NCRC is a national trade association representing more than 800 community based organizations and local public agencies who work daily to promote economic justice in America and to increase fair and equal access to credit, capital, and

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banking services to traditionally underserved populations in both urban and rural

areas. NCRC thanks you for the opportunity to testify today on the subject of predatory

lending. In particular, I will focus our testimony on:

• Defining predatory lending; • Identifying why existing statutory and regulatory consumer protections are inadequate; and • Strongly endorsing new public policy legislation and private sector initiatives to

eliminate the practices that perpetuate the dual lending market in our Nation.

With all due respect to the representatives from the subprime lending industry

who are testifying in these series of hearings, it is important to ‘‘cut to the chase’’ and to challenge the myths associated with subprime lending. First, subprime lending is not responsible for the all time high levels of homeownership in the United

States. Second, subprime lending is not responsible for ending redlining in our communities. Third, responsible subprime lenders will not stop underwriting mortgage

loans in our neighborhoods simply because new legislation prompts industry ‘‘best

practices’’ to replace ‘‘predatory practices’’ in our cities and counties. And fourth, unfortunately existing law—and certainly industry suggestions of consumer education

alone—are not adequate to foster greater compliance on a voluntary, statutory or

regulatory level.

The Community Reinvestment Act and fair lending laws have been responsible for

leveraging tremendous increases in loans and investments for underserved communities. For example, vigorous enforcement of existing CRA and fair lending laws encourage depository institutions to compete for business in minority and lower-income communities—precise areas predatory lenders target. Unfortunately, financial

modernization legislation has opened the doors for too many nondepository lending

institutions and affiliates of depository institutions to escape the scrutiny of regular

CRA and fair lending reviews. One of the unintended consequences of financial

modernization has been to allow some lenders to operate in an unregulated environment, fearless of oversight and in a predatory manner. By itself, regulatory enforcement cannot ensure that the millions of annual lending transactions are free

of abusive and predatory terms and conditions.

Mr. Chairman, Senator Gramm, there are lenders and brokers in the marketplace

engaged today, not only in deception and fraud, but also discrimination. They need

to be held accountable. While they masquerade as good neighbors, bankers, brokers,

and legitimate business people, these ‘‘predators’’ systematically defraud innocent

individuals out of their money and property. They accomplish their illicit purposes

by means of fraudulent loans and high-pressure, unscrupulous methods. Using these

loans, predatory lenders extract unconscionable and unjust fees from their victims

until there is no money left to extract; then they expropriate their victims’ homes

through foreclosures which, in many cases, the loans were specifically designed to

facilitate. Predatory subprime lenders intentionally misuse and exploit the weaknesses in existing laws and regulations to their benefit and injure our communities

every day. This was powerfully addressed by the victims of predatory lending who

testified at yesterday’s hearing.

The collective efforts of the advocates at this table and others around the Nation

are responsible for 2001 heralding the death of single-premium credit life— Citigroup, Household, American General and several other companies and their respective trade associations have abandoned the product.

It is our hope that 2001 will also be the year that Congress and the President,

in cooperation with the GSE’s, the industry and community organizations, will enact

protections to ensure equal professional service, fair lending and equal access to

credit based upon risk, not race and community demographics, in the subprime

lending market. New law is needed to cover both loan origination and purchases

made in the secondary market. In partnership with the GSE’s and responsible lenders we can create funds to refinance predatory loans and realize sensible and profitable market corrections. Freddie Mac’s and Fannie Mae’s recent entry into the

subprime market is prompting subprime loan originators to review problematic

products and policies, that is, credit life, through monitoring of portfolios and clear

subprime underwriting guidelines. Through new legislation, reinvigorated use of existing laws, enlightened regulatory oversight, and consumer empowerment and sunshine concerning the issues of credit scoring in loan origination and automated underwriting, we can make 2001 truly a remarkable year.

Definitions

A subprime loan is defined as a loan to a borrower with less than perfect credit.

In order to compensate for the added risk associated with subprime loans, lending

institutions charge higher interest rates. In contrast, a prime loan is a loan made

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to a creditworthy borrower at prevailing interest rates. Loans are classified as ‘‘A,’’

‘‘A-minus,’’ ‘‘B,’’ ‘‘C,’’ and ‘‘D’’ loans. ‘‘A’’ loans are prime loans that are made at the

going rate while ‘‘A-minus’’ loans are loans made at slightly higher interest rates

to borrowers with only a few blemishes on their credit report. The so-called ‘‘B,’’ ‘‘C,’’

and ‘‘D’’ loans are made to borrowers with significant imperfections in their credit

history. ‘‘D’’ loans carry the highest interest rate because they are made to borrowers with the worst credit histories that include bankruptcies.

In contrast, a predatory loan is defined as an unsuitable loan designed to exploit

vulnerable and unsophisticated borrowers. Predatory loans are a subset of subprime

loans. They charge more in interest and fees than is required to cover the added

risk of lending to borrowers with credit imperfections. They contain abusive terms

and conditions that trap borrowers and lead to increased indebtedness. They pack

fees and products onto loan transactions that consumers cannot afford. They do not

take into account the borrower’s ability to repay the loan. They prey upon unsophisticated borrowers who rely in good faith on the expertise of the loan originator or

their agent. Ultimately, predatory loans strip equity and wealth from communities.

Recent Trends In Subprime Lending

Since predatory lending is a subset of subprime lending, it is important to take

a closer look at the subprime market and its growth to better understand the

growth of the predatory lending problem facing underserved communities today. Increasingly, subprime lending is becoming the only option of all too many low-income

and minority borrowers. This reality sadly documents the continued existence of the

race line in America and the continued existence of the dual lending market in the

United States. Whereas before, African-Americans were openly denied access to

credit, today the ‘‘race tax’’ is more sophisticated, more costly—and equally exploitative. Where once redlining undermined communities, today ‘‘reverse redlining’’ has

become the norm and threatens to undermine our communities’ economies, social

services, and tax base. On an individual level, the emotional and financial cost of

predatory lending cannot even be calculated, and endangers every family’s investment in their home and future. If, for example, an African-American female head

of household who lives in Baltimore, Maryland, with good credit refinances a

$150,000 loan at 6.75 percent for 30 years, the cost to the consumer in interest is

$200,240. If, however, this same African-American female is pressured or coerced

into refinancing with a subprime loan at 14.75 percent for 30 years, the total interest paid over the life of the loan will be $522,015—a difference of $321,775. These

are funds that the mortgage holder could have used for home improvements, a college education, to start a small business or for financial security. This is how the

dual lending market imposes a ‘‘race tax’’ upon our communities. In fact, predators

have made the ‘‘race tax’’ situation worse for our victim by charging her closing

costs in excess of four points, tying in a high interest credit card, and including an

exorbitant prepayment penalty fee—all standard predatory practices.

Sadly, an analogy to racial profiling is appropriate here. We have all become familiar with the term ‘‘Driving While Black.’’ Subprime predatory lending has become the equivalent of ‘‘Borrowing While Black.’’

The attached exhibits, which map subprime and conventional lending patterns

using census data, vividly reveal lending disparities in predominantly white and

predominantly minority census tracts. For example, the map of Trenton, New Jersey

shows that minority neighborhoods in 1999 were 4 times more likely to receive

subprime refinance loans. Subprime lenders made more than 43 percent of loans in

Trenton minority census tracts but only 11 percent in predominantly white tracts.

The disparity in subprime market share by minority level of neighborhood in Austin, Texas and Baltimore, Maryland was also very large. In Austin, subprime lenders’ market share in minority neighborhoods was about 3.5 times greater than their

market share in predominantly white neighborhoods. And in Baltimore, subprime

lenders issued approximately 50 percent of all the conventional refinance loans

issued in minority neighborhoods in 1999. When subprime lenders dominate the refinance market in minority and low-income neighborhoods, they are apt to take advantage of their dominance and make abusive loans. Stronger antipredatory laws

combined with stepped up CRA enforcement of prime lenders is necessary to eliminate abuses and increase competition and choices of loan products in these neighborhoods. The appendix to the NCRC testimony provides data tables and maps

showing lending disparities across States including New Jersey, New York, Texas,

and Maryland. These maps easily could represent disparities in any urban community in the United States today. The practices which gave rise to these lending patterns undermine our Nation’s commitment to fair lending, CRA and corporate responsibility and best practices.

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A national poll conducted for NCRC in 2000 by the bi-partisan team of Jennifer

Laszlo and Frank Luntz; found that Americans overwhelmingly support fairness in

lending. Of those surveyed, 92 percent said they believed that every creditworthy

person should, by law, be given information about the best loan rate for which they

qualify. With abusive subprime and predatory lending, this is not the practice.

NCRC, and our members, have documented over 30 widespread lending practices

that despite existing legal protections have contributed to the problem of predatory

lending. These predatory practices, which I will now identify, include issues relevant

to the marketing, sale, underwriting, and maintenance of subprime loans.

Marketing:

• Aggressive solicitations to targeted neighborhoods • Home improvement scams • Kickbacks to mortgage brokers (Yield Spread Premiums) • Racial steering to high rate lenders

Sales:

• Purposely structuring loans with payments the borrower can not afford • Falsifying loan applications (particularly income level) • Adding insincere cosigners • Making loans to mentally incapacitated homeowners • Forging signatures on loan documents (that is, required disclosure) • Paying off lower cost mortgages • Shifting unsecured debt into mortgages • Loans in excess of 100 percent LTV • Changing the loan terms at closing

The loan itself:

• High annual interest rates • Product packing • High points or padded closing costs • Balloon payments • Negative amortization • Inflated appraisal costs • Padded recording fees • Bogus broker fees • Unbundling (itemizing duplicate services and charging separately for them) • Required credit insurance • Falsely identifying loans as lines of credit or open end mortgages • Forced placed homeowners insurance • Mandatory arbitration clauses

After closing:

• Flipping (repeated refinancing, often after high-pressure sales) • Daily interest when loan payments are late

• Abusive collection practices

• Excessive prepayment penalties

• Foreclosure abuses

• Failure to report good payment on borrower’s credit reports

• Failure to provide accurate loan balance and payoff amount

Congress, therefore, on a bipartisan basis, should pass the strongest legislation

possible to end these practices and establish law that the industry, regulators, State

attorneys general, advocates, and consumers can use to safeguard the public interest. In 2001 to date, 31 States have introduced over 60 legislative measures attempting to combat predatory lending practices. Additionally, nine major metropolitan cities and counties have introduced local ordinances to deal with predatory lending. Surely, a meaningful national standard is preferable.

Keeping in mind our definition of a predatory loan—an unsuitable loan designed

to exploit vulnerable and unsophisticated borrowers—enacting relevant consumer

protections becomes a straightforward legislative policy exercise which clarifies and

complements existing civil rights, consumer protection, and disclosure laws.

The Truth Behind the Statistics

Over the past several years, there has been a tremendous explosion in subprime

lending. According to the Department of Housing and Urban Development (HUD),

subprime refinance lending increased almost 1,000 percent from 1993–1998. The

backing of Wall Street investment firms has helped fuel much of the explosion in

subprime lending in recent years. As a relevant New York Times/ABC News investigation revealed, from 1995 to 1999 the amount of money raised on Wall Street for

subprime lenders rose from $10 billion to nearly $80 billion annually.

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1 Anthony Pennington-Cross, Anthony Yezer, and Joseph Nichols, Credit Risk and Mortgage

Lending: Who Uses Subprime and Why? Working Paper No. 00–03, published by the Research

Institute for Housing America. 2 New Leader After Year of Upheaval at ACB, American Banker, October 30, 2000.

NCRC has serious concerns about this exponential rise, especially given its disproportionate growth among low-income and minority neighborhoods. Again, HUD

documents that individuals in low-income neighborhoods are three times more likely

to receive subprime refinance loans than those living in high-income neighborhoods.

In African-American neighborhoods, HUD’s analysis shows that borrowers living

there are five times more likely to receive subprime refinancing than those living

in white neighborhoods.

National data analysis done by NCRC shows that 67 percent of all subprime refinance loans made in 1998 were sold to private investment firms and other financiers, compared to just 20 percent of all prime home refinance loans. The most

recent manifestation of this widespread practice is financial service corporations

that only purchase subprime loans on the secondary market in order to avoid complying with the Community Reinvestment Act, minimize HOEPA and related consumer protections—such as the Truth In Lending Act (TILA) and the Real Estate

Settlement Procedures Act (RESPA)—and to avoid compliance with our Nation’s civil rights protections.

Thus, while some maintain that subprime lending has been responsible for the

surge in homeownership among minorities and low- and moderate-income borrowers, NCRC believes that increased prime lending by CRA-covered banks has

played the major role in the increase in homeownership. Proponents of subprime

lending caution against aggressive antipredatory lending regulation and legislation,

saying that such efforts will choke off credit in underserved communities. NCRC,

in contrast, asserts that antipredatory legislation and regulation will not constrain

home mortgage lending to traditionally underserved communities and is needed to

protect communities from unscrupulous actors.

These very extreme disparities in subprime lending by race and income cannot be

solely related to the credit history or risk of the borrower. In fact, as Freddie Mac

and Fannie Mae have estimated, anywhere between 30 and 50 percent of subprime

borrowers could qualify for prime loans. This is product steering or ‘‘reverse redlining’’ at its worst. Mr. Chairman, there are lenders and brokers out there engaged

not only in deception and fraud, but also discrimination, who need to be held accountable. However, with the exception of a handful of actions brought by the Federal Trade Commission, the recommendations of recent HUD/Treasury Report go

unfulfilled. Over the past 5 years thousands of seniors, African-Americans, Latinos,

and women have been victimized by predatory lending practices. As a result, public

opinion has developed into consensus. Predatory lending, payday lending, predatory

insurance, and credit cards are all receiving ‘‘strict scrutiny’’ from public and private

sector ‘‘attorneys general.’’ A recent study by the Research Institute for Housing America (RIHA) concludes

that minority borrowers are more likely to receive subprime loans after controlling

for credit risk factors. RIHA cautions against a conclusion that price discrimination

alone explains this since minority borrowers may have different techniques of

searching for lenders—or access to credit limited only to subprime lenders. However,

when one considers the totality of the research by NCRC, HUD, Fannie Mae,

Freddie Mac, RIHA, and others, it seems fair to say that the burden of proof lies

with those who assert that discrimination and predatory lending is the exception

to the rule and not the norm in the subprime market.1

In late October 2000, the incoming Chairman of America’s Community Bankers

told an American Banker reporter that ‘‘We need to be very careful that subprime

lending, which has a useful place, does not get confused with predatory lending . . .

because lending to borrowers with imperfect credit history . . . is one of the reasons

we have increased homeownership to record levels in the United States.’’ 2

The home mortgage lending data do not support the contention that subprime

lending has driven the surge in homeownership for traditionally underserved populations. In 1990, low- and moderate-income borrowers (LMI borrowers have up to

80 percent of area median income) received 18.5 percent of all home mortgage loans

made in the country (loans to borrowers with unknown incomes were excluded from

the calculations). By 1995, LMI borrowers received 26.9 percent of all home mortgage loans, or 8.4 percentage points more than they had in 1990. By 1999, LMI loan

share had increased to 30.7 percent or only 3.8 more percentage points than in

1995. The surge in subprime lending occurred from 1995 to 1999, yet LMI borrowers

experienced the largest gains in home mortgage lending from 1990 to 1995. The first

part of the decade witnessed a tremendous increase in conventional and affordable

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3 Analyzing Trends in Subprime Originations and Foreclosures: A Case Study of the Atlanta

Metro Area, Abt Associates Inc., February 2000. 4Department of the Treasury, Office of the Comptroller of the Currency, Federal Reserve System, Federal Deposit Insurance Corporation, Proposed Agency Information Collection Activities

(Collecting subprime lending information on call reports), Federal Register, May 31, 2000, pages

34801–34819. 5 HUD-Treasury Curbing Predatory Lending report, p. 85.

prime loans as depository institutions worked in partnership with community organizations to make CRA-related home mortgage loans.

The story is similar for home mortgage lending trends to African-Americans and

Latinos. African-Americans and Latinos received 10.1 percent of the home mortgage

loans in 1990 made to African-Americans, Latinos, and Whites. The African-American and Latino loan share climbed to 14.4 percent in 1995 and to 16.1 percent in

1999. The share of home mortgage loans made to African-Americans and Latinos

increased by 4.3 percentage points from 1990 to 1995, but only 1.7 percentage points

from 1995 to 1999. Pundits and proponents of subprime lending talk about how it

has made homeownership accessible, but the statistics show the biggest gains for

minorities occurred in the first part of the decade when CRA-related lending

surged—as opposed to the second part of the decade when subprime lending soared.

The RIHA study cited earlier concludes, ‘‘Yet there is little evidence to support

the idea that subprime lending (primarily) serves lower-income households or households with little wealth to use as a down payment.’’ And RIHA should know what

it is talking about, since it is a research institute founded by mortgage banks and

their trade association, the Mortgage Bankers Association of America.

NCRC acknowledges that responsible subprime lenders play a role in the marketplace. However, most predatory lenders are primarily consumer lenders and should

not be confused with CRA-covered lenders that have done the most work in making

the American Dream of homeownership possible. Despite this, even a portion of

CRA-covered loans has become predatory since the onset of financial modernization.

In particular, price discrimination, or charging higher interest rates than is necessary to cover risk, by subprime mortgage divisions of banks has become all too

common. Next, opponents of tighter control of subprime lending suggest that improved disclosure of terms and conditions of loans will provide the needed protections against

predatory lending. Loan transactions, particularly mortgages, can be the most complex transaction in a typical consumers lifetime, making it difficult for the average

American to understand loan terms, choice of products, and that counseling or consumer protections may be available. I offer that consumers not only need the disclosures, but also need assistance safety net of new legislative protections.

Legislative Remedies

NCRC believes that current law and regulation are weak and err on the side of

allowing exploitative practices that are not economically justified in terms of being

necessary to make loans profitable. Steep prepayment penalties on high interest

loans, high balloon payments, repeated flipping, credit insurance, and fee and product packing were not necessary for profitable home mortgage loans made to first

time homebuyers during the tremendous homeownership expansion in the 1990’s,

especially in the first half of the decade. These products and practices remain inappropriate today in the current economy of supercharged loan origination, refinance

and home improvement. Instead, these abusive terms and conditions trap and exploit unsophisticated borrowers. Their unsuitability to the borrower and lender is

demonstrated by higher foreclosures associated with predatory lending.3 Indeed, the

FDIC has found that although subprime lenders constitute about 1 percent of all

insured financial institutions, they account for 20 percent of depository institutions

that have safety and soundness problems.4

In order to protect consumers and the lending industry from unsafe and predatory

practices, NCRC favors Federal antipredatory legislation that builds and expands

the Homeownership and Equity Protection Act of 1994 (HOEPA). HOEPA defines

loans that exceed a certain interest rate and fee threshold as high interest loans.

It then outlaws various terms and conditions on high interest loans. The shortcoming with HOEPA is not its structure but its high interest rate and fee thresholds. The current interest rate threshold, for example, is 10 percentage points above

Treasury bill rates which currently translates into interest rates of 16 percent and

higher. The HUD/Treasury Task Force on Predatory Lending estimates that the current HOEPA interest rate threshold covers only about 1 percent of subprime loans.5

NCRC strongly supports the Predatory Lending Consumer Protection Act of 2001

(H.R. 1051) introduced by Representative LaFalce and soon to be introduced by Senator Sarbanes. Many of the provisions and protections included in the legislation are

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6Fannie Mae Chairman Announces New Loan Guidelines to Combat Predatory Lending Practices, Fannie Mae News Release of April 11, 2000. 7Fannie Mae April 11 press release and letter to the editor of the American Banker by David

Andrukonis of Freddie Mac on April 6, 2000.

what NCRC has been advocating for tighten up HOEPA. NCRC believes that

HOEPA should be amended in the following manner:

• Coverage—HOEPA should be expanded to cover home mortgage lending, reverse

mortgage lending, and open-ended transactions secured by real estate. Currently,

HOEPA applies only to closed-ended consumer transactions secured by a borrower’s home. In order for HOEPA’s protections to be comprehensive, it is time

to extend it to all lending secured by a borrower’s principal dwelling.

• Interest Rate Threshold—The interest rate threshold should be lowered from 10

percentage points above Treasury bill rates to 4 percentage points above Treasury

rates. Using the figures in the HUD/Treasury report, NCRC estimates that this

would cover about 70 percent of all subprime lending, or the percentage of

subprime lending which is estimated to contain prepayment penalties.

• Fees—NCRC believes that the fee threshold should be lowered from 8 percent of

the loan amount to 3 percent of the loan amount. Fannie Mae has indicated that

it will not purchase loans with fees exceeding 5 percent of the loan amount. This

is a significant policy statement from a major secondary market player indicating

that Fannie Mae does not believe that fees above 5 percent are economically justified from a profitability point of view.6 In addition, NCRC maintains that ‘‘yieldspread’’ premiums should be included in the calculation of the fee threshold.

NCRC also agrees with the HUD/Treasury recommendation that for high interest

rate loans, a ceiling should be established on the percentage of fees that are financed and added to the loan amount instead of being paid up-front. The HUD/

Treasury recommendation is that fees exceeding more than 3 percent of the loan

amount must not be financed.

