SPEAKERS CONTENTS INSERTS
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PREDATORY LENDING PRACTICES
WEDNESDAY, MAY 24, 2000
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.
The committee met, pursuant to call, at 9:40 a.m., in room 2128, Rayburn House Office Building, Hon. James A. Leach, [chairman of the committee], presiding.
Present: Chairman Leach; Representatives McCollum, Roukema, Baker, Castle, Campbell, Ney, Ose, Biggert, Terry, LaFalce, Vento, Waters, Sanders, C. Maloney of New York, Watt, Bentsen, J. Maloney of Connecticut, Meeks, Lee, Inslee, Schakowsky, Moore, Jones and Capuano.
Chairman LEACH. The hearing will come to order.
The committee meets today in response to concerns that have been raised in recent months in various parts of the country about certain practices by a small number of lenders, including allegations that senior citizens and low-income persons have been targeted for fleecing or abusive tactics. We will hear from representatives of consumers, the industry, as well as State and Federal regulators.
Before introducing the first panel, let me say that this is not the first time this issue has been before this committee. Six years ago, Congress approved the Home Ownership and Equity Protection Act, HOEPA, in an effort to address abusive practices aimed at unsophisticated homeowners who were encouraged to use equity in their homes as security for additional credit. That law passed about 410-12, and by a voice vote in the Senate. It gave Federal regulators the authority to promulgate additional regulations to deal with new concerns as they arose.
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In terms of regulators, today we will hear from a number, including the Comptroller of the Currency, representatives of HUD, as well as a whole spectrum of Federal regulators. We have a number of people who want to speak on this subject, and I want to get to the hearing process as soon as possible.
I will say that, because this issue and the distinction between subprime lending and what might be considered predatory lending is such a difficult one to parse through, that I have been working for several weeks trying to develop some basic principles that I think we ought to be concerned about. I would like to read a series of precepts that I believe should be considered as part of addressing the predatory practices issue.
The first is that consumers deserve meaningful and clearly understandable disclosures of loan agreements so that borrowers are informed, rather than confused, by all the paperwork before them.
Second, lenders should not extend credit to a borrower unless they have applied appropriate analysis to determine that the borrower is capable of repayment under the terms of the loan.
Third, lenders should not require a borrower to finance points and fees associated with a high-cost loan. The consumer should receive a clear disclosure that the financing of points and fees is optional.
Fourth, a lender should not charge a borrower points or fees to renew, extend, or otherwise modify a high-cost home loan if, after the modification, the loan remains a high cost loan; or if it is no longer a high-cost loan, the APR has not been decreased by at least 1.5 percentage points.
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Fifth, lenders should not use misleading or deceptive sales and marketing practices that induce consumers to enter loan agreements they cannot afford.
Sixth, attempts to curb abusive practices should not be made at the expense of credit availablity in underserved neighborhoods.
Seventh, frequent refinancings, or ''loan flipping,'' which unnecessarily increase the loan balance and eliminate equity should not be acceptable. Points and fees associated with refinancing of a high-cost loan should result in a net benefit to the borrower.
Eighth, greater efforts should be undertaken to educate the public about borrowing. For example, consumers should be able to easily comprehend that a drop in their monthly payment may not translate into owing less over the long term, and may, in fact, increase their overall costs.
In addition, lenders should provide disclosures prior to closing, which encourage consumers to seek credit counseling.
Regulators should take necessary measures to ensure that an institution's CRA rating does not improve as a result of loans that were made to low- and moderate-income individuals, but have predatory terms.
Finally, the secondary market should not be a facilitator of predatory lending, but should take measures to ensure that loans which contain predatory terms are not purchased.
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I would just lay out these precepts. I know there are others that may be placed on the table as a beginning point of trying to distinguish between rules and regulations that apply to predatory lending, as contrasted with rules and regulations that apply to a more commercial set of circumstances.
At this point, let me recognize Mr. LaFalce.
Mr. LAFALCE. Thank you, Mr. Chairman.
I appreciate the fact that we are conducting a hearing today on predatory mortgage lending. I really think we need to conduct many, many more hearings on issues of concern to consumers. Too, I think in the next Congress, we should consider changing the name of this committee to something like the Committee on Consumer, Housing and Financial Services to give emphasis to the fact that the primary concern of this committee should be the consumer.
With respect to predatory lending, for several years now I have been concerned with the rapid growth of an alternative financial services structure, one consisting largely of less-regulated entities that provide higher cost credit and services to predominantly lower income and minority households and persons with inadequate or impaired credit.
I fear that too many Americans are being relegated to the permanent status as subprime borrowers and trapped with perpetual high-cost debt. The process can begin when they are encouraged to take on excessive credit card debt as students and may only end when they are robbed of the equity in their homes in old age.
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The expansion of subprime markets to provide credit to more Americans is, in itself, a positive development. Certainly not all subprime lending is predatory. We all want financial institutions to reach out to those too long outside the financial mainstream, but we must be concerned with the manner in which the growth in subprime lending is occurring.
It should be of major concern to our committee that the fastest growing segment of our financial sector is not the large banks, nor even the credit unions, but the chains of check cashing and payday lending businesses. It should be a concern of our committee that for the first time the Federal Reserve reports that regulated financial institutions owed less than half of all consumer debt and that commercial banks have been replaced by less regulated mortgage companies as the primary source of mortgage and credit to consumers. The magnitude and speed of the growth in subprime lending alone, growing by nearly 1,000 percent over the past five years, requires detailed hearings by our committee.
The fact that recent studies by HUD and separately by the Woodstock Institute both show that subprime lending is predominantly targeted to minority neighborhoods, possibly overturning years of progress on fair lending, also demands detailed examination by our committee.
The rapid growth in this alternative subprime market and the flaws or gaps in our traditional banking sector that are feeding this growth should be a fundamental concern in our committee's oversight of the banking system.
Of the many consumer issues which merit greater attention by our committee, the problem of predatory lending may well be the most pressing issue that needs to be addressed. I fear this problem has reached epidemic proportions in many parts of the country and in many communities. However, we lack detailed statistical data to document the extent of this problem. We do know though that American families are being stripped of billions of dollars in equity each year, and that too many families are losing their homes in foreclosure.
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I believe this problem requires strong legislative remedies. I have introduced legislation with a number of my Democratic colleagues that I believe combines the best of a number of different approaches that have been proposed by State and national organizations. Senator Sarbanes, the Ranking Democrat on the Senate Banking Committee, has introduced companion legislation in the Senate.
I am encouraged by the fact that all the financial regulatory agencies that will testify today have recognized the problem of predatory mortgage lending and are now proposing steps to address it, at least within the scope of their current authority.
The Federal Reserve Board has established a special working group to address the issue and the Treasury Department and HUD are in the process of conducting regional hearings to help document the extent and scope of the problem. The issue is also being addressed by the States. North Carolina was the first State to enact comprehensive legislation to combat predatory mortgage practices last year. My own State of New York also has led the Nation on this issue. Our Attorney General, Elliott Spitzer, has initiated a number of major actions against predatory lenders, and the New York Superintendent of Banks, Elizabeth McCall, has issued the most comprehensive regulations to curb predatory practices of any State.
I appreciate the fact that today's witness panels include a representative of the New York Attorney General's Office, Mr. Andrew Celli, from Rochester, New York, Bureau Chief for Civil Rights, and also includes Martin Eakes, who led the effort to enact legislation in North Carolina. I believe we can learn a great deal from both States' experiences.
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Finally, let me extend a special welcome to Under Secretary Gensler, Comptroller Jerry Hawke, Chairman Donna Tanoue, Director Ellen Seidman, and other representatives of the regulatory agencies who will testify on the first panel, and also to all of today's witnesses. I appreciate the fact that this is going to be a long day with many witnesses and I look forward to your testimony.
Today's hearing is going to be the beginning, not the end, to our committee's inquiry into subprime markets and predatory lending practices, and other important consumer concerns.
I thank the Chair.
Chairman LEACH. Thank you, Mr. LaFalce.
Let me say, I would like to begin as rapidly as possible, but if there is someone who wants to make a brief opening statement, I would be happy to welcome it at this time. We have a five-minute rule, but that applies to the general witnesses.
Mr. VENTO. Mr. Chairman, I will just place my statement in the record and thank you for holding the hearing.
I would posit that one predatory loan that unjustly denies someone's equity is one too many, especially when there is no practical recourse. I think with the growth of the subprime market, the misclassification and all the other problems that are visited upon people, I would hope we would end up with tougher standards.
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I appreciate the States trying to do what they are trying to do, but I want to commend the federally-chartered secondary mortgage institutions for attempting to add standards. Obviously, they are part of the problem if they were not to add such standards, and our other programs like the FHA and others. I think especially since these tend to focus around home ownership, it becomes even more important that we look to try to establish standards.
I might also say I think this is part of the same issue with the under-banked and unbanked sort of phenomena that is going on with the check cashing operations. We need to pay closer attention to bring individuals and families into the financial marketplace in a way that they can receive the services and the benefits that we associate as necessary for consumers.
I was especially appreciative of the criteria and precepts that you set down and hope we can work with you on that. I think we are going to need, in my judgment, a concentrated effort to deal with this. I had hoped we could act on legislation this year, at least in the House, on the LaFalce legislation and the Sarbanes legislation as a starting point.
I am pleased to see our colleague from the Senate here, a former Member and good friend, Senator Chuck Schumer, who is taking a keen interest in this matter as well.
Thank you, Mr. Chairman.
Chairman LEACH. I would like to turn to Bob Ney next if I could. Congressman Ney has introduced legislation on the subject and Ms. Schakowsky has introduced legislation on the subject, as well as Mr. LaFalce. All will be reviewed as the day goes on, I am sure.
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Let me recognize Bob Ney at this point.
Mr. NEY. Thank you, Mr. Chairman.
I realize we have witnesses, so I will put my opening statement in the record.
I just wanted to say I do have H.R. 4213. There is a lot of different opinions on these different pieces of legislation. I am sure almost everyone will dislike these for one reason or another. I think this is a good hearing and airing out issues is good for the consumers and good for the country.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Ms. Schakowsky.
Ms. SCHAKOWSKY. Thank you, Mr. Chairman.
I also will be brief in deference to the witnesses and Mr. Schumer.
