A Tale of Three Markets Revisited

I. Introduction Susan Wachter's and Elizabeth Renuart's comments highlight two phenomena that are critical to understanding predatory lending: the paucity of legitimate risk-based pricing in the subprime market and the steering of people of color to predatory loans. We agree completely with Dr. Wachter's assessment that information asymmetries have impeded the evolution of a well-functioning home mortgage market.1 Without closure of these information gaps or regulations that compensate for the information gaps, predatory lenders will continue to capture excess rents. We likewise endorse Ms. Renuart's timely and astute observation that predatory lending, among other things, must be understood as a story of race and place.2 White customers tend to secure prime loans with favorable rates. In contrast, lenders often steer black and Hispanic customers in poorer neighborhoods to costly subprime loans, regardless of their credit ratings.3 Without question, racial targeting is a marker of predatory lending and is deeply troubling. While we agree with these and many other assessments the commentators make, we do part company in certain places. In this brief reply, we address the areas in which we disagree with Ms. Renuart and Dr. Wachter and respond to other issues they raised in their comments. II. Discussion A. The Suitability Standard and Rules In her comments, Dr. Wachter expresses concern that our suitability proposal, in the absence of rulemaking, will create an incentive for lenders to be overly cautious and adopt unnecessarily stringent rules.4 Alternatively, she posits that without sufficient understanding of markets and the impact of predatory lending sanctions, it may be premature to render explicit suitability rules.5 We agree that bright-line rules are essential to an effective suitability standard. For that reason, we recommend that any suitability legislation provide that borrowers can only bring claims for violations of rules promulgated by the agency vested with implementing authority. Furthermore, we strongly urge that the agency adopt bright-line rules whenever possible. In other words, we do not suggest that suitability provide a cause of action in the absence of a rule violation. Such a course would inevitably lead to inconsistent judicial interpretation. Several years ago, we would have echoed Dr. Wachter's alternative concern: "Do we know enough today to determine optimal national regulation in this area?"6 We contend that there is sufficient evidence today to begin Grafting suitability rules. For starters, there are several practices that policymakers and responsible lenders agree are predatory per se (e.g., lending without regard to ability to pay, the use of yield-spread premiums, and the packaging of single-premium credit life insurance with subprime mortgages). These practices could thus be subject to rulemaking without further investigation.7 In evaluating the utility of other potential suitability rules, we can look to a number of sources. The Mortgage Bankers Association of America, for example, has promulgated model guidelines that can provide direction.8 We can also draw on federal, state, and municipal initiatives to address lending abuses. For instance, there is a growing body of experience under the Home Ownership and Equity Protection Act (HOEPA).9 Similarly, states that have enacted predatory lending laws, like North Carolina, serve as laboratories for testing the impact of predatory lending provisions on the home mortgage market.10 Although the results are not in from every jurisdiction, the evidence from North Carolina suggests that the North Carolina law has deterred some of the worst lending abuses without unduly hampering the legitimate home mortgage market.11 This evidence together with empirical and theoretical understandings of the market, is now sufficient to inform an initial set of suitability rules. Just the same, it is premature to promulgate a fixed and complete set of suitability rules. …