• Flipping—NCRC agrees with the HUD/Treasury recommendation that refinances

of high interest rate loans that occur within 18 months of the original loan should

be prohibited unless a tangible net benefit accrues to the borrower. Such a benefit

should include a reduction in the loan interest rate of 1.5 percentage points.

• Prepayment penalties—HOEPA currently allows prepayment penalties in the first

5 years. HOEPA must be changed to either eliminate prepayment penalties altogether on loans that exceed the interest rate and fee threshold or at least prohibit

prepayment penalties beyond the first year after the origination of a high interest

loan.

• Balloon payments—HOEPA prohibits balloon payments on high interest loans

within the first 5 years of origination. NCRC agrees with the HUD/Treasury recommendation that balloon loans must be prohibited until 15 years after the

issuance of high interest rate loans. A shorter time frame invites flipping as predatory lenders convince borrowers facing steep balloon payments to refinance, usually at higher interest rates and added fees.

• Single-premium credit insurance—This is an abuse that must be ended on all

loans. Fannie Mae and Freddie Mac have indicated that they will not purchase

loans with single-premium credit insurance.7 Congress should follow their lead

and prohibit single-premium insurance. If financial institutions wish to sell credit

insurance, it should be on a monthly basis and must allow the borrower to cancel

it at any time.

Additional HOEPA reforms should outlaw mandatory arbitration clauses and prohibit high interest rate loans with negative amortization and/or which exceed 50

percent of the borrower’s income. With such changes, public policy will respond to

the pervasive abuses occurring in the marketplace that cannot be addressed solely

through improved disclosures or more extensive financial literacy and prepurchase

counseling.

Further, NCRC recommends that this Committee strongly consider amending the

Home Mortgage Disclosure Act (HMDA) to include loan terms and conditions, and

the CRA and fair lending exams should be improved to help stamp out predatory

lending. Disclosures of annual percentage rates (APR’s) will be vital for fair lending

enforcement to ensure that minorities and/or women of similar income levels and

buying homes of similar values (or refinancing similar dollar amounts) are not

charged significantly higher amounts than whites and/or males.

The Senate Banking Committee should also strongly consider the Community Reinvestment Modernization Act of 2001 (H.R. 865), introduced by Representatives

Barrett and Gutierrez with 34 cosponsors. This legislation will allow the Community

Reinvestment Act to keep pace with the tremendous changes taking place in the fiVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00360 Fmt 6601 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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nancial industry by extending CRA to all lending affiliates of financial holding companies. Mortgage companies, insurance agents, and other nontraditional lending

affiliates of holding companies would be required to comply with CRA. Lenders

would be penalized on CRA exams for making predatory loans. In addition, the bill

would extend CRA-like requirements to insurance companies and securities firms.

Insurance companies would be required to publicly disclose data on the race, income, and gender of their customers. Mergers between depository and nondepository

institutions would be subject to public comment periods with regulatory agency decisions based on CRA, fair lending, safety and soundness, and antitrust factors.

Regulatory Responses and Remedies

There are regulatory steps that can be taken today by the Federal banking agencies, particularly the Federal Reserve Board, to combat predatory activities. The

Board has direct jurisdiction over the practices of those subprime lenders that are

bank holding company subsidiaries. In addition, the Board also has jurisdiction over

many companies that underwrite, purchase, and service mortgage-backed securities

based on subprime loans by nonbank lenders.

The Federal Reserve Board can conduct examinations, including fair lending examinations, of any bank holding company subsidiary, including subprime lenders— and it should start doing so. It should be noted that the Federal Reserve, in its July

2, 2001 approval order concerning the Citigroup-European American Bank merger,

did commit to conduct a thorough examination of CitiFinancial. However, the Board

still refuses to routinely conduct such examinations. The General Accounting Office

(GAO) and the HUD/Treasury Report have both recommended that the Federal Reserve Board conduct such examinations. Another important way the Board has jurisdiction over the portion of the subprime market that is predatory is through its

supervision of companies which underwrite, purchase, and service mortgage-backed

securities based on subprime loans by nonbank lenders and companies that make

warehouse loans to, or do underwriting, servicing or trustee/custodian work for,

other subprime lenders.

It is quite clear, Mr. Chairman, that while all of the regulatory action recommended by NCRC is necessary to combat predatory lending, it is not sufficient.

To truly end this scourge, Congress must pass strong antipredatory lending legislation that significantly strengthens and expands current consumer protection provisions under HOEPA. Even if the Federal Reserve adopted its Regulation Z proposal

to lower the HOEPA interest rate threshold to 8 percentage points above Treasury

securities, only 5 percent of subprime loans would be covered under the Federal Reserve’s own admission. Congress alone can change the HOEPA statute to make the

interest rate threshold lower. The Predatory Lending Consumer Protection Act of

2001 would lower it to 6 percentage points above Treasury securities, and cover

about 25 percent of subprime loans as estimated by HUD. In addition, the Federal

Reserve does not believe that it has the power to eliminate credit insurance on

subprime loans. The current predatory lending bill includes such provisions, which

are needed to prohibit these practices.

Federal banking regulators must also increase their scrutiny of subprime lending

during CRA exams and accompanying fair lending reviews. CRA has been instrumental in leveraging a tremendous increase in safe and sound lending to traditionally underserved communities. It is one of the most important means by which to

stimulate conventional lending institutions to compete against predatory lenders in

lower-income and minority communities. But for CRA to succeed in this endeavor,

it must be enforced rigorously.

Recently, disturbing evidence indicates that some CRA examiners are giving depository institutions CRA ‘‘credit’’ or points for payday lending and other suspect activities without scrutinizing the terms and conditions of this lending. The Federal

Deposit Insurance Corporation has just publicly indicated that it will not count

predatory loans for CRA credit. The Office of Thrift Supervision recently failed a

thrift that was making abusive payday loans. NCRC is also pleased that the Federal

banking agencies just updated their interagency CRA Question and Answer document to indicate that bank CRA ratings will be downgraded if they make predatory

loans in violation of the Truth in Lending Act, the Real Estate Settlement Procedures Act, and HOEPA. We urge the Federal banking agencies to codify this during

the CRA regulation review that is just starting. Too many other questionable

subprime and payday lenders have passed their CRA exams—and NCRC can provide examples upon request. There are signs that this will be changing; increased

scrutiny from Capitol Hill will help make sure that unscrupulous lenders will fail

their CRA and fair lending exams.

NCRC and its members, working with fair lending experts and its nationwide

membership, have crafted a model antipredatory lending bill as part of our efforts

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to eliminate the problem. It is attached as an exhibit to this testimony. NCRC is

pleased that many of the provisions included in its model bill are also included in

the various antipredatory lending bills currently circulating in Congress.

Conclusion

NCRC acknowledges the fact that subprime lending does play a role in expanding

access to credit for those with blemished credit records. However, a growing portion

of this industry is responsible for the ‘‘balkanization of credit,’’ whereby vulnerable

low- and moderate-income, minority, and elderly individuals are being targeted by

predatory lenders whose only intent is to deceive and dispossess them of their property and wealth. Senators Sarbanes, Schumer, and Representatives LaFalce and

Schakowsky have consistently and forcefully echoed this concern, and are to be commended for their leadership in proposing strong legislation to combat predatory

practices. Representatives Barrett and Gutierrez should also be applauded for their

sponsorship of the Community Reinvestment Modernization Act of 2001 in the

House.

Stronger legislation and regulation are needed to end the scourge of predatory

lending. Noble attempts have been made at the State and local level to implement

legislative and regulatory protections against predatory lending. NCRC applauds

these initiatives and supports them. However, a comprehensive HOEPA statute, accompanied by stronger regulations, is needed to establish uniformity and prevent

predators from preying upon borrowers in States with weak laws. A uniform national framework will promote competition from prime lenders and responsible

subprime lenders. It will benefit communities and lenders alike by prohibiting unsafe and unsound lending that is designed to exploit borrowers and neighborhoods

and strip them of their wealth. It will empower Federal and State regulators and

enforcement agencies to use the law effectively to stem the tide of predatory lending.

Mr. Chairman, under the law, if a person holds someone up at gunpoint and robs

them of their possessions, that person goes to jail. However, if a lender uses deception, high-pressure sales tactics, and other abusive means to steal another person’s

home—their most prized possession—the lender profits. Predatory lending is no different than robbery at gunpoint, and both our laws and regulations must adequately

reflect that fact.

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1 Hearings on S. 1275, Community Development Banking and Financial Institutions Act of

1993 before the Senate Banking, Housing, and Urban Affairs Committee, 103d Cong., 1st Sess.,

168 (1993) (Written Testimony by Deepak Bhargava, Legislative Director, ACORN on behalf of

ACORN, Center for Community Change, Consumer Federation of America, Consumers Union

and National Council of LaRaza). 2 Id.

PREPARED STATEMENT OF GEORGE J. WALLACE

COUNSEL, AMERICAN FINANCIAL SERVICES ASSOCIATION

JULY 27, 2001

Good morning. I represent the American Financial Services Association (AFSA).

AFSA is a trade association for a wide variety of market-funded lenders, many of

whom make both prime and subprime loans to American consumers. AFSA looks

forward to working with the Committee to examine the issues raised by the hearings held yesterday and today.

Allegations of predatory lending, particularly in the subprime mortgage market,

have received a significant level of attention in recent months. Advocates of increased regulation have claimed that stepped up fraudulent or ‘‘predatory’’ marketing practices have persuaded vulnerable consumers to mortgage their homes in

unwise loan transactions. Some consumer advocates have gone considerably farther

and asserted that various loan products and features common to the mortgage market are ‘‘predatory’’ and should be outlawed.

Most of the regulatory changes sought have a common, very troubling, approach.

They impose significantly restrictive new regulation on all mortgage loans, or all

loans over a designated interest rate or points threshold, even if there is no evidence

of fraudulent marketing. This approach confuses the symptoms with the causes and

its adoption would be a serious mistake, because it fails to recognize or address the

real causes of the problem, and would seriously undercut the important goal of

maintaining the availability of credit for working American families.

Much of this proposed regulation seeks to control credit prices, directly or indirectly, by limiting or discouraging points, fees, and higher interest rates. Some proposals also restrict credit terms or require burdensome new compliance steps, such

as extended new disclosures. Several others aim at restricting marketing methods,

particularly when refinancing is involved. Finally, several proposals have urged

turning the already strong remedial and penalty provisions of present law into extremely broad punitive provisions.

These proposals, taken as a whole, would dramatically reduce loan revenue, increase the risk, and/or increase costs the lender must bear. While initially the resulting burdens fall on the lenders who continue to make loans subject to new regulation, in the long term, the effects will almost always be felt directly by working

American families, either because of decreased loan availability, higher credit prices

or less flexible loan administration.

Thus this call for increased regulation, well intended as it undoubtedly is, strikes

at the very heart of the efforts over the last quarter century of Congress, many

States, consumer advocacy groups, and the lending industry to make efficiently

priced consumer credit available to working American families, including minorities,

single parent families, and others who for so long were unable to obtain credit. In

testimony before this Committee in 1993, Deepak Bhargava, Legislative Director for

ACORN, spoke of ‘‘a credit famine in low- and moderate-income and minority communities in urban and rural areas’’ demonstrated by ‘‘[a]bundant anecdotal and statistical evidence [pointing to] massive problems of credit access in many communities around the country, particularly in minority and low-income areas’’.1 He also

pointed out that ‘‘[l]ack of access to credit thwarts community development efforts,

and the creation of employment and housing opportunities for millions of American

families.’’ 2

In 1993, subprime credit was a very small part of the credit market. Today,

subprime credit is approximately 25 percent of home equity credit outstanding, and

a very significant part of purchase money credit. Yet some of the legislative proposals advanced by consumer advocates this year would unwisely impose stringent

new regulations and disclosures, including what amounts to strict price and terms

limitations, on virtually all of that credit. Even the pending Federal Reserve Board

proposals would impose heavy additional regulatory burdens. A study of AFSA

member loans originated over the last 5 years suggests that the pending Federal

Reserve Board proposal would increase the number of first mortgages covered by

HOEPA from 12.4 percent today to 37.6 percent, and second mortgages from 49.6

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3Michael E. Staten and Gregory Elliehausen, The Impact of The Federal Reserve Board’s Proposed Revisions to HOEPA on the Number and Characteristics of HOEPA Loans, 5–6 (July 24,

2001). 4See editorial by David A. Andrukonis, Chief Credit Officer, Freddie Mac, ‘‘Freddie Mac Defends Purchase of Subprime Mortgages,’’ American Banker, April 6, 2000, also available at

www.freddiemac.com/newsanalysisambankerlet.html. 5 A study of the impact on the loan market in North Carolina of impact recent loan legislation

there had on the availability of credit to low- and moderate-income borrowers likewise suggests

that the approach to reform urged by the advocates is counterproductive. In North Carolina,

loans made by 9 AFSA companies to borrowers with incomes under $50,000 shrunk dramatically

in the first 6 months after the North Carolina legislation went into effect. Michael E. Staten

and Gregory Elliehausen, The Impact of The Federal Reserve Board’s Proposed Revisions to

HOEPA on the Number and Characteristics of HOEPA Loans, 1418 (July 24, 2001). 6 Analysis of approximately 1.3 million mortgage loans originated between 1995 and July 1,

2000 by 9 AFSA members. The percentages stated in the text are based on all loans in the pool

with relevant variables.

percent to 81.1 percent.3 The effect, if not the goal, of these proposals will likely

be to substantially shrink the subprime mortgage market, a point underlined by

Freddie Mac’s announcement in the spring of 2000 that it would not purchase any

HOEPA loan, a policy now mirrored by Fannie Mae.4, 5

Subprime lenders, spurred on by Congress, have been enormously successful in

delivering efficiently priced consumer credit to working American families, regardless of race, ethnicity, or background. Such families use mortgage credit for many

purposes, among them acquiring homes, working their way out of credit difficulty

by consolidation and refinancing, making home improvements, and college education. We are proud to report that during the last 5 years, 96 percent of those who

have borrowed from AFSA members using subprime mortgage loans have used the

credit successfully. Eighty five percent of those subprime borrowers paid in full and

on time. The remaining 11 percent, in varying degree, may have missed a payment

here and there, but ultimately used the credit successfully.6 It is true, of course,

that subprime lending does experience higher losses than conventional lending.

That is why it is priced as it is. But the basic point is that most Americans who

use subprime credit use it successfully. Under what policy prescription would the

Government deny to Americans with less than first class credit access to all the benefits of credit that middle class Americans enjoy? The 96 percent of Americans

who use the credit extended by AFSA members successfully are not asking for that

interference.

There are some people who have been the victims of fraudulent, deceptive, illegal,

and unfair practices in the marketing of mortgage loans. Advocates have mistakenly

focused on loan products and features as the reason why these victims experienced

such adverse outcomes, and reached the faulty conclusion that if regulation just

barred certain loan features, the harm would have been avoided. Pursuing that mistaken reasoning, they have tried to label as ‘‘predatory,’’ highly regulated loan products and features, which are entirely legal (such as credit insurance, prepayment

penalties, balloon payments, arbitration, and higher rates and fees). However, most

of the loan features called ‘‘predatory’’ are not generally known as ‘‘predatory’’ practices—they are legitimate, legal, and common in mainstream prime and subprime

lending. Any legitimate consumer good or service can be marketed fraudulently. Indeed, the scam artist prefers to use legitimate products, like loans, as a cover because consumers want and need the product. The illegality comes in the fraudulent

marketing of the good or service, not in the good or service itself.

We urge that Congress not confuse the loan products that consumers want and

need, with the fraudulent marketing practices that a few isolated operators have

used to prey upon the unfortunate. Predatory lending is fundamentally the result

of misleading and fraudulent sales practices already prohibited by a formidable

array of Federal and State laws, including Section 5 of the Federal Trade Commission Act, criminal fraud statutes, State deceptive practices statutes, and civil rights

laws. Aggressive enforcement efforts by the FTC, HUD, and the Civil Rights Division of the Justice Department, as well as by the States’ Attorney Generals are underway. The existing array of State and Federal regulation of fraudulent practices

is already sufficient to deal with the deceptive, fraudulent, and unfair practices that

make up ‘‘predatory lending,’’ and we suggest that there is no better deterrent to

this type of behavior than successful prosecution. On the other hand, the subprime

market is already very heavily burdened with restrictions and requirements imposed at the State and Federal levels. Additional regulation of the type advocates

have proposed will hurt the vast majority of working American families by raising

credit prices and reducing credit availability. That is simply not a desirable policy

outcome, particularly when it is not likely to deal with the real problem.

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If fraudulent and deceptive practices are the root of the problem, what is the appropriate policy to address predatory lending?

• First, Congress should do no harm to the present system which has been extremely successful in delivering consumer credit to America’s working families. As

said before, more restrictions on credit prices, terms, and practices does not address the fraud which is the root of the problem, and it results in taking away

from working American families the lending products they desire and it has been

the goal of Congress to provide. Remember that over a 5 year period, 96 percent

of those who used subprime lending from AFSA members did so successfully. Such

policy prescriptions as lowering HOEPA thresholds and forbidding such features

as balloon payments, financed single-premium life, accident, and health insurance

and prepayment fees in more and more loans is not appropriate policy, because

it takes away legitimate tools to shape credit to the needs of America’s working

families.

• AFSA has been a leader in developing educational programs to help meet the

enormous need American consumers have for greater financial literacy. As a

founding member of the Jump Start Coalition, a coalition of industry, Government, and private groups dedicated to increasing financial literacy, it has for several years pushed strongly for increased efforts to educate Americans about credit.

We urge Congress to support these and other efforts, because they hold the greatest promise to help over the long run. As we all know, the best defense against

fraudulent sales practices is the informed consumer, and informed consumers can

best evaluate whether they want or can afford to borrow more.

• Industry self regulation likewise plays an important role. AFSA has developed

‘‘Best Practices’’ which its member companies have voluntarily adopted. They address the controversial terms which consumer advocates have often targeted, and

they strike a balance between reasonable limits and providing legitimate consumer benefits in appropriate circumstances. Other associations of lenders, including the Mortgage Bankers Association, have adopted ‘‘Best Practices’’ as well,

and they hold a great deal of promise. A copy of AFSA’s best practices on home

equity lending (Statement of Voluntary Standards for Consumer Mortgage Lending) is attached as Appendix A.

• Government’s role is appropriately the vigorous enforcement of the deceptive practices and civil rights laws. Any objective analysis of these laws must reach the

conclusion that they provide powerful tools to address both fraudulent sales practices and discrimination. Strong enforcement is appropriate because it addresses

the real problem, the fraudulent and discriminatory practices that make an otherwise legitimate loan ‘‘predatory,’’ without affecting the overall ability of lenders

to make loans available to working American families with less than perfect

credit. That is the appropriate policy balance between dealing with the real misfortunes which a few borrowers have experienced and the continued availability

of credit to working American families. We urge Congress to encourage that an

appropriate balance be maintained.

Thank you for the opportunity to address the Committee, and I look forward to

any questions you may have.

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PREPARED STATEMENT OF LEE WILLIAMS

CHAIRPERSON, STATE ISSUES SUBCOMMITTEE

CREDIT UNION NATIONAL ASSOCIATION, AND

PRESIDENT, AVIATION ASSOCIATION CREDIT UNION, WICHITA, KANSAS

JULY 27, 2001

Good morning, Chairman Sarbanes and Members of the Committee. I am Lee Williams, President of Aviation Associates Credit Union, a $38 million State-chartered

credit union in Wichita, Kansas. I am testifying this morning on behalf of the Credit

Union National Association (CUNA), which represents over 90 percent of the 10,500

State and Federal credit unions nationwide. In my capacity as chair of CUNA’s

State Issues Subcommittee, I have had the privilege of carefully considering issues

surrounding the abusive practices of predatory lending and appreciate the opportunity to present some of our findings.

The credit union system abhors the predatory lending practices that are being

used by some mortgage brokers and mortgage lenders across the country. America’s

more than 10,000 credit unions—member owned, not-for-profit cooperatives—strive

to help their 80 million members create a better economic future for themselves and

their families.

Predatory lending is a complex and difficult issue to resolve, as evidenced by the

many witnesses that have testified before this Committee over the past 2 days. The

primary targets of predatory lenders are subprime borrowers. Subprime borrowers

are consumers who do not qualify for prime rate loans because of a poor credit history, or in some cases, simply a lack of a credit history. This segment of the population is of particular interest to the credit union industry because historically it is

that population that has turned to credit unions for our flexibility and wide range

of credit options.

CUNA is concerned that the term ‘‘predatory’’ has become synonymous with

‘‘subprime’’ in the minds of some policymakers. We believe it is important to distinguish the difference between subprime loans and predatory lending practices when

formulating laws or regulations to eliminate predatory lending practices. If subprime lending is unintentionally restricted through efforts to prohibit predatory

lending practices, the result could be a significant decrease in available credit to

borrowers with blemished credit histories.

Credit Unions Are Not Predatory Lenders

Credit unions do not engage in predatory practices. Credit unions are nonprofit,

cooperatively owned financial institutions. All profits are returned to the credit

union members, after expenses and distribution to reserves. To participate in any

activity that would take advantage of our members, who are also our owners, would

be counterproductive to our operations, our structure, and our philosophy.

