Consumer Protection: Federal and State Agencies Face Challenges in Combating Predatory Lending
Published: 2004-02-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: While there is no universally accepted definition, the term "predatory lending" is used to characterize a range of practices, including deception, fraud, or manipulation, that a mortgage broker or lender may use to make a loan with terms that are disadvantageous to the borrower. Concerns about predatory lending have increasingly garnered the attention and concern of policymakers, consumer advocates and participants in the mortgage industry. This statement is based on GAO's report, released at today's hearing, and discusses federal and state efforts to combat predatory lending; factors that may make elderly consumers more susceptible to predatory lending; the roles of consumer education, mortgage counseling, and loan disclosures in preventing predatory lending; and how the secondary mortgage market can affect predatory lending.
section_title: What GAO Found
paragraphs: Federal agencies have taken a number of enforcement actions, sometimes jointly, using various federal consumer protection laws to combat predatory lending. The Federal Trade Commission (FTC) has played the most prominent enforcement role, filing 19 complaints and reaching multimillion dollar settlements. The Departments of Justice and Housing and Urban Development have also taken various predatory lending-related enforcement actions. Federal banking regulators report little evidence of predatory lending by the institutions they supervise. However, concerns exist about nonbank mortgage lending companies owned by financial or bank holding companies. While FTC is the primary federal enforcer of consumer protection laws for these entities, it is a law enforcement agency that conducts targeted investigations. In contrast, the Federal Reserve Board is well equipped to routinely monitor and examine these entities and, thus, potentially deter predatory lending activities, but its authority in this regard is less clear. As of January 2004, 25 states, as well as several localities, had passed laws to address predatory lending, often by restricting the terms or provisions of certain high-cost loans; however, federal banking regulators have preempted some state laws for the institutions they supervise. Also, some states have strengthened their regulation and licensing of mortgage lenders and brokers. While there are no comprehensive data, federal, state, and consumer advocacy officials report that elderly people have disproportionately been victims of predatory lending. According to these officials and relevant studies, predatory lenders target older consumers in part because they are more likely to have substantial home equity or may live on limited incomes that make them more susceptible to offers for quick access to cash. Older consumers may also have cognitive or physical impairments such as poor eyesight, hearing, or mobility that limit their ability to access competitive sources of credit. GAO's review of literature and interviews with consumer and federal officials suggest that consumer education, mortgage counseling, and loan disclosures are useful, but may be of limited effectiveness in reducing predatory lending. A variety of factors limit their effectiveness, including the complexity of mortgage transactions, difficulties in reaching target audiences, and counselors' inability to review loan documents. The secondary market--where mortgage loans and mortgage-backed securities are bought and sold--benefits borrowers by expanding credit, but may facilitate predatory lending by allowing unscrupulous lenders to quickly sell off loans with predatory terms. In part to avoid certain risks, secondary market participants perform varying degrees of "due diligence" to screen out loans with predatory terms, but may be unable to identify all such loans.

section_title: Letter
paragraphs: I appreciate the opportunity to be here today to discuss federal and state  efforts to deter predatory home mortgage lending, especially as it affects  the elderly. While there is no universally accepted definition, the term  “predatory lending” is used to characterize a range of practices, including  charging excessive fees and interest rates, making loans without regard to  borrowers’ ability to repay, or refinancing loans repeatedly over a short  period of time without any economic gain for the borrower. No  comprehensive data are available on the extent of these practices, but they  appear most likely to occur among subprime mortgages—those made to  borrowers with impaired credit or limited incomes. Predatory practices,  often targeted at the elderly, minorities, and low-income homeowners, can  strip borrowers of home equity built up over decades and cause them to  lose their homes.
My statement today is based on the report on predatory lending that you  requested and are releasing today. Specifically, my statement discusses  (1) federal laws related to predatory lending and federal agencies’ efforts  to enforce them; (2) actions taken by states to address predatory lending;  (3) factors that make elderly consumers susceptible to predatory lending  practices; (4) the roles of consumer education, mortgage counseling, and  loan disclosure requirements in preventing predatory lending; and (5) how  the secondary market for mortgage loans can affect predatory lending. The  scope of this work was limited to home mortgage lending and did not  include other forms of consumer loans. In preparing the report, we  examined federal laws, as well as selected state and local laws, and  interviewed officials from federal, state, and local agencies. At GAO’s  request, federal agencies identified enforcement or other actions they have  taken to address predatory lending. We also met with officials from  industry and consumer advocacy groups and reviewed relevant literature.  We conducted our work in accordance with generally accepted  government auditing standards from January 2003 through January 2004.
