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Tuesday, March 30, 2004
U.S. House of Representatives,
Subcommittees on Financial Institutions and Consumer Credit,
And Housing and Community Opportunity
Committee on Financial Services,
Washington, D.C.
    The subcommittees met, pursuant to call, at 10:08 a.m., in Room 2128, Rayburn House Office Building, Hon. Robert Ney [chairman of the Housing and Community Opportunity subcommittee] presiding.
    Present: Representatives Baker, Bachus, Royce, Lucas of Oklahoma, Ney, Ose, Miller of California, Tiberi, Kennedy, Feeney, Hensarling, Garrett, Kanjorski, Waters, Sanders, Maloney, Velaquez, Watt, Carson, Sherman, Lee, Moore, Hinojosa, Lucas of Kentucky, Crowley, Clay, McCarthy, Baca, Miller of North Carolina, Scott, and Davis.
    Chairman NEY. [Presiding.] The Housing Subcommittee and Financial Institutions Subcommittee hearing on subprime lending will come to order.
    I want to also thank everyone for being here today to discuss what I think is an extremely important issue in the United States: subprime lending. It is obviously not without controversy, but it is an issue I believe that absolutely has to be addressed.
    And I want to also especially thank, my good friend, Chairman Bachus, for taking the time from his busy schedule to also chair this hearing with me.
    Spence has been a real leader on consumer credit issues, working diligently to pass FCRA, which I think some people had some bets would never happen.
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    I bet on you and made some money on you, so I am just happy with that.
    And he passed FCRA last year and he is now working on predatory lending. And also want to welcome all the members from both sides of the aisle.
    The purpose of this hearing is to look at the subprime lending market in the United States. Over the past decade, we have seen the number of people receiving subprime loans increase dramatically.
    What we do not know is what this trend means for consumers. This committee has not looked at whether the increase in use of subprime loans means that consumers are paying more for credit or if consumers, who had previously not been eligible for credit, are now getting access to the mortgage market.
    And I think we need to determine that.
    Furthermore, we have only begun to look at the implications for consumers if subprime lending is restricted by onerous State and local predatory lending laws or a hodge-podge of laws across the United States.
    I believe that in order to truly gauge the effect of predatory lending laws at the State and local levels and in order to truly be able to assess the need for a national standard for mortgage lending, Congress first has to understand the subprime marketplace in order to make decisions.
    Our two panels of witnesses today represent a good cross-section of the lending community, academics and consumer groups.
    I think with all of them we will be able to do a good job of sharing a picture of who gets subprime loans, what those loans cost and most importantly, how important are subprime loans in helping consumers either obtain credit for the first time or reenter the credit market after previous problems that they have encountered.
    And I know that everybody here has heard stories about State and local predatory lending laws cutting off credit for those who need it most. I look forward to hearing those stories brought out in our hearing today and talked about.
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    Again, I want to thank Chairman Bachus and all of the members from both sides of the aisle of this committee. And I want to thank the witnesses for being here.
    Gentleman from Pennsylvania?
    Mr. KANJORSKI. Thank you, Mr. Chairman. I think that this is a hearing that we have all looked forward to over the months.
    I have had the occasion to direct my attention to subprime lending over the last year and I think that from this testimony today I am trying to extract what I think appears to me to find a market that has been underserved, but particularly is in a destabilized condition because of the State variances in the legislation.
    And I hope that in the examination today we are going to receive evidence that will further encourage the committee to go forward with examining a national standard, recognizing that we want to stop the violations that occur and the abuses that occur.
    But on the other hand, provide funding available with those that are best served and need the subprime market.
    I particularly am aware of the fact that we have today in private bankruptcies more than 1.7 million individuals and under normal procedures it would seem to me many of those, or most of those individuals would not be able to get normal, conventional financing at normal rates.
    So, in order to reconstruct their financial positions and to gain the benefits of homeownership again; many of those individuals have to go through the subprime market.
    On the other hand, we have all heard the ugly stories across the country that are classified as predatory lending.
    And it seems to me that the responsibility of this committee and the Congress to examine whether in fact these stories have any merit, if they do, how we can correct them. And on the hand, provide for this new market that is occurring.
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    I understand that the market in 1994 was only about $9 billion; today it exceeds $200 billion, obviously, a sufficient amount to warrant the examination of this Congress.
    So, once again, I would like to thank you, Mr. Chairman and Mr. Bachus, for putting together this hearing and hopefully it will help us to go forward in a bi-partisan effort to provide some needed solutions to the problems that exist.
    Thank you.
    Chairman NEY. Thank you.
    Chairman Bachus?
    Mr. BACHUS. Chairman Ney, I want to commend you on your leadership on this issue and as well, Mr. Lucas and Mr. Kanjorski.
    There are several other members of our committee that have done a lot of work and proposed legislation in this field.