I do want to thank you for laying out the precepts; Mr. LaFalce, for introducing his bill, of which I am a co-sponsor, and I also have a bill with some differences; and Mr. Ney for his bill. It gives me hope with all of the interest that we will pass legislation.
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I just wanted to note that in Chicago, it is a very big problem. The National Training and Information Center has shown that home foreclosures have doubled since 1993, going from 2,000 to 4,000, and that the subprime loans have increased in that period from just about 3,000 to almost 51,000.
We have a particular problem there, although it is a national problem. The Mayor of the City of Chicago has made this a priority, our State legislature has begun work on this, but my hope is that we can deal with this on a national level. I would hope we would have consideration of my bill as well, H.R. 3901, which has provisions to address this problem.
I would ask that my statement be put in the record.
Chairman LEACH. Without objection the gentlelady's statement and the statements of all Members of the panel will be placed in the record.
Mr. LAFALCE. Would the gentlelady yield?
First of all, I want to commend the gentlelady, she has been a real leader on the issue of predatory lending and I have worked very, very closely with her and look forward to working even more closely in the future as we come to grips with this.
Second, Mr. Vento referred to our first witness, Senator Schumer, as being the Senator from the State of New York. Where I come from, we refer to him as the ''Senator from Upstate New York.''
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[Laughter.]
Mrs. ROUKEMA. Mr. Chairman, I do want to ask unanimous consent to have my opening statement included in the record and particularly to ask unanimous consent, because it has become quite an issue, the question of whether or not Freddie Mae and Freddie Mac have written guidance in terms of predatory loans, I would ask that their standards and guidance written statement be included in the record.
Chairman LEACH. Without objection, so ordered.
Chairman LEACH. Ms. Lee.
Ms. LEE. Let me ask unanimous consent to put my statement in the record also.
Chairman LEACH. Without objection.
Ms. LEE. I want to thank you and our Ranking Member, and Congresswoman Schakowsky for all of your focus and hard work on this issue and for the hearing today.
All of us recognize the fact that in many communities here in this country we do have an economic boom. However, in low-income areas where banks have disappeared, we have seen the emergence of check cashing facilities, and sometimes in California, we have seen banks actually getting into the check cashing business.
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Low-income residents have an opportunity and a right also to access credit, to be able to purchase homes, but they should not be victims to what really amounts to loansharking activities. So, predatory lending is a big issue for those of us who represent especially urban and low-income districts.
I want to thank you on behalf of my constituents and consumers in the country for actually holding this hearing and giving us a chance to really look at how to make sure this stops and how to make sure that low-income residents do have access to reasonable credit mechanisms and vehicles.
Thank you very much.
Chairman LEACH. Mrs. Jones.
Mrs. JONES. Thank you, Mr. Chairman.
I am glad to be able to join with my Ranking Member, Mr. LaFalce, as original co-sponsor in his legislation. I thank you for sponsoring this hearing this morning.
In the City of Cleveland that I represent, we have had the greatest number of housing starts than since the Korean War. It has been a wonderful opportunity for people of all incomes to have housing in our community. We have even had a lot of renovation and backfill in housing.
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My concern, as well as my colleagues, is the whole issue of predatory lending and the senior citizens who are doing reverse mortgages and are not quite sure what it means to have a reverse mortgage. I am pleased to be a part of this hearing and I would ask my statement be admitted to the record as well.
Thank you, Mr. Chairman.
Chairman LEACH. Thank you.
Let me first ask unanimous consent to place the testimony of the following groups into the record: the Mortgage Bankers Association, the National Credit Union Administration, the National Association of State Credit Union Supervisors, the National Association of Federal Credit Unions, the American Land Title Association, and the National Neighborhood Housing Network. Without objection, their statements will be put in the record.
Let me say briefly, before introducing the witnesses, that we will shortly have a vote on the House floor, so it would be my hope to hear from Senator Schumer, then probably proceed to the vote and then we will go to the next panel.
Before introducing Senator Schumer, the Chair has to place a statement of a conflict of interest on the record. That is that my niece has recently become engaged to Mr. Schumer's campaign manager.
[Laughter.]
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Chairman LEACH. It is a matter of some sensitivity in the family, but she is a wondrous young woman. Someday she will, hopefully, become more Republican in her instincts.
I would also say we are always delighted to welcome Chuck. He is a graduate of this committee; he is one of the most distinguished United States Senators.
Please proceed as you see fit.
STATEMENT OF HON. CHARLES E. SCHUMER, A UNITED STATES SENATOR FROM THE STATE OF NEW YORK
Senator SCHUMER. Thank you, Mr. Chairman.
It is great to be back, and I want to thank you for your courtesy and everything else. Yes, we look forward to that marriage, and if it is anything like American politics, it will probably move both sides to the middle. I thank you for that, and thank you for your great work as Chair. As always, you have been fair and even-handed and on top of every issue this committee ought to be on top of, I think. Both sides of the aisle salute you for your stewardship as Chairman of the Banking Committee.
I also want to thank my good friend, John LaFalce, who has been a leader on these issues for a very, very long time. His intelligence and dedication—and I can tell you, as much as I aspire to be a well-known figure in Upstate New York, I am in Western New York in his shadow, and that is a good place for me to be.
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I also want to just say it is so good to see my friend, Bruce Vento, here today and looking well. I thought I heard your voice in the gym this morning. I don't know if that was the case, but I heard that Minnesota Vento and I went around the aisles looking for you just to say hello, and I am glad we found each other here.
I thank all the Members of the committee for their indulgence and to see the committee has expanded, to see there is a Mr. Gonzalez on the committee once again is good news too. In any case, I will be brief, because I know you have the vote, Mr. Chairman, and would ask that my entire statement be entered in the record.
Chairman LEACH. Without objection, that will occur.
Senator SCHUMER. Mr. Chairman, this is a huge problem throughout our country and certainly in my State of New York. The problem of predatory lending has paralleled the increase in subprime lending, as everyone here has noted. Subprime lending is not the same as predatory lending. There are decent subprime lenders, and subprime lending plays an important role in financing mortgages, but while not all subprime lending is predatory, all predatory lending is subprime. While not all predatory lending is in minority neighborhoods, they seem to be the target of the worst loan scams.
I have sat with people who lived by the American dream. They saved their $25 a week for five or ten years, a subway motorman or a clerk in a supermarket. We told them ''play by the rules,'' and finally that great day came when they could have their little piece of the rock, a home. And in swoops a predatory lender, and two years later, they have no money, no home, no dreams. That is a dagger in the heart, not only of that family, but to all of us who believe in the American dream for everybody. So we have to move with alacrity on this subject.
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Let me just point out one of the reasons that we have such predatory lending in minority communities—there are many, and I am just beginning to learn them. I am exploring the role of brokers, which sometimes, because of RESPA, are encouraged to use the predatory or subprime lender rather than the commercial lender; I am looking at credit histories and how Fannie Mae and Freddie Mac could help in that area. One thing that happens—and this is something that is troubling—is a vacuum is created in many communities with commercial lending and that is why the subprimes, and particularly the predatory subprimes, can come in.
We just did a study using HMDA data, a law we all worked to pass, in New York City, and it was incredible. This was talking about conventional lending. A black family with an income of $60,000 was more likely to be turned down for a loan than a white family with $40,000. You went to beautiful middle class, even upper middle class neighborhoods that were primarily African-American, Laurelton, Queens, average income $60,000-$70,000, half their lending was subprime. You go three miles north to Bayside, another neighborhood in Queens, whose income was a little lower, $57,000, but it is all white, and only 9 percent of their lending is subprime. I have been meeting with the leading bankers in New York to try and figure this out, why is it that the vacuum created that allows the subprime and often the predatory to come in?
I am not going to ask that the record have our entire study, but we have a summary of it which is only three pages. We took six neighborhoods in New York City, six black and Latino neighborhoods, and six primarily white neighborhoods of the same income levels, and this pattern was exactly the same in each one. You might be on two different planets in terms of mortgage lending. So that is one issue I think we have to look at in terms of CRA and everything else.
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The second thing we have to do after trying to deal with the vacuum is to look at the relationships in communities. As I mentioned, what is the role of brokers and realtors? Do they steer people to subprime lenders? How can the banks get more trust in communities? We heard a story where an African-American doctor, very high-income level, bought a home in White Plains, which is a well-to-do suburban neighborhood, and his broker referred him to a lender and the lender was subprime. He has a cousin who works for a bank and she said, ''My bank can get you a loan at a much lower rate,'' but he was so afraid that he would be turned down by the bank that he went ahead with the subprime. So there is an issue of establishing trust as well.
Finally, the other thing we have to do is go after the predatory lending practices. I know there is legislation here from a good number of my colleagues from New York, along with my friend and Senator from Maryland—Senator Sarbanes has introduced excellent legislation. I have introduced a bill which has many of the same practices. We can, I believe, thread the needle, Mr. Chairman. We can keep subprime lending and yet go after predatory lending which is through the roof and has been unexplored. I have introduced legislation, as well, which goes a little further, but is the same basic template as the legislation that has been introduced.
I hear the bells ringing and I know today is a very, very busy day in the House, so in conclusion, I would urge the committee to explore three things. One, why a vacuum is created, even in middle-income and upper middle-income minority neighborhoods in terms of mortgage lending? Two, what kinds of relationships exist there, and have existed for a long time, so that even if conventional mortgages are available, they are not being used? Three, going after the predatory lenders who are really the bottom-crawlers—when you hear the stories, it turns your stomach of what they do to people—going after them with a hammer so that we can clean up the subprime lending industry.
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With that abbreviated testimony, I want to thank the committee, not only for the opportunity and the courtesy always extended, but for the great work you are doing in this area which is going to be groundbreaking and is going to help make the American dream much more available to many more Americans, particularly Americans of color.
Chairman LEACH. Thank you, Senator.
We do have a vote on the floor, but if we have time, I have one question from Mr. LaFalce.
Mr. LAFALCE. Senator, I look forward to working with you and Senator Sarbanes on this as we have in the past. One very important question for today.
Senator Moynihan and Mr. Lazio, and Hillary Rodham Clinton have given us a recommendation to vote yes on PNTR, do you want to give any counsel and advice?