Credit unions are not in business to make money by providing financial services.

In part, they are in business to provide financial services because people need them

and, all too often, cannot obtain them at reasonable costs and terms. As the socalled ‘‘fringe’’ banking industry, such as payday lenders, pawn shops, and check

cashers, has significantly expanded over the past decade, credit unions have been

out in front to combat the devastating effects of these high-cost money brokers by

offering alternative services at reasonable rates.

CUNA Combats Predatory Lending

America’s credit unions support the elimination of lending practices that are intentionally structured in a manner that is deceptive and disadvantageous to borrowers. CUNA and credit unions across the country have been establishing programs to help our members fight back against the effects of high-cost and predatory

loans.

At Aviation Associates Credit Union, we recently initiated the ‘‘Take Control’’ program, which provides resources for our members allowing them to take control of

their financial well-being and effectively deter the success of payday lenders and the

predatory mortgage lenders in our community.

Let me provide an example. Members with high interest mortgage loans acquired

from a mortgage broker have asked our credit union for help because they cannot

make their monthly payments. My initial response is to refinance these onerous

loans and reduce the interest rate. But often that is no solution. Typically, these

types of loans have been initially packed with so many fees—paid up front and financed—that the Loan to Value ratio is pushed as high as 125 percent. My credit

union, and few others, can refinance such a loan.

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Even in such a dire situation, our ‘‘Take Control’’ program can improve the member’s financial circumstances. Our program does so through member education.

With the help of an on-site consumer credit counselor (available twice a week),

members can learn how to pay down loans faster, obtain lower fees and rates, and—

even in the grip of such a ‘‘predatory mortgage loan’’—learn how to build equity

faster so that the credit union can eventually refinance the loan.

This is only a Band-Aid on a serious injury. When the credit union refinances for

the member, the predatory lender wins. At Aviation Associates Credit Union, we believe our members must never fall victim to predatory lenders in the first place.

That is why the ‘‘Take Control’’ program includes a significant education component

to teach our members how to avoid the predatory mortgage trap. We are convinced

that education is a critical tool in our efforts to obtain financial independence for

our members.

On a national level, CUNA and credit unions are active on several fronts to combat predatory lending. Last summer, CUNA developed ‘‘Mortgage Lending Standards and Ethical Guidelines’’ to be adopted by credit unions across the country.

These guidelines were designed to help emphasize credit unions’ concern for consumers and further distinguish credit unions as institutions that care more about

people than money.

The guidelines prohibit:

• interest rates that are significantly above market rates and which are not justified by the degree of risk involved in providing the credit

• excessive balloon payments that require refinancing at a rate that is more than

the rate on the existing note

• lending without regard to whether the borrower has the ability to repay

• requirements for frequent refinancing of the loan resulting in additional costs to

the borrower and significant erosion of the borrower’s equity;

• repayment penalties, in excess of actual costs incurred and unpaid

• exorbitant fees and insurance premiums that the borrower may be required to finance, further jeopardizing equity

• misleading or false advertising

A copy of these guidelines are attached to this statement.

One of the most important programs CUNA is currently promoting to combat

predatory lending practices is financial education of our Nation’s youth. Credit

unions believe that by educating our young people in the area of personal finance

they will learn to make sound financial decisions and choose not to use high-cost

or predatory lenders.

CUNA has partnered with the National Endowment for Financial Education

(NEFE) and the Cooperative Extension Service (CES) to expand financial education

among teens throughout America. Through this partnership CUNA, NEFE, and

CES provide an educational curriculum and materials to high schools across the

country to combat financial illiteracy.

In addition to providing necessary materials, credit unions actively participate in

the classrooms. During the 1999–2000 school year credit unions conducted over

5,000 financial education presentations reaching approximately 130,000 students

nationwide.

Because credit unions are an important component of the solution to predatory

lending—not part of the problem—CUNA has supported regulatory proposals that

would strategically address predatory lending concerns without unduly burdening

credit unions in the process. For example, CUNA supports the Federal Reserve

Board’s proposed change to Regulation Z, which is targeted only to high-cost loans

under the scope of the Home Ownership and Equity Protection Act. CUNA has not

supported regulatory proposals that are not carefully constructed to address only

predatory lending problems, such as the Fed’s proposed changes to amend Regulation C, Home Mortgage Disclosure Act (HMDA). This proposal would require all covered lenders, whether they make high-cost loans or not, to face additional, significant and costly reporting burdens not required by the HMDA. CUNA will continue

working with the regulators to develop strategies that will protect consumers without imposing broad-based requirements that divert them from their primary mission

of serving the financial needs of their members.

Credit Unions Often Use Subprime Lending Programs

To Improve Consumers’ Credit

A growing number of credit unions offer subprime loans to members who do not

qualify for a prime rate loan. Subprime loans are offered to members at rates above

the prime rate to offset the higher risk of lending to members with poor credit histories. Credit union subprime loans are not predatory. They are a necessary tool

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that gives borrowers with poor credit histories the ability to build, or rebuild, their

credit.

To help illustrate some of the alternative subprime lending programs offered by

credit unions, CUNA created the Equitable Subprime Lending Task Force last February. The Task Force has recently completed a handbook entitled: Subprime

Doesn’t Have to Be Predatory—Credit Union Alternatives, which is included as an

attachment to this statement.

Some credit union subprime loan programs, such as Aberdeen Proving Ground

Credit Union’s ‘‘Credit Builder’’ program in Aberdeen, Maryland, are designed to

help borrowers improve their credit standing. This program offers subprime loans

at 2 percent or 4 percent above normal rates, depending on collateral, but these

higher rates automatically drop when the borrower makes 12 on-time payments.

In this program, the borrower is well informed that if he or she has one payment

that is over 30 days past due any time during the first year of the loan, then the

borrower is locked into the higher rate for the life of the loan. But, if the borrower

makes the first 12 payments on time, the loan rate will automatically drop to the

prime rate. However, the borrower must continue the timely payments for the life

of the loan to retain the lower rate. If, after the first year of on-time payments, the

borrower misses a payment, then the rate reverts to the higher rate again for the

life of the loan. This loan is structured as an incentive to make on-time payments.

In Seattle, Washington, the Washington State Employees Credit Union all too

often saw single income families struggling to make ends meet while the American

Dream of homeownership remained beyond their grasp. To help more consumers

buy homes, the credit union developed the ‘‘First Step’’ program. This program requires only percent down, an interest rate of .50 percent above the standard Fannie

Mae 30 year fixed rate, and certification that the borrower has attended a homebuyer education seminar by a local agency or group. To qualify for this loan, the

borrower’s income cannot be above a certain level and the purchase price of the

home must be below maximum limits.

The credit union staff work closely with these borrowers through the life of the

loan offering financial guidance and budgeting assistance to promote success for this

program, as well as for the borrowers.

The credit union has allocated $20 million to this program and has been very successful getting people into homes that could not ordinarily qualify for a mortgage

anywhere else.

And Antioch Schools Federal Credit Union, located in California, offers its

subprime borrowers several ways to reduce their interest rates, while picking up

smart credit habits in the process. This ‘‘Rate Reduction’’ program includes:

• a 1⁄2 percentage rate reduction for attending one consumer credit counseling class;

• a 1 percent rate reduction for attending more than one consumer credit counseling

class;

• a 1 percent rate reduction for each year of the term of the loan that there are

no draws or escalation of debt during that year;

• and to promote savings, the Antioch Schools Credit Union will drop a subprime

borrower’s rate one half percent if the borrower makes a deposit of at least $15

a month to a savings account and keeps it on deposit for a year.

With the many positive programs being developed in the subprime lending market

to assist consumers of all economic circumstances, credit unions urge policymakers

to address the abuse of lending practices rather than complete prohibition of practices that, when used legitimately, provide flexibility and credit options to meet individual borrowers’ needs.

Credit Unions Urge: Eliminate Predatory Practices, Not Subprime Lending

Credit unions urge policymakers to use a scalpel, not an elephant gun, when

drafting legislation to eliminate predatory lending practices. Subprime borrowers

need to be served. Credit unions do not want to lose their ability to create flexible

subprime loan programs.

For example:

• Bona Fide Discount Points Should Not Be Eliminated. Credit unions are concerned that a definition of ‘‘high-cost mortgage’’ that includes ‘‘total points and

fees’’ and lowers the HOEPA threshold to 5 percent could restrict the use of discount points, which in many cases borrowers pay for the purpose of reducing the

interest rate or time-price differential applicable to the loan. This is an important

loan option for some borrowers who intend to stay in their home for a long time.

CUNA recommends that bona fide buy down points be excluded from the

definition of ‘‘high-cost mortgage’’ where the borrower has a completely free

choice among a set of interest rate and point combinations.

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• Legitimate Balloon Notes Should Not Be Prohibited. Credit unions are concerned

that strictly prohibiting balloon payments will eliminate a legitimate credit option

for lenders who wish to extend loans without holding excessive interest rate risk

or for borrowers, under specific circumstances, to obtain lower monthly payments.

CUNA recommends that balloon payments be allowed if the borrower has

the option of continuing the loan at the then current interest rate available

from that lender for similar borrowers with no additional costs or fees.

• Financing Points and Fees Should Be Allowed When in the Best Interest of the

Borrower. There may be cases where it is in the consumer’s best interest to refinance an existing high-cost mortgage. Credit unions are concerned that a strict

prohibition of the financing of certain points and fees could limit borrowers’ options and in many cases, access to credit.

CUNA recommends that legislation restricting the financing of points and

fees include an exception for transactions in which: (a) the action provides

a material benefit to the consumer, and (b) the amount of the fee or charge

does not exceed, (i) an amount equal to 1.0 percent of the total loan

amount, or (ii) $600 in any case in which the total loan amount of the mortgage does not exceed $60,000.

Again, let me say that I am very pleased you are holding these hearings. Credit

unions are very anxious to see the abusive practices of predatory lending eliminated.

Credit unions have taken positive steps in that direction through their voluntary efforts to educate their members and provide them with fair and sound alternative

products. It is our hope that we will have allies in our efforts to assure that all consumers have access to credit products that do not unfairly take advantage of their

circumstances.

Thank you, and I will be happy to answer any questions.

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PREPARED STATEMENT OF MIKE SHEA

EXECUTIVE DIRECTOR, ACORN HOUSING

JULY 27, 2001

Good morning, Chairman Sarbanes and Members of the Banking Committee. My

name is Mike Shea, and I am Executive Director of ACORN Housing Corporation,

which has worked for the past 17 years to build equity through increased homeownership in low- and moderate-income communities and communities of color. We

have been fighting to allow people in our neighborhoods to buy their own homes,

and worked with some of the major banks to make that happen. AHC now has offices providing housing counseling in 27 cities across the country and last year alone

helped 9,400 families close on home purchase loans.

The subprime industry likes to claim credit for increasing homeownership among

minorities and low- and moderate-income families. but the vast majority of their

business is in refinancing loans and making second mortgages, not helping people

buy homes. According to last year’s HUD/Treasury report, of first-lien mortgages

made by subprime lenders. Eighty two percent were refinances.

The increased rates of homeownership among underserved populations over the

last decade are due almost entirely to banks starting to live up to their obligations

under the Community Reinvestment Act. That is happening for a variety of reasons—continued pressure from community organizations like ACORN, somewhat

more effective monitoring of CRA preformance, and, most importantly, the banks’

realization that they had been neglecting good business opportunities. Do not get

me wrong—there is a tremendous amount yet to be done and many banks that receive passing grades are not living up to their CRA obligations, but we have made

progress and that needs to be recognized.

Increasingly, however, we are finding that predator lending abuses are threatening that progress. As soon as families in our communities start to build up some

equity, they are bombarded with offers to refinance their mortgages or take out additional debt—receiving three or four letters a week and regular phone calls.

We know people have heard the numbers before, but we really need to seriously

think through the consequences of more than half of refinance loans in communities

of color being made by subprime lenders. Now not all subprime lending is predatory,

but it is a sad fact that abusive practices are running rampant in the subprime

industry.

When you consider that number in combination with the observations that Fannie

Mae and Freddie Mac and others have made about the market—that 30 percent,

40 percent, or more of borrowers in subprime loans could have qualified for ‘‘A’’

loans, you are clearly talking about an incredible drain of equity from those communities which can least afford it. At a minimum, these numbers represent huge numbers of borrowers paying interest rates 2 to 3 percent higher than they would be

if they instead had gotten an ‘‘A’’ loan. Over the life of a 30 year mortgage for

$100,000, the difference in payments between interest rates of 8 percent and 10.5

percent is over $65,000.

Too often, however, predatory features make this bad situation even worse—by

stripping the equity from borrowers homes with high financed fees, prepayment

penalties, and add-ons like financed single-premium credit insurance. Borrowers are

effectively trapped in unfair high-rate loans by these features, or they lose tens of

thousands of dollars of equity from the encounter. Sometimes, they even lose their

homes entirely. The lender wins and wins, the borrower loses and loses.

There is a desperate need for Federal legislation to prevent the abuses, cut down

on the stripping of equity, and help families keep their homes. While it is impossible

to prevent every bad loan, good legislation could solve a lot of the problems in the

subprime industry and make a huge difference in protecting homeowners.

If we want a subprime market that works for consumers’ interests, we cannot

have huge fees financed into home loans—six times what banks are charging for

providing the same service. We cannot have long extended prepayment penalties for

several thousand dollars that trap borrowers in high-cost loans. As more lenders are

recognizing in response to public pressure, we cannot have single-premium credit

insurance policies that strip equity and tack on additional interest charges to an already overpriced product. If we want a market that works for borrowers, we cannot

have loans being flipped over and over. That means taking away the current incentive for lenders to keep profiting from huge fees and other add-ons and make lenders’ income streams more dependent on their loans actually being repaid.

In short, we have to get rid of all the tricks and hidden practices that make it

impossible for borrowers to know what kind of loan they are getting into. What you

have now is a situation where it is very difficult for even trained loan counselors

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sometimes to understand all the damaging bells and whistles in many subprime

loans—let alone a borrower trying to look for their own interests. That should not

be how getting a home loan should work. It is not what happens in the ‘‘A’’ market.

But that is what happens everyday in the subprime market. And despite the industry’s substantial public relations efforts, the market has not taken care of it. We

need a strong, clear set of rules that will allow homeowners to navigate the

subprime market with some basic assurances of safety. Without such rules, large

numbers of borrowers will not stand a chance.

We hear the argument that we do not need legislation, but just more education

and financial literacy for borrowers. We certainly support financial literacy efforts—

in fact I would venture that we have, in fact, done more to inform people in lowerincome and minority communities about these issues than most. Part of what we

have learned from this experience, though is what the limits of this approach are.

First, there is the question of resources—until we are ready to spend the $1,500 to

$2,000 per borrower that lenders can spend hawking their products we will never

catch up. And second, no advertisement, or bus billboard, or even workbook, is going

to compete with the one-on-one sales pitch of a lender—who still knows more about

the process.

We have also heard the argument that all that is needed is better enforcement

of existing laws. We see a lot of borrowers in heartbreaking situations, and we have

tried to use current laws to help protect them, applying all the pressure we know

how to get it enforced. But by and large, this has not worked. HOEPA covers only

a tiny fraction of loans, and even there it mostly requires disclosures—as long as

the right paper was slipped somewhere into the pile, there is often little the borrower can do. Fraud and deceit are against the law, but they have also been extraordinarily difficult to prove. It turns into a matter of ‘‘he said, she said’’ and when

the lender knows more about the transaction, and has the paperwork, the borrower

loses. And when we hear certain industry groups suggest the solution is better enforcement of current law, we are left wondering how they expect that to happen if

they routinely include mandatory arbitration clauses in their loans.

What we need are some basic rules covering a broader group of high-cost loans

that create a level playing field where a borrower in the subprime market, like a

borrower in the ‘‘A’’ market, has a set of understandable options to choose between.

Buying or refinancing a home is a lot more like buying medicine than like buying a pair of shoes; if you are misled and buy the wrong one, the consequences are

pretty serious. We do not expect every patient to read the New England Journal

of Medicine and evaluate for themselves which drugs are safe and which are not.

Instead, the FDA makes some rules about what is too dangerous to be sold. And

then inside that relatively safer space, patients still have plenty of work to do to

figure out what is best for them. We need to make some rules in the same way

about home loans.

With regard to regulation, I should add that we were pleased that the Federal

Reserve Board issued a proposed rule on HOEPA and one on HMDA. And that we

are now growing extremely concerned about their silence since then. The Board

needs to issue their rule, and they need to insist on the limited steps laid out in

the proposed version—like improving the collection of HMDA data to include APR

information. That said, the proposed rules were silent on many crucial areas crying

out for action, and which we need legislation to address.

In the spirit of comity, I will end on an issue of clear agreement with the lending

industry. We share the industry’s belief that a variety of State and local antipredatory lending legislation is not the ideal solution. We would like to see Federal

protections for all Americans, and that is why we strongly support legislation the

Chairman will be introducing in the near future.

As long as there is not Federal legislation, though, it is clear to us that our members, and community residents and State and city officials around the country will

not, and cannot, sit by idly while borrowers are so badly hurt by predatory loans.

The list of States and localities where antipredatory lending measures have been

considered, or are presently being considered, include California, New York, Massachusetts, North Carolina, Philadelphia, Sacramento, DeKalb County (Georgia), and

the list will keep growing. Just on Tuesday, the Oakland city council voted unanimously for a strong local ordinance restricting predatory lending practices, and

there are many more like that to come. We are going to keep pushing our Senators

and Representatives to get on board, but we are not going to wait for you. The

stakes are too high.

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RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM JUDITH A. KENNEDY

Q.1. Is there a definition for predatory lending? Or do you know

it when you see it?

A.1. NAAHL recently conducted a symposium for advocates, lenders, and policymakers on developing workable solutions to predatory lending. Based on remarks at the symposium, a profile of

predatory lending emerged. Loan flipping, home improvement

scams, asset-based and unaffordable mortgage loans, repetitive

financings with no borrower benefit, packing single-premium credit

life insurance and other products into the loan amount, all of which

can strip equity and trigger foreclosures.

Q.2. What can be done about the unregulated brokers and home

improvement contractors who are bad actors?

A.2. More needs to be done at the Federal level. Currently, a significant amount of mortgage lending is not covered by a Federal

framework. As the Federal Reserve has pointed out, only about 30

percent of all subprime loans are made by depository institutions

that have periodic exams. To stop the predators, we need to close

the barn doors on examination and reporting. In addition, increased Federal resources for expanding existing public and private

sector consumer education programs in neighborhoods that are

vulnerable to predators could be extremely helpful in combating

predators.

Q.3. In the securities industry, there is a ‘‘suitability standard’’ for

brokers putting clients into appropriate brokerage activities. What

do you think about applying a suitability standard for brokers/lenders who put low-income borrowers into subprime loans?

A.3. We believe such standards would be appropriate. In NAAHL’s

comment letter earlier this year to the Federal Reserve on proposed

changes to the Homeowners Equity Protection Act (HOEPA), we

supported a number of proposals by the Fed that would help ensure that subprime loans are appropriate for borrowers. Frequent

refinancings, commonly known as ‘‘loan flipping,’’ generally are not

in the borrower’s best interest. Therefore, we strongly supported

the proposed prohibition on refinancing loans within the first 12

months, unless the creditor can demonstrate that the refinancing

is in the borrower’s best interest.

Similarly, we are in favor of the proposed prohibition on refinancing zero-rate or other low-cost loans within 5 years unless the

creditor can demonstrate that the refinancing is in the borrower’s

best interest. In addition, we believe there is merit in the proposal

to require creditors to demonstrate a consumer’s ability to repay

HOEPA loans to mitigate the practice of making asset-based

HOEPA loans. We also supported the proposed prohibition on

HOEPA demand loans and the structuring of what, in reality, are

closed-end loans into open-end financing merely to avoid HOPEA

restrictions on asset-based loans.

Q.4. Why are better disclosures and/or financial education not sufficient remedies for predatory lending problems?

A.4. NAAHL’s recent symposium on solutions to predatory lending

showed that predatory lending is a multifaceted problem requiring

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a multifaceted response. Better disclosure and additional financial

education are certainly part of the solution, but the problem is

broader. As I indicated earlier, the Federal Reserve estimates that

only 30 percent of subprime loans are made by institutions that

have periodic exams. If the Federal Reserve were to do periodic

compliance exams of the subsidiaries of financial holding companies, that would take it up to about 40 percent. Nonetheless, the

majority of subprime loans still would not be covered. In a town

with no sheriff, the bandits are in charge.

Q.5. I understand Philadelphia enacted a city ordinance regarding

predatory lending and the Pennsylvania legislature passed a law

preempting county and/or city ordinances. What do you think about

State legislatures preempting county and/or city ordinances regarding predatory lending?

A.5. The broader issue is the need for a level playing field in oversight and enforcement. Insured depository institutions, the vast

majority of whom engage in best practices in the subprime lending

market, are of course subject to regulatory oversight and compliance. But the majority of subprime lenders are not subject to the

same regulatory oversight, do not have the same level of compliance management and often do not even file HMDA reports. The

growing plethora of widely varying State and local laws only exacerbates this disparity—and threatens to drive out responsible lenders who will choose not to offer legitimate subprime loans. The

solution is to bring all lenders under a uniform Federal framework

that eliminates predatory practices without turning off the flow of

legitimate subprime credit.