    I want to commend Congressman David Scott for his work on H.R. 1864, the Prevention of Predatory Lending through Education Act and Congressman Mel Watt and Congressman Brad Miller, who recently introduced H.R. 3974 the Prohibit Predatory Lending Act of 2004.
    I look forward to working with Congressman Ney, Congressman Kanjorski, who has proposed legislation and those others working on legislation: Congressman Lucas, Scott, Watt, Miller and all my other colleagues as we continue to look at this, what is sometimes a complex issue.
    I will just basically hit four points here this morning.
    First of all, there is a confusion between the word predatory lending and subprime lending. Subprime lending is a very legitimate form of financing for housing, home improvements, things of that nature.
    Many Americans now own their homes because they have been able to get a subprime mortgage. This is a good thing if it is not accompanied by abusive lending practices.
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    In fact, many homeowners would be shut out of the market because of either past bad credit history or lack of credit history; perhaps a bankruptcy and they have no choice other than subprime lending.
    And these commercialized mortgage loans work very well for them.
    We probably have a responsibility, and I think Mr. Kanjorski mentioned that we have basically the one figure: in 1994 there were $34 billion in subprime mortgages, in 2002 the last year we have total results, $213 billion, so you have had an astronomic increase in subprime lending.
    And the vast majority of those loans are not in default.
    However, as I said earlier, with any responsible lending industry, there are those who are bad actors and their abusive lending practices. And I think most all of us have had to go through the litany of some of these practices.
    I will simply say that the timing of this hearing, I don't think, could be better because we have had many States and localities that had responded to these abusive lending practices with legislation.
    This legislation, however, only covers the OTS and the OCC. Their rules and regulations, first of all, only cover those institutions which they regulate.
    It does not cover really, the majority of institutions which makes up prime lending loans.
    And so, we have an unbalanced system of regulation here.
    The other thing you have, as obviously, anyone on this committee knows the controversy of surrounding the OCC and the OTS preempting a part, and not the entire subprime lending field, but just a part of it: singling out a part of it because they only regulate a part of it.
    There is concern that the OCC and the OTS might not adequately regulate and address these abusive practices.
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    And I can note, by looking at our first panel, we are going to have a wide diversity of views on this. I think it is the first time that we have had ACORN seated at the table as opposed to outside in the hall.
    But it is certainly a much quieter hearing with Mr. Butts, with you at the table. And we look forward to hearing from you and from all our other panelists.
    But Mr. Ney, in conclusion, as I have told people in private meetings and otherwise, I think on our side, you are going to the lead committee person on this issue and I think you have a challenging job ahead of you.
    I yield back the balance of my time.
    [The prepared statement of Hon. Spencer Bachus can be found on page 98 in the appendix.]
    Chairman NEY. I want to thank you.
    Ranking member?
    Ms. WATERS. Thank you very much, Mr. Chairman, for scheduling this hearing to consider the many important issues raised by subprime lending.
    While there are many topics that need to be covered in today's hearing, I hope that our witnesses will direct their testimony particularly to the tremendous harms to minorities, to the elderly and to low and moderate income borrowers that stem from the abusive practices known as predatory lending and to the types of remedies that are required to prevent such lending.
    The amount you pay for a loan should not vary depending on where you live or what you look like.
    I also hope that our witnesses will address the extent of the correlation between subprime loan rates and foreclosures.
    While not all subprime loans are predatory, predatory lending is concentrated in the subprime loan market. Predatory lending preys upon poor and minority neighborhoods, where the best loans are rarely available: neighborhoods where the number of subprime loan outlets usually vastly exceed the number of banks available.
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    Meaningful access to low-cost products depends on branch access and presence.
    Household Beneficial Corporation has six branches serving upper income clients in California, while at the same time it has 177 subprime Household Finance and Beneficial branches that offer higher cost products to California's diverse population.
    No bank should have fewer branches than its subprime affiliate.
    Predatory lending often results in home foreclosures and in borrowers losing their equity. While housing counseling and better education are valuable and important consumer protections there is no way that counseling and education alone can prevent predatory lending.
    Unfortunately, there are still unscrupulous lenders in the market who will take advantage of consumers' lack of understanding, of complicated mortgage transactions and use aggressive sales pressure techniques to market loan products that are harmful to the consumer.
    Marketing a subprime loan tends to focus on specific neighborhoods, often through door-to-door sales or repeated telephone solicitations.
    Surveys of low-income, subprime borrowers indicate that a large percentage of borrowers had not sought out the subprime lender and many were not even seeking a mortgage loan, but were contacted by lenders, brokers or contractors and persuaded to take out a home repair or home equity loan.
    While there clearly is a place for responsible subprime loans where a higher interest rate is used to address the enhanced risk posed by borrowers with past credit problems, there are far too many subprime loans that contain abusive terms or conditions.
    There are far too many loans with rates and fees that are much higher than can be reasonably justified by the borrower's credit records.