Senator SCHUMER. Far be it for me to give such wise Members counsel on such an important issue. I am watching the House very carefully.
Mr. WATT. Mr. Chairman, may I just ask a question of the Chair?
Chairman LEACH. Yes, of course.
Mr. WATT. I don't seem to have Mr. Schumer's testimony and I would dearly like a copy of the study he referred to and to know who did it, if we could get that information.
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Chairman LEACH. Without objection, the summary of the study will be placed in the record. Second, perhaps you could respond now?
Senator SCHUMER. I would like to send every Member of this committee a copy of the entire study we did. My guess is if you did it in Chicago or in smaller communities, like Charlotte——
Mr. WATT. Smaller communities?
Senator SCHUMER. Smaller than Chicago.
Mr. WATT. It is quite obvious Mr. Schumer never knew where Charlotte was and still doesn't know.
[Laughter.]
Senator SCHUMER. Somewhere south of Brooklyn. I know that much.
In any case, my guess is you would find this study would be replicated throughout the country, big communities and even bigger ones.
Chairman LEACH. Chuck, we thank you very much for your testimony.
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The hearing is in recess pending the vote.
[Recess.]
Chairman LEACH. The hearing will come to order.
Our first panel will consist of: Gary Gensler, Under Secretary for Domestic Finance, Department of the Treasury; Bill Apgar, Assistant Secretary for Housing, FHA Commissioner, Department of Housing and Urban Development; Edward Gramlich, Board of Governors of the Federal Reserve System; Ms. Ellen Seidman, Director, Office of Thrift Supervision; John D. Hawke, Jr., Comptroller of the Currency, Office of the Comptroller of the Currency; Donna Tanoue, Chairman, Federal Deposit Insurance Corporation; David Medine, Associate Director, Division of Financial Practices, Federal Trade Commission; Thomas Curry, Commissioner of Banks, Commonwealth of Massachusetts on behalf of the Conference of State Bank Supervisors; and Andrew D. Celli, Bureau Chief for Civil Rights, Office of the Attorney General for the State of New York.
This is an extraordinarily large panel and the Chair would ask unanimous consent that all statements will be placed in the record in full and without objection, so ordered. Each of you are entitled to proceed as you see fit.
Let me begin with Secretary Gensler. Welcome back to the committee. You have a wonderful reputation here. Please proceed.
STATEMENT OF HON. GARY GENSLER, UNDER SECRETARY FOR DOMESTIC FINANCE, DEPARTMENT OF THE TREASURY
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Mr. GENSLER. Mr. Chairman, I will try to be brief and summarize my remarks.
It is good to be here with this committee and all of you, Representative LaFalce and all the Members.
I appreciate the opportunity to talk about this critical issue and how to contain and combat the prevalence of abusive lending practices and predatory lending.
At Treasury, we believe this is one of the most important issues that we can work on. Our mission is to ensure all Americans can participate in this great economic advance that our Nation has been participating in.
That is why Secretary Summers, working with Secretary Cuomo, has convened a Joint Task Force on Predatory Lending. We are conducting field hearings, we have had four and will have one more this month. The hearings will culminate with a report to Congress, not only on the practices of predatory lending, but with a specific plan and recommendations on behalf of the Administration on how best to combat these abusive practices.
These practices, I would say, hurt not only individuals and families, but whole communities, threaten the economy and threaten to undo enormous progress that we have made in the past several years.
Before I talk about some of these abuses, I just wanted to say a few words about the subprime market that I know you will hear much about today.
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Subprime lending, which is a commonly used term for lending to individuals who have either impaired credit or have not been a part of the credit market yet, tends to be primarily for debt consolidation—70 percent of subprime lending is for consumer credit card consolidation—and borrowing against a home.
Subprime lending generally is characterized by higher risk, lower loan amounts, higher loan origination costs and faster prepayments, meaning people keep these loans out for a shorter period than prime loans. As a consequence of this, they tend to have higher fees and costs, but there are also predatory practices that lead to yet even higher costs.
Since Congress last looked at this in a serious way and passed the HOEPA laws in 1994, subprime lending has grown in a five-year period tenfold and is now a very large market at $370 billion of subprime lending in aggregate.
While the large increase of subprime lending has expanded access to credit for many borrowers, abusive practices have also grown. In our public forums, we have found a number of trends. I will just highlight some of these and the testimony has more detail.
One area is ''loan flipping.'' This is the practice of repeated refinancing, which has the unfortunate consequence of stripping equity out of an individual's home.
Two is excessive fees. Sometimes these excessive fees pack in unneeded services to the individual, such as single premium credit life insurance. It is often rolled into the loan and the individual doesn't even understand the fees.
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Three is the prevalence of asset-based lending, where there is not enough focus on an individual's ability to repay from either their income or other assets.
Four is outright fraud. I am sorry to say there is a great prevalence there. In my hometown of Baltimore, we had a hearing last week. As one example, there is a particularly pernicious form of fraud called ''asset flipping,'' where a local broker or home improvement contractor will actually buy a home, do a little spit and polish with a paint job, get a fraudulent appraisal, double the price—or sometimes more—and then package it all together and sell the home. I am not talking about one or two examples, but in Baltimore, of hundreds of examples of this that are well documented. HUD has held a series of hearings on this and the FHA is actually taking action.
These patterns have emerged for several reasons. First, certain actors prey on the most vulnerable in our society, whether the elderly, recent immigrants, minorities or individuals of lower income and less education.
Second, borrowers in these markets often have limited access to mainstream financial services. This leads to two things, as the Senator said earlier. Some borrowers who really would qualify for prime loans—we estimate anywhere between 15 and 35 percent of the subprime market could qualify for prime and cannot get that prime loan. Second, the rate and term competition is limited. Subprime lenders don't tend to compete as much on price.
The third theme, beyond preying on vulnerable populations, beyond the limited access to mainstream financial services, is that abusive practices tend to be coupled with high-pressure sales tactics, whether by a mortgage broker, a home improvement contractor, sometimes a lender themselves in the local community.
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In terms of where HUD and Treasury are going with this report, we plan to have a report for Congress next month, but there are certain areas that we wish to highlight. Let me name four areas very briefly.
First is consumer financial literacy, consumer education, clear disclosure of the possibility of reforms on the various laws, RESPA and the others and better consumer counseling.
Second is sales practices. While enhanced consumer literacy is a start, we must recognize it is not enough. In terms of sales practices, unscrupulous actors in this market are still engaging in deceptive and fraudulent practices and they victimize the most vulnerable amongst us. We are looking very closely at this and also are considering how to encourage good sales practices in these markets.
Third, because we believe that literacy and sales practices are not enough, we are also looking very closely at specific abusive practices, such as the prevalence of single premium credit life insurance or balloon payments, to name two as an example.
Lastly, we are looking specifically at market structure, how to bring more competition into this marketplace, not only amongst the subprime lenders, but all the way through the chain and looking from the primary market to what is called the secondary market as well.
In conclusion, as we work with HUD to finalize our report. We hope to develop very specific recommendations that will appropriately balance preventing these abusive practices, which really have no place in our society, with the important promotion of access to capital to all Americans to participate in the great economic success of our Nation.
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Thank you.
Chairman LEACH. Thank you very much, Mr. Gensler.
Mr. Apgar.
STATEMENT OF HON. WILLIAM APGAR, ASSISTANT SECRETARY FOR HOUSING, FHA COMMISSIONER, DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
Mr. APGAR. On behalf of HUD Secretary Andrew Cuomo, I want to thank you for the opportunity to testify today on what HUD believes to be the widespread abusive lending practices commonly termed ''predatory lending.'' While abusive practices unfortunately occur in all segments of the mortgage market, my testimony focuses today on the subprime market.
While we have heard that the rapid growth of subprime lending has many positive features, unfortunately predatory lending threatens to undermine all that is good about subprime lending. Recognizing these growing problems, HUD Secretary Andrew Cuomo joined forces with Treasury Secretary Larry Summers to form a HUD Task Force, hold hearings and develop a series of recommendations. I co-chair the task force at HUD with my colleague, Gail Laster, our General Counsel.
At each forum, we have heard from the victims of predatory lending. More powerful than statistics or analysis, these victims tell us what the problem is. In California, we heard a story of a 62-year-old woman who owned her house dead free, that was until she signed up for a $30,000 subprime reverse mortgage loan. The initial loan terms looked good, but unbeknownst to her, the method of calculating the interest rate would change after four years and the lender would obtain a 55 percent equity stake in her home. When she sold her home six years later, the lender took $126,000, more than half the equity in her home. Remember, this was for a $30,000 loan.
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In Atlanta, we heard from a 70-year-old African-American woman who is about to lose her home to the practice of loan flipping that Gary Gensler described. In 1989, this woman had $40,000 in equity. Today, after a series of costly refinances, she is burdened with a $97,000 mortgage that she cannot pay and is about to lose her home.
We also heard from a woman who wanted to finance the purchase of a $1,500 gas heating system. Rather than getting appropriate consumer credit, a mortgage broker convinced her to refinance the $26,000 mortgage she had on her home into a new $33,000 mortgage with high interest rates and excessive fees. She is struggling to meet the payments on that loan.
These are just some examples of the predatory practices that were identified in the recent HUD/Fed report on RESPA, TILA and other matters. As detailed in the HUD/Fed report, predatory practices include charging illegitimate fees, employing bait-and-switch tactics, aggressive sales solicitation, targeting low-income, minority and elderly homeowners and racial steering to high-rate lenders and home improvement scams.
Admittedly, it is difficult to get detailed information on the current extent of each of these practices, but there can be little doubt that these practices are on the rise. This is the consistent report of State consumer affairs organizations, housing counselling agencies and legal services agencies. When we go to a town for one of our forums, people say they are now overwhelmed with folks coming in who are victims of these predatory practices.
The most dramatic evidence of the growth of predatory practices is the wave of foreclosures that is now coming out of the subprime market. These foreclosures, as Secretary Gary Gensler mentioned, not only ruin the financial futures of families, they threaten to destabilize entire communities.
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You will hear testimony today from Gail Cincotta. Her group documented that foreclosures on subprime mortgages rose dramatically in Chicago from 1993 to 1998. In Atlanta, we heard the same story. Between 1996 and 1999, overall foreclosures rose by 7 percent. Foreclosures by subprime lenders grew by 232 percent. Abt Associates, who did that study, also found that subprime's share of foreclosures is the highest in the lower income and predominantly minority communities.