Q.6. Is your concern about SPCLI related to the product or the

marketing of the product?

A.6. We are concerned with the product itself, which has been associated with high-cost loans that strip equity from the home.

If I can provide any additional information, please call me. Our

members are very committed to working with policymakers on addressing this critical problem, and we would be happy to help you

in any way.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM ESTHER ‘‘TESS’’ CANJA

Q.1. Is there a definition for predatory lending? Or do you know

it when you see it?

A.1. Conceptually, a higher-interest rate premium paid by an appropriately classified subprime borrower should be proportionate to

the added risk the borrower may pose to a lender. Anything in excess of that proportionate premium is exploitive. Of course, to

misrate a borrower as being a subprime risk when in fact the borrower should be ‘‘A’’-minus rated, would also be exploitive and thus

predatory in nature. In direct response to your question: The four

principal Federal banking regulators (FRB, OCC, RTS, and FDIC)

issued guidance to their examiners in January 2001 in which they

provide a common threshold definition of predatory lending as:

• making loans that a borrower will be unable to repay;

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• inducing borrowers to refinance a loan in order to charge high

fees or points (so-called ‘‘loan flipping’’); and • engaging in fraud or deception to conceal the true nature/features of a loan.

While AARP believes that this definition is too narrow in scope,

it does identify the core features of a predatory loan.

Q.2. What can be done about the unregulated brokers and home

improvement contractors who are bad actors?

A.2. Older homeowners have lost their homes because of home repair or consolidation loans made at exorbitant interest rates and

fees by unscrupulous lenders and brokers. AARP believes that the

U.S. Department of Housing and Urban Development’s regulations

should require that lenders disclose to consumers the amount and

source of mortgage broker fees before any agreement is reached.

Special premiums or other kickbacks paid by lenders to mortgage

brokers for steering customers to higher-yield loans should be outlawed or, at a minimum, disclosed upfront before consumers apply

for a loan. Clearly, new protections need to be enacted for home improvement borrowers victimized by contractor nonperformance or

malfeasance.

Q.3. In the securities industry there is a ‘‘suitability standard’’ for

brokers putting clients into appropriate brokerage activities. What

do you think about applying a suitability standard for brokers/lenders who put low-income borrowers into subprime loans?

A.3. The notion of a suitability standard for brokers and lenders

has some appeal if it is based on concrete protective provisions.

Specifically, mortgage brokers and lenders should be required to

comply with fair-lending rules addressing, among other things, interest rates, fees, marketing, service areas and application acceptance procedures. Mortgage brokers/lenders should be required to

provide a binding offer of mortgage terms and costs that would be

good for a set period of time after issuance. The binding offer would

include the principal amount of the loan; the interest rate, points,

and any other costs; the type and term of the mortgage; a consolidated rate or price tag similar to an annual percentage rate; and

the amount of the monthly payment. A lock-in of terms (as reflected in the binding offer) should be required once a consumer applies for the loan.

In addition to these standards, AARP believes that the Home

Ownership and Equity Protection Act of 1994 (HOEPA) should be

strengthened by lowering current trigger mechanisms (interest

rates, points, and fees) so that the protections of the Act apply to

more loans. More effective measures should be enacted for policing

unscrupulous loan practices that typically target older homeowners

with low incomes. And finally, enhanced protections and remedies

need to be created to make the standards effective.

Q.4. Why are better disclosures and/or financial education not sufficient remedies for predatory lending problems?

A.4. AARP does believe that both better disclosures and financial

education are important and necessary tools that can help many

consumers avoid being victimized by predatory lenders. However,

better disclosure and education alone are not sufficient remedies

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for preventing the financial exploitation of many of those who are

among the most vulnerable. Limiting the remedy to disclosures and

nonmandatory, nonstandardized financial literacy campaigns would

have the effect of shifting the burden for prevention to a portion

of the population with the fewest skills to benefit from these remedies, that is, those with the least formal education.

Consider the complexity of mortgage finance documentation and

processes and the frequent disconnect between the level and timing

of and limits of exposure to financial literacy campaigns. On the

other hand, what part of the remedy would hold the predatory

lender accountable? The right to protection against predatory lending practices should be equally valid for all consumers who have

or may be victimized, and lenders/brokers that use these tactics

should be held accountable for their acts and for harm done.

Q.5. I understand Philadelphia enacted a city ordinance regarding

predatory lending and the Pennsylvania legislature passed a law

preempting county and/or city ordinances. What do you think about

State legislatures preempting county and/or city ordinances regarding predatory lending?

A.5. On the issue of preemption, AARP recognizes that cities and

counties derive their authority from the State government. The

State of Pennsylvania can and did act. We are disappointed, however, that after looking at the apparent prevalence of predatory

lending practices in the Philadelphia area, the State did not move

to protect vulnerable consumers—especially the elderly, throughout

the State. It is the gaps in State level protection of consumers

across the Nation from the practices of predatory lenders that is

stimulating the desire for minimum Federal standards.

Q.6. Is your concern about single-premium credit life insurance

(SPCLI) related to the product or the marketing of the product?

A.6. Both. On the one hand, we are concerned that brokers and

lenders be prohibited from engaging in unfair, deceptive, or unconscionable practices in connection with a consumer credit transaction. And on the other hand, we have questions about why

SPCLI is needed and how SPCLI is being financed. The packing of

‘‘lump-sum’’ insurance products is a commonly used tactic of highcost lenders to inflate the mortgage loan amount, and thus, the

monthly payments of at-risk borrowers, while evading HOEPA’s

reach. This practice is particularly problematic because this type of

insurance is generally packed onto mortgage loans without the borrower’s knowledge or actual consent. Moreover, credit insurance

can be the most expensive component of the loan.

Q.7. If SPCLI is removed from the marketplace, what are subprime

borrowers to do when they wish to insure their financial obligations

and monthly alternatives have not been approved in their States?

A.7. AARP believes that credit insurance and insurance substitutes

should be optional, but if accepted as part of the loan, should be

included in the HOEPA points and fees trigger. In the latter case,

however, one important issue would remain: If the borrower were

given the ability to cancel the insurance and receive a ‘‘full refund,’’

it would still not adequately address the problem of insurance

packing. Unless the refund is structured so that the refund is apVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00429 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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plied to reduce the amount of the loan, the borrower continues to

pay interest on it over the life of the loan. It is AARP’s view that

if the borrower truly wants insurance, it can be sold on a monthly

basis—easily cancelable—and without HOEPA implications.

Q.8. Yesterday [July 26], we had a lively discussion about the cost

of SPCLI. One witness said that if you go to a Monthly Outstanding Balance basis it is more expensive than over the term of

the loan. Another witness disputed that. Do you have a view on

this issue?

A.8. We have not done the calculations, and so do not have a recommendation to offer. As we mentioned above, AARP’s principal

concern is that this type of insurance or its substitutes be optional,

and that it not be financed as part of a home equity loan.

Q.9. I have heard that SPCLI is a better deal for consumers over

41 years of age because it is cheaper and it is generally more available than the traditional term life insurance. Would anyone care to

comment on that view?

A.9. AARP believes that borrowers must first be informed of any

requirement and/or need for SPCLI or its substitutes as part of securing a home equity loan, their options and alternatives, before

cost comparisons become meaningful.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM IRV ACKELSBERG

Q.1. Is there a definition for predatory lending? Or do you know

it when you see it?

A.1. Much like the term ‘‘unfair and deceptive practices,’’ predatory

lending encompasses a range of abusive activities that, when

present, enable someone who knows what to look for, to ‘‘know it

when he sees it.’’ But it certainly can be defined, to varying degrees

of precision, with the understanding that no definition could ever

exhaust all imaginable lending abuses. A recent New Jersey appellate decision adopted a simple guidepost: predatory lending is the

‘‘target[ing] of certain populations for onerous credit terms.’’ Associates Home Equily Services, Inc. v. Troup, 2001 N.J. Super. LEXIS

318 (decided July 25, 2001). This is a good place to start. Predatory

lending encompasses lending that takes advantage of certain borrowers, involving both targeting of vulnerable ‘‘prey,’’ and credit

products that carry onerous terms. This definition can be refined

by looking, alternatively, at each of these two perspectives, (1) the

targeting behavior of the lenders and (2) credit terms that are ‘‘onerous’’ under agreed upon standards.

Regarding the use of targeting, it is important to distinguish targeting from marketing. Often, a predatory lending scenario involves an offer of money that seeks out a borrower, rather than a

borrower with a particular credit need who is shopping for the best

product. Predatory lenders tend to target rather than market, identifying individuals or neighborhoods as having characteristics that

make them vulnerable. For example, many lenders or brokers target borrowers who already have a subprime mortgage recorded on

their property, a fact that identifies a consumer who might be vulnerable to sales pitches laced with promises to improve on the existing loan and to ‘‘put cash in your pocket.’’ Sometimes the tarVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00430 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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geting is done by intermediaries, such as brokers, contractors, or

collectors, rather than by the lenders. For example, in depositions

of Equicredit employees we have learned that this lender regards

the ‘‘customer’’ as the broker who brings it the loan, not the borrower, with whom the lender has no direct communications at all

prior to a closing.

From the perspective of the loans themselves, a predatory loan

involves a mismatch between the cost of the credit, on the one

hand, and the risk to the lender or the needs of the borrower, on

the other. These loans tend to be extremely costly, containing price

components that are well in excess of any calculated risks. Often,

loans that are already priced with rates that reflect higher risk are

also packed with excessive points, fees, and insurance products.

Fannie Mae and Freddie Mac have determined that a substantial

segment of the subprime mortgage market actually involves borrowers who have credit decent enough to qualify for prime products. This mismatch between cost and risk can also be apparent in

loan terms other than price, where, for example, balloon clauses,

prepayment penalties and ‘‘no doc’’ income verifications are imposed in clearly inappropriate circumstances. In addition to seeing

loans containing costs and terms disproportionate to risk, we also

see costs disproportionate to the actual benefit obtained by the consumer. Every day we see cases of borrowers paying extremely high

transaction costs for credit that is providing them with little or no

discernible benefit, as for example, when borrowers refinance to

higher rates, or consolidate obligations that they have no reason to

pay, such as utility bills deferred by low-income assistance programs.

Finally, predatory lending can also be defined in terms of the

‘‘equity stripping’’ that results from including excessive fees and

charges in loan principals and from unnecessary consolidations of

unsecured debt. This effect is multiplied each time a refinancing

occurs.

Q.2. What can be done about the unregulated brokers and home

improvement contractors who are bad actors?

A.2. One clear thing that could be done would be to pin responsibility for their bad acts on the lenders who utilize these intermediaries as ‘‘bird dogs.’’ Section 3(f)(2) of S. 2415 would subject

‘‘any assignee or holder’’ of a covered mortgage ‘‘which was made,

arranged, or assigned by a person financing home improvements’’

to all claims and defenses which the consumer could assert against

the contractor and, if a broker were involved, to claims against the

broker, as well. I describe this issue at some length in my written

testimony. In analyzing the problem of bad brokers, one additional

obstacle to developing consumer remedies is the insistence of many

mortgage brokers—often supported by State regulators—that they

have no fiduciary obligations toward borrowers. Indeed, I have frequently heard the brokers claim that they are neither agents of the

borrowers or the lenders and that they somehow are representing

only themselves. Congress could certainly put a stop to such claims

by requiring brokers to represent either the borrower or the lender

and to disclose the nature of their role.

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Q.3. In the securities industry there is a ‘‘suitability standard’’ for

brokers putting clients into appropriate brokerage activities. What

do you think about applying a suitability standard for brokers/lenders who put low-income borrowers into subprime loans?

A.3. Your question directly addresses the ‘‘mismatches’’ in predatory lending scenarios that I discussed in response to your first

question, namely, the need to do something about the clash between credit terms that are imposed and what seems appropriate

under the circumstances. I am familiar with proposals to impose a

‘‘suitability standard’’ on brokers and or lenders. I think each of

these actors should be looked at separately.

There certainly is a need to make explicit the legal responsibility

of mortgage brokers toward the borrowers whose loans they are arranging. The simplest way to do this is make clear that brokers

have fiduciary relationships with borrowers. If Congress were to do

that, there would be ample common law on the duty of fiduciaries

that would then be applicable to mortgage brokers. While a Federal

suitability standard would be an improvement over the current

state of affairs, I fear that ‘‘suitability’’ would be regarded similarly

as the ‘‘unconscionability’’ doctrine in contract law, namely, a vague

standard that would give little comfort to lenders and judges who

are generally looking for more bright lines to guide their decisions.

I realize that ‘‘fiduciary relationship’’ has some vagueness to it as

well, but I believe that the extensive common law development of

this concept would lend itself to be a more effective tool. I also suspect that lenders would prefer this approach because if a broker

were a fiduciary of a borrower, a court would likely not characterize the broker as an agent of the lender.

While lenders are not ordinarily viewed as having fiduciary-like

obligations toward applicants for credit, I do believe that lenders

should be more accountable for the credit terms they impose in the

case of loans that exceed agreed upon levels of cost. This is the existing approach under HOEPA, and is much easier to apply to lenders than a ‘‘suitability’’ standard. Any lender that prices a loan beyond statutory cost thresholds should simply be prohibited from including certain features in a loan, like, for example, repayment

terms that the borrower cannot verifiably afford.

Q.4. Why are better disclosures and/or financial education not sufficient remedies for predatory lending problem?

A.4. The best way I can answer this is to make the comparison to

other dangerous products in the marketplace. Should consumer

education about the danger of SUV’s tipping over on the highway

be a sufficient response to manufacturer greed and negligence?

Should a ‘‘just say no’’ campaign be the only policy response to the

drug pushers on urban streetcomers? Predatory loans are poisonous. While we need to educate vulnerable homeowners about

the dangers, we should also be attempting to address the abusive

practices directly.

As for improving the disclosures that are part of the paperwork

in a mortgage transaction, it is difficult for me to see this as an

effective strategy. Presently there are about five or six pieces of

paper in a typical transaction that contain Federally mandated disclosures. These papers are among the 30 or so loan documents preVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00432 Fmt 6601 Sfmt 6601 82969.TXT SBANK4 PsN: SBANK4
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sented to a borrower at a loan closing, in a paperwork stack at

least an inch thick, and their usefulness is often undermined by

the order of signing and the oral explanation that is provided by

the party conducting the closing. Tinkering with the five or six disclosure documents is not going to effect the size or readability of

the entire stack, or these other contextual impediments to the information in the disclosures actually getting to the consumers.

From my experience, the bad actors would be very happy to see

Congress impose new disclosures and support consumer education,

while leaving them free to continue the stripping of equity out of

vulnerable communities.

Q.5. I understand Philadelphia enacted a city ordinance regarding

predatory lending and the Pennsylvania legislature passed a law

preempting county and/or city ordinances. What do you think about

State legislatures preempting county and/or city ordinances regarding predatory lending?

A.5. For me the important question is whether Government is adequately protecting those consumers who are in need of protection,

not whether this protection comes from local, State or Federal policymakers. Uniform protections are better than local ones, but local

protections are better than none.

In April 2001, the Philadelphia City Council unanimously enacted antipredatory lending to protect the homeowners of Philadelphia. Philadelphia is a home rule city that retains the power to legislate in all areas not preempted by State legislation. In June, the

legislature passed preemption legislation on the last night of the

legislative session; they did so as an amendment to an already

passed bill, without any study and without any public hearing. The

State legislation does nothing to protect vulnerable homeowners. It

duplicated the coverage and protection under HOEPA, and limited

consumer remedies to a damage action that must prove ‘‘pattern

and practice’’ and actual intent to violate the law. Thus, for example, a consumer who gets a balloon payment prohibited by the law

cannot do anything to undo the transaction. Because the State superceded strong local legislation with nonexistent State protections,

the preemption ended up hurting Philadelphia consumers under

the banner of ‘‘uniformity.’’

The Pennsylvania lesson is an important one for Congress. State

and local laws that protect consumers should not be preempted

without ensuring that adequate Federal restrictions and remedies

are in place to combat predatory practices.

Q.6. Is your concern about single-premium credit life insurance

(SPCLI) related to the product or the marketing of the product?

A.6. Both. The product itself is overpriced because its pricing builds

in too much profit for the middlemen. Further, it is not even really

known how overpriced it is, because in addition to upfront commissions, there are back-end revenue sharing mechanisms, which may

not show up as commissions. State insurance departments have a

difficult time in monitoring the true reasonableness of the rates,

because the insurers sometimes ‘‘fog’’ the data and, because of insufficient enforcement resources, credit insurance ends up being a

lower priority for those limited resources than the much larger

standard life, health, and property insurance.

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Until there is pricing reform on the product itself, marketing reforms will not work, as three decades of effort in that regard have

proven. When the profit is too great, a way will be found to sell

the product. Indeed, it is not even accurate to refer to the selling

as ‘‘marketing,’’ given the ever-present ‘‘packing’’ of insurance products into the loans of lenders who have been most involved in the

sale of SPCLI. Affidavits from former employees of The Associates,

for example, have made very clear that loan officer job performance

and compensation were dependent on their getting borrowers to

sign up for SPCLI, just like car salesmen are expected to sell ‘‘extras’’ like rustproofing or service contracts.

Q.7. If SPCLI is removed from the marketplace, what are subprime

borrowers to do when they wish to insure their financial obligations

and monthly alternatives have not been approved in their States?

A.7. Few borrowers who truly understood the full financial impact

of SPCLI, and the often limited benefits it provides, would choose

to purchase it. It is only because the full cost and the limited benefits are obscured, or because borrowers are fooled into purchasing

it, that the product is sold. Even, an industry-financed study indicated that fully 40 percent of borrowers thought that SPCLI was

required, strongly urged, or that there would be delays if they did

not buy it. Consequently, the number of borrowers who do purchase it cannot, with statistics like that, be considered a valid indicator of ‘‘demand.’’ As for alternatives, noncredit term life insurance is more value

for the dollar, and most objective advisors (for example those who

do not make money from the product) advise to use the noncredit

insurance. As for delays in State approvals of monthly alternatives

to SPCLI, it is typically the providers who approach the insurance

departments for approval when they want to sell the monthly alternative. And, once this occurs, there is no reason to expect long

delays. On the contrary, for example, when Household Finance announced last month that it would stop selling SPCLI in favor of

monthly premium insurance, it announced at the same time that

it already had obtained the approval of 34 States to offer this

monthly alternative.

Q.8. Yesterday [July 26], we had a lively discussion about the costs

of SPCLI. One witness said that if you go to a Monthly Outstanding Balance basis it is more expensive than over the term of

the loan. Another witness disputed that. Do you have a view on

this issue?

A.8. The witness who made that claim never explained his calculations, and, quite frankly, I do not believe he had any supportable

basis for that claim. Paying the real price of something without

paying interest on it will always be less expensive than paying that

price with interest, especially at rates that range from 10 percent

to 22 percent. If his point was that it is cheaper to spread out the

cost of 5 years of coverage for an extra 15 years after the insurance

has lapsed, ask yourself whether anyone would freely choose to pay

an extra $66,000 of interest to purchase $10,000 of insurance for

14 years after it no longer protects the borrower. My understanding

is that is exactly what happened in the case described by Iowa Attorney General Miller in his testimony.

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Q.9. I have heard that SPCLI is a better deal for consumers over

41 years of age because it is cheaper and it is generally more available than the traditional term life insurance. Would anyone care to

comment on that view?

A.9. I sincerely doubt that SPCLI is ever a better deal and would

suggest that you look carefully at the calculations of anyone making this claim. (Obviously, you also have to make sure that you are

comparing apples to apples. Often, unlike term insurance which

provides benefits in a fixed amount, SPCLI is structured to provide

declining benefits over time, sometimes at a rate that results in

benefits not high enough to pay off the outstanding balance.). It

can only be cheaper when you do not factor in the time value of

the money paid for future insurance coverage and when you do not

factor in the cost of financing it. This latter point is particularly

important. When an insurance premium is added to the principal

of the loan, the borrower pays two ways in addition to the inflated

cost of the insurance itself. First, when the cost of the premium is

added to the principal, then percentage-based fees (‘‘points’’ and

broker fees) are also increased. Second, interest is then applied,

over the life of the loan to that extra principal. As for SPCLI being

‘‘more available,’’ that argument is usually predicated on lenders

not conducting underwriting before they sell the insurance. This

argument ignores the fact that the insurers often engage in postclaim underwriting by denying coverage and then refunding the

premium. Thus, the ‘‘availability’’ advantage can be little more

than an illusion.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM NEILL A. FENDLY, CMC

Q.1. Is there a definition for predatory lending? Or do you know

it when you see it?

A.1. There is no generally accepted, succinct definition of ‘‘predatory lending.’’ Whether or not an individual loan can be considered

‘‘predatory’’ depends on a number of circumstances and even then

is largely in the eye of the beholder. While some consumer advocates believe that certain loan terms and products are always

‘‘predatory,’’ mortgage professionals generally believe that ‘‘predatory lending’’ is a problem of deceptive sales practices, not products.