Federal agencies have addressed predatory lending by enforcing a  variety of federal laws, including the Federal Trade Commission Act,  the Home Ownership and Equity Protection Act (HOEPA), the Real  Estate Settlement Procedures Act (RESPA), and the Truth in Lending  Act (TILA). The Federal Trade Commission (FTC) took 19 enforcement  actions against predatory home mortgage lenders and brokers between  1983 and 2003—17 of them between 1998 and 2003—to combat alleged  deceptive acts or other illegal practices, with some resulting in  multimillion dollar settlements. The Department of Justice and the  Department of Housing and Urban Development have also taken  individual and joint enforcement actions related to abusive lending.  While federal banking regulators—the Federal Deposit Insurance  Corporation, the Board of Governors of the Federal Reserve System  (the Board), the Office of the Comptroller of the Currency, the Office of  Thrift Supervision, and the National Credit Union Administration— report little evidence of predatory lending by the depository  institutions that they supervise, concerns exist about nonbank  mortgage lending companies that are owned by financial or bank  holding companies. Our report recommends that Congress consider  making statutory changes to provide the Board with clear authority to  monitor, examine, and take enforcement actions against nonbank  mortgage lending subsidiaries of financial and bank holding companies.
As of January 2004, 25 states, 11 localities, and the District of Columbia  have passed their own laws addressing predatory lending, according to  a database that tracks state and local legislation. In addition, some  states have strengthened the regulation and licensing of mortgage  lenders and brokers, and state law enforcement agencies and banking  regulators have taken a number of enforcement actions under state  consumer protection and banking laws. However, a state law may not  apply to all mortgage lenders within the state. The Office of the  Comptroller of the Currency, the Office of Thrift Supervision, and the  National Credit Union Administration have asserted that federal law  preempts some state predatory lending laws for the institutions they  regulate, stating that federally chartered lending institutions should be  required to comply with a single uniform set of national regulations.
While there are no comprehensive data, government officials and  consumer advocacy organizations have reported that elderly  consumers have been disproportionately targeted and victimized by  predatory lenders. Elderly consumers appear to be favored targets for  several reasons—for example, because they may have substantial  equity in their homes or live on limited incomes that make them  susceptible to offers for quick access to cash. Further, some seniors  have cognitive or physical impairments such as poor eyesight, hearing,  or mobility that may limit their ability to access competitive sources of  credit. While most government and private class-action enforcement  activities seek to provide redress to large groups of consumers, some  private efforts have focused on helping older victims of predatory  lending.
A number of federal, state, nonprofit, and industry-sponsored  organizations offer consumer education initiatives designed to deter  predatory lending by, among other things, providing information about  predatory practices and working to improve consumers’ overall  financial literacy. Most of these efforts seek to serve the general  consumer population, but a few education initiatives have specifically  addressed predatory lending and the elderly. GAO’s review of literature  and interviews with consumer and federal officials suggest that while  consumer education, mortgage counseling, and disclosures are useful,  they may be of limited effectiveness in reducing predatory lending. For  example, consumer education is hampered by the complexity of  mortgage transactions and the difficulty of reaching the target  audience. Similarly, unreceptive consumers, lack of access to relevant  loan documents, and the sheer volume of mortgage originations each  year limit the potential impact of universal counseling. And while  efforts are under way to improve the federally required disclosures  associated with mortgage loans, the complexity of mortgage  transactions hinders the effectiveness of disclosures, especially given  the lack of financial sophistication among many borrowers who are  targeted by predatory lenders.