The HUD report last week targeting Baltimore area issues identified the same pattern. Their subprime loans made up 33 percent of the 1998 market share for loans and loan communities. By early 2000, subprime lenders accounted for 50 percent of the foreclosures in these areas. Moreover, many of the subprime loans were in foreclosure only months after they originated. In Baltimore, on average, subprime foreclosures occurred less than two years after the loan was originated.
These local studies mirror a national report that you will hear about this afternoon from Cathy Lesser Mansfield, who will testify on the explosion of foreclosures coming out of subprime lending across the country. Now is the time for action. The foreclosure data shows the tremendous cost imposed by predatory practices.
At HUD, we are working on a task force formed at the request of Senator Barbara Mikulski. Last week we announced a series of reforms to make sure that subprime lending did not gain a foothold in the FHA programs.
Our work in Baltimore and in the public forums with Treasury have underscored for us the urgency with which we must act.
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I would like to highlight eight areas for your consideration. First and foremost, we need better information on high-cost lending. To me it is simply unacceptable that Congress and this committee and others charged with the oversight of the Nation's housing finance system, and the public do not have readily available data on the extent of high cost lending in our communities.
As the President stated last year, we also need to extend HOEPA protections to cover a larger share of high-cost loans. Congress could consider restricting certain loan features strongly associated with abusive lending, including single premium life insurance.
We must improve consumer protection by increasing enforcement against fraudulent loan practices.
Fifth, we must review whether creditors making high cost loans should be required to take into account the consumer's ability to repay. Setting the consumer up for a quick foreclosure has no place in today's marketplace.
The task force is also looking at how best to provide borrowers more accurate and meaningful disclosures. We are taking a careful look at the role of secondary markets in purchasing and securitizing predatory loans.
Finally, we need to expand consumer education. This year, the Administration requested $24 million for counseling and Congress should fully fund this request.
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These are just some of the recommendations that will be forthcoming from the HUD/Treasury Task Force and I look forward to submitting the complete report to the Congress in the middle of June.
Chairman LEACH. The hearing will recess briefly.
[Recess.]
Chairman LEACH. I apologize. A lady in the audience needed some medical attention and the staff is ensuring that she gets it.
Please proceed.
Mr. APGAR. I have completed my testimony.
Chairman LEACH. Thank you, Mr. Secretary.
Governor Gramlich.
STATEMENT OF HON. EDWARD M. GRAMLICH, MEMBER, BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. GRAMLICH. Our testimony includes a lot of the information that is also in the other testimonies on what predatory lending is and how difficult it is to define. In the interest of time, I will pass over that and just go right to the part of the testimony that says what the Fed is doing about the issue.
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Let me start with the report that Mr. Apgar just referred to that we made to the Congress in July 1998. The Board and HUD submitted a report to the Congress on the issue of how certain lending and housing laws might be reformed. This report included a detailed analysis of the problem of abusive practices in mortgage lending and we had several recommendations in that report. We have attached it to our testimony.
The report noted that any regulatory scheme involves tradeoffs. Overly broad rules could unnecessarily burden the entire home equity credit industry in an effort to regulate the minority of unethical or dishonest players. Any legislation should try to focus on abusive practices without interfering with the legitimate credit transactions. If I may say, that is the trick in this. This is a difficult issue for that reason.
Given the wide range of practices that are included in the notion of what is ''predatory,'' a multifaceted approach is likely to be the most effective policy procedure. The Board has convened a nine agency working group that has been referred to by various speakers and includes most of the agencies sitting here today.
The aims of the group are to tighten enforcement of existing statutes and to establish a coordinated approach to predatory practices across all the nine agencies.
The Board is also required to hold periodic hearings on the effectiveness of HOEPA in curbing abusive lending. We last did so in 1997 and that formed the basis of our 1998 report. We are planning another round of hearings this year and we are actually leapfrogging on the hearings that have already been held by Treasury and HUD to try not to go over well-trodden ground. We are planning these new hearings and we are enlisting our Consumer Advisory Council in forming the specific questions and preparing for specific recommendations.
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We are also pursuing other strategies. Trade associations for subprime lenders and mortgage brokers have been actively engaged in developing self-regulatory guidelines. Secondary market participants such as Fannie Mae and Freddie Mac are developing their strategies for ensuring that they do not finance predatory loans.
Finally, a big problem in this—and we have all stressed this in our testimony, but I would like to end on this note—that consumer education is very important. Community outreach efforts including many of our own, consumer education, counseling and all of these types of things should be used to increase consumer understanding of their credit options and to make sure they don't get themselves involved in credit transactions that become very unfavorable to them.
Thank you very much.
Chairman LEACH. Thank you very much.
Ms. Seidman.
STATEMENT OF HON. ELLEN SEIDMAN, DIRECTOR, OFFICE OF THRIFT SUPERVISION
Ms. SEIDMAN. Good morning.
Thank you for having this hearing and for the forward-looking precepts that you, Mr. Chairman, have enunciated this morning and for the thoughtful legislation that Members of this committee have introduced.
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Predatory lending is an issue of serious concern to OTS, not only from a consumer perspective, but also because both directly and indirectly, it can have a negative impact on safety and soundness.
I appreciate the opportunity to add our voice to those raising the alarm about predatory lending. I will skip over the description of what constitutes predatory lending. Our best efforts at it are in our testimony and there has already been a lot of discussion.
Let me talk to you about what OTS is doing. To learn more about predatory mortgage lending practices and how to address this problem, on April 5, we published an advance notice of proposed rulemaking. The ANPR sets forth six goals that we will balance in considering whether changes to our lending regulations are appropriate.
These include encouraging safe, sound and innovative lending activities; averting lending that preys upon consumer lack of knowledge or limited options; and enabling thrifts to compete responsibly with other lenders. We hope you will have an opportunity to review the ANPR and we welcome your comments and suggestions.
We will share the information we gather from the ANPR with our fellow regulators and with you.
We have identified three interrelated approaches to combat predatory lending, what I call the three ''E's'': examination for enforcement of existing laws and regulations; encouragement of responsible subprime lending; and education of consumers and investors.
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For Federal banking agencies, ensuring enforcement of existing laws that govern predatory practices begins with fulfilling our supervisory role. Consumer compliance exams are a standard part of OTS oversight. Examiners follow interagency procedures to ascertain an institution's record of compliance with Federal consumer protection laws and regulations.
Our approach emphasizes the need for institutions to establish and implement proper policies and maintain internal controls appropriate to their particular business operations and operating risks. This approach has a sound track record.
When an examination identifies management deficiencies that allow illegal predatory lending practices to develop, and I must say we have seen very little of this, but we have seen some, less in the mortgage area than the credit card area, OTS can take action to prevent or remedy a problem.
Some believe that the problem of predatory lending can be sufficiently controlled by beefing up disclosures. As demonstrated in my written testimony, while enhanced disclosures may be useful, we cannot rely on them. Those targeted by predatory lenders often do not have the background to understand the impact of technical and sophisticated loan terms. Pressure tactics that dissuade borrowers from taking the time to ask for help from an independent source are part and parcel of predatory practices.
While enforcement is a piece of the solution, unfortunately it is generally after the fact and limited in scope. At best, it provides restitution, not restoration of the home ownership, and functions as a preemptive warning to others.
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A systemic approach requires attention to the other two ''E's'': encouragement of responsible subprime lending and education of consumers and investors.
Perhaps the best way to fight predatory lending is in the marketplace itself. An environment that encourages responsible competition in underserved markets will weed out predatory lenders. One of the reasons these lenders are successful is the absence of competition in markets where they operate.
Many retailers have discovered that historically unattractive markets have been undervalued in terms of business opportunity and overestimated in terms of risk. Retailers are opening profitable businesses in neighborhoods like Harlem, South Central Los Angeles and Chicago's Little Village. The opportunities only seem to be expanding.
Seeking responsibly priced business with responsible terms in these underserved markets is a matter of enlightened self-interest for depository institutions. We are encouraging thrifts to look hard at their changing marketplace and to think about their future strategically. Institutions must figure out who their customers are today, who they will be tomorrow, and how to deliver the products and services they need to meet this challenge.
The third element of our solution is education. Providing consumers information about their options for obtaining credit from responsible lenders, and about the abuses of those who prey on the vulnerable, can be a strong bulwark against the predatory lender.
Community-based organizations play a critical role in this area. Together with financial institutions, they can teach not only perspective homeowners, but also those who have owned their own homes for years, often free and clear, how to avoid potential home equity scams.
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Education can also help investors to be more discerning in their purchase of securities backed by high-cost loans. The activities of large predatory lenders will quickly shrivel if they are denied financing. Participants in the secondary market, in particular, Fannie and Freddie, are beginning to recognize that predatory loans are not good business, not simply because they are unethical, but because they can damage reputations and hurt stock prices.
It is critical, however, not to pursue this in a manner that threatens the viability of responsible subprime markets.
The American dream of home ownership is at the heart of the progress we have made as a Nation toward the goal of giving all citizens the opportunity to earn their share of our prosperity. During the first quarter of this year, we achieved a new record of 67 percent of all families owning their homes.
In the last few years, the pride we have all taken in the steady increase in home ownership has been tempered by stories about some lenders who have preyed on homeowners who are least-able to defend themselves. Let us look back on this year as the turning point in the fight against predatory lending, knowing that future home ownership records will be even more impressive, because fewer new and existing homeowners will be at risk of losing what they have always dreamed of.
Thank you.
Chairman LEACH. Thank you, Ms. Seidman.
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Our next witness is the Comptroller of the Currency, John Hawke. Please proceed.
STATEMENT OF HON. JOHN D. HAWKE, JR., COMPTROLLER OF THE CURRENCY, OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. HAWKE. Mr. Chairman, Ranking Member LaFalce, and Members of the committee, I appreciate this opportunity to appear before you today to testify on issues regarding predatory lending practices in the consumer credit industry.
A number of witnesses have made the point that a distinction needs to be drawn between subprime lending and subprime lending that carries abusive practices. I will not go over that ground again.