Predatory practices could include, but are not necessarily limited

to, such practices as fraudulent and deceptive marketing of loans;

deliberate failure to provide disclosures of costs and loan terms to

the customer as required by law; and high-pressure sales tactics

that cause consumers to accept loans, especially repeated and frequent refinancings, that are offered to the borrower primarily to

generate more fees for the lender or broker and may not be beneficial to the borrower given his/her financial circumstances and

goals. Responsible mortgage professionals do not engage in such

practices.

Q.2. What can be done about the unregulated brokers and home

improvement contractors who are bad actors?

A.2. Mortgage brokers are regulated, by State licensing laws in all

but two States and by more than 10 Federal statutes. Mortgage

brokers in most States are subject to regular examinations, and

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many States recently have enacted new laws requiring basic and

continuing education and minimum experience requirements for

mortgage brokers. NAMB and its State affiliates have been at the

forefront of efforts to impose and strengthen State mortgage broker

licensing laws.

Eliminating ‘‘bad actors’’ is largely a function of enforcing these

existing laws. NAMB is working with the National Association of

Attorneys General and the American Association of Residential

Mortgage Regulators to improve enforcement of State laws, and

State enforcement of Federal laws such as RESPA. NAMB also

supports increased enforcement of existing Federal laws, including

RESPA, TILA, HOEPA, and the FTC Act, all of which address

most types of abusive lending practices.

Q.3. In the securities industry there is a ‘‘suitability standard’’ for

brokers putting clients into appropriate brokerage activities. What

do you think about applying a suitability standard for brokers/lenders who put low-income borrowers into subprime loans?

A.3. While the concept of a ‘‘suitability standard’’ may have some

intuitive appeal, in fact such a standard would be impossible to

develop for mortgages. In the investment market, customers are

looking for only one thing—a certain return on their investment,

consistent with their tolerance for risk. It is relatively easy to set

standards of risk for various investments and then to determine

whether a particular investment is suitable for an investor given

his/her assets and risk tolerance. On the other hand, people may

seek mortgages for a variety of reasons, including obtaining cash

quickly, reducing monthly debt payments, financing home improvements, etc., and therefore people judge the suitability of a mortgage

according to their own needs and financial goals. For example, a

borrower may choose a higher-rate subprime mortgage even if he

qualifies for a lower rate, because he does not want to reveal all

the sources of his income as is required by most conforming mortgage lenders. A borrower may choose to accept a prepayment penalty because the loan with the penalty has a substantially lower

interest rate and lower monthly payments than does the loan without the penalty, and the borrower’s only goal is to reduce his

monthly payments as much as possible. Mortgages can be structured with various terms, lengths, documentation requirements,

and other features that are tailored to the needs and goals of almost any borrower, even though some of these mortgages might appear to others as ‘‘unsuitable.’’ Thus the suitability of a particular

mortgage product for an individual borrower can really be defined

only by the borrower, and it is impossible to impose a ‘‘bright-line

test’’ for mortgages. Any attempts to impose an arbitrary suitability

standard for subprime mortgages would necessarily involve prohibiting or limiting certain loan terms, and this would have a perverse

effect of reducing choices for borrowers and reducing the availability of credit to low- and moderate-income borrowers.

Q.4. Why are better disclosures and/or financial education not sufficient remedies for predatory lending problems?

A.4. These are, in fact, very important parts of the overall solution

to abusive lending problems. Simpler and more meaningful disclosures will empower consumers to be better shoppers, reduce the

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ability of unscrupulous lenders to hide fees and onerous terms in

‘‘fine print’’ and prevent lenders from surprising consumers with

large fees at the closing table. More consumer education will also

help people avoid being victims of unscrupulous lenders and better

understand their rights to disclosures, limitations on fees, and

their right to rescind certain types of loans even after closing. Congress can be most effective in eliminating abusive lending by simplifying the mortgage lending disclosure statutes and encouraging

more financial education in Federally funded education programs.

However, the third element we believe must be addressed is better enforcement of existing laws, at the State and Federal level.

Even if consumers are fully informed and armed with better disclosures, there may still be unscrupulous people who will continue to

try to hide excessive fees, trick people into buying unnecessary ancillary products, and deceive or pressure people into borrowing

more than they really want at higher costs. Existing laws prohibit

such practices but need to be better enforced to send the message

to these people that they cannot continue to abuse consumers.

Q.5. I understand Philadelphia enacted a city ordinance regarding

predatory lending and the Pennsylvania legislature passed a law

preempting county and/or city ordinances. What do you think about

State legislatures preempting county and/or city ordinances regarding predatory lending?

A.5. NAMB strongly supported the Pennsylvania legislation and

supports other efforts, including litigation, to overturn other similar local ordinances. It is absurd for local governments to decide

that arbitrary city or county borders should govern whether or not

someone can get a certain kind of mortgage. Such regulation of financial services and products has never been considered the purview of local governments. Consumer advocates are supporting

these ordinances only because they have failed to win the restrictive legislation they want at the Federal or State levels. If any of

these ordinances succeed, all they will do is drive mainstream

subprime lenders out of those localities and leave borrowers within

the localities far fewer choices for home financing. In fact, some

major lenders have already stopped making certain subprime loans

in localities that have passed these ordinances, including DeKalb

County, Georgia.

Q.6. Is your concern about single-premium credit life insurance

(SPCLI) related to the product or the marketing of the product?

A.6. Mortgage brokers generally do not sell credit life insurance of

any kind and so NAMB does not offer an opinion on the value of

the product. However, it seems clear that there have been some

abuses in marketing this product, and other forms of credit life insurance may be available or developed soon that offer equally good

protection to borrowers without eating up so much of their equity.

Q.7. If SPCLI is removed from the marketplace, what are subprime

borrowers to do when they wish to insure their financial obligations

and monthly alternatives have not been approved in their States?

A.7. The fact is that if this occurs, some consumers will not have

the choices they want. Low-income people are generally underinsured and credit life insurance can be a good product for them.

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If monthly premium products are not available, a borrower could

be at risk of losing the home if a coborrower passes away and had

no other form of life insurance. This illustrates the problem with

complete prohibition of any products or terms in the subprime market. Almost no product or term is always abusive, and a wide range

of product choices most helps consumers at all income levels to

achieve their financial goals and minimize their risks.

Q.8. Yesterday [July 26] we had a lively discussion about the cost

of SPCLI. One witness said that if you go to a Monthly Outstanding Balance basis it is more expensive than over the term of

the loan. Another witness disputed that. Do you have a view on

this issue?

A.8. We have no opinion on this issue, except that we believe consumers should have choices of different types of products and payment plans and choose for themselves which one is most cost-effective for them.

Q.9. I have heard that SPCLI is a better deal for consumers over

41 years of age because it is cheaper and it is generally more available than the traditional term life insurance. Would anyone care to

comment on that view?

A.9. We would answer this question the same as question 8.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM DAVID BERENBAUM

Q.1. Is there a definition for predatory lending? Or do you know

it when you see it?

A.1. Contrary to industry representation, there is a definition of

predatory lending. It is important, however, to first clarify and distinguish between subprime lending and predatory lending. A

subprime loan is defined as a loan to a borrower with less than

perfect credit. In order to compensate for the added risk associated

with subprime loans, lending institutions charge higher interest

rates. In contrast, a prime loan is a loan made to a creditworthy

borrower at prevailing interest rates. Loans are classified as ‘‘A,’’

‘‘A-minus,’’ ‘‘B,’’ ‘‘C,’’ and ‘‘D’’ loans. ‘‘A’’ loans are prime loans that

are made at the going rate while ‘‘A-minus’’ loans are loans made

at slightly higher interest rates to borrowers with only a few blemishes on their credit report. The so-called B, C and D loans are

made to borrowers with significant imperfections in their credit

history. ‘‘D’’ loans carry the highest interest rates because they are

made to borrowers with the worst credit histories that include

bankruptcies.

In contrast, a predatory loan is defined as an unsuitable loan

designed to exploit vulnerable and unsophisticated borrowers.

Predatory loans are a subset of subprime loans. They carry higher

in-terest rates and fees than is required to cover the added risk of

lending to borrowers with credit imperfections. They contain abusive terms and conditions that trap borrowers and lead to increased

indebtedness. They have fees and products packed onto loan transactions that consumers cannot afford. They do not take into account the borrower’s ability to repay the loan. They prey upon

unsophisticated borrowers who rely in good faith on the expertise

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of the loan originator or their agent. Ultimately, predatory loans

strip equity and wealth from communities.

Q.2. What can be done about the unregulated brokers and home

improvement contractors who are bad actors?

A.2. While it is extremely important to combat unregulated bad actors, it is important to focus on the more overt problem of brokers

and contractors who fall within the existing State and local regulatory framework. Currently, mortgage brokers originate over 50

percent of subprime loans, yet only about 41 States regulate mortgage lending and brokering. State regulations for mortgage brokers

are minimal and are in most cases promulgated with little to no

enforcement authority. Some States only require brokers to be registered while others go far in requiring licensing, brick and mortar,

education and experience. The result is a very complex statutory

and regulatory framework that unfortunately allows the bad actors

to conduct business virtually unchecked.

During the question and answer portion of the hearing, NCRC

addressed the issue of mortgage brokers from a slightly different

perspective: the collusion factor. From the initiation of the transaction, borrowers are immediately thrown into a realm of bad actors all working together to bilk individuals of their money and

property. The real estate agent, the appraiser, the mortgage

broker, and the subprime lender all work together on the same

predatory transaction. In most cases, these collaborators operate

under the radar of existing fair lending laws, particularly as it applies to the nondisclosure of brokers fees and compensation prior

to the Good Faith Estimate (GFE).

NCRC believes that although Federal fair lending laws (Equal

Credit Opportunity Act, Truth in Lending Act, Home Ownership

and Equity Protection Act and Real Estate Settlement Protection

Act) have established a framework to protect certain consumers,

they by no means go far enough to protect all consumers. It is our

position that the only way to combat bad actors is to expand the

scope of current legislation/regulation to cover their business lines

together with enacting some comprehensive antipredatory lending

legislation.

Q.3. In the securities industry there is a ‘‘suitability standard’’ for

brokers putting clients into appropriate brokerage activities. What

do you think about applying a suitability standard for brokers/lenders who put low-income borrowers into subprime loans?

A.3. NCRC has strongly supported the prohibition under HOEPA

of making loans without regard for the consumer’s ability to pay.

We would favor a ‘‘suitability standard’’ that takes into account

whether or not a particular loan is suitable for a particular

borrower and helps meet his/her needs without undue financial

hardship.

NCRC also has advocated for policy that affords protections

against a borrower being misled regarding his/her ability to qualify

for a prime loan. In that regard, we would disagree with a standard limited to brokers/lenders who put low-income borrowers into

subprime loans. Suitability should be afforded to all borrowers in

both prime and subprime markets.

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Q.4. Why are better disclosures and/or financial education not sufficient remedies for predatory lending problems?

A.4. NCRC has strongly supported increased financial education

and better disclosures; in fact, our financial education program is

highly regarded by industry and community groups throughout the

country. However, it is our longstanding position that education

and disclosure, in and of themselves, are not adequate to foster

compliance of existing fair lending laws on a voluntary, statutory,

or regulatory level.

Financial education is invaluable, but much like the car owner

who relies on the mechanic for his/her technical expertise and professional judgement and guidance, mortgage applicants too must

rely on the honesty and knowledge of the officer processing the

loan. No amount of financial education can equip a mortgage applicant to combat predatory lending; it can only help the consumer

identify what might be predatory practices. Financial education

may help alert the consumer that he/she is not being treated fairly,

but without any enforcement of regulation of unfair practices, the

only recourse left for the consumer is to refuse the offer of the

predatory loan, leaving the consumer no access to credit. The consumer is left to hope that free-market forces will eventually force

predatory lenders to change their practices. Relying on financial

education and disclosure alone, without regulatory and/or statutory

enforcement, diffuses the responsibility of enforcement to consumers. Financial education must be accompanied by strong regulatory and/or statutory enforcement policies.

Q.5. I understand Philadelphia enacted a city ordinance regarding

predatory lending and the Pennsylvania legislature passed a law

preempting county and/or city ordinances. What do you think about

State legislatures preempting county and/or city ordinances regarding predatory lending?

A.5. To date in 2001, 31 States have introduced over 60 legislative

measures attempting to combat predatory lending practices. Additionally, nine major metropolitan cities and counties have introduced local ordinances to deal with predatory lending. In that

regard, NCRC supports a national standard and strongly advocates

for Congress, on a bi-partisan basis, to pass the strongest legislation possible to end the unscrupulous lending practices of predatory

lenders.

A very similar situation to what happened in Philadelphia has

now started in DeKalb County. In both cases, the American Financial Services Association filed lawsuits to stay effective dates of

already enacted local legislation. In its Philadelphia suit, AFSA

stated: ‘‘the ordinance is an attempt by the municipality to directly

regulate the lending activity of financial institutions.’’ In commenting on the suit, AFSA’s president stated: ‘‘Financial services

legislative activity must be remanded to the appropriate venue of

the State legislature or, where appropriate, to the U.S. Congress or

appropriate Federal agency.’’

Local predatory lending ordinances are important examples of

where policymakers at one level are tired of waiting for another

level to take action in protecting consumers. And perhaps the same

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can be said true of the increase in State legislative measures—actions initiated as a result of neglect by the Federal Government.

Q.6. Is your concern about SPCLI related to the product or the

marketing of the product?

A.6. NCRC is very concerned about both the marketing of SPCLI

and the product itself. It is our position that credit insurance which

is paid through a single up-front payment and financed into the

total loan amount is a serious abusive lending practice (that is,

predatory).

NCRC does not take issue with credit insurance when presented

to the consumer as an option and choice: up-front lump sum or

monthly pay option. And when it is presented in such a manner

that the consumer can compare the final/total costs of both products prior to closing.

Our opposition to the SPCLI product is that in the majority of

cases, the consumer’s monthly payment for the financed SPCLI is

more than the monthly payment under monthly options. The only

scenario in which the SPCLI monthly payment is less than the

month-to-month product is when the period of coverage is significantly shorter than the term of the loan (that is, a 5 year SPCLI

term on a 30 year loan). NCRC strongly supports Martin Eakes’ testimony that cost savings calculations comparing SPCLI and

month-to-month almost never favor SPCLI, and SPCLI almost always results in a bad deal for consumers.

Scenario: The 1999 average subprime loan in the United States to a low- to moderate-income borrower is $91,000 via a 30 year

mortgage. Using a typical subprime rate of 12 percent, the total interest cost of that loan would be $245,973.

But if the lender sells the consumer a $5,000, 5 year SPCLI policy rolling that amount into the mortgage balance, the total interest cost rises $13,516, which is almost three times the effective cost

of the insurance.

We oppose SPCLI marketing because in the majority of predatory lending victims we work with, the following practices are regular occurrences:

• The consumer did not know he/she purchased credit insurance. • The consumer was never told it was an option and not required

to close the loan. • The consumer was pressured into agreeing to SPCLI because he/

she was told they would not get the loan without it. • The consumer was coerced by the lender/broker saying: ‘‘If you

die, will your spouse have the income to make the monthly payments? Would you want your family to assume your financial obligations? You need this product to protect your family.’’ • The consumer was never told that the SPCLI was a policy with

a term significantly shorter than the duration of the loan. • The consumer could not cancel the insurance product.

Q.7. If SPCLI is removed from the marketplace, what are subprime

borrowers to do when they wish to insure their financial obligations

and monthly alternatives have not been approved in their States.

A.7. The major players in subprime lending market have sent a collective signal supporting consumer rights on this issue via the discontinuation of SPCLI products. CitiFinancial, who dropped its

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SPCLI in June, has since gained approval in 35 States to sell its

monthly premium policy. In July, Household, the Nation’s largest

issuer of subprime loans, also dropped its SPCLI on real estate secured loans and has gained approval in 34 States. These major

subprime lenders are actively working with State insurance departments to secure approval for their consumer choice products.

If SPCLI is removed from the marketplace and the borrower

would like the financial security of a credit insurance product in a

State where monthly payment options are not approved, one solution could be to refer the consumer to an outside insurance counselor who can then work with the consumer on buying life insurance for the loan amount.

Q.8. Yesterday, [July 26], we had a lively discussion about the cost

of SPCLI. One witness said that if you go to a Monthly Outstanding Balance basis over the term of the loan it is more expensive. Another witness disputed that. Do you have a view on this

issue?

A.8. It is NCRC’s position that, if the borrower chooses to purchase

credit life insurance, the monthly outstanding balance (MOB) payment option is the only viable option. After reviewing the written

testimony of both witnesses in addition to studies from other organizations, frankly, we do not understand the assertion made by

Charles Calomiris that ‘‘the monthly cost of single-premium insurance is much lower than the cost of monthly insurance.’’

For example, assume a credit insurance policy is purchased that

covers the entire loan period of 10 years with a total premium of

$10,000. With MOB, monthly payments will be calculated as the

premium divided by the number of months covering the term of the

loan, or $83.33 per month. With any single-premium policy, the

amount paid each month will increase because the numerator is increased based on the interest rate, yet the denominator remains

the same. For a loan just under the HOPEA threshold at 15.5 percent, the monthly payment would increase to $164, almost twice

the amount paid with MOB. When comparing the same premium

amount over the same term, it is impossible for a payment method

that charges any interest to be less expensive than one that

charges zero interest. (See Exhibit 1).

Only in a situation where the term of the credit insurance is substantially shorter than the term of the mortgage can SPCLI have

monthly payments lower than MOB. Even so, payments on the

truncated credit insurance over the longer life of the loan in no way

offsets the nominal monthly savings to the borrower because of the

interest payments. (See Exhibit 2). The borrower is covered for a

period of time much shorter than the life of the loan, yet continues

to pay off the credit insurance for the remainder of the loan.

SPCLI also precludes the borrower from canceling the insurance.

With monthly payments, the borrower pays each month and is covered for that month. The borrower can choose to continue or cancel

the insurance each month. Because credit insurance can only be

purchased from the lender and not an outside party, the borrower

has but one choice. With MOB, the borrower has more choice, such

as traditional life insurance. With SPCLI, because the premium is

paid in full upfront and financed, the borrower is locked in for the

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life of the insurance. Canceling SPCLI entitles the borrower to a

refund much lower than the remaining value of the insurance because of the interest owed on the policy. Additionally, a report

issued by the Coalition for Responsible Lending entitled Single Premium Credit Insurance Should be Banned Outright notes that for

SPCLI ‘‘in most States, lenders are not obligated to cancel credit

insurance coverage after a grace period, generally 30 days.’’ If a

borrower finds that he/she cannot pay for credit insurance for a

particular month, under MOB, he/she can cancel the policy. With

SPCLI, the borrower is delinquent on the mortgage payment and

risks foreclosure.

Lenders have no monetary incentive to offer borrowers credit insurance on the most favorable terms to the borrower. Underwritten

by an insurer, credit life insurance is structured as a group policy

sold to the lender who in turn issues the insurance to the borrower,

the ultimate consumer of the insurance. Credit insurers market

their products to lenders, not borrowers. Borrowers generally have

no say in the choice of insurance products, and certainly have no

voice in negotiating the terms of the insurance. They can either accept or decline the credit insurance package offered by the lender.

The lender sells the insurance on behalf of the insurer, and receives compensation for each sale in the form of a commission,

which in some cases is based on the profitability (higher rates) of

the insurance. Most States establish prima facie rates that are the

maximum rates that can be levied on credit insurance and these

are generally the rates that are charged. According to a joint report

published by Consumers Union and the Center for Economic Justice in 1999, entitled Credit Insurance: The $2 Billion A Year RipOff, ‘‘creditor compensation averaged more than 30 percent of the

premium dollar for credit life.’’ The report further notes that in

some cases, the lender was rewarded additional compensation in

the form of personal computers, software, and calculators.

While the lenders and the insurers are benefiting from the sale

credit life insurance, the Consumers Union/Center for Economic

Justice report found that borrowers have been excessively overcharged. The report notes that the loss ratio on credit life insurance nationally was 41.6 percent in 1997. The National Association

of Insurance Commissioners sets a 60 percent loss ratio threshold

as the minimum level considered to provide reasonable benefits to

consumers. In Georgia, the loss ratio in 1997 was slightly better

than the national figure at 48.9 percent. With the reverse competition prevalent in the credit insurance market, it is always the borrower who pays the most dearly.

Q.9. I have heard that SPCLI is a better deal for consumers over

41 years of age because it is cheaper and it is generally more available than the traditional term life insurance. Would anyone care to

comment on that view?

A.9. Through our research on the available options for a given 41-

year old male borrower living in Georgia, we found that term life

insurance is generally a better option than credit life insurance.

Assuming that the borrower is a nonsmoker, a $100,000 policy for

a 10 year term will cost between $12 and $17 a month (quotes obtained from term life insurance broker Term.com at www.term.com.

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Applying the Georgia prima facie rate of $.45 per annum per $100 of indebtedness for decreasing term credit life insurance,

the borrower would be charged a total premium of $11,610.25 for

a 10 year policy on a $100,000, 30 year mortgage with an interest

rate of 10 percent. With MOB, monthly payments would be $96.75,

while for a single-premium payment financed into the loan, monthly payments would be $101.89. Traditional term life insurance is

clearly a much better deal. Even for those borrowers with health

problems who may not qualify for premium health insurance rates

and credit life insurance is the only available option, MOB payments make more sense than SPCLI. (See Exhibit 3).