    Many borrowers who may qualify for prime mortgage credit are paying higher costs for subprime loans. Freddie Mac has estimated that between 10 percent and 35 percent of AA-minus subprime borrowers actually qualified for prime rates, but received and were paying for more expensive loans.
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    AARP has found that 11 percent of older borrowers with credit scores that qualify for prime credit owe more expensive subprime mortgages. Franklin Raines, the chairman of Fannie Mae, has estimated that perhaps as many as half of those receiving subprime loans could have qualified for a loan on better terms.
    There are simply far too many borrowers who could have qualified for prime loans who are receiving subprime loans because they were steered to subprime products. And because they lack the knowledge and sophistication and the bargaining power to insist on and obtain better terms.
    Mr. Chairman, when it comes to predatory lending it is simply not acceptable to say that the borrower should have read and understood all of the terms in the complicated loan documents that were given to him.
    In my view, this is an area where the doctrine of quote, let the buyer beware, quote-unquote, can never be good enough. Financing of excessive fees, charging higher interest rates than a borrower's credit warrants, larger pre-payment penalties, refinancing without financial benefits, hidden variable interest rates, loans with extremely loans-to-value ratios that result in negative amortization from day one.
    These are just some of the outrageous burdens on consumers as a result of predatory lending.
    Then there is the disgraceful practice of sending live checks to consumers to entice them to address their immediate financial needs without regard to the costs imposed or the mortgage terms, including balloon payments, negative amortization and pre-payment penalties that appear as options to reduce the interest rate on prime loans are routinely inserted and higher rate subprime mortgages, sometimes without the knowledge of the borrower.
    Even when subprime loans do not involve deceptive or abusive practices they tend to expose borrowers to higher risk than conventional prime loans because of the higher financial burden they impose.
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    In October 2003, ACORN released a report entitled ''The Great Divide: Home Purchase Mortgage Lending'' nationally and in 115 metropolitan areas.
    The ACORN report confirms that minority applicants for conventional loans are rejected significantly more often than whites, and the disparity has grown over time, with rejection ratios in 2002 higher than 2001 and higher than they were 5 years ago.
    Minorities of all incomes are rejected more often than whites of the same income for conventional purpose loans and the disparity increases as the income level increases. Minorities with higher incomes are denied more often than whites with lower income.
    Mr. Chairman, I guess some of us have been singing this song for a long time and frankly, I almost did not come today because it seems that I have doing this over and over for so long now and I don't know where it is going to take us.
    But I think in the final analysis, if we don't get some relief from these kinds of practices we are going to have to employ other more direct responses to those lenders who are involved in subprime predatory lending.
    Again, I recognize that all subprime lending isn't predatory, but too much of it is and we are just going to have to rally and protest and bring people to some of these institutions in ways that banks and some of our mortgage companies would not like to see. I don't know what else to do.
    We talk about it all the time, but nothing changes.
    Chairman NEY. I appreciate you being here and your input and hopefully we will get something, I don't want to say fair and balanced, that pertains to Fox News, but hopefully we will get something that is decent for consumers and still allows the market to flow.
    Thank you.
    Chairman Baker?
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    Mr. BAKER. Thank you, Mr. Chairman. I will be brief. I appreciate your courtesy in calling this hearing on this important matter.
    Certainly doing whatever we can to facilitate extension of credit to all interested parties is an admirable goal and should be pursued with every ability we can muster. At the same time, unreasonable constraints on common sense business practice do not make sense not only for the business person, but for the consumer as well.
    Denying someone the opportunity for homeownership simply because the rate or the terms of repayment are different from an AAA-credit rated individual doesn't make sense.
    I would like to commend those in the industry who have spent considerable time and effort on trying to identify first what constitutes predatory action, not already prohibited by either State or federal laws.
    Secondly, on one's finding, whatever that might be, eliminating that loan from their portfolio and taking action not to allow those activities in the course of ordinary business practice be incorporated into the portfolio of these organizations.
    I do believe there is a need to continue to improve. I do believe that there is evidence that there are individuals who take advantage of the uninformed consumer.
    I do believe that the current body of law is sufficient to catch the bulk of the adverse practitioners, but we should take additional steps to ferret out the very last and most offensive of these practices and open up the access to the lines of credit for homeownership for everyone.
    And to that end, Mr. Chairman, I will strongly support your efforts in this regard.
    I yield back.
    Chairman NEY. I want to thank Chairman Baker.
    Further opening statements?
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    Mrs. MALONEY. First, I would like to thank both of the chairs for calling this and we continue to make a practice on this committee of praising the virtues of homeownership as a wealth creator for our constituents and the success represented by near-70 percent homeownership in this country.
    These are incredible successes that demonstrate the competitiveness of our housing industry, which is constantly evolving and coming up with new products that put more people in their homes.