The secondary market for mortgage loans—which allows lenders and  investors to sell and buy mortgages and mortgage-backed securities— provides lenders with an additional source of liquidity and may benefit  borrowers by increasing access to credit and lowering interest rates.  But the secondary market may also inadvertently serve to facilitate  predatory lending, both by providing a source of funds that enables  unscrupulous originators to quickly sell off loans with predatory terms  and by reducing incentives for these originators to ensure that  borrowers can repay their loans. Secondary market participants use  varying degrees of “due diligence”—a review and appraisal of legal and  financial information—to avoid purchasing loans with abusive terms,  but even the most extensive due diligence may not detect some  predatory lending practices. Some states have passed laws making  secondary market buyers liable for violations by loan originators,  although such laws may have the unintended consequence of reducing  the availability of legitimate credit to consumers.
subsections: section_title: Background
paragraphs: While there is no uniformly accepted definition of predatory lending, a  number of practices are widely acknowledged to be predatory. These  include, among other things, charging excessive fees and interest rates,  lending without regard to borrowers’ ability to repay, refinancing  borrowers’ loans repeatedly over a short period of time without any  economic gain for the borrower (referred to as “loan flipping”), and  committing outright fraud or deception—for example, falsifying  documents or intentionally misinforming borrowers about the terms of a  loan. These types of practices offer lenders that originate predatory loans  potentially high returns even if borrowers default, because many of these  loans require excessive up-front fees. No comprehensive data are available  on the incidence of these practices, but banking regulators, consumer  advocates, and industry participants generally agree that predatory loans  are most likely to occur in the market for “subprime” loans. The subprime  market serves borrowers who have limited incomes or poor or no credit  histories, in contrast with the prime market, which encompasses  traditional lenders and borrowers with credit histories that put them at  low risk of default. Subprime lending is not inherently abusive, and,  according to officials at HUD and the Department of the Treasury, the  emergence of a subprime mortgage market has enabled a whole class of  credit-impaired borrowers to buy homes or access the equity in their  homes. Originators of subprime loans most often are mortgage and  consumer finance companies but can also be banks, thrifts, and other  institutions.
Serious data limitations make the extent of predatory lending difficult to  determine. However, there have been a number of major settlements  resulting from government enforcement actions or private party lawsuits  in the last 5 years that have accused lenders of abusive practices affecting  large numbers of borrowers. For example, in October 2002, Household  International, a large home mortgage lender, agreed to pay up to $484  million to homeowners to settle states’ allegations that it used unfair and  deceptive lending practices to make mortgage loans with excessive  interest and fees. In addition, the rate of foreclosures of subprime loans  has increased substantially since 1990, far exceeding the rate of increase  for subprime originations. Some consumer groups and industry observers  have attributed this development, at least in part, to an increase in abusive  lending, particularly loans made without regard to borrowers’ ability to  repay. Additionally, groups such as legal services agencies have reported  seeing an ever-growing number of consumers, particularly the elderly and  minorities, who are in danger of losing their homes as a result of predatory  lending practices.
section_title: Federal Agencies Have Taken Enforcement and Other Actions to Address Predatory Lending, but Face Challenges
paragraphs: As shown in figure 1, Congress has passed numerous laws that federal  agencies and regulators have used to combat predatory lending. Among  the most frequently used laws—HOEPA, the Federal Trade Commission  Act, TILA, and RESPA—only HOEPA was specifically designed to address  predatory lending. Enacted in 1994, HOEPA places restrictions on certain  high-cost loans, including limits on prepayment penalties and balloon  payments and prohibitions against negative amortization. However,  HOEPA covers only loans that exceed certain rate or fee triggers, and  although comprehensive data are lacking, it appears that HOEPA covers  only a limited portion of all subprime loans. The Federal Trade  Commission Act, enacted in 1914 and amended on numerous occasions,  authorizes FTC to prohibit and take action against unfair or deceptive acts  or practices in or affecting commerce. TILA and RESPA are designed in  part to provide consumers with accurate information about the cost of  credit.
Other federal laws that have been used to address predatory lending  practices include criminal fraud statutes that prohibit certain types of  fraud sometimes used in abusive lending schemes, such as forgery and  false statements. Also, the Fair Housing Act and Equal Credit Opportunity  Act—which prohibit discrimination in housing-related transactions and  the extension of credit, respectively—have been used in cases against  abusive lenders that have targeted certain protected groups.