Additionally, with credit life insurance, the bank is named the

beneficiary of the policy. If the borrower dies, the lender is repaid

the remainder of the loan. Under tradition term life insurance, the

insured designates a beneficiary. It is possible that the beneficiary

would not want to pay off the loan balance, but would prefer to

continue monthly loan payments and apply the insurance benefits

elsewhere. Traditional term life insurance provides a great deal

more flexibility for the beneficiaries of the estate.

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RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER

FROM LEE WILLIAMS

Q.1. Is there a definition for predatory lending? Or do you know

it when you see it?

A.1. We define predatory loans as those that are high-rate, highfee home equity products that are intentionally structured in a

manner that is deceptive and disadvantageous to borrowers.

Q.2. What can be done about the unregulated brokers and home

improvement contractors who are bad actors?

A.2. They should be licensed and regulated.

Q.3. In the securities industry, is there a ‘‘suitability standard’’ for

brokers putting clients into inappropriate brokerage activities.

What do you think about applying a suitability standard for brokers/lenders who put low-income borrowers into subprime loans?

A.3. We would agree with this if we are correct in assuming that

a ‘‘suitability standard’’ requires brokers to explain to consumers

fully that they must obtain a subprime loan instead of a prime

rate.

Q.4. Why are better disclosures and/or financial education not sufficient remedies for predatory lending problems?

A.4. While financial education may not be a sufficient remedy for

predatory lending problems in the short run, we are convinced

that, combined with disclosure, it will be an extremely important

tool in combating this problem over the long run. As stated in our

Ethical Guidelines that are attached to our written testimony, we

also support voluntary and other means of prohibiting some abusive practices.

Q.5. I understand Philadelphia enacted a city ordinance regarding

predatory lending and the Pennsylvania legislature passed a law

preempting county and/or city ordinances. What do you think about

State legislatures preempting county and/or city ordinances regarding predatory lending?

A.5. We are pleased that the State legislatures are recognizing the

importance of this issue and passing Statewide legislation to combat predatory practices in our communities.

Q.6. Is your concern about SPCLI related to the product or the

marketing of the product?

A.6. Both—the product is unnecessarily expensive, and in some

cases it is included without any disclosure to the borrower.

Q.7. If SPCLI is removed from the marketplace, what are subprime

borrowers to do when they wish to insure their financial obligations, and monthly alternatives have not been approved in their

States?

A.7. One alternative might be the purchase of term life insurance

or reliance on existing life insurance; another option may be to

work with the State legislatures to provide a monthly alternative

as a way to combat predatory lending practices.

Q.8. Yesterday [July 26], we had a lively discussion about the cost

of SPCLI. One witness said that if you go to a Monthly Outstanding Balance basis, it is more expensive that over the term of

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the loan. Another witness disputed that. Do you have a view on

this issue?

A.8. It would seem that the witness arguing that single-premium

credit life is cheaper than the monthly alternative was in error.

Q.9. I have heard that SPCLI is a better deal for consumers over

41 years of age because it is cheaper and it is generally more available that the traditional term life insurance. Would anyone care to

comment on that view?

A.9. If that is true, then the consumer, with a little knowledge and

perhaps disclosure, would seem to have a viable alternative, but

this does not indicate if SPCLI for those over 41 years of age is

cheaper than the monthly alternative, which is always a better

deal for the consumer.

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1TILA, § 103(aa)(1). 2TILA, § § 103(aa)(4)(C) and 106(e). 3S. Rep. 103–169 at 24 (1993).

STATEMENT OF THE AMERICAN LAND TITLE ASSOCIATION

JULY 27, 2001

The American Land Title Association (ALTA) membership is composed of more

than 2,000 title insurance companies, their agents, independent abstracters and attorneys who search, examine, and insure land titles to protect owners and mortgage

lenders against losses from defects in titles. Many of these companies also provide

additional real estate information services, such as tax search, flood certification,

tax filing, and credit reporting services. These firms and individuals employ nearly

100,000 individuals and operate in every county in the country.

ALTA appreciates the concerns that have prompted the Committee to engage in

oversight hearings on the issue of ‘‘predatory lending’’ and the introduction of the

Predatory Lending Consumer Protection Act of 2000 (S. 2415; H.R. 4250) and other

legislation. Predatory lending practices can be a source of substantial claims loss to

title insurers. In general, we support reasonable legislative and regulatory action to

address the problems and abuses that may exist with regard to ‘‘predatory’’ lending

practices targeted at vulnerable consumers. We recognize that there is a fine line

between subprime and predatory lending. We are therefore concerned that Congress, in reducing the thresholds for determining when loans are subject to the additional limitations and restrictions imposed by the HOEPA (Homeownership and

Equity Protection Act) amendments to the Truth in Lending Act (TILA) and in

eliminating the current exclusion for ‘‘residential mortgage transactions,’’ does not

inadvertently reduce the availability of legitimate financing to low income or lessthan-prime borrowers.

We hope that the Congress, the agencies, and the lending industry develop a fair,

reasonable, solution to these problems. Because we are clearly not central to the

lending decisions, and only see the results of these loans at closing, or in limited

situations, where claims arise, we are limiting our comments to those provisions of

S. 2415, one of the major proposals before the Committee, which directly affect the

title insurance industry.

If the Committee ultimately concludes that legislation is needed, we would like

to draw your attention to three aspects of the ‘‘Predatory Lending Consumer Protection Act of 2000’’ (S. 2415) which cause concern.

First, we do not believe that the current exclusion for ‘‘residential mortgage transactions’’—transactions in which the loan is being used to acquire or construct the

dwelling—contained in the current language of TILA § 103(aa)(1) should be eliminated. The concerns raised about predatory lending practices have related to refinance and second mortgage transactions. There is simply no reason to extend

HOEPA to potentially millions of purchase money mortgage transactions in which

there has been no evidence of the kind of abuses to which HOEPA is addressed.

Second, the bill eliminates a current provision of HOEPA that we believe should

be retained. Under the current law, a second mortgage or loan refinance is subject

to the HOEPA requirements if it bears a high annual percentage rate (that is, more

than 10 percentage points higher than the yield on Treasury securities having a

comparable maturity) or if ‘‘the total points and fees payable by the consumer at

or before closing will exceed the greater of (i) 8 percent of the total loan amount;

or (ii) $400.’’ 1 In determining what constitutes ‘‘points and fees’’ for purposes of this

provision, HOEPA provides that certain settlement charges, including ‘‘[f]ees or

premiums for title examination, title insurance, or similar purposes’’ are not included if:

• the charge is reasonable;

• the creditor receives no direct or indirect compensation; and

• the charge is paid to a third party unaffiliated with the creditor.2

ALTA believes that this current exclusion is both reasonable and appropriate.

Some ALTA members do engage in independent operations, and participate in affiliated business arrangements, and we do recognize the policy rationale behind the inclusion of affiliated business arrangement fees under current law. As the Senate

Banking Committee report on the 1994 HOEPA legislation made clear, the purpose

of imposing a trigger based on points and fees charged in the transaction was to

‘‘prevent unscrupulous creditors from using grossly inflated fees and charges to take

advantage of unwitting customers.’’ 3 On the other hand, if the lender is not benefiting from the charge, the charge is made by an unaffiliated third party, and the

charge is reasonable, the charge does not affect in any way whether the loan is

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‘‘predatory.’’ Congress concluded in 1994, that there was no reason why such

charges should be included in determining the trigger for HOEPA coverage. We

hope that the Committee keeps in mind that title insurance fees are regulated in

most States, and that these fees are based on costs and risk, and that adherence

is required to ensure solvency and consumer protection.

Unfortunately, S. 2415, eliminates this aspect of HOEPA. In fact, the rationale

for maintaining the current language is even stronger in light of the other changes

made to HOEPA by S. 2415. S. 2415 would modify the total amount of points and

fees that triggers HOEPA coverage from 8 percent of the loan, or $400, whichever

is higher, to 5 percent of the total loan amount, or $1,000, whichever is higher. The

reduction from 8 percent to 5 percent would mean that, on a $50,000 refinance loan

or second mortgage (for example), total fees and points of $2,500 would trigger

HOEPA coverage, whereas under current law the total points and fees would have

to exceed $4,000 before the loan would be deemed a ‘‘high-cost’’ loan triggering

HOEPA coverage.

While Congress may conclude that this reduction is justified where the lender is pocketing the $2,500 in points and fees (and therefore may have an incentive to engage in equity stripping and repetitive refinancings), there is no justification in also

eliminating the current exclusion for reasonable third-party charges in which the

lender does not participate. Indeed, by reducing the trigger amount and eliminating

that exclusion, S. 2415 risks converting many nonpredatory, nonabusive loans into

HOEPA-covered loans. This prospect could adversely affect the availability of financing to higher-risk borrowers.

Accordingly, we recommend that § 2(b)(3) of the bill, to the extent that it eliminates the third-party charge exemption from the current language of § 103(aa)(4)(C)

of TILA, be changed so as to leave in place the current language of § 103(aa)(4)(C).

Our third concern relates to new § 129(k) of TILA that would be added by section

4(a) of S. 2415. The new provision would prohibit a creditor, in connection with a

HOEPA-covered mortgage loan, from charging a borrower for credit insurance or a

debt cancellation contract on a single premium basis through an upfront charge paid

by the borrower at the outset of the loan. We express no views on whether such

a prohibition is desirable or appropriate. What we are concerned about is that

the language of new § 129(k)(1) states that ‘‘no creditor or other person may require

or allow’’ the collection of such premiums. The ‘‘no . . . other person may . . .

allow’’ language is unnecessary, ambiguous, and would set a questionable legislative

precedent.

The language is unnecessary because the provision, without the additional words,

would still prohibit lenders from collecting single premiums for credit insurance.

The language is ambiguous, because it imposes obligations on unidentified ‘‘other

persons’’ not to ‘‘allow’’—whatever that means—lenders to collect such premiums.

Finally, it would set an unfortunate precedent for Congress, when it imposes direct

obligations or requirements on particular parties (in this context, on lenders), to extend such obligations to ‘‘other persons’’ who may be deemed to have ‘‘allowed’’ an action to take place.

Our members are involved in the closing of mortgage loans. Accordingly, we are

concerned about impractical obligations being imposed on us because title companies

who close loans or who issue title insurance policies to lenders might be viewed as

‘‘other persons’’ who have ‘‘allowed’’ the lender to obtain the single premium in connection with the transaction. Neither TILA, nor indeed other comparable consumer

protection statutes, have sought to impose such obligations on third parties, and

Congress should not start down that road in this bill. Further, in some States, mortgage loans are ‘‘net funded’’ and checks are not written for the lender items. In addition, in many instances, there may not be enough detail for a closing agent to determine that there is a single-premium credit insurance premium. There is no need

for this additional language and we urge the Committee to delete the reference to

‘‘or other person’’ on page 14, line 24, of the bill.

We thank the Chairman and the Committee for the opportunity to submit this

statement.

—————

STATEMENT OF THE CONSUMER BANKERS ASSOCIATION

JULY 27, 2001

The Consumer Bankers Association (CBA) is pleased to submit this testimony to

the Committee on Banking, Housing, and Urban Affairs of the U.S. Senate, in response to the hearings entitled ‘‘Predatory Mortgage Lending: The Problem, Impact,

and Responses.’’

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1See Remarks of Ellen Seidman, Director, Office of Thrift Supervision, The Financial Service

and E–Commerce Practice Group of the Federalist Society Presents A Lunch Exchange on the

Predatory Lending Debate: ‘‘Are Banks Empowering or Robbing Customers?’’ October 20, 2000;

Kathleen Day, Raising the Roof on Riskier Lending, The Washington Post, February 6, 2001,

at 2 (quoting Alan Greenspan). 2See Curbing Predatory Home Mortgage Lending: A Joint Report, U.S. Department of Treasury and U.S. Department of Housing and Urban Development, June 2000, at 33–35 (hereinafter ‘‘HUD-Treasury Report’’). 3See Robert E. Litan, Vice President and Director, Economic Studies Program, The Brookings

Institution, A Prudent Approach to Preventing Predatory Lending, February 2001, at 9. 4See Remarks of Edward M. Gramlich, Governor, The Federal Reserve Board, before the Federal Reserve Bank of Philadelphia, Community and Consumer Affairs Department Conference

on Predatory Lending, December 6, 2000. 5See HUD-Treasury Report at 29. 6See id. at 2.

CBA was founded in 1919 and represents the majority of the major banks engaged in consumer lending. It provides leadership and representation on retail

banking issues such as privacy, fair lending, and consumer protection legislation

and regulation. Member institutions are the leaders in consumer home equity finance, electronic retail delivery systems, bank sales of investment products, small

business services, and community development. The CBA comprises the Nation’s largest bank holding companies. CBA members hold two-thirds of the industry’s total assets and make billions of dollars of loans to borrowers who could not qualify

for prime loans. Our membership actively participates in the nonprime lending industry in the United States. We are proud of the role our members have played in

expanding the availability of mortgage credit to borrowers not qualified for conventional mortgage financing due to little or poor credit experience.

We appreciate the opportunity to share with this Committee the position of our

members with respect to the complex issues and challenges facing the mortgage

lending industry. We are hopeful that the spotlight this Committee is placing on

these issues will be helpful to our membership as they seek to continue to expand

home ownership opportunities through fair and nondiscriminatory lending practices.

The growth in responsible nonprime lending over the last decade has been celebrated as ‘‘the democratization of credit’’ by Federal Reserve Board Chairman Alan

Greenspan and lauded as ‘‘one of the great success stories of American economics’’

by Director of the Office of Thrift Supervision Ellen Seidman.1 It has enabled many

consumers to obtain home loans who previously would have had limited, if any, access to the credit market due to impaired credit histories. This access to credit is

instrumental to helping borrowers purchase and improve their homes, access equity

for emergencies, and obtain basic goods and services.

Nonprime lending is generally described as the extension of credit to borrowers

exhibiting higher delinquency or default characteristics than those of traditional

borrowers. For example, the U.S. Department of Housing and Urban Development

and the U.S. Department of Treasury reports that nonprime mortgages were five

times more likely to be delinquent than prime mortgages.2 Because of the fact that

delinquency rises significantly as credit scores decline, interest rates in the

nonprime market are tied to the risk of delinquency posed by nonprime borrowers.3

Thus, nonprime lending involves lending at rates above the prime rate to cover the

increased risk and transaction costs of lending to borrowers who pose greater credit

risks. When done the right way, the loan is structured to correlate with the borrower’s income stream and promotes the borrower’s ability to repay the loan.

In the last decade, lower-income and minority consumers, who historically had difficulty in getting mortgage credit, have been granted loans at unprecedented levels.

Indeed, Federal Reserve Governor Gramlich recently observed that conventional

home mortgage lending to low income borrowers between 1993 and 1998 increased

nearly 75 percent, compared with a 52 percent increase for upper income borrowers.

At the same time, conventional home mortgage lending to African-Americans increased 95 percent, and to Hispanics 78 percent, compared to a 40 percent increase

overall.4

Much of this democratization of credit can be attributed to the development of the

nonprime mortgage market. Notably, in their Joint Report, the U.S. Department of

Housing and Urban Development and the U.S. Department of Treasury indicate

that the number of nonprime loans has gone from 80,000 in 1993 to 790,000 in

1998, an 880 percent increase.5 Nonprime loan originations increased from $35 billion in 1994 to $160 billion in 1999, representing a 360 percent increase.6

Unfortunately, these very positive developments have become overshadowed by

the conduct of a few unscrupulous brokers and lenders, who in many cases are not

subject to Federal supervision and oversight. These brokers and lenders sometimes

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7See, for example, Remarks of Edward M. Gramlich, Governor, The Federal Reserve Board,

before the Community Affairs Research Conference of the Federal Reserve System, Washington,

DC, April 5, 2001, at 2; Press Release of Office of the Comptroller of the Currency, OCC Addresses Subprime Lending Risk Issues (quoting John D. Hawke, Jr., Comptroller), April 5, 1999;

Jim Peterson, Lender Beware, American Banking Journal, Vol. 93, Issue 2, February 1, 2001,

at 27 (quoting Senator Gramm). 8See Max Jarman, U.S. Youths Flunking Credit 101, The Arizona Republic, May 5, 1998

at 1. 9See Jinhook Lee and Jeanne M. Hogarth, The Price of Money: Consumers’ Understanding

of APR’s and Contract Interest Rates, 18 J. Publ. Pol’y & Mkt. 66, April 1, 1999, at 1. 10See Curbing Predatory Home Mortgage Lending: A Joint Report, U.S. Department of Treasury and U.S. Department of Housing and Urban Development, June 2000, at 59 (citing Howard

Lax, Michael Manti, Paul Raca and Peter Zom, Subprime Lending: An Investigation of Economic

Efficiency (unpublished paper), February 25, 2000).

impose unfair and unreasonable loan terms on vulnerable borrowers, often by deceit

and misinformation. Our members are greatly concerned about the harm this causes

to consumers. Furthermore, such conduct has tarred the entire lending community

and is now undermining our members’ efforts to expand credit access through fairly

priced and adequately disclosed nonprime loan products. Thus, CBA joins this

Committee in condemning these abusive sales practices and in seeking effective

solutions.

It would be unfortunate, however, if in the quest to root out the deplorable conduct of a relatively few unscrupulous lenders, continuing progress in the democratization of credit is halted. We are concerned that the current blurring in the

distinction between the nonprime mortgage lending activities of responsible lenders

and the lending practices of predatory lenders may cause such a result. It is critically important that this Committee recognize the need for responsible nonprime

lending and the importance of expanding credit access from responsible nonprime

lenders, such as those represented within the CBA membership.7 Abusive lending

must be eradicated, but not at the cost of severely constricting responsible nonprime

lending.

CBA members understand that they have an important role in ensuring the continuing availability of responsible nonprime loan products. Our members are good,

well-intentioned companies who are committed to industry best practices. CBA

members must, and will, lead by example.

Three of the initiatives the CBA and its members have supported to enhance consumer protections and promote industry best practices are efforts to: (i) expand financial literacy; (ii) streamline and simplify mortgage lending; and (iii) improve

oversight and registration of mortgage brokers and home improvement contractors.

I. The CBA believes that comprehensive consumer financial education is the

key to consumer protection. Consumer education and better consumer counseling can help consumers avoid becoming the victims of abusive lending practices. Recent studies, however, show that most American children and young

adults have not mastered the most basic personal financial skills. For example,

a survey of 12-year-olds conducted by Consumer Reports in 1997 found that

only 58 percent of the respondents knew that if one borrowed $100 from a bank,

one would have to pay back a greater amount.8

Many consumers tend to be unfamiliar with financial concepts, lack an understanding of the loan products offered on the market and do not understand the benefit of shopping for mortgage credit. According to a University of Michigan Survey

of Consumers, at least 40 percent of mortgage borrowers do not understand the relationship between the contract interest rate and the annual percentage rate (APR).9

In another survey, 12 percent of nonprime borrowers said they were not familiar

with basic financial terms such as the interest rate and the principal of the loan.

One-third of nonprime borrowers said they were not familiar with the types of mortgage products available.10

The CBA believes that industry regulators and consumer groups should work

together on this issue to ensure that borrowers understand the mortgage lending

process and the terms of their loans. We believe that an uninformed consumer is

more likely to fall victim to an unscrupulous lender than one who has even a basic

understanding of the products and services available. Thus, it follows that the more

consumers understand finance, the better equipped they will be to make informed

judgments.

Congress has clearly taken an interest in financial literacy as well, and CBA has

been a supporter of efforts to provide funding in this area. For example, CBA supports the concepts in the education reform bills, S. 1 and H.R. 1, which have passed

their respective Houses and are expected to go to Conference. Both contain language

authorizing the use of funds to promote financial literacy in a number of ways. We

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also support a variety of Government financial literacy initiatives that are under

consideration by the Federal Reserve Board, the Federal Trade Commission, and the

U.S. Department of Treasury, and others.

Moreover, CBA is releasing a report examining banking industry financial education initiatives for consumers. A copy of the report is attached to this testimony.

(This report is held in the Senate Banking Committee files.) It documents the types

of programs and products banks routinely offer, in an effort to educate consumers

on managing their finances. It shows that CBA member institutions are substantially engaged in various financial literacy efforts, including mortgage, credit, and

foreclosure prevention counseling to borrowers, small business development training, and financial literacy for students in grades K–12 and college. Virtually all of

the 48 banks that participated in the survey, representing more than half of the

banking industry’s assets, said they contribute to financial literacy efforts in some

way. In particular, 98 percent offer mortgage or homeownership counseling and affordable mortgage programs with flexible terms, typically for lower income, firsttime homebuyers. Most of the banks that responded serve as the primary sponsor

of some homeownership counseling programs, and many also indicated that they

financially support literacy programs delivered by nonprofit and/or community organizations. Further, some banks have created full-time positions within their institutions to manage financial literacy efforts. CBA will continue to track the activities

of banks in this area, to encourage further efforts, and to share with the entire lending industry examples of bank programs that prove effective.

II. The CBA has long believed that a more streamlined mortgage process,

with a greater opportunity to shop for credit terms, would eliminate some of the

possibility of abuse by making mortgage loans more transparent to consumers.