    Subprime lending as an innovation deserves some of the credit for the vibrancy of these housing markets.
    It is a great thing that people with damaged or limited credit histories have a much better chance of buying a home today because of credit innovations and the competitiveness of the subprime market.
    At the same time, the explosion of subprime has coincided with increased opportunities to fleece borrowers and a rise in foreclosure rates and predatory lending.
    While it is perfectly acceptable for lenders to charge higher prices to riskier borrowers, the fact that a disproportionate high number of subprime loans go to minorities, the poor and the elderly, demand that this market receive very strict oversight.
    With this in mind, one of my biggest concerns is that subprime loans only go to those borrowers who need them and that more credit-worthy borrowers be given the opportunity to receive prime loans when appropriate.
    I would like to hear from the panel today what can be done, in their view, to attack this problem.
    Is it simply a matter of education or are specific policies needed on the books at lenders that have both subprime and prime units, mandating that borrowers be referred to the prime units if they qualify?
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    Besides ensuring that subprime loans go to those that qualify for them, I have a major concern with the question of assigning liability.
    I strongly believe that borrowers who are victims of predatory lending deserve to be made whole; it is not their fault that the predatory lender who sold them their loan no longer has it on his books and doesn't have any money.
    At the same time, legal certainties for the secondary market is extremely important.
    The secondary market is really the goose that laid the golden egg in regard to the U.S. mortgage markets. The last thing we want is to scare away investors and home mortgages which provide the liquidity that keeps the whole system funded.
    Yesterday a report came out from the bond association on this question and one of the main points of their white paper was that they prefer a national standard which they say would be more efficient than the current 40 different standards they face.
    I am not personally sold that a national standard is necessary, but I am sympathetic to the argument that the secondary market should only be assigned liability for lending violations that can be detected in a review of the regular loan documents.
    I must add, since this is also a housing hearing, the really inappropriate funding levels of federal support for public housing in America.
    I yield back the balance of my time and I look forward to the comments of the panel.
    Chairman NEY. The time of the gentlelady has expired.
    Further opening statements?
    No further opening statements? Mr. Sherman?
    Mr. SHERMAN. Thank you. I would like to thank the chairs and the ranking members of the two subcommittees for holding these important hearings.
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    As other speakers have indicated, this is a hugely important part of our economy and it is important that we get a balanced view because in our work as individual members of Congress, we naturally hear about the bad side of subprime lending.
    We hear about the predatory practices and we hear about the situations where it was just bad luck, where somebody got a loan that perhaps they should have gotten, but then something happened and now they are in desperate straits.
    We need to hear also the other side, the success stories of people who were rejected for conventional lending and then got a subprime loan to the benefit of their family or to finance a business.
    As we seek to protect consumers, we have to understand that the best consumer protection is competition. That is what drives prices down, that is what gives people better terms.
    And that competition is imperiled by the idea of every municipality in my state adopting their own laws about lending.
    What that does is it will create a lender who specializes in one municipality, to the exclusion of all others. And you will log into ditech.com, having endured 500 annoying commercials, only to find, ''Hey, you can't get the loan, you have to go to that very banker that they vilify in their commercials, who has a captive market in that municipality.
    Now, it is true that computers allow subprime lenders to deal with the complexity of, but there is a limit to how much complexity you can deal with if every municipality adopts its own, or even every state, has its own different set of laws with draconian penalties when you violate the slightest one of numerous requirements.
    I should point out also, that as an old tax collector, I am not sympathetic to those in your industry who make it easy for somebody to come in and say, ''You know, I have a lot of income, I just don't put it on my tax return.''
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    I would appreciate that one of the standards for giving someone a loan is that it is based on the income that they actually report to the agency represented by those of us here, namely the federal government.
    I want to think our Ranking Member Maxine Waters has identified some of the bad practices that we need to look at.
    But I want to disagree with her on just one small point: I don't think it is bad for a lender to concentrate on subprime lending or to specialize.
    If it is good to be in that market and some company decides to be exclusively in that market and all of their outlets in our state are subprime lending facilities, that makes sense, just as some other financial institution might specialize in the other end of the market.
    I know that a number of states have adopted confusing laws, creating inefficiencies, allowed their municipalities to come up with draconian penalties and confusing statutes and I want to thank those states and municipalities, because what they have done is they have inspired industry——
    Chairman NEY. Time has expired.
    Mr. SHERMAN. If I could just continue——
    Chairman NEY. Finish your statement surely. I just wanted to——
    Mr. SHERMAN.—because it is those actions, inefficient actions, which have inspired industry to come to us and say you want national standards and I assure you those national standards should not be set at and will not be set at the lowest common denominator. We will get effective consumer protections for all the citizens of the country.
    Thank you. I yield back.
    Chairman NEY. Thank the gentleman.