Using these or other authorities, federal agencies have taken a number of  enforcement actions and other steps, such as issuing guidance and  revising regulations. Among federal agencies, FTC has a prominent role in  combating predatory lending because of its responsibilities in  implementing and enforcing certain federal laws among lending  institutions that are not depository institutions supervised by federal  banking regulators. FTC reported that it has filed 19 complaints—17 since  1998—alleging deceptive or other illegal practices by mortgage lenders or  brokers and that some actions have resulted in multimillion dollar  settlements. The Department of Justice, which is responsible for enforcing  certain federal civil rights laws, has taken two such enforcement actions  related to predatory mortgage lending practices and has taken an  additional action on behalf of FTC. The Department of Housing and Urban  Development has undertaken enforcement activities related to abusive  lending that focus primarily on reducing losses to the Federal Housing  Administration insurance fund. It has also taken three enforcement  actions in abusive mortgage lending cases for violations of the Real Estate  Settlement Procedures Act’s prohibitions on certain types of fees.
Federal banking regulators have stated that their monitoring and  examination activities have uncovered little evidence of predatory lending  in federally regulated depository institutions. Four of the five federal  banking regulators reported taking no formal enforcement actions  involving predatory mortgage lending, while the fifth—the Office of the  Comptroller of the Currency—reported that it has taken one formal  enforcement action against a bank engaged in abusive mortgage lending.  Regulators noted that they have taken informal enforcement actions to  address questionable practices raised during the examination process and  required their institutions to take corrective actions. The banking  regulators have also issued guidance to the institutions they supervise on  avoiding direct or indirect involvement in predatory lending. In addition, in  2001 the Board made changes to its regulations implementing HOEPA that,  among other things, increase the number of loans HOEPA covers. The  Board also made changes to its regulations implementing the Home  Mortgage Disclosure Act in 2002 that make it easier to analyze potential  patterns of predatory lending.
Federal agencies and banking regulators have coordinated their efforts to  address predatory lending on certain occasions through participation in  interagency working groups and through joint enforcement actions. For  example, FTC, the Department of Justice, and the Department of Housing  and Urban Development coordinated to take an enforcement action  against Delta Funding Corporation, with each agency investigating and  bringing actions for violations of the laws within its jurisdiction.
Issues related to federal oversight and regulation of certain nonbank  mortgage lenders may challenge efforts to combat predatory lending.  Nonbank mortgage lending companies owned by financial or bank holding  companies (i.e., nonbank mortgage lending subsidiaries) account for an  estimated 24 percent of subprime loan orginations, according to the  Department of Housing and Urban Development, and some have been the  target of notable federal and state enforcement actions involving  allegations of abusive lending. The Board may be better equipped than  FTC to monitor and examine these holding company subsidiaries because  of its role in overseeing financial and bank holding companies, but the  Board does not have clear authority to do so. Our report recommends that  Congress consider (1) making appropriate statutory changes that would  grant the Board the authority to routinely monitor and, as necessary,  examine the nonbank mortgage lending subsidiaries of financial and bank  holding companies for compliance with federal consumer protection laws  applicable to predatory lending practices and (2) giving the Board specific  authority to initiate enforcement actions under those laws against these  nonbank mortgage lending subsidiaries. In commenting on our report, the  Board stated that while the existing structure has not been a barrier to  Federal Reserve oversight, the approach we recommended for  consideration by the Congress would likely be useful for catching some  abusive practices that might not be caught otherwise. The Board also  noted that the approach would present tradeoffs, such as different  supervisory schemes being applied to nonbank mortgage lenders based on  whether or not they are part of a holding company, and additional costs.  However, these nonbank mortgage lenders are already subject to a  different supervisory scheme than other lenders. We agree that costs could  increase and believe that Congress should consider both the potential  costs and benefits of clarifying the Board’s authorities.
section_title: Many States Have Passed Laws Addressing Predatory Lending, but Federal Agencies Have Preempted Some Statutes
paragraphs: In response to concerns about the growth of predatory lending and the  limitations of existing laws, 25 states, the District of Columbia, and 11  localities have passed their own laws addressing predatory lending  practices, according to a database that tracks such laws. Most of these  laws regulate and restrict the terms and characteristics of high-cost  loans—that is, loans that exceed certain rate or fee thresholds. While some  state statutes follow the thresholds for covered loans established in  HOEPA, many set lower thresholds in order to cover more loans than the  federal statute. The statutes vary, but they generally cover a variety of  predatory practices, such as balloon payments and prepayment penalties,  and some include restrictions on such things as mandatory arbitration  clauses that can restrict borrowers’ ability to obtain legal redress through  the courts.