For instance, CBA was an active participant in the broad-based ‘‘Mortgage Reform Working Group’’ that worked toward just such a goal. This group, comprising many industry and consumer representatives, sought to refine various

reform options in the financial services industry to streamline the lending process. A key recommendation that emerged from the process—endorsed at the

time by the Federal Reserve Board and many consumer advocates—is to permit

lenders to provide a guaranteed closing cost disclosure early in the application

process, giving the consumers better information on which to shop for credit.

In press reports, HUD Secretary Martinez has recently expressed support for efforts to make the mortgage lending process more accessible to consumers. CBA will

continue to work on this effort, so that the complexity of the mortgage lending process cannot be used by unscrupulous brokers and lenders to further their aims, and

so that the information can be better used by consumers to shop for credit.

III. Many of the abusive practices in our industry appear to involve mortgage

brokers or home improvement contractors, yet we believe insufficient attention

has been paid to this part of the marketing and sale of mortgage loans. CBA

supports efforts to improve the oversight of these entities. For example, we recommend that States adopt minimum licensing requirements for brokers and

contractors, which might be encouraged by Federal law. Such licensing criteria

might include, among other things: demonstration of financial responsibility

and specified net worth, continuing education requirements, and a restriction

on licensing of persons with criminal or civil judgments within certain time periods for fraud, dishonesty, or deceit. CBA also supports a national registry for

mortgage brokers and home improvement contractors. This would allow the

States, consumers and community organizations to monitor individual mortgage

brokers and home improvement contractors so that ‘‘bad actors’’ are identified,

even if they move from State to State. Further, CBA members support consumer education efforts that include information on the role of mortgage brokers and home improvement contractors in the mortgage lending process.

For these reasons, we believe the activities of CBA members, including reputable

nonprime mortgage lending and efforts to protect consumers through outreach and

education, are part of the solution—not the problem. CBA and its members are committed to working with this Committee and the regulatory community to resolve the

challenges we face. We recognize that the mortgage lending system is not perfect

and that additional steps are necessary to root out predatory lending practices.

Later this year, CBA will be sponsoring an industry forum, at which a cross-section of industry representatives with knowledge and experience in this area, will be

invited to convene. One of the goals of the forum will be to permit a wide array

of industry participants to share information, in order to learn about those best

practices and innovative programs that are working in communities to combat abusive practices. We will discuss financial literacy, community development programs,

regulatory oversight or enforcement, and other activities. By facilitating the sharing

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11See Remarks of Edward M. Gramlich, before the Community Affairs Research Conference,

supra note 7, at 2.

of such information among industry participants from all over the country, we hope

to allow the more effective steps to be replicated.

In closing, the CBA is proud of the contribution it and its members have made

to expanding mortgage credit access to Americans who, until recently, had few opportunities in the financial services industry. We encourage this Committee to proceed with caution when reviewing any proposal for new legislation or regulatory

change in this area. It is important to remain mindful, as recognized by Governor

Gramlich and others, that expansive regulatory action may have the unintended

consequence of discouraging or even prohibiting legitimate lenders from providing

nonprime loans and could impede access to credit in the nonprime market.11 While

there may be disagreement about what regulatory changes and enforcement efforts

are desirable in this industry, we welcome the opportunity to work with you to develop appropriate solutions.

—————

STATEMENT OF THE CONSUMER MORTGAGE COALITION

JULY 27, 2001

The Consumer Mortgage Coalition (CMC), a trade association of national residential mortgage lenders and servicers, appreciates the opportunity to submit its written testimony concerning predatory mortgage lending to the Senate Committee on

Banking, Housing, and Urban Affairs.

In considering the problem and impact of, and possible responses to, ‘‘predatory

lending,’’ we emphasize the following key points:

• Many abusive practices are the result of outright fraud. As we examine the anecdotal descriptions of borrowers being abused, it is clear that many of the abuses

resulted from misrepresentation, deception and other practices that violate existing laws. New laws are not needed to address these problems. Rather, there must

be a renewed emphasis on devoting the necessary resources to enforce existing

law. • Predatory lending is hard to define. Practices (other than those constituting current illegal conduct) that are often labeled predatory can have both adverse and

beneficial consequences for consumers. As policymakers consider restricting individual terms and provisions, such as prepayment penalties and yield spread

premiums, they must understand that these terms have legitimate uses that can

benefit consumers, for example, by reducing interest rates or upfront costs. • It is not in the interests of lenders and servicers to make loans, whether prime

or subprime, which result in default or foreclosure. Lenders and services do not

benefit from defaulted loans. Rather they lose money often significant amounts.

Simply put, a lender whose loans that go into default represent more than a small

proportion of its total loans will not long be in the lending business. In fact, because subprime borrowers by definition present a greater risk, subprime lenders

must devote additional resources to ensuring that they will not end up with a defaulted loan. • The goal of policymakers in addressing ‘‘predatory lending’’ should be to educate

and empower consumers to make appropriate decisions about their financial

affairs, not to restrict consumers’ option. The CMC is convinced that both consumers and lenders are better off if lenders have the freedom to offer and consumers have the freedom to choose from the widest range of financial options.

Consumers, however, must be put in a position to make an informed decision that

is most appropriate for their needs and situation. • Current regulatory requirements do not allow consumers to understand their

choices. They often act as barriers to competition that could reduce costs. Studies

have shown that the innumerable disclosures required by a variety of Federal and

State laws often confuse, and sometimes mislead, consumers who are attempting

to shop for loans. In addition, while lenders compete on their offerings based on

interest rate and points, because of regulatory restrictions, there is little incentive

to compete on the basis of ancillary settlement costs.

The CMC, working with other trade groups, has developed a five-part program

that we believe best addresses ‘‘predatory lending’’ without unduly restricting con- sumer’s options or unduly burdening the efficient operation of the mortgage market.

The program consists of the following:

• Adequate enforcement of existing law

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• A nationwide licensing registry that allows constant monitoring by state regulators and consumers of licensing complaints, suspensions and revocations • A comprehensive public awareness and education campaign • Implementation of Federal regulators’ existing authority to address predatory

practices • Reform of mortgage origination regulatory requirements to give consumers simpler, more uniform disclosures that allow them to understand and effectively comparison shop for loans, to give lenders the ability to offer ancillary settlement

services at lower cost, and to provide certain substantive protections.

Following a brief note describing our coalition, we examine each component of this

comprehensive solution. In addition, in Tab 1 of this testimony, we describe the

subprime market. In Tab 2, we describe the products and practices that often are

labeled ‘‘predatory,’’ and show how they can be used to the benefit of borrowers and

how our solutions would mitigate any abuses they could cause. Finally, in Tab 3,

we describe the mortgage origination process, its participants and the compensation

each receives for their role.

About the CMC

The CMC was formed, in large part, to pursue reform of the mortgage origination

process. From our perspective, one of the principal goals of mortgage reform is to

streamline the mortgage origination process so that consumers would be better informed when making credit choices. Complementary to our goal of streamlining the

mortgage origination process is the goal of reducing abusive lending practices. We

believe that better disclosures and substantive protections can enhance consumer

protection. The goal should be to allow consumers to make educated choices in the

credit market.

We commend the Committee for its continued attention to the issue of predatory

lending. The CMC is particularly concerned because of the damage caused by deceptive lenders to consumers and to the image of our industry. We support the goal

of protecting consumers from unscrupulous lending practices and recognize that

some elderly and other vulnerable consumers have been subjected to abuses by a

small number of mortgage lenders, brokers and home contractors. We share the

Committee’s objective of developing approaches that prevent predatory lending practices without restricting the supply of credit to consumers or unduly burdening the

mortgage lending industry.

The CMC’s Alternative: A Comprehensive Solution to Predatory Lending

Rather than further restrictions on products, terms and provisions, the CMC

favors a multitiered, comprehensive solution to predatory lending, including increased enforcement of existing prohibitions against fraud and deception, coordinated, nationwide enforcement of licensing requirements, and better consumer education on the mortgage process.

Most significantly, the CMC believes that comprehensive reform of the regulation

of the mortgage origination process is needed so that all consumers, but particularly

those most vulnerable to predatory lending practices, can better protect themselves.

As noted above, our solution has five parts.

Part I: Devoting Adequate Resources To Enforcing Existing Laws

We agree with Federal Reserve Board Chairman Alan Greenspan’s comments that

enforcement of existing laws is the first step that should be taken. Many examples

of predatory lending involve fraudulent practices that are clearly illegal under current law. Adequate resources at both the Federal and State levels of government

need to be devoted to pursuing those committing fraud. Therefore, the appropriate

Federal and State agencies should advise policymakers of the resources they need

to combat mortgage fraud.

Part II: A Nationwide Licensing Registry

We recommend that all mortgage brokers and companies be licensed, and that a

Federal system be established to ensure that if a broker or company loses its license

in one State as a result of predatory practices, all licenses would be revoked, suspended, or put on regulatory alert nationally. A ‘‘Consumer Mortgage Protection

Board’’ could be established to maintain a clearinghouse to identify mortgage brokers and companies whose licenses have been revoked or suspended in any State.

The goal of this recommendation is to prevent those engaging in predatory practices from being able to move from one jurisdiction to the next and continuing to

prey upon vulnerable consumers while keeping one-step ahead of law enforcement

authorities in prior jurisdictions.

This new Consumer Mortgage Protection Board could also be responsible for,

among other things, reviewing all new and existing Federal regulations and proceVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00456 Fmt 6601 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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1The Mortagage Reform Working Group (MRWG) was an ad hoc group, comprised of over 20

trade associations and consumer advocate organization, that was organized at the request of

Former Congressman Rick Lazio (R–NY) with the goal of reaching a compromise on a

conprehensive mortgage reform proposal that would streamline and simplify the mortgage process for consumers while simultaneously reducing the liability for the industry. While all parties

did not reach an agreement, many of the recommendations that were developed in that process

formed the basis for the recommendations made in the Joint Report issued by the Federal Reserve Board and the Department of Housing and Urban Development.

dures relating to the mortgage origination process and make recommendations that

will simplify and streamline the lending process and make the costs of the process

more understandable to consumers. The Board could also be used to initiate and

oversee public awareness media programs (described below) that will help consumers evaluate the terms of loan products they are considering.

Part III: Increasing Public Awareness and Improving Consumer Education

Consumer advocates have long advised industry and Government officials that

certain consumers, particularly elderly seniors, were not able to clearly understand

the loan terms disclosed in the innumerable disclosures provided to consumers during the mortgage process.

We recommend a three-step program to increase public awareness and improve

consumer understanding of their loan obligation:

1. Public Service Campaign. Federal policymakers should implement an ongoing, nationwide public service campaign to advise consumers, but particularly

the more vulnerable such as senior citizens and the poorly educated, that they

should seek the advice of an independent third party before signing any loan

agreements. Public service announcements could be made on radio and television, and articles and notices could be run in local newspapers and selected

publications.

2. Public Awareness Infrastructure. Once alerted, consumers will need to be

able to avail themselves of counseling services from unbiased sources. Those

sources can always include family and friends and industry participants. In addition, however, a nationwide network should be put in place to ensure that all

consumers can easily access advice and counseling to help them determine the

loan product that best fits their financial needs. A public awareness infrastructure could be built out that would include 1–800 numbers with independent

counselors, using sophisticated computer software, to help consumers talk

through the loan product they are considering. In addition, programs could be

developed with community organizations and other organizations serving senior

citizens to provide on-site counseling assistance at local senior and community

centers and churches. HUD’s 800 number for counseling could be listed on required mortgage disclosures as an initial step to increase awareness of available

advice.

3. ‘‘Good Housekeeping Seal of Approval’’ for On-Line Mortgage Calculators.

The Joint Report on the Real Estate Settlement Procedures Act and Truth in

Lending Act of the Board of Governors of the Federal Reserve System and the

Department of Housing and Urban Development, issued in 1998 (Joint Fed/

HUD Report) recommended that the Government develop ‘‘smart’’ computer

programs to help consumers determine the loan product that best meets their

individual needs. Since this idea was first discussed in the Mortgage Reform

Working Group,1 mortgage calculators or ‘‘smart’’ computer programs have become available online. Since these computer programs were already developed

by the private sector and are widely available, a more appropriate role for the

Government today would be for the Federal Government to approve a limited

and unbiased generic mortgage calculator module that could be incorporated

into any online site that helps consumers evaluate various loan products. (Legislation may be needed to advance this initiative. But there may be resources

in agencies’ current budgets that could be tapped to implement this recommendation.)

Part IV: Use Existing Federal Regulatory Authority to

Stop Abusive Practices

Regulators may have existing authority to implement changes to existing regulations to prevent loan flipping and other questionable practices. Where such authority exists, action should be taken to change existing regulations. Regulators may

also be able to use their rulemaking powers under existing law to implement some

of the mortgage reform proposals discussed in Part V.

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Part V: Comprehensive Mortgage Reform

The Joint Fed/HUD Report found that consumers do not understand the disclosures required by the current TILA and Real Estate Settlement Procedures Act

(RESPA). There is widespread agreement that the mortgage loan origination process

is overly complex and that the current legal structure is often an obstacle to improving that process.

Comprehensive mortgage reform would reduce confusion and improve competition,

lowering prices for all consumers while discouraging predatory lending. The CMC

has been at the forefront of industry efforts to reform and improve the laws and

regulations governing the home mortgage origination process in this country. The

mortgage reform that we, along with others in the industry, have advocated would

directly address many of the weaknesses in current law that allow predatory lenders

to operate. We note that some of these reforms can be achieved through regulatory

changes while others will require legislation.

Some of the features of mortgage reform that bear directly on the predatory lending problem include:

• Early disclosure of firm closing costs, leading to greater certainty for consumers

on closing costs and increased price competition for both loans and ancillary services required to make the loan. A common feature of most allegations of predatory

lending is that the borrower was either confused or deliberately misled about the

amount of closing costs that he or she would have to pay. The central feature of

mortgage reform is a proposal that mortgage originators disclose to consumers the

firm, not estimated, costs of the ancillary services needed to make the loan for

which the consumer has applied. If the borrower receives a clear disclosure of

firm closing costs early in the transaction, it will be more difficult for an abusive

lender or broker to misrepresent the terms of the loan and the borrower will have

time to seek financing from other sources if the terms are unfavorable.

Offering guaranteed closing cost packages will not work without a corresponding exemption from Section 8 of RESPA for arrangements negotiated between the lender or mortgage broker and the providers of ancillary services whose

costs are included in the firm closing costs disclosure. Thus, for example, lenders

would be free to negotiate volume discounts or other pricing arrangements with

their service providers without the restrictions of Section 8. If a lender or broker

charged more than the total listed on the firm closing costs disclosure, other than

those few items, such as taxes and per diem interest, which are not included in

the disclosure, it would risk losing its Section 8 exemption. Under current law,

the constraints imposed by Section 8 give lenders little incentive to reduce thirdparty closing costs.

• Simplified, understandable disclosures of key information about the loan. Mortgage reform would consolidate and highlight disclosures of the key terms of a

mortgage credit product so that applicants could easily comparison-shop for loans.

It would eliminate confusing disclosures such as the ‘‘Amount Financed,’’ which

has actually been used to mislead consumers about the true amount of the obligation. The disclosure of firm closing costs, noted above, would include any mortgage

broker fee paid by the borrower.

• Proportional remedies so that lenders are the targets of less litigation over harmless or minor errors while consumers can be compensated for actual harms. The

remedies in the mortgage reform proposal, in contrast to current law, are structured to ensure that the borrower receives a loan on the terms that were disclosed. Lenders that detect and correct errors quickly will not be penalized, while

those that engage in knowing and willful violations will be penalized more severely than under current law.

• Substantive protections against loan flipping to protect the most vulnerable consumers from abusive loans. The focus of the mortgage reform effort is on reforming the mortgage process for all consumers, but we include an enhancement to

the Home Ownership and Equity Protection Act (HOEPA) in the form of protections against loan flipping. Under the proposal, when making a HOEPA loan that

refinances an existing mortgage loan and that is entered into within 12 months

of the closing of that loan, the originator may not finance points or fees payable

to the originator or broker that are required to close the loan in an amount that

exceeds 3 percent of the loan amount. This limitation does not apply to voluntary

items such as credit insurance, nor to taxes and typical closing costs for settlement services such as appraisal, credit report, title, flood, property insurance, attorney, document preparation, and notary and closing services provided by a third

party, whether or not an affiliate.

Limiting the financing of points will mean that borrowers would have to bring

cash to closing to pay high points and fees. This will mean that borrowers of

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HOEPA loans will be less likely to be ‘‘flipped’’ numerous times. Consistent with

regulations adopted by the New York State Banking Department, the limit on refinancing points does not apply to typical third-party closing costs. Significantly,

this restriction is not limited to refinances by the same lender and would thus

apply to a much broader number of loans that may not be in the category of

‘‘flipped’’ loans. For this reason, it is appropriate that a reasonable amount of

points and fees be eligible to be financed in order to meet real credit needs.

• Substantive protections affecting prepayment penalties. On non–HOEPA loans, no

prepayment penalty would be permitted after 5 years from the date of the loan.

However, prepayment penalties would be authorized during this 5 year period,

notwithstanding State law. Any prepayment penalty permitted would be limited

to a maximum of 6 months’ interest on the original principal balance.

• Foreclosure reforms to provide additional protections to borrowers facing the loss

of their home without reducing the value of lender’s security interest in the property. Lenders and servicers have in recent years significantly changed their procedures for dealing with delinquent borrowers. Workouts, forbearance, and other

loss mitigation tools are employed and foreclosure is increasingly seen as an expensive (for everyone) last resort. In addition to this business trend, we would

support the enactment of a new Homeowner’s Equity Recovery Act (HERA), which

would apply at the time lender notifies consumer of consumer’s default and rights

under HERA.

HERA protections would apply if the consumer’s indebtedness (origination balance and interest, junior liens, etc.) is not more than 80 percent of

the origination valuation. A consumer would have the right to list the property with a real estate broker or otherwise make a good faith effort to sell

the property.

We believe that the consumer protections made available through HERA strike

a reasonable balance between the rights of lenders and investors for repayment

of amounts owed and the consumer’s right to ‘‘breathing room’’ if the consumer

is attempting to resolve the default. However, we do not support the expansion

of mandatory judicial foreclosure because it is costly both to the consumer and

lender, and is too time consuming, which, among other things, puts the collateral

at risk. In addition, we note that the Federal tax code (REMIC provisions), under

which loans are sold to the secondary market, places limitations on types of compromise that a lender can offer to a defaulting borrower.

• Substantive protections affecting collection practices. Under the proposal, the prohibitions contained in Section 806 of the Fair Debt Collection Practices Act

(FDCPA) concerning harassment and abuse would be extended to the collection

of mortgage loan debts by a creditor or its affiliates. The law would be clarified

to ensure that loan servicers that collect debts as part of their servicing function

would not be treated as debt collectors.

• Federal preemption of State laws so that lenders can comply with a uniform set

of disclosure requirements that will adequately protect consumers and result in

lower costs to lenders and lower rates for borrowers. Imposing uniform laws and

regulations ensures that consumers—across the Nation—are afforded the same

protections. Preemption would also reduce the number of documents to be signed

by consumers at closing. ‘‘Information overload’’ is an almost universal feature of

complaints about predatory lending.

Federal preemption is particularly important because the need for uniformity

has never been greater. There has recently been a proliferation of State and local

legislation to combat predatory lending practices. Although well-intentioned, these

initiatives can be counterproductive because they can impose very high-costs on

lenders in comparison to the potential number of loans affected.

In one recent example, the city of Philadelphia enacted antipredatory-lending

legislation that was so broad in its sweep that it threatened to cut off much legitimate, mainstream lending as well as the practices at which it was targeted. Lastminute legislative intervention at the State level was necessary to prevent this

legislation from taking effect and shutting down most mortgage lending in Philadelphia.

Another example of the unintended negative effects of State and local regulation

has recently occurred in Chicago, where the city of Chicago, Cook County, and the

State of Illinois have all enacted new laws aimed at preventing predatory lending.

Name-brand, well-capitalized lenders and servicers are reluctant to put their capital and reputation at risk to make new loans in Chicago because of the risk that

they could be found to be making predatory loans under one of the three, varying,

and sometimes conflicting and/or unclear definitions (or under the Federal

HOEPA).

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If the Committee decides that clarification of the existing legislation prohibiting

abusive practices is needed, we strongly urge that it create a single, nationwide

standard that cannot be undermined by myriad local initiatives.

The CMC appreciates the opportunity to submit its views on the problem of, and

appropriate responses to, ‘‘predatory lending.’’ We look forward to working with the

Committee on constructive, practical solutions to address abuse practices without

restricting the availability of credit, reducing consumers’ options, or burdening the

efficient operation of the mortgage market.

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STATEMENT OF RICHARD STALLINGS

PRESIDENT, NATIONAL NEIGHBORHOOD HOUSING NETWORK

JULY 27, 2001

Mr. Chairman and Members of the Committee on Banking, Housing, and Urban

Affairs, I appreciate the opportunity to submit testimony to the Committee on Banking, Housing and Urban Affairs on behalf of the National Neighborhood Housing

Network (NNHN).