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    Ms. LEE. Thank you, Mr. Chairman. I want to thank you and Mr. Bachus and our Ranking Member Waters and Sanders for convening this very important hearing on subprime lending. I would also just like to welcome all of our witnesses today who will discuss the costs and benefits of the subprime market.
    The subprime market exists because it provides credit access to borrowers who otherwise would not and could not obtain loans. However, far too often, people in the subprime market, particularly minorities and the elderly, are truly victims of predatory lending.
    These individuals are actively and purposely preyed upon by lenders who know there is no true punishment or strong federal mandate that will stop them from unjustly profiting off of our most vulnerable communities.
    So Mr. Chairman, we must begin out of this hearing, to stop this growing trend and establish a base federal standard that punishes bad actors and champions local and State ordinances against predatory lenders.
    And I am very proud to say that my hometown of Oakland, California has passed a local ordinance against predatory lending which will, hopefully, stop the growing trend that we see in Northern California, of not only first-time predatory home loans, but also more often the predatory refinanced loans.
    So, I hope that we can work with everyone in the industry: our consumer groups, members of the community, to truly educate and protect people before, during and after the homeowner process.
    Of course, education starts with financial literacy, housing and foreclosures counseling, and really good faith from the lending community. So, I believe that we can work together and create the protections and guidelines that will benefit everyone.
    So, today's hearing is a very good start. I hope the dialogue will grow, but I also hope that we come to some realistic approach to deal with the very bad actors that are out there, some of which are subprime, some of which are not.
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    Thank you, Mr. Chairman and I yield the balance of my time.
    Chairman NEY. Thank you.
    Mr. HINOJOSA. Thank you Chairman Ney and Bachus. And I want to also acknowledge Ranking Members Waters and Sanders.
    I thank you for calling this very rare joint hearing of two important subcommittees on the topic of particular concern to me and to my constituents: subprime lending and predatory lending.
    I hope that this will be the first in a series of hearings that you will hold on this subject in both subcommittees and then the Full Committee. As many of you are aware, subprime lending has increased abusive lending practices, particularly aimed at vulnerable populations, such as the Hispanic populations in my district.
    These constituents do not qualify for prime loans and must trust subprime lenders not to impose unnecessary fees or to trap them into schemes where they end up losing their homes, thereby, transforming a subprime lender into a predatory lender.
    I was concerned to read in Mr. Smith's testimony that a study by ABT and Associates in Atlanta found that foreclosures attributed to subprime lenders accounted for 36 of percent in all foreclosures in predominantly minority neighborhoods in 1999. While their share of loan originations was between 26 and 31 percent in the preceding 3 years.
    However, I understand that lenders need to maintain appropriate capital levels and to weigh the risks of the loans they make to lenders. The need exists for a subprime lending market for individuals that pose more of a risk to the lending institution.
    However, subprime lending has yet to be defined and some claim that it is impossible to define. If that is the case, then I wonder if we are chasing our tails here today. Perhaps we should wait until it is defined.
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    Regardless, legislation has been introduced on subprime lending and predatory lending by my esteemed colleagues, Congressman Ney and Lucas and Congressmen Miller and Watt. I intend to review those proposals, carefully, prior to taking any positions on the legislation. It is also my understanding that our Ranking Member, Paul Kanjorski, is working on draft legislation that will be available in 30 to 60 days on this same subject.
    My staff has already expressed to his staff my desire to work with him on his legislation to ensure that it addresses the needs of the Hispanic population, and other minority populations in the United States, to ensure that our views are protected under its clauses and provisions to every degree possible.
    My ultimate goal is to protect my constituents from predatory lenders, while ensuring that they receive fair, subprime loans if they do not qualify for the prime loans. I have yet to review the preemption issue at any great length.
    Mr. Chairman, I yield back the balance of my time.
    Chairman NEY. Thank you.
    Mr. Royce, gentleman from California?
    Mr. ROYCE. Thank you, Mr. Chairman.
    The title of today's hearing is Subprime Lending: Defining the Market and its Customers. Personally, I have always been surprised with a debate on non-prime lending.
    What non-prime lending does is it prices risk, which is the borrower's ability to repay. This is not a phenomenon reserved solely for non-prime mortgages.
    If we took a look at other examples in the U.S. bond market, investors demand that State and municipal governments pay a higher rate of interest than the U.S. government pays on treasuries.
    That does not mean that the investors are engaged in predatory lending in that case, I would assume. What you are actually doing is you were looking at the question of risk.
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    Banks and investors tend to charge start-up companies a higher rate of interest on loans than they charge a Fortune 500 firm. Question is: ''Is this predatory?''
    Insurance firms usually charge higher premiums on drivers convicted of DWIs than on drivers who have perfect records. Is this a predatory practice?
    On balance, I think that non-prime lending has greatly benefited millions of Americans and on balance, I think it has helped our economy and I think we should keep that in mind as we move forward with this debate.
    And I thank you, Mr. Chairman.