I will simply say that those lenders who engage in abusive practices undermine the objectives of longstanding national social and economic policies. In particular, the promotion of home ownership and the corresponding benefits of stronger neighborhoods and the building of wealth for a broader spectrum of American families. This committee's focus on abusive lending practices is therefore of significant national importance.
The OCC is fully prepared to use its authority to combat abusive, unfair and deceptive lending practices if they are engaged in by national banks. We will employ our supervisory powers through our safety and soundness, fair lending and consumer compliance examinations, our licensing and chartering process, and individual enforcement actions to deter lending practices that can be characterized as abusive or predatory.
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One common characteristic of predatory lending that we can address through our supervisory process is the practice of making home equity loans under circumstances where the lender cannot reasonably expect repayment other than through a foreclosure sale of the borrower's home. This is a classic type of unsafe and unsound lending.
To help address this problem, we plan to issue guidance that directs examiners to carefully review lending policies and practices to ensure that they would not permit loans to be made without a reasonable expectation of repayment without resort to the collateral. If the review indicates a heightened risk of problems in this area, our guidance will direct examiners to take appropriate action. Loans predicated on home equity where the borrower does not demonstrate the capacity to repay the loan as structured would be adversely classified, and further accrual of interest on the loan may be disallowed.
Through our supervisory process, we can also address the adverse fair lending implications of predatory loans. In the near future, the OCC will be issuing additional guidance emphasizing that abusive lending practices can involve unlawful discrimination. Our examiners will be directed to look at factors associated with abusive lending practices that may indicate an increased risk of illegal discrimination. This guidance will help set the scope and focus for our fair lending examinations and may lead to targeted fair lending investigations.
On a related issue, a significant concern has been raised about the appropriate consideration under the Community Reinvestment Act of loans—both originations and purchases—that can be characterized as abusive or predatory. Certainly, it is fair to ask how an institution can be helping to meet the credit needs of its entire community if it engages in lending that is designed to strip equity from low- or moderate-income homeowners. We need to address how loans with these characteristics can be identified in a CRA exam. We also need to address the CRA implications of such loans, specifically, whether they should receive no, or even negative, CRA credit. This is a subject that needs to be addressed on an interagency basis by all of the agencies having CRA supervisory responsibilities.
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Because of the limitations of the current legal framework, we believe it is important for Congress to address these issues. The bills that are now before the committee would fill gaps in the current law and address many of the concerns that have been raised, and we believe they are worthy of prompt and serious consideration.
It is important to ensure that any reform be carefully crafted to avoid unintended consequences. While we clearly need to address real abuses that exist, particularly in connection with home-secured loans, we also need to preserve and encourage consumer access to credit, meaningful consumer choice, and competition in the provision of financial services to low- and moderate-income families. Determining how to draw the line between predatory and legitimate credit practices in a way that will both combat abuses and advance these other objectives is a major challenge. I commend the committee for beginning the debate on these important concerns.
Thank you for allowing me this opportunity to present the OCC's views, and I will be happy to take any questions the committee may have.
Chairman LEACH. Thank you.
Ms. Tanoue.
STATEMENT OF HON. DONNA TANOUE, CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION
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Ms. TANOUE. As your letter of invitation and the various legislative proposals put forward by the Members of this committee suggest, abusive lending practices in the home mortgage industry do exist. Unfortunately, they are often directed at low-income, elderly and minority borrowers.
While the FDIC recognizes that predatory lending practices raise a number of consumer and safety and soundness concerns, we believe that federally-insured institutions have a good record of avoiding involvement in such activities.
Nonetheless, the FDIC is concerned that insured institutions, like other institutional investors, may be involved in the predatory loan market in an indirect fashion. The FDIC is currently addressing the issue of predatory lending in a number of ways.
First, we are writing guidance for insured institutions describing effective practices to keep them from inadvertently acquiring loans that have predatory features or acquiring securities backed by such loans.
Second, we will work on an interagency basis to revise CRA exam practices so that a bank's purchase of loans or securities backed by such loans that have predatory terms or features cannot be used to improve a bank's CRA rating.
Third, we are giving positive CRA consideration to bank-sponsored programs that combat predatory lending by fostering financial literacy.
Fourth, we are working with the other agencies to review certain consumer protection laws and regulations to determine whether changes may be warranted.
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Fifth, the FDIC also is working on a financial literacy campaign to educate consumers about the risks of predatory lending.
Sixth, and finally, we are holding several public forums in which community organizations, Government officials and members of the financial sector can meet and explore effective means to protect consumers. We held one such meeting in Boston yesterday, hearing from twenty-two panelists.
Interestingly, Nick Retsinas, Harvard University's Director of the Joint Center for Housing Studies, someone familiar to this committee, told us about a novel type of predatory loan that is showing up—cash leasing. Intended to circumvent State usury laws, predatory lenders lease cash at 30 percent interest rates for fifteen days.
We heard from the panelists that predatory lending is a complex problem not susceptible to a quick and easy fix. It will require a multifaceted approach involving many institutions and organizations individually and collectively.
It has become increasingly clear that the only way to really fight predatory lending is to take the incentives away, to do this from all directions using legislation, regulation, effective and vigilant enforcement and perhaps most importantly, public education. Also, mainstream financial institutions must make a greater effort to serve markets that predatory lenders target.
In conclusion, I would say that we at the FDIC look forward to working with this committee and all of our regulatory colleagues in combating predatory practices.
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Thank you.
Chairman LEACH. Thank you.
Mr. Medine.
STATEMENT OF DAVID MEDINE, ASSOCIATE DIRECTOR, DIVISION OF FINANCIAL PRACTICES, FEDERAL TRADE COMMISSION
Mr. MEDINE. Mr. Chairman, Members of the committee, I appreciate the opportunity to appear before you today on behalf of the Federal Trade Commission to discuss the serious problem of abusive lending practices and the subprime lending industry, commonly known as ''predatory lending.''
The Federal Trade Commission is working in a number of ways to address abuses in the subprime market. First, the Commission has made halting subprime lenders who engage in predatory lending practices a top enforcement priority. This past March, the Commission announced a settlement, along with the Department of Justice and the Department of Housing and Urban Development, with Delta Funding Corporation, a national subprime mortgage lender.
The Commission alleged that Delta extended high-cost loans to borrowers based on the borrower's collateral, rather than considering the borrower's ability to make the scheduled payments. The settlement provides for nationwide injunctive relief.
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Last year, as part of Operation Home Inequity, the Commission settled cases with seven subprime mortgage lenders for violations of the Home Ownership and Equity Protection Act, the Truth in Lending Act, and Section 5 of the FTC Act.
The HOEPA violations included failure to provide required disclosures, asset-based lending and use of prohibited terms—such as improper use of balloon payments, increased interest rates after default and prohibited prepayment penalties. The Commission obtained substantial remedies, including redress of over half-a-million dollars and in the case of one lender, a ban against any future involvement with high-cost loans secured by consumers' homes.
Also last year, the Commission settled charges that a major mortgage lender, Fleet Finance, failed to provide accurate and timely disclosure of credit terms of home equity loans and failed to provide consumers with information about their right to cancel their credit transactions. The settlement provided for $1.3 million in consumer redress as well as injunctive relief.
In January 1998, the Commission filed a complaint in Federal District Court against Capital City Mortgage Corporation, a Washington, DC. area mortgage lender and its owner, alleging numerous violations of a number of Federal laws resulting in serious injury to borrowers, including the loss of their homes. Many borrowers allegedly faced foreclosures on their properties after which the company would buy the properties at auction at prices much lower than the appraised value of the properties. That case is still pending in court.
In addition to its enforcement activities, the Federal Trade Commission also has an aggressive consumer education program and has published a series of free publications specifically for homeowners and potential home buyers in order to help consumers avoid predatory lending practices.
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While some of the predatory lending practices we have seen can be addressed through current laws and regulations, additional statutory changes would enhance consumer protection in this area. The Commission offers four recommendations.
First, the Commission urges the committee to consider expansion of HOEPA to prohibit loan ''packing'' through the financing of single premium or lump sum credit insurance premiums, as well as other loan ''extras,'' in loans covered by HOEPA. A single premium scheme that commits consumers up-front to long-term credit insurance precludes them from ever making a separate decision about insurance, adding significant cost to the loan.
We also recommend that lump sum finance credit insurance premiums and other extras count toward HOEPA's fee-based trigger so that predatory lenders will not be able to avoid HOEPA's requirements simply by shifting the cost of the loan to credit insurance.
We also recommend that HOEPA provide the Commission and other law enforcement agencies with the power to impose civil penalties for HOEPA violations. In the absence of a specific civil penalty provision under HOEPA, damages and law enforcement actions may be viewed as simply a cost of doing business by predatory lenders.
Finally, we recommend that the Congress prohibit mandatory arbitration clauses in loans covered by HOEPA. Mandatory arbitration agreements undermine consumers' ability to exercise statutory rights that protect consumers in the credit marketplace.
At this time, the Commission recommends only these changes to HOEPA, although it is considering other possibilities and examining predatory lending generally and may have additional recommendations in the future, including imposing individual liability on lenders subject to HOEPA.
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Using its enforcement authority, the Commission continues to work to protect consumers from predatory lending abuses. In addition, the Commission supports the expansion of HOEPA protections to enhance consumer protections against predatory lending.
Thank you.
Chairman LEACH. Thank you.
Our next witness is Mr. Curry.
STATEMENT OF HON. THOMAS J. CURRY, COMMISSIONER OF BANKS, COMMONWEALTH OF MASSACHUSETTS, ON BEHALF OF THE CONFERENCE OF STATE BANK SUPERVISORS
Mr. CURRY. Thank you for the opportunity to testify today on high-cost lending and predatory practices associated with high-cost loans.
I am Thomas J. Curry, Commissioner of Banks for the Commonwealth of Massachusetts and Chairman of the Conference of State Bank Supervisors. Today I am testifying on behalf of CSBS.
As State regulators, we are keenly aware of the elements that make this issue so complex. These include the clear benefit to traditionally underserved consumers from the wider availability of credit through acceptable forums of subprime lending.
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The abusive predatory practices that have at times been associated with such lending and the frustrations that States that pass laws and enact regulations to protect consumers, but which sometimes hinder their efforts by Federal law and preemptive interpretation.