Some states have also increased the regulation of and licensing  requirements for mortgage lenders and brokers, in part to address  concerns that some unscrupulous lenders and brokers have been  responsible for lending abuses and that these entities have not been  adequately regulated. For example, some states have added educational  requirements that lenders and brokers must meet in order to obtain a  license. In recent years, state law enforcement agencies and banking  regulators have also taken a number of actions against mortgage lenders  involving predatory lending. For example, an official from Washington  State’s Department of Financial Institutions reported that the department  had taken several enforcement actions to address predatory lending,  including one that resulted in a lender being ordered to return more than  $700,000 to 120 Washington borrowers for allegedly deceiving them and  charging prohibited fees.
Three federal banking regulators—the National Credit Union  Administration, the Office of the Comptroller of the Currency, and the  Office of Thrift Supervision—have issued opinions stating that federal  laws preempt some state predatory lending laws for the institutions that  they regulate. The regulators note that such preemption creates a more  uniform regulatory framework, relieves lending institutions of the burden  of complying with a hodgepodge of state and federal laws, and avoids state  laws that may restrict legitimate lending activities. State officials and  consumer advocates that oppose preemption argue that federal laws do  not effectively protect consumers against predatory lending practices and  that federal regulators do not devote sufficient resources toward  enforcement of consumer protection laws for the institutions they oversee.  In response, federal banking regulators have noted that federally  supervised institutions are highly regulated and subject to comprehensive  supervision. The regulators also said they found little to no evidence of  predatory lending by the institutions they regulate.
section_title: Predatory Lenders May Target Elderly Consumers
paragraphs: Consistent observational and anecdotal evidence, along with some limited  data, indicates that, for a variety of reasons, elderly homeowners are  disproportionately the targets of predatory lending. Because older  homeowners, on average, have more equity in their homes than younger  homeowners, abusive lenders could be expected to target these borrowers  in order to “strip” the equity from their homes. According to federal  officials and consumer groups we contacted, abusive lenders often try to  convince elderly borrowers to repeatedly refinance their loans, adding  more costs each time—an abuse known as loan flipping. In addition, some  brokers and lenders aggressively market home equity loans as a source of  cash, particularly for older homeowners who may have limited incomes  but require funds for major home repairs or medical expenses. The  financial losses older people can suffer as a result of abusive loans can  result in the loss of independence and security and a significant decline in  their quality of life.
A number of factors may make the elderly particularly susceptible to  predatory lending practices. For example:    Diseases and physical impairments associated with aging—such as  declining vision, hearing, or mobility—can restrict elderly consumers’  ability to access financial information and compare credit terms. In  such situations, potential borrowers may be susceptible to the first  lender to offer what seems to be a good deal, especially if the lender is  willing to visit them at home or provide transportation to the closing.
Some older people may also have diminished cognitive capacity, which  can impair their ability to comprehend and make informed judgments  on financial issues. According to a report sponsored by the National  Academy of Sciences, elderly people may be more likely to have  conditions or disabilities that make them easy targets for financial  abuse and they may have diminished capacity to evaluate proposed  courses of action. Representatives of legal aid organizations have said  that they frequently represent elderly clients in predatory lending cases  involving lenders that have taken advantage of a borrower’s confusion  and, in some cases, dementia.
Several advocacy groups have noted that some elderly people lack  social and family support systems, potentially increasing their  susceptibility to unscrupulous lenders who may market loans by  making home visits or offering other personal contact.