    Chairman NEY. I thank the gentleman.
    Mr. Baca?
    Mr. BACA. Thank you very much, Mr. Chairman and Ranking Members Waters and Sanders for having this hearing.
    First of all, let me thank the panelists for appearing here today. I look forward to hearing your testimony. I look forward to hearing, about the important issues that pertain to the Hispanic and low-income communities: the issues of subprime lending and predatory lending.
    Today, there are over four million Hispanic homeowners throughout the nation and more and more are becoming homeowners, especially in my district.
    The subprime market plays an important role in increasing access to homeownership for Hispanics; especially those with poor credit histories, subprime loans represent 20 percent of home purchase loans to Hispanic versus 7.5 percent to white borrowers.
    Similarly, subprime loans represent 18 percent of the mortgage refinancing loans to Hispanic versus 6.7 percent to white borrowers. That is why predatory lending practices that sometimes occur in the subprime lending industry are so troubling.
    Our committee and Congress must look at protecting all consumers from such abusive lending practice.
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    That means helping consumers learn how to protect themselves through effective financial literacy programs and making substantive changes in HOEPA.
    We must be careful to do so without adversely affecting the ability of minorities and others to receive affordable credit.
    Again, I look forward to hearing you testimony and learning more about these important issues.
    Thank you very much, Mr. Chairman and ranking members.
    Chairman NEY. Thank you. Thank you.
    Gentlelady from Indiana: Ms. Carson?
    Ms. CARSON OF INDIANA. Thank you very much, Mr. Chairman and certainly all the conveners. This issue of predatory lending has been around for a long time, we just haven't given it any public hearings.
    I am sure those of you who are in the mortgage business, who have been around a long time remember the reprehensible district in my district, Indianapolis, about 15 years ago where a young man who was being foreclosed, who did not look like me, did not live like me, who took on the mortgage lender and walked the president down the street behind a gun for like three hours, since they were taking his property.
    And interestingly, the man who was doing the gun holding aroused a lot of interest and support in the community for his actions.
    I don't believe that we can hold one entity responsible for the problems that emanate from this whole issue. In my district alone, Indianapolis, Indiana, ZIP Code 46201, has the highest incidence of foreclosures in the nation in Indianapolis, Indiana.
    Indiana and Indianapolis, unfortunately, exhibit high rates of foreclosures among homeowners. And I have convened several meetings and was inspired to create a 1-800 number, which is overwhelmed now: 1-800-888-7228.
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    And what I want that number to do before people sign their names for any reason on anything, they call that number and they get the help of a consumer counselor, and they also get the help of legal services, if they are in the midst of being foreclosed, or if they are being threatened with foreclosure, because we have to protect the consumer.
    And I also recommend that the lending institutions have got to assume more responsibility before they approve these loans.
    I know that you don't do it alone, necessarily, but it is like the mathematical axiom: that the sum equals the whole of its parts, and while you might have a lender that has a wealth of integrity, that lender may be dependent on some appraiser, who is just a fly by-night appraiser, who is going to escalate the value of a home charged a bunch of money and before the consumer realizes it, a big moving truck is being put out on the street in front of their house that they did not send for.
    You have title companies that has jumped into the business now that are major culprits that perpetuate this problem abound.
    And I think as we look at this, we can't just look at Countrywide or Irwin Mortgage or other companies that is in the business of lending money, but we have got to look at the whole equation, in terms of how do people end up in this kind of predicament.
    Do lenders rely solely on some appraiser that comes in and tells them that a house is valued at so much money or not?
    Do the lenders, and should the lenders, take some responsibility before they write the check over in behalf of the consumer and end up in a very precarious situation?
    Mr. Chairman and the conveners, thank you very much for your time and I will yield back.
    Chairman NEY. Thank you.
    Anyone else on this side?
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    Mr. Miller?
    Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman.
    For most Americans, the purchase of a home is the most important investment they will ever make. For Americans living in poverty or near-poverty, the purchase of a home is a huge step into the middle class. The equity they build in their home becomes the bulk of their life savings.
    American homeowners borrow against the equity in their home, their life savings, for a variety of reasons: for their children's education, for unexpected medical expenses, for retirement, for home repairs, for all the various rainy days that all of us experience in life.
    I am committed to protecting access to credit for American consumers to buy homes and to borrow against the equity in their home when they need to.
    Yes, many lower income borrowers present a higher credit risk to lenders. Yes, that risk could be reflected in interest rates and lenders should make a fair profit from the credit they extend to higher risk consumers.
    But there has been a dramatic increase in unconscionable practices that take advantage of the most vulnerable consumers and take from them the equity in their home: their life savings.
    Consumers sign long documents, page after page of indecipherable legalese, knowing only how much money they will get at the closing and how much they will have to pay each month.
    What they don't know is that they paid exorbitant fees at closing that came straight out of their life savings, straight out of their equity in their home. And once they sign those documents, it is gone forever.