I can assure you that the issue of predatory lending is at the top of the agenda of many State legislatures and State regulatory agencies. However, I must add that all legislators and regulators, both State and Federal, should consider whether enforcement of existing laws is adequate before considering additional new laws or regulations to the books.
As I have detailed in our written testimony, many States have responded through statute or regulation to protect consumers from predatory practices. Recently, States such as North Carolina through statute and New York through regulation have targeted responses aimed at emerging predatory practices. New York also has been unique in its focus on preventing the securitization of predatory loans. The New York State Banking Department is also currently working with the SEC on guidelines for the securitization of these loans.
States have also focused on enforcement of existing laws to address abusive lending tactics. In my own State, we have aggressively reviewed the actions of subprime lenders and moved against those entities deemed to be engaged in predatory lending. Recently, my office has worked closely with our Attorney General's office on two egregious cases arising from our license lender examination program.
Washington State's Department of Financial Institutions also recently took a lead in investigating and then revoking the license of a major mortgage lender engaged in predatory lending.
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A number of States such as New Jersey and Virginia have expressed considerable frustration in their ability to enforce their State laws because of Federal preemption. It has been perhaps the unintended consequence of Federal preemption under the Alternative Markets Transactions Parity Act that has made it difficult for many States to offer the protection that their consumers demand. This result was illustrated by the February 7 General Accounting Office report to you, Mr. Chairman, on the Parity Act and OTS and OCC preemption.
What we have concluded from this report is that preemption is a multifaceted issue requiring a deeper level of communication between Federal and State regulators than we have had in the past. Federal legislation and regulation must consider the consequences of preemption and recognize the important role States play in the area of consumer protection.
We acknowledge that preemption may at times be necessary to facilitate a modern banking system, but preemption must be held to a high standard. It must be used under the principle that it is for the benefit of both businesses and consumers. That is why Federal preemption, we argue, must be done in the manner that clearly spells out both its necessity and its benefits.
The States are the laboratory for innovation and for developing the best practices and products and services and consumer protections. States are often the first to see trends and problems and the first to develop safeguards that both protect consumers and allow depository institutions to thrive. Federal polices and procedures should support and not hinder the States' role.
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Again, thank you for the opportunity to testify to the committee on behalf of CSBS and I look forward to responding to any questions you may have.
Chairman LEACH. Mr. Celli.
STATEMENT OF ANDREW G. CELLI, JR., CHIEF OF CIVIL RIGHTS BUREAU, OFFICE OF THE ATTORNEY GENERAL, STATE OF NEW YORK
Mr. CELLI. I would like to thank everyone for inviting the New York Attorney General's Office. My name is Andrew Celli and I am Chief of the Civil Rights Bureau in that office.
As you may know, the New York Attorney General has been investigating the subprime industry at both the lender and the broker levels for more than a year. In September 1999, our office entered into a detailed Federal court consent decree with a major subprime lender, Delta Funding Corporation. Along with the New York State Department of Banking, and with the assistance of a nationally known accounting firm, we continue to monitor Delta's compliance with that consent decree.
This experience of investigating and litigating against, negotiating with and monitoring major subprime lenders has given our office some insights into the nature of predatory lending in New York and the principles and practices that work best to combat such abuses. Today, I want to talk about some of the issues we found in our investigation and continuous monitoring.
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First, a principal point, good subprime loans can be an important mechanism for bringing credit to underserved communities and borrowers, but not all credit is good credit, even in areas where credit is scarce. Indeed, in this market, credit that is inappropriate to the borrower or extended on unfair terms is what predatory lending is all about.
Predatory lending practices occur when subprime lenders, and mortgage brokers with whom they deal, exploit the vulnerability of higher risk borrowers, as well as the unavailability of other forms of credit, to take unconscionable profits. I will skip over all the details, because you have heard so much from the Federal regulators and move on to what we found in our investigation and what we are trying to do.
Today, I want to discuss three practices that, in my view, are at the core of the problem with the subprime industry. First is the extension of credit without regard to the borrower's ability to repay; second, the practice of pressuring borrowers to refinance loans simply for the purpose of churning additional fees, even when a refinancing puts the borrower in a worse financial position than he or she had been before; and third, the charging of excessive broker fees.
Turning to the issue of extending credit without regard to ability to repay, this is a practice sometimes referred to as asset-based lending. Homeowners—often those with little or no financial experience or sophistication, and in New York, too often members of racial or ethnic minority groups—are often pressured into taking subprime mortgage loans which they clearly have no ability to repay.
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For example, some owners are pressured to take out loans with monthly payments so high that they are left with less than $100 every month to meet their other expenses. Needless to say in these kinds of cases, which we saw repeatedly in our investigation of Delta Funding, default and foreclosure become all but certain.
As this committee knows, the Home Ownership and Protection Act of 1994, HOEPA, forbids lenders from extending loans without regard to the borrower's ability to repay. HOEPA's prohibition covers so-called ''high cost'' loans, that is, loans on which the points and fees exceed 8 percent of the total. As important as this prohibition is, its powers in real world relevance are diminishing.
We found that the number of HOEPA-covered loans is shrinking as lenders evade the HOEPA definition by bringing in loans under the statutory definition of ''high cost.'' We also found that HOEPA's standard of ''without regard to ability to repay'' is sufficiently vague that enforcing it in court raises real challenges.
Our decree, the Delta decree, deals with these issues by applying strict residual income requirements to all Delta loans, not just HOEPA loans. Residual income requirements are designed to ensure that borrowers have the financial wherewithal both to make the payments on the proposed loan and to pay for life's essentials—food, clothing, utilities and so on.
Before a Delta loan can be approved, Delta underwriters must demonstrate that after accounting for the expected monthly payment, the proposed borrower still has a certain absolute amount of income left over to cover other expenses. Residual income—which is pegged to the cost of living in a relevant geographic area and the number of persons within the household—is a fixed dollar amount, not a percentage.
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To be sure, residual income requirements mean that some potential borrowers will not get loans, but our experience was that such consumers ought not get loans, because in all likelihood they will not be able to make their payments on a sustained basis.
Turning to the issue of ''flipping.'' Flipping occurs when homeowners are pressured to refinance their existing loans and thus pay a new round of fees, even though the new loan provides virtually no material benefit. When flipping occurs, the new loan leaves the borrower worse off than she had been under the previous loan as the new fees generated for the lender and the broker create a greater total indebtedness and higher monthly payments.
For example, in one case, the borrower with a $75,000 mortgage was pressured into refinancing that mortgage with a new $90,000 loan. The additional $15,000 all went to cover fees to the lender and the broker. The borrower did not receive a single penny.
The Delta decree effectively prevents this by requiring that whenever a loan is refinanced, the borrower's monthly payments may not increase by more than 2.5 percent of the new funds which the borrower obtained from the loan. Because the lender cannot charge the commensurate increase in overall monthly payments that would ordinarily result from paying interest on new extra fees, the 2.5 percent rule bars pure flipping and creates a strong disincentive to make loans that provide only marginal benefits to the borrower.
Finally, the third practice involves excessive broker fees. Many mortgage brokers in the subprime industry receive fees up to 10 percent of the total loan. Other brokers inflate their fees through what is known as a ''yield spread premium.'' I am sure the committee is very familiar with this.
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A yield spread premium is paid by the lender to the broker whenever the broker convinces a borrower to take out a loan at an interest rate above ''par,'' that is, at a rate higher than the rate the lender would otherwise quote to a comparable borrower.
Our investigation uncovered standing agreements between brokers and lenders, by which lenders automatically approved borrowers for higher-than-par interest rates—without telling the borrower—just so that broker can receive his yield spread premium.
There are two changes to the law that we think would tend to eliminate these problems. First, given the grave abuse of yield spread premiums, we have supported State proposals to prohibit them entirely. In the alternative, we have supported a rule that permits lenders to pay and brokers to collect yield spread premiums only where they can show that such yield spreads result in a lower, up-front broker fee to the borrower. In other words, the lender must show that the borrower received a real benefit in return for the higher interest rate.
In addition, we have advocated an outright cap on fees in the subprime market. In the regular prime market, a mortgage broker's fee of 1 or 2 percent is standard. Notably, even when Delta originates a loan and does the broker's work, it only charges a 2 percent fee for this work. Our investigation revealed no reason for allowing significantly higher broker fees when dealing with the subprime market and therefore, we advocate a 3 percent overall cap on broker fees and limiting the definition of what goes into a broker fee or expanding the definition so that it is a true 3 percent and not a false 3 percent.
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Chairman LEACH. Mr. Celli, you have gone over quite a bit. Can you summarize?
Mr. CELLI. In summary, these are proposals we have implemented. I am happy to be here and I am prepared to answer your questions.
Chairman LEACH. Thank you very much.
Let me make a couple of observations. One, even though the majority of problems aren't federally-insured institutions, we have some difference of judgment here. Mr. Curry, on behalf of the Conference of State Bank Supervisors, in his statement has indicated that according to data at the CSBS, as well as the General Accounting Office study, the Comptroller's Office and the Office of Thrift Supervision, two arms of the Executive Branch, have overridden, in effect, State laws in a number of areas.
Using the GAO and CSBS information, they include as part of these laws reporting requirements for licensed lenders, prohibition on prepayment penalties, license and bonding requirements for subsidiaries, limitations and up-front fees for home equity loans, limitations on State charges, prohibitions and negative amortization, disclosures for high rate, high point mortgages, limitations on appraisal fees and prohibitions on balloon mortgages.
We all understand there is a competition between who gets to be a regulator, the State or the Federal, but the Conference of State Bank Supervisors is saying that State laws that are strong in this area have been preempted by Federal regulators who want to bring people into the Federal system. How would you respond, Mr. Hawke and Ms. Seidman?
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Mr. HAWKE. I think the suggestion that preemption has resulted in a widespread overruling of State laws is not accurate, Mr. Chairman. There has been, under what is called the Parity Act, some preemptive effect from regulations of the OCC and the OTS, but with the purpose of facilitating the offering of variable rate mortgages in the States.
Before we can issue a preemption opinion on any matter of State law, we are required to give public notice and go through a notice and comment process. There have not been proceedings, to my knowledge, that have raised that kind of question with respect to most State consumer protection laws.