Elderly homeowners often live in older homes and are more likely to  need someone to do repairs for them. Federal officials, legal aid  services, and consumer groups have reported that home repair scams  targeting elderly homeowners are particularly common. For example, a  joint report on predatory lending by the Department of Housing and  Urban Development and the Department of the Treasury noted that  predatory brokers and home improvement contractors have  collaborated to swindle older consumers. A contractor may come to a  homeowner’s door, pressure the homeowner into accepting a home  improvement contract, and arrange for financing of the work with a  high-cost loan. The contractor then does shoddy work or does not  finish the agreed-on repairs, leaving the borrower to pay off the  expensive loan.
Federal agencies, states, nonprofits, and trade organizations have  conducted and funded financial education for consumers as a means of  improving consumers’ financial literacy and, in some cases, raising  consumers’ awareness of predatory lending practices. Because the elderly  may be more susceptible to predatory lending, government agencies and  consumer advocacy organizations have focused some of their education  efforts on this population. For example, the Department of Justice offers  on its Web site the guide “Financial Crimes Against the Elderly,” which  includes references to predatory lending. The Department of Health and  Human Services’ Administration on Aging provides grants to state and  nonprofit agencies for programs aimed at preventing elder abuse,  including predatory lending practices targeting older consumers. AARP,  which represents Americans age 50 and over, sponsors a number of  financial education efforts, including a borrower’s kit that contains tips for  avoiding predatory lending.
However, federal consumer protection and fair lending laws that have  been used to address predatory lending do not generally have provisions  specific to elderly persons. For example, age is not a protected class under  the Fair Housing Act, which prohibits discrimination in housing-related  transactions. In addition, the Home Mortgage Disclosure Act (HMDA)— which requires certain financial institutions to collect, report, and disclose  data on loan applications and originations—does not require lenders to  report information about the age of the applicant or borrower. An  exception is the Equal Credit Opportunity Act, which prohibits unlawful  discrimination on the basis of age in connection with any aspect of a credit  transaction.
Little comprehensive data exist on the ages of consumers involved in  federal and state enforcement actions and private class-action lawsuits  involving predatory lending. Such actions generally seek to provide  redress to large groups of consumers, but a few cases have involved  allegations of predatory lending targeting elderly borrowers. For example,  FTC, six states, AARP, and private plaintiffs settled a case with First  Alliance Mortgage Company in March 2002 for more than $60 million. The  company was accused of using misrepresentation and unfair and  deceptive practices to lure senior citizens and those with poor credit  histories into entering into abusive loans; an estimated 28 percent of the  8,712 borrowers represented in the class-action suit were elderly.
Some nonprofit groups—such as the AARP Foundation Litigation, the  National Consumer Law Center, and the South Brooklyn Legal Services’  Foreclosure Prevention Project—provide legal services that focus, in part,  on helping elderly victims of predatory lending. The AARP Foundation  Litigation, which conducts litigation to benefit Americans 50 years and  older, has been party to 7 lawsuits since 1998 involving allegations of  predatory lending against more than 50,000 elderly borrowers. Six of these  suits have been settled, and the other is pending.
section_title: The Usefulness of Consumer Education, Counseling, and Disclosures in Deterring Predatory Lending May Be Limited
paragraphs: While representatives of the mortgage lending industry and consumer  groups have noted that financial education may make some consumers  less susceptible to abusive lending practices, GAO’s review of literature  and interviews with consumer and federal officials suggest that consumer  education by itself has limits as a tool for deterring predatory lending.  First, mortgage loans are complex financial transactions, and many  different factors—including the interest rate, fees, provisions of the loan,  and situation of the borrower—determine whether a loan is in a  borrower’s best interest. Even an excellent campaign of consumer  education is unlikely to provide less sophisticated consumers with enough  information for them to determine whether a loan contains abusive terms.  Second, predatory lenders and brokers tend to use aggressive marketing  tactics that are designed to confuse consumers. Broad-based campaigns to  make consumers aware of predatory lending may not be sufficient to  prevent many consumers—particularly those who may be uneducated or  unsophisticated in financial matters—from succumbing to such tactics.  Finally, the consumers who are often the targets of predatory lenders are  also some of the hardest to reach with educational information.