    Consumers learn that there is a balloon payment or that the lender can call the loan requiring that it all be paid immediately and they can't possibly make the payments.
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    They borrow again, losing still more equity, more of their home's equity, or they lose their home to foreclosure.
    And just as purchasing a home is a huge step into the middle class, losing a home to foreclosure is a huge step back into poverty.
    The profit that lenders derive from those practices go well beyond what is fair. But those unconscionable practices that strip the home equity of vulnerable consumers are all perfectly legal under federal law.
    Mr. Watt and I have introduced legislation to provide protections to all America's consumers that North Carolina consumers now have under state law passed in 1999.
    I am delighted to accept Mr. Bachus' invitation to work with him; to work with Mr. Ney; to work with Mr. Kanjorski; to work with Mr. Watt; to work with industry, with banks, mortgage bankers and brokers, with consumer groups; with all of God's children to try to achieve workable legislation to protect vulnerable consumers from abusive lending practices and still make credit available on fair terms.
    I look forward to the testimony today.
    Mr. BACHUS. [Presiding.] I appreciate that Mr. Miller. And I think it is our goal, all our goals should be here today, to preserve this affordable lending, but to crack down on the abusive practices.
    Mr. Scott, did you have an opening statement?
    Mr. SCOTT. Thank you very much, Mr. Chairman.
    I want to thank Chairman Ney, Chairman Bachus and Ranking Member Waters for holding this joint hearing with the financial institutions subcommittee today regarding subprime lending. I also want to thank the distinguished panel of witnesses today for their testimony on this subject as well, for it is indeed, a most important subject.
    About half a typical family's wealth is in home equity, yet many communities are clearly missing out on one of the basic assets of wealth building.
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    I have heard from some representatives from the mortgage industry that subprime lending provides homeowner opportunities for many individuals who normally would not qualify for prime loans.
    I have also heard from consumer advocates that subprime mortgage lending provides ample opportunity for amazing and tragic predatory lending practices and gives incentives to liberally approve loans to individuals who cannot afford a loan.
    I look forward to today's hearing to help identify the true benefits of opening credit markets to more consumers, while examining the unsavory lending practices and high default rates that accompany the expansion of credit to at-risk communities.
    Advocates from consumer advocates and subprime lenders both, would like to see the creation of a national predatory lending law. But what I want to know is, if such a law is indeed necessary, and if so, how should we preempt state laws.
    We must fight predatory lending without harming legitimate businesses that offer mortgage services to consumers with less than perfect credit histories.
    As a former member of the Georgia State Senate, I can speak of the impact that overly strong regulatory measures can have a housing market. I was one of the first individuals at the State level to put forth a predatory lending act in response to the difficult problems we had with fleet finance coming into Georgia and using our usury laws unfairly.
    But 2 years ago, the Georgia Fair Lending Act had several provisions, including assigning liability to secondary markets, which caused financial companies to pull out of my State and withdraw some lending products.
    The Georgia General Assembly had to revisit that law last year to prevent additional companies from leaving the State. In an effort to stop unscrupulous lending practices that fair lending act caused hardship to legitimate lenders.
    While it is not a panacea, we must bring homebuyer education directly to communities to help stop predatory lending practice.
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    That is why I am pleased to have worked with Chairman Ney, other members of this committee, Congresswoman Velazquez, to introduce H.R. 3938, the Expanding Housing Opportunities through Education and Counseling Act.
    Several sections of H.R. 3938 are similar to the legislation that I introduced last year.
    H.R. 3938 will establish a housing counseling commission in HUD and will create a real 1-800 toll-free number for consumers to call to learn about loan policies and home owners' issues.
    That bill will also provide grants to local home counseling agencies and study predatory lending practices. No, it is not a panacea, but education is the key.
    If we can arm our most vulnerable populations with the education information they need and put a 1-800 number out there, so that they can have a lifeline to call and speak to a human being on the other end of the line, we will go a long way in helping to provide them with the ammunition to protect themselves so that they can have a way to call a number before they sign on the dotted line.
    I look forward to hearing today's testimony to help address the devastating impact caused by predatory lending practices.
    And again, Mr. Chairman, I commend you and thank you for recognizing me.
    Mr. BACHUS. Thank you.
    And just for the record, Mr. Scott, you have 1865? Is that not the correct number of the bill that you have now: the Prevention of Predatory Lending through Education Act or is 3938?
    Mr. SCOTT. It is 3938. What happened was we incorporated some of the features, most of the features from my previous legislation into that.
    Mr. BACHUS. Okay.
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    Mr. SCOTT. Chairman Ney was kind enough to oblige me and I appreciate it.
    Mr. BACHUS. Have you, is 1865 still? Is that still pending, too?
    Mr. SCOTT. Yes.
    Mr. BACHUS. Okay. All right. Thank you.