Chairman LEACH. Ms. Seidman.
Ms. SEIDMAN. First, with respect to the Parity Act, I would like to mention a couple of things. New York was one of the States that opted out. Delta Funding is a case from New York State. I don't think that we can say that having the Parity Act in action is what causes predatory lending.
Second, the ANPR that we have published is, in fact, devoted in large part to the question of exactly what has happened with the Parity Act in the eighteen years since it has been passed. Is it a law that still makes sense, and is its goal—namely that State lenders have parity with federally-chartered lenders—something that is being taken care of in other respects by changes in State law?
Third, let me say that even when we have the Parity Act at work, many, many, many things are not preempted. HOEPA is not preempted; Fair Lending is not preempted; State civil and criminal fraud penalties are not preempted; the Equal Credit Opportunity Act is not preempted. What we are talking about here are a limited number of loan terms and that is why we have the ANPR out to ask whether we should make some changes.
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In 1996, OTS changed its regulations after a full notice and comment process. No State bank regulator participated in that full public notice and comment process. It was a 90-day comment period in the Federal Register, and we didn't receive a single comment from the State bank regulators.
I wasn't here in 1996, most of the State bank regulators who are now in office were not in office in 1996 either, but I just want to say that we went through a full notice and comment process, we are going to do it again, and I certainly hope that this time we keep up the spirit of cooperation which we have begun to really build with the State bank regulators and we all participate together in making sure that the system works right.
Chairman LEACH. I want to get out of this conflict between the State banks and national banks. I want to get into the subject at hand. I would say there is a footnote here. For whatever reason, OTS is not normally subject to the same comment regulations as the OCC, which is bizarre in my personal view.
Having said that, the Congress, six years ago, passed a law which was very strong in its sense of purpose in outlawing predatory lending, in effect, and then, because Congress felt that the subtleties of this were beyond Congress, we gave to Federal regulators, most specifically the Federal Reserve Board of the United States, the authority to make definitions and to move in this direction.
If there is a problem out there, generally speaking, one thinks the strongest response of Congress is to pass a law saying this is a problem and assigning to the regulators the discretion to come up with the subtleties.
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Just to go back to this law, what we said, particularly to the Fed, is that the Board, by regulation or order, shall prohibit acts or practices in connection with mortgage loans the Board finds to be unfair, deceptive or designed to evade the provisions of this law, and in connection with refinancing of a mortgage loan that the Board finds to be associated with abusive lending practices or that are otherwise not in the interest of the borrower.
So the question becomes, if there is a problem out there, if Congress has given very strong authority to regulators and the Federal Reserve, our regulators, is the Federal Reserve AWOL? That is a question I think demands a response. I would like Governor Gramlich to respond.
Mr. GRAMLICH. What you say is true, and we did hold hearings in 1997, as I said in my statement, and we produced a report to Congress in mid-1998. The difficulty is that there are some things that can be done administratively and there are some things that must be done legislatively.
Our 1998 report tried to take a broadbrush approach to this and get everything together. For example, if we moved administratively on HOEPA, there would be some inconsistencies with other statutes of the Congress.
Chairman LEACH. We have other statutes that say we favor predatory lending?
Mr. GRAMLICH. No. For example, there is the computation of the APR that sets the HOEPA trigger—which is actually done under TILA, the Truth in Lending Act. There are some costs—closing costs and so forth—that are statutorily excluded from the APR in TILA. We could have changed the HOEPA triggers, but then there would not be consistency with TILA.
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Chairman LEACH. If I could interrupt, because I have limited time and I want to be fair to others.
I issued a set of guidelines this morning. Are any of those in conflict with other statutes? You are accountable, the Federal Reserve Board of the United States, unfair and deceptive practices. What you have just referred to seems to me to be outside the scope of the profoundness of the problem.
Let me ask you specifically, the guidelines that I laid out this morning, do they seem reasonable to the Fed?
Mr. GRAMLICH. They do, Mr. Chairman.
Chairman LEACH. If they are reasonable, can the Fed adopt them?
Mr. GRAMLICH. The Fed is thinking of adopting all of those. We are having new hearings. HUD and the Treasury have had new hearings. We are now considering using our rulemaking authority under HOEPA to limit predatory practices and we don't want to jump in irrationally without due consideration. We are now in that process.
Chairman LEACH. Fair enough.
My time has expired. We want to work cooperatively with you. I would only stress that we have in place in statute very powerful words on this subject. Congress certainly has the authority to pass more legislation. It is my view that any additional legislation is profoundly at the margins and that doesn't mean that it isn't possible and appropriate, but that a great deal of authority rests already with you. I hope that as we go forward in the future that we go forward with that understanding.
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Mr. LaFalce.
Mr. LAFALCE. Thank you, Mr. Chairman.
Let me first address the always-present tension between Federal law and State law, Federal regulation and State regulation. I think, as a general rule, we must understand that Federal law can preempt actions of the State, but that very, very frequently, it is not the intent of Federal law to preempt, especially when consumer protections are concerned and the State is advancing greater consumer protections than might exist under Federal law.
Further, in order for the Federal law to preempt, usually we must speak explicitly to the issue of preemption. In the absence of explicit language, in dealing with a State consumer protection, it is my judgment that deference should be given to the State consumer protection, as a matter of general construction. We will have more dialogue about that in the future. That is not always the case, but it seems to me that should be a general rule of construction.
To go to the specific issue of predatory lending, we have some individuals who say there is ample regulatory authority to deal with the problems of predatory lending if only the regulators would use it. We have some who say it is imperative that we have new legislation. I suspect that both are correct, but what I would like from you is a delineation.
What regulatory authority do you think you might have and have not used so far? As I read the 1998 report, it seemed to me, Mr. Gramlich, that there was almost a statement that you had no further authority to act. I just don't think that is accurate.
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Are there areas where you think you have authority to act, but would like clarification, buttressing of that and other areas where you think you just don't have the adequate authority and you clearly want legislative imprimatur to go forward? Would any of you care to comment on that?
Mr. GRAMLICH. I may have to get back to you with specifics.
Mr. LAFALCE. I think that would be a good idea. I would like your tentative responses now and then I would like each and every one of you to get back to me with specifics on that issue. So I officially request it.
Mr. GRAMLICH. We will certainly do that, but I should say our primary focus in 1998, since this was a report asked for by Congress, was on what could be done legislatively. We took a rather broadbrush approach to it, but there are things we can do on our own. We are looking at them and there may be some areas where we need clarification. We are looking at that too. We will certainly get back to you with a specific list of what we need from you, what we can do on our own, what is in doubt and we will try to be fairly precise about that.
Mr. LAFALCE. Any others wish to comment on that?
Mr. Hawke.
Mr. HAWKE. Mr. LaFalce, I would like to simply focus on the difference between approaching these problems on an individual case basis and approaching them on an across-the-board statutory or rulemaking basis.
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We have a number of different sources of authority to address practices on an individual case basis. Our examiners can look at individual loans and determine whether lenders have underwritten them properly, including whether they have determined that the borrower has an ability to repay without recourse to the collateral—which is a very fundamental precept of sound lending. That is necessarily an examiner-by-examiner, bank-by-bank kind of approach, as is the approach of looking at unfair and deceptive practices on a case-by-case basis. We don't have rulemaking authority regarding unfair and deceptive practices.
One of the advantages of legislation would be to set across-the-board, substantive rules that would really stake out what the appropriate standard of conduct is for everybody at one time.
Mr. LAFALCE. Ellen Seidman.
Ms. SEIDMAN. Let me say a couple of things in this regard.
First of all, with respect to the Parity Act. One of the things we will be very much trying to work our way through, after we receive the comments from the ANPR, is how Congress' direction that we must give parity to State-regulated, State-supervised entities over which OTS has no authority, that OTS never supervises, never examines, how that meshes with the peculiarities of the Federal system where the Homeowners Loan Act tells us we must have national best practices and it is a Federal system and we are in there examining every year, every two years for compliance. It is quite a different system. Some States regulate tightly, some don't. So that will be a big issue for us.
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Mr. LAFALCE. Mr. Vento and I are the only two Members of this committee who were co-sponsors of that Parity Act. That is why I articulated what I thought to be the appropriate rule of construction.
Ms. SEIDMAN. And we heard you.
The second thing is that, as with the OCC, we are putting together examiner guidance. We have at least one pilot exam going on right now to try to see if we can find whether predatory practices exist, without having our examiners look at every single loan application that has been made in the institution since the prior exam, to see if there is some way to screen this and to understand it. We will be working through this throughout the summer and doing some training.
When we get those results, we will have a much better idea of whether there are problems we cannot reach, either under existing consumer protection rules and regulations, or under our safety and soundness jurisdiction.
Mr. LAFALCE. Mr. Gensler.
Mr. GENSLER. I was going to say we share your view that some of this can be done on the regulatory front. In terms of the report that HUD and Treasury will come forward with, we perceive several categories that would call for new legislation, but also several categories that would be in the regulatory regime today. We hope we can help this committee when we forward that report.
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Mr. APGAR. Just to amplify on that, six years is a short time maybe in terms of legislation, but it is forever in the financial services market. The data suggests that six years ago, subprime lending was a minuscule portion of our market areas and it just exploded. A large share of what we classify as subprime loans don't fall within the HOEPA triggers, less than a percent. So I think we have to look at what has happened in the last six years and that will give us new eyesight as to why.
Mr. LAFALCE. Of course, my bill and the other bills change the triggers.
Mr. APGAR. Absolutely.
Ms. TANOUE. I would just say it seems clear that current law doesn't fully address a number of the predatory practices that we see in the mortgage market today. I think it is clear that all of us here at the table are looking at ways to refine and tweak the laws and regulations.
Having said that, the FDIC is looking within our current authority to refine guidance not only for the institutions, but for examiners as well in terms of CRA exams.
Mr. LAFALCE. Thank you.
Chairman LEACH. Mr. Baker.
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Mr. BAKER. Thank you, Mr. Chairman.
If I am understanding the observations of the panel concerning predatory practices, there seems to be an inability of the borrower to understand sophisticated financial terminology as an element. Misunderstandings about particular aspects of the loan closing document, for example, unexplained acceleration clauses, unexpected costs at the closing table like discount points or others, and a failure to obtain the best credit based on the individual's history in the current market conditions.