First I would like to thank Senator Sarbanes for holding hearings on predatory

lending—an issue that is of great concern to all of NNHN’s members. The purpose

of my testimony is to raise awareness of the growing presence of predatory lenders

in low income urban and rural communities and to encourage Congress to take action to curtail their activity. I also want to clarify the differences between subprime

and predatory lending and discuss the importance of making sure that low- and

moderate-income consumers have access to home mortgage credit and other forms

of financing through responsible lenders.

National Neighborhood Housing Network

As the president of NNHN, I represent a network of 120 community-based organizations including my own, Pocatello Neighborhood Housing Services in Pocatello,

Idaho. NNHN is a nonprofit organization that advocates for better neighborhoods

and housing for low to moderate income Americans. The NNHN organization is

made up of 120 NeighborWorks organizations (NWO’s) who use Neighborhood Reinvestment Corporation’s funds to leverage private dollars to create new homeowners, revitalize distressed communities, and build single family and multifamily

housing for low- to moderate-income families. NWO’s are nonprofit organizations

dedicated to helping families buy and maintain homes. We are committed to assisting low- and moderate-income Americans recognize the dream of becoming homeowners and living in safe and stable neighborhoods.

Owning a home can lead to not only stability and security for individuals and

families but can also contribute to the greater stability and security of communities

as the tax base is strengthened, the business environment stabilizes and wealth in

the community grows. However, the full benefit of home ownership accrues to communities only if these homes become secure investments with the potential for asset

accumulation for the homeowner. Our mission, as affordable housing providers, is

to ensure that communities receive the full benefits of home ownership and we do

this by creating strong, educated consumers as well as default-resistant owners.

Subprime Versus Predatory Lending

There is a distinct difference between subprime lending and predatory lending.

Whereas subprime lending takes a borrower’s potential risk into account and provides manageable lending rates, predatory lending includes tactics which purposefully damage a borrower’s equity and credit, enabling the lender to take advantage

of the borrower. These tactics include inflated points and fees, and encouraging

loans that rely on home equity rather than the borrower’s income and ability to pay.

These tactics often end in borrowers? losing their homes.

In my own community I have witnessed the damage that predatory lenders can

have. In fact, I have seen an increase in the presence of predatory lenders over the

last 5 years. In part these lenders have moved in to fill the vacuum left by conventional lenders who have moved out of the area. Unfortunately, we are usually contacted by homeowners after they have fallen prey to predatory lending schemes and

we can do little to rectify the situation.

Predatory loans can have any number of abusive or deceptive characteristics and

frequently these loans include one or more of the following features:

• carry excessive interest rates, fees and closing costs, which are often hidden in

fine print;

• impose onerous conditions and terms of repayment, such as penalties for paying

off the loan early or large balloon payments at the end of the loan term;

• involve mortgage loans to homeowners without verification of income or regard to

whether they can afford to pay the loan back; and

• are marketed through deceitful or unfair practices, such as last minute changes

to loan terms or inadequate disclosure of the loan terms.

Let me stress that it is not just the presence of these loan features that qualifies

a loan as a predatory loan—but also the manner in which the financing is marketed

and targeted specifically to vulnerable consumers.

Once locked into a predatory loan, a homeowner may be forced to borrow still

more money to stay afloat, and all too often may be forced to give up the home to

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foreclosure. Predatory lending is believed to be a major factor in the dramatic 300

percent increase in home mortgage foreclosures since 1980. Predatory lenders will

make loans to homeowners with little or no attention to the borrowers ability to

repay, but instead focus on the amount of equity they have in the home and how

that can be drained. If left unchecked, these practices will cost American homeowners billions of dollars in home equity over the next several years.

A recent study completed by the Neighborhood Reinvestment Corporation and the

NeighborWorks Campaign for Home Ownership 2002 documents a significant increase in subprime lending in the Boston metropolitan area. This study, Analyzing

Trends in Subprime Originations: A Case Study of the Boston Metro Area, analyzed

Home Mortgage Disclosure (HMDA) data from eight counties in the Boston metropolitan area from 1994 to 1998. The study found that loan originations by subprime

lenders grew by 435 percent as compared to the growth of all conventional loan

originations by 119 percent. The growth of subprime lending was much more significant for properties located in low-income and minority neighborhoods than for properties in other parts of the city. The study revealed that the market share of

subprime lenders is significantly higher in low income largely minority communities

where they accounted for 13 percent of the overall originations which is more than

three times their share for the entire metropolitan area. The study also found that

subprime lending activity in minority and low-income communities is especially concentrated in the refinancing market where much of the predatory lending practices

are put to use.

The National Training and Information Center (NTIC) in Chicago recently conducted a similar study looking at the increase of subprime lending and the number

of foreclosures in Chicago. According to the NTIC study, high interest rate lenders

made more than 50,000 loans in 1997 in the Chicago area which is 15 times greater

than the number of loans they made in 1991. In addition, the number of foreclosures

tied to these predatory loans rose dramatically. In 1993 subprime lenders were responsible for 1.4 percent of all foreclosures in the city and in 1998 they were responsible for 36 percent of the years foreclosures.

NTIC’s study also describes the effects that predatory lending practices have on

neighborhoods. By looking at a 36 block area in the Chicago Lawn neighborhood,

NTIC was able to demonstrate that predatory lending activity was directly responsible for the increase in foreclosures and vacant buildings in the area. Specifically

NTIC found that 40 of the 72 foreclosures were initiated by subprime lenders. In

addition, NTIC found that an additional 22 abandoned properties in the target area

were foreclosures submitted by subprime lenders.

Promoting Responsible Subprime Lending

I do want to stress that NNHN supports the increased flow of mortgage credit

into low income and minority communities. The NNHN network is made up of organizations that are committed to working with low and moderate income individuals

who for a variety of reasons, including poor or nonexisting credit histories or unstable employment backgrounds, are unable to secure conventional mortgage financing.

As responsible subprime lenders, NWO’s work to provide these consumers with a

range of financial services and products to enable them to become homeowners. We

do this both as direct lenders as well as by working with conventional lenders.

Responsible subprime lending entails working with a consumer to come up with

a loan product at a price and with terms that appropriately compensate the lender

for any risk taken on, inclusion of reasonable return for the lender, and understandable by and appropriate for the borrower. Our concern is that the credit and other

financing tools be made available to low- and moderate-income individuals in a responsible manner and that these consumers become educated and empowered

through the process of becoming a homeowner.

NNHN supports curtailing the practices of predatory lenders through legislation

and we believe this legislation must:

• prohibit points and fees from being financed as part of a homeowner’s loan

• prohibit equity stripping where lenders make loans based on the equity a homeowner already has in the home as opposed to the borrower’s ability to repay the

loan

• prohibit abusive lending practices such as ‘‘flipping’’ the repeated refinancing

of a home so the lender can collect upfront fees and eat away at the equity in

the home or ‘‘insurance packing,’’ when unnecessary and overpriced insurance is

financed as part of the financing package often without properly informing the

consumer.

NNHN also feels that consumer education is a critical component to any strategy

aimed at eliminating predatory lending practices and curtailing unnecessary foreVerDate 11-MAY-2000 14:39 Dec 19, 2002 Jkt 000000 PO 00000 Frm 00500 Fmt 6601 Sfmt 6621 82969.TXT SBANK4 PsN: SBANK4
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closures. Such education needs to focus on building the financial literacy skills of

consumers and homeowners to empower them to make sound borrowing decisions.

Predatory Lending In Maryland

As you know, predatory lending is a nationwide problem. I would like to give you

some examples of predatory lending in your home State of Maryland, Mr. Chairman,

and describe to you the responses by the NNHN members there. As I have mentioned, those homeowners who have become victims of predatory lending often come

to the NeighborWorks Organizations when it is already too late. We have, however, been able to prevent many homeowners from ever falling prey by educating

them beforehand and being available to them for advice following the education.

The first example in Maryland that I wish to share is the Salisbury Neighborhood

Housing Services, Inc. There is one particularly sad story of an elderly woman who

went to the organization after being on the verge of losing her home. In 1993, she

had purchased a home in the Westside neighborhood using owner financing from

her landlord. Her landlord, a local attorney, sold her the house for $30,000 and set

up a balloon payment.

The house was in disrepair when he sold it to her and because of the monthly

payment she could not afford to fix up the house. When she was cited by the city

for the condition of her house, the landlord agreed to refinance the home for her

and to add funds to the original loan amount to fund the cost of some of the repairs.

He charged her additional fees and closing costs and added them into the loan

amount. Under the pretense of helping her he then refinanced the loan yet again

through the Ford Consumer Finance Company in 1995. By the time she went to

Salisbury Neighborhood Housing Services, she owed $55,000 on her house, and the

contractor’s estimate to bring the house up to code was $53,000. In 1997, less than

2 years from the time she took out the loan with Ford, she signed a Deed in Lieu

of foreclosure and lost her home.

Another example, which worked out somewhat better, comes from the Neighborhood Housing Services of Baltimore, Inc. A couple of years ago over 100 families became victims of predatory lending in the neighborhood of East Baltimore, near Patterson Park. The Neighborhood Housing Services of Baltimore first heard about

these problems of loan flipping and fraudulent loan documents from an individual

case of a woman who went to them for help. The NHS discerned problems with the

documents immediately, and quickly learned of the other families plagued by the

same lender. The NHS worked in collaboration with other East Baltimore nonprofit

organizations and a local attorney to file a class action suit against the lender. The

case never went to court; the lender is currently settling with the plaintiffs. One

of the aspects of the settlement, which has already taken effect, is the reduction of

principal balances on some of loans. The NHS is currently working with many of

the families to provide loan packaging and rehabilitation. The city has also contributed some funds to assist these families.

In both of these cases, predatory lenders have caused irreparable damage to

homeowners and their credit histories.

Mr. Chairman, on behalf of the National Neighborhood Housing Network, I applaud your past efforts in addressing this problem that is destroying families and

neighborhoods. This country has made great strides in increasing homeownership

nationwide and your commitment to this issue ensures that this is not in vain. The

Government’s own funds are at stake when Federal Housing Administration (FHA)

mortgages and Neighborhood Reinvestment Corporation loans fall prey to unregulated lenders.

These hearings are a wonderful opportunity to find out exactly what is happening

in our communities. We hope that with the overwhelming, indisputable evidence

that you find here, you will reintroduce the important legislation that you proposed

last year, S. 2415 Predatory Lending Consumer Protection Act of 2000. As stated,

the bill will ‘‘amend the Home Ownership and Equity Protection Act of 1994 and

other sections of the Truth in Lending Act to protect consumers against predatory

practices in connection with high cost mortgage transactions [and] to strengthen the

civil remedies available to consumers under existing law.’’

I would like to invite you and your colleagues to visit the NeighborWorks Organizations in Maryland and nationwide. I know you are already familiar with our

work, and I hope that we will be able to work together in the future to achieve our

mutual goals of curtailing predatory lending practices and strengthening the availability of responsible credit to all low- and moderate-income individuals.

I wish to thank the Committee again for this opportunity to submit testimony regarding predatory lending.

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STATEMENT OF MARIAN B. TASCO

COUNCILWOMAN, NINTH DISTRICT, CITY OF PHILADELPHIA, PENNSYLVANIA

JULY 26, 2001

I want to thank Chairman Sarbanes and the Members of the Banking, Housing,

and Urban Affairs Committee for this opportunity to submit my remarks on predatory lending. My name is Marian Tasco and I represent the Ninth Councilmanic

District in the City Council of Philadelphia. I am the sponsor of the landmark legislation passed by the Philadelphia City Council to stop the epidemic of predatory

lending currently ravaging Philadelphia’s neighborhoods.

I know that you have already heard testimony from Leroy Williams, a homeowner

victimized by predatory lending in Philadelphia and from his attorney, Irv

Ackelsberg, the managing attorney from Community Legal Services who has been

leading the legal assault against predatory lending not only in Philadelphia but also

around the State and the Nation. I do not intend to repeat what they have already

eloquently presented to your Committee concerning the devastating effects of predatory lending both in our city and throughout the country.

Instead I want to share with the Committee the story of how we in Philadelphia

came to pass the Nation’s strongest antipredatory lending laws and how the predatory lending industry, along with the legitimate financial institutions in Pennsylvania, thwarted our efforts by convincing the State Legislature and Governor to

completely preempt municipalities in Pennsylvania from regulating lending practices within their borders.

The legislation passed by a unanimous Philadelphia City Council on April 5, 2001

closely mirrors Senator Sarbanes’s pending legislation. Under our legislation we set

the thresholds for covered loans at 4.5 percent over the applicable Treasure rate for

first lien mortgages and 6.5 percent over the applicable Treasury rate for junior

mortgages. Threshold loans are not prohibited per se under the Ordinance, unless

they are issued without the consumer first receiving home loan counseling or if they

are issued without regard to the consumer’s ability to repay. Our definition of highcost loan closely mirrors the triggers of Senate Bill 2415. While we lacked the legal

authority to directly prohibit the making of high-cost loans, our legislation seeks to

discourage the making of high-cost loans by bringing economic sanctions upon any

high-cost lender or its affiliate which seeks to do business with the city.

We often hear that it is difficult to define predatory lending, but the Philadelphia

Ordinance makes definite progress in itemizing the characteristics of predatory

loans. We can take direction from the Supreme Court on this one. As with obscenity,

a definition may be elusive, but we know it when we see it; and we are beginning

to see it more than we would like. We defined a predatory loan as any threshold

or high-cost loan with any one of thirteen characteristics. The list roughly approximates the same terms as are contained in Senate Bill 2415 except that under the

Philadelphia Ordinance home loan counseling is mandatory for all threshold loans

and no loans are allowed to have prepayment penalties.

The Philadelphia Ordinance adopts a dual approach to the stopping predatory

lending practices. For those persons over which the city of Philadelphia has the

home rule authority to exercise its regulatory police powers, the ordinance prohibits

those persons from issuing, arranging, or assisting others in making predatory

loans, making any threshold loan without home loan counseling and directly paying

home improvement loan proceeds to home repair contractors. The Philadelphia Ordinance also requires home repair contractors to provide a warning notice to all customers and requires all lenders and brokers to file a certification of compliance with

the new law for recording with the mortgage instrument.

In addition to the regulatory approach, we also sought to use Philadelphia’s substantial financial power as a market participant to bring economic sanctions to bear

on the predatory lenders preying upon our residents and their affiliates. Toward

that end the Philadelphia Ordinance cuts off the ability of high-cost or predatory

lenders or their affiliates to enter into city contracts, removes city deposits from any

depository financial institution engaged directly or through affiliates in predatory or

high-cost lending practices, prohibits the bundling of city administered Federal

CDBG funds with any loans originated by a high-cost or predatory lender or its affiliate and divests city pension funds from any securities issued by a high-cost or predatory lender or its affiliate, including predatory loan backed mortgage securities.

The process to draft Philadelphia’s antipredatory lending began several years ago.

I first became aware of this predatory lending issue in the winter of 1999 through

a segment on ‘‘Good Morning America.’’ We had had some earlier problems in my

Councilmanic District. The segment told the lamentable story of a homeowner who

had obtained a loan for housing improvements. The loan had so many complicated

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terms and costs which the homeowner had not expected and could not pay, she lost

her home in foreclosure. During hearings on Philadelphia’s Community Development Block Grant application for fiscal year 2001, several representatives from

home and loan counseling agencies testified as to how the practices had entered into

the Philadelphia market and was creating havoc for our residential homeowners.

The witnesses indicated that some protections and safeguards had to be put in place

immediately. Northwest Counseling Services set up a variety of community meetings to discuss the issue. Congressman Bob Brady and I made the rounds of the

sessions to alert consumers to possible pitfalls in the home mortgage process, and

this is still a much-needed message.

Out of the same Community Development Block Grant hearing, I began a conversation with ACORN, which expressed an interest and willingness to participate

in drafting a piece of legislation based on their case files, both locally and nationally. In the fall of 2000, I supported the establishment of a local predatory lending

task force under the direction of Michelle Lewis of Northwest Counseling Services.

Jeff Ordower, the local organizer for ACORN took the issue to the editorial board

of the Philadelphia Daily News. I am most grateful to both of these organizations

in their leadership for their involvement and commitment to this project and for

keeping it on the front burner.

I also called together an ad hoc task force composed of leading housing counseling

agencies, ACORN, the Urban League, and the city’s Office of Housing and Community Development, to draft comprehensive municipal legislation based upon the following understandings:

• Philadelphia is experiencing an epidemic of foreclosures and equity stripping in

its minority and distressed neighborhoods resulting from a dramatic rise in predatory lending practices.

• Most but not all of the predatory loans resulted from direct solicitations of homeowners from home repair contractors, mortgage brokers or mortgage lenders.

• Most but not all of the predatory loans were taken out by existing homeowners

wishing to cash in on their home’s equity.

• Legal advocates for the victims of predatory lending have insufficient resources

to address this growing epidemic because existing Federal and State statutes are

inadequate in providing effective means to stop this epidemic.

• Philadelphia has the largest network of housing counseling agencies which can be

trained to provide antipredatory lending counseling to every borrower at risk of

predatory lending practices.

• While the city has limited power to regulate the financial services and lending industry due to Federal and State statutory preemptions it has unlimited power to

regulate home repair contractors and mortgage brokers, which are the prime

forces behind the predatory lending epidemic in the city.

• The city has unlimited market powers to determine with whom it chooses to contract, deposit funds, invest its pension fund or bundle its governmental financial

assistance. While the city has no direct business relationships with most predatory lenders or brokers, the city does have such relationships with affiliates of

these entities. By leveraging the desire of these affiliates to maintain their lucrative relationships with the city, the city can exercise enormous pressure on their

affiliated predatory and high-cost lenders to cease their practices within the city.

I have always maintained that the cooperation of the lending community is crucial

to the ultimate success of any legislative effort to stamp out the abusive and harmful practice of predatory lending. Throughout the process of drafting the legislation

we met numerous times with organizations representing the financial lending industry, many of which testified before this Committee. We held a special public meeting

solely designed to solicit their input which was attended by over 100 lenders, brokers, and home repair contractors.

At every meeting I called upon the industry to propose constructive legislative

proposals which would benefit the homeowners of Philadelphia. Unfortunately, for

the most part we received proposals designed to gut our legislation or to enact special exemptions to remove one or another of the financial institutions from the regulatory or economic sanctions portions of the bill.

The greatest disappointment for me was the complete unwillingness of the banking community to engage in a constructive dialogue on the legislation. Rather than

sit down to design a bill that would allow legitimate lending activities to flourish

and discourage only those which are abusive and deceptive, the bankers locked arms

with the predatory lenders for a total defeat of our legislation. Swarms of lobbyists

descended on City Hall disseminating falsehoods about the scope and impact of the

legislation. Fortunately, we were able to mount an immediate and effective response

to each deceptive claim. It turned out that our greatest weapon against the bankers

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lobby, surprisingly, was not the strength of our arguments as much as the weakness

of theirs. Even Councilmen sympathetic to the bankers’ messages concluded that

their opposition to the legislation lacked any credibility. The bankers could not articulate why they were opposed to legislation which exempted them from coverage

and which regulated a practice which banks do not engage in.

In the end, our legislation passed by a unanimous vote of 16 to 0, with Republicans joining Democrats in a clear and unmistakable message to the financial industry: You have utterly failed to police yourselves and through your failure to act

you have given a green light to the unscrupulous predators to strip the wealth from

the hard working citizens of our city. The only proper and credible response to this

crisis was swift and decisive Government action.

Only weeks after our legislative victory, the financial industry launched a twopronged assault on the Philadelphia Ordinance. The American Financial Services

Association, which in its testimony before this Committee called the massive explosion of predatory lending ‘‘[a] system which has been extremely successful in delivering consumer credit to America’s working families,’’ brought suit against the city

seeking to enjoin the implementation of the Ordinance on the grounds that the

State legislative scheme regulating mortgage lenders and brokers preempts the Ordinance by implication and that the city exceeded its powers under its home rule

charter. Perhaps fearing that their arguments of an implied State preemption would

not carry the day, the predatory lending industry, led by Household Finance, and

the Pennsylvania Bankers Association drafted State legislation containing the

broadest preemption language ever proposed in Harrisburg. The legislation, Senate

Bill 377, was practically secretly passed by overwhelmingly majorities in the Republican controlled House and Senate on the second day after it was introduced, without any opportunity for hearings or floor debate.

The preemption language of Senate Bill 377 is so wide sweeping that it not only

prohibits Philadelphia and all municipalities from regulating predatory lending

practices, but also attempts to prevent any local community from determining

whether or not to enter into contracts, deposit funds or invest pension funds based

upon the lending practices of the private business or an affiliate. To make matters

worse, the legislation prohibits municipalities from even passing any resolutions

concerning lending practices.

Mr. Chairman, Senate Bill 377 is the poster child for the need for strong and effective Federal legislation to stop predatory lending. Not only has our State legislature stripped the home rule powers which Philadelphia sought to invoke to stop the

scourge of predatory lending in our midst, but they have given the predators the

green light to continue robbing Philadelphia’s home owners of their hard earned

wealth. Congress is our last and best hope for a legislative solution that will bring

real and immediate relief to the past and future victims of predatory lending not

only in our city, but also throughout the country.

I applaud your efforts to pass meaningful legislation and pledge our support to

you.