Prepurchase mortgage counseling—which can offer a “third party” review  of a prospective mortgage loan—may help borrowers avoid predatory  loans, in part by alerting consumers to predatory loan terms and practices.  The Department of Housing and Urban Development supports a network  of approximately 1,700 approved counseling agencies across the country  and in some cases provides funding for their activities. While beneficial,  the role of mortgage counseling in preventing predatory lending is likely to  be limited. Borrowers do not always attend such counseling, and when  they do, counselors may not have access to all of the loan documents  needed to review the full final terms and provisions before closing. In  addition, counseling may be ineffective against lenders and brokers  engaging in fraudulent practices, such as falsifying applications or loan  documents, that cannot be detected during a prepurchase review of  mortgage loan documents.
Finally, disclosures made during the mortgage loan process, while  important, may be of limited usefulness in reducing the incidence of  predatory lending practices. Certain federal laws, including TILA and  RESPA, have requirements covering the content, form, and timing of the  information that must be disclosed to borrowers. However, industry and  consumer advocacy groups have publicly expressed dissatisfaction with  the current disclosure system. In July 2002, the Department of Housing  and Urban Development issued proposed rules intended to streamline the  disclosure process and make disclosures more understandable and timely,  and debate over the proposed rules has been contentious. Although  improving loan disclosures would undoubtedly have benefits, once again  the inherent complexity of loan transactions may limit any impact on the  incidence of predatory lending practices. Moreover, even a relatively clear  and transparent system of disclosures may be of limited use to borrowers  who lack sophistication about financial matters, are not highly educated,  or suffer physical or mental infirmities. Finally, as with mortgage  counseling, revised disclosures would not necessarily help protect  consumers against lenders and brokers who engage in outright fraud or  who mislead borrowers about the terms of loans in the disclosure  documents themselves.
section_title: The Secondary Market May Benefit Consumers but Can Also Facilitate Predatory Lending
paragraphs: The existence of a secondary market for subprime loans has benefited  consumers by increasing the sources of funds available to subprime  lenders, potentially lowering interest rates and origination costs for  subprime loans. However, the secondary market may also inadvertently  facilitate predatory lending by providing a source of funds for  unscrupulous originators, allowing them to quickly sell off loans with  predatory terms. Further, the existence of a secondary market may reduce  the incentive for originating lenders—who generally make their profits  from high origination fees—to ensure that borrowers can repay.
Purchasers of mortgage loans undertake a process of due diligence  designed to avoid legal, financial, and reputational risk. However, the  degree of due diligence purchasers undertake varies. Officials of Fannie  Mae and Freddie Mac—which are estimated to account for a relatively  small portion of the secondary market for subprime loans—told us that  their organizations undertake a series of measures aimed at avoiding the  purchase of loans with abusive characteristics that may have harmed  borrowers. In contrast, according to some market participants, the due  diligence of other secondary market purchasers of residential mortgages  may be more narrowly focused on the creditworthiness of the loans and  on their compliance with federal, state, and local laws. However, even the  most stringent efforts cannot uncover some predatory loans. For example,  due diligence may be unable to uncover fraud that occurred during the  loan underwriting or approval process, some excessive or unwarranted  fees, or loan flipping.
Under some state and local legislation, purchasers of mortgages or  mortgage-backed securities on the secondary market may be held liable  for violations committed by the originating lenders—referred to as  “assignee liability” provisions. Assignee liability is intended to discourage  secondary market participants from purchasing loans that may have  predatory features and to provide an additional source of redress for  victims of abusive lenders, but some argue that it can also discourage  legitimate lending activity. Secondary market purchasers that are  unwilling to assume the potential risks associated with assignee liability  provisions have stopped purchasing, or announced their intention to stop  purchasing, mortgages originated in areas covered by such provisions.  Assignee liability provisions of the Georgia Fair Lending Act were blamed  for causing several participants in the mortgage lending industry to  withdraw from the market, and the provisions were subsequently  repealed.
Mr. Chairman, this concludes my prepared statement. I would be happy to  answer any questions at this time.
section_title: Contacts and Acknowledgements
paragraphs: For further information on this testimony, please contact David G. Wood  at (202) 512-8678, or Harry Medina at (415) 904-2000. Individuals making  key contributions to this testimony included Jason Bromberg, Randall C.  Fasnacht, Jr., Elizabeth Olivarez, and Paul Thompson.
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