I don't know if any of you have had occasion to sit through a first mortgage loan closing in Louisiana lately, but I will guarantee you there are very few attorneys and absolutely no consumers who go through the 63 pages that are required to close a first mortgage loan document and fully understand what they are doing.
It would seem to me the circumstances which are being outlined as predatory are very difficult to segregate from appropriate subprime lending. Mr. Apgar, you just indicated that six years ago, it was a minuscule portion of the economic activity and today it is a burgeoning part of the economy. To me, that is good news. It means that people who previously had no access to legitimate lines of credit are now being afforded opportunities for home ownership or to do modernization to an outdated home.
The idea that the Federal Government needs to increase regulatory oversight in the financial marketplace I find rather extraordinary, given the demonstration that, in most cases, subprime is not equal with predatory. It would appear to me—and this is not a question, but a venting of my frustration with the subject—nobody has defined what constitutes ''predatory.'' It depends on the individual's own credit history, the value of the asset being acquired and the terms of that loan document.
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We cannot say that an additional point over traditional current market rates is inappropriate until you know the risk related to the borrower's profile. I think that individuals would much rather have access to the credit and move into their own home as opposed to continuing to pay outrageous levels of rent in a dilapidated housing project.
I would just say, let us be very cautious before we move ahead in this arena and understand the consequences of additional regulation. There are people today in homes in America, because of the subprime lending activity, who otherwise would continue to live in less-than-desirable circumstances if they were not afforded—albeit higher-priced—credit that did not exist a few years ago.
If anybody can give me three points that consistently constitute predatory practices and tell me that we don't have sufficient regulatory capacity to stop it, I am for it. I will co-sign. I don't believe that there is a regulatory inability to stop what is an abusive consumer practice once there is proof that the credit terms extended were inappropriate, abusive, deceptive or fraudulent. Let us go get them, but let us do it on a case-by-case basis and not stop the overall performance of the market which, in my opinion, is responding to a worthwhile credit need of consumers across the country.
Thank you, Mr. Chairman.
Chairman LEACH. Mr. Vento.
Mr. VENTO. I would just comment on Mr. Baker and your comment about the need for legislation. I think I heard the regulators all say whether it is the Parity Act from 1982 or whether it is the 1996 law, they really haven't moved decisively in those areas. So I think, especially with the inconsistent laws, that it might be well for us to at least look at doing something this year to kind of coordinate this in terms of some measure that would be necessary.
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It might be that they have the authority, but I think as indicated by the testimony from Mr. Apgar, that the practices have eclipsed existing regulations and policies, so I think it might be to our advantage to try and get out in front of this, at least at this point, with whatever coordination we could do in terms of law to bring this together. I do think it is a practice that is dealing with the underbanked earlier and dealing with the new classifications that are involved in terms of subprime and whether they are appropriately being applied to the individuals.
The silver lining of this, I believe, is in terms of CRA. Putting aside the predatory lending for a moment, how does subprime lending impact low-income minority neighborhoods? In my opening statement, I note that the Treasury has concluded a review of CRA and pointed out nearly a half-billion dollars in mortgage loans to low- and moderate-income borrowers, so it is working.
In doing the work, in terms of creating the subprime market, the fact is that it is helping, I believe, low-income and minority neighborhoods. Mr. Hawke, would you care to comment on that report and on the subprime lending?
Mr. HAWKE. Mr. Vento, I think we would all agree that there has been a significant change in the marketplace, that what is called subprime lending has provided access to credit for many people who haven't had access to credit in the past. I think we all have expressed the view that we have to be extremely careful in any intervention in the market to make sure that fair access to credit is not inhibited or frustrated.
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I don't think there is any question but that there are predatory practices, practices that anybody would define as predatory. I mentioned in my testimony the practice of institutions extending credit where there is no reasonable prospect that the borrower will be able to repay except through a foreclosure on a home. We think some unregulated lenders are actually targeting the equity in borrowers' homes for that purpose. They are targeting the equity to capture it in foreclosure and reap the fees and profits that come from these transactions.
Mr. VENTO. Can CRA examination be a positive factor in terms of evaluation of this process as well?
Mr. GRAMLICH. Let me comment on that. It certainly can and that is one of the things we are looking at. I think a number of the testimonies mentioned, at a minimum, denying CRA credit for predatory loans.
Mr. VENTO. The Chairman mentioned this too in his precepts.
Mr. GRAMLICH. The Chairman did. Denying CRA credit and maybe even penalizing banks if there is some evidence of predatory practices.
One thing that you should understand is that these are somewhat different problems, because the CRA obligation is attached to deposit insurance, which means that it is done by banks and thrift institutions. A lot of the predatory lending is alleged to take place outside of that system, by loan companies and mortgage companies, and so forth, that don't have a CRA obligation.
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Mr. VENTO. I think the solution there might be how broadly based the CRA might become in terms of affiliates and bringing under the umbrella some additional activities. This becomes very important as we look at modernization of affiliates and looking at the loans that are sold in the secondary market which is exactly where are federally-chartered secondary market entities are looking.
We don't have time, Mr. Chairman, but I think I have made my point in terms of the importance of using and employing CRA and this idea of coordination, which I hope we could visit in a noncontroversial manner this year in terms of bringing this together. Rather than have them work on these individual 1982 laws and the 1996 law, try to bring this together so we can get some focus.
Chairman LEACH. The gentleman makes a good point.
We have four minutes to vote, so we are going to recess pending the vote. Let me say to Ms. Seidman, I understand you have an extraordinarily important event and you are excused for that event. I want to thank you for your testimony.
Ms. SEIDMAN. I will try to come back.
Thank you.
Chairman LEACH. The hearing will be in recess pending the vote.
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[Recess.]
Chairman LEACH. Mr. Bentsen.
Mr. BENTSEN. If I might, in looking at the testimony of all the regulators, everyone makes the obvious statement that it is very difficult to determine between legitimate subprime lending and predatory lending. I have a couple of questions related to that.
It seems to me that if you can make that determination reasonably that one way to address this problem is to cut off the funding of this type of lending. If there is not funding either through the asset-backed market, secondary market or through the regulated depository institution system, you are going to eliminate very much of this.
My questions are this. One, are the regulators able to develop underwriting standards? A number of you identify in your testimony issues that you see as indicative of what you would consider predatory lending. Can you establish a set of underwriting standards for regulated depository institutions for loans they might carry in their portfolio?
Second, could you apply such underwriting standards to mortgage-backed securities which institutions might carry in their portfolio for purposes of meeting the mortgage test they may need to have?
Mr. Hawke talked in his testimony about what Freddie and Fannie are doing with underwriting standards. Do you have the authority to mimic those types of standards if you think those are going to be worthwhile?
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The other question is this. All the regulators—I didn't get a chance to go through the Fed's testimony—indicated upon at least cursory review, you do not see a preponderance of ''predatory loans'' in the portfolios of the institutions that you regulate. Obviously through mortgage-backs, there would probably be more.
If this is a $370 billion market in total in the subprime market, how large would you classify the predatory market of that amount and where are those? Are those institutional investors, individual investors in the form of asset-backed securities? Where are those being held?
Mr. GRAMLICH. I will try your second question. I cannot do it in terms of dollar amounts, but in terms of institutions, something like one-third of the institutions in the subprime market are remotely under some sort of compliance exam. That is where the regulators come in.
The rest of the subprime business takes place really outside of the normal bank compliance exam cycle and it is the FTC that would then have the primary responsibility. It is about one-third of the institutions in and two-thirds out. I don't know what the number is in dollar amounts, maybe FTC does.
Mr. BENTSEN. I want to get to the first question, but these obviously are not just loans held necessarily in somebody's portfolio; it is quite a bit of paper to be out there. Some of them, I guess, are Freddie and Fannie guaranteed and that is why they are apparently trying to impose some standards—or others, FHA guaranteed. In the home improvement market, where we have had problems in our area, are they unguaranteed, are they privately guaranteed? Where is that?
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Mr. GENSLER. Why don't I try to take a crack at that. A great deal of the market of subprime is today securitized, and there are great benefits that come to that market through securitization. It may well be that over half of the subprime annual originations are now securitized. Very little of that is actually done by the GSEs. Most of it is done through other structures by various investment banks on the street and so forth.
In terms of your question about how much of that would include some of the predatory lending and how much is not, the answer is mixed, because a great deal of predatory practices happen on the street level. It is fraudulent and deceptive practices on the street level that by the time that loan gets pooled in a securitization, and there are thousands of loans in a securitization, might be mixed in there, particularly those loans that have high fees. The high fees often will stay on the street level and then the loan will come up the financial chain, so to speak, and be securitized.
Mr. BENTSEN. Let us get to my first question which the other regulators have not answered. Do you have the authority to establish underwriting standards, does it make sense to establish underwriting standards? If you had certain standards, wouldn't you be able to look at a portfolio—you obviously cannot look at every single loan—and say this is not a conforming loan for purposes of standards related to predatory lending and therefore has to be kicked out, because of high fees, whatever standards you might set?
Mr. HAWKE. There are certain aspects of predatory lending that would lend themselves to that kind of treatment. As I said in my testimony, the practice of lenders extending credit without determinating that the borrower has the ability to repay absent recourse to a foreclosure on the collateral is the sort of thing bank examiners look at. That is something that can be determined on the basis of the documents that a bank would normally retain in its loan files. That is something we intend to bear down on. That is not a new concept or anything that is radical at all.
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As Secretary Gensler said, much of what gets included under the heading of predatory lending is not reflected in loan files, and it would be very difficult to adopt underwriting standards that could be reviewable, say, in the process of doing due diligence on a securitization. There are limited aspects of predatory lending that can be made subject to either the scrutiny of bank examiners after the fact or underwriters doing due diligence.
Mr. BENTSEN. My time is up, but you are saying when a bank puts together a portfolio and securitizes it, they do look at the credit quality of the loans that are going into it. At least they have some screen they put across it see that it meets some sort of standards. You don't believe in cases where you raise the loan where there is not sufficient non-mortgage assets that could be used to repay the loan, that would not be picked up anywhere?
Mr. HAWKE. That should be picked up in the bank's basic loan underwriting from the very sta