    Ms. VELAZQUEZ. Mr. Chairman?
    Mr. BACHUS. Are there——
    Ms. VELAZQUEZ. Mr. Chairman?
    Mr. BACHUS. All right.
    Without objection.
    Thank you.
    Are there other members who wish to make opening statements? If not, we will proceed to our first panel.
    First panel is made up of six individuals. First, from my left is Sandy Samuels—and I understand that Mr. Sherman would like to introduce Mr. Samuels.
    Before he does, I would direct everyone's attention to Mr. Samuels' testimony. I think it debunks several of the fictions about who takes out a subprime loan and the demographics of those borrowers. I think it is a very useful opening statement in that regard. He goes into a lot of facts and figures about who their customers are.
    Mr. Sherman, I will introduce you at this time.
    Mr. SHERMAN. Thank you, Mr. Chairman, for the opportunity to introduce Sandy Samuels to the members of both subcommittees.
    Sandy joined Countrywide in 1990 and is Senior Managing Director and Chief Legal Officer for Countrywide Financial Corporation. In this capacity, he oversees the transactional, regulatory and litigation affairs of Countrywide.
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    He holds an undergraduate degree from Princeton and far more importantly, a law degree from UCLA.
    He has roughly 20 years of experience dealing with the very issues that these hearings address. I have known Sandy for many years. He represents the largest financial institution based in the Los Angeles area, which plays such an important role, not only in the Los Angeles area in general, but the valley Las Virgines area, in particular.
    Let me just add. Sandy, I have read your testimony. I have to rush off to a non-proliferation hearing.
    Mr. BACHUS. Now, if you introduce a witness, you have to stay for their testimony.
    Mr. SHERMAN. I will inform Chairman Hyde to delay the start of the hearing on nuclear proliferation.
    Mr. BACHUS. Thank you.
    Before you go, Mr. Samuels, let me introduce the rest of the panel and then we will start with your testimony.
    Our next panelist is Ms. Teresa Bryce; she is the vice president and general counsel of Nexstar Financial Corporation in St. Louis, Missouri. She heads the legal department for Nexstar.
    Prior to NexStar, she held a number of senior positions in the legal divisions of various mortgage companies, including Bank of America Mortgage, Bank of America Corporation; PNC Mortgage Corporation of America and Prudential Home Mortgage Company.
    And you are testifying, Ms. Bryce, on behalf of the Mortgage Bankers Association. So, we welcome you.
    Our next panelist is William M. Dana, president and CEO of Central Bank of Kansas City, testifying on behalf of the American Banking Association. He serves on the ABA's community banking counsel and on its communications staff counsel.
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    And I guess that is why you are here, communicating with us today?
    Mr. Dana has had varying degrees of experience in all levels of community banking management for over 30 years. You began your career as a teller and worked in every phase of banking to his current position as CEO, which you have held for the last 11 years, as I understand it.
    Mr. Dana has been a featured speaker at various national conventions on banking and community development. We look forward to your testimony.
    Mr. George Butts. Mr. Butts is program director of ACORN Housing Corporation of Pennsylvania and is testifying on behalf of the Association for Community Organization for Reform Now. From 1991 to 2003 Mr. Butts served as president of the ACORN Housing Corporation.
    We welcome you, Mr. Butts.
    Mr. Eric Stein, senior vice president for the Center for Responsible Lending of North Carolina and that is an affiliate of Self-Help. Mr. Stein holds a law degree from Yale Law School and a B.A. from Williams College.
    In addition, his work experience includes Fannie Mae's office of Low and Moderate Income Housing and he works with Congressman David Price for U.S. Fourth Circuit Court of Appeals Judge Sam J. Irwin III.
    Is that Senator Irwin's son? Okay. Good.
    Self Help is a North Carolina-based non-profit community development lender that includes a credit union and a loan fund. Mr. Stein manages its home loan secondary market, commercial lending and real estate development programs.
    So we appreciate your testimony, as well as Mr. Butts.
    And last Terry Theologides. He is executive vice president, general counsel and secretary of New Century Financial Corporation and is testifying on behalf of the Coalition for Fair and Affordable Lending.
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    He is a frequent speaker on predatory lending prevention and avoidance from the perspective of loan originators and secondary market participants.
    Received his law degree from Columbia University School of Law; earned his Bachelor's degree from Princeton University.
    Mr. Theologides runs the Compliance Legal and Fair Lending functions at New Century which is the country's second largest non-prime lender.
    So, we welcome our panelists, obviously very knowledgeable panelists. We look forward to you informing our committee about the day-to-day practices of the subprime lending market.
    Mr. Samuels, I am sorry, this is the first I have called your first name, but if you will, Sandor, if you will open the testimony.
    Mr. SAMUELS. Good morning Chairman Bachus, Chairman Ney, Ranking Members Waters and Sanders and members of the subcommittees.
    I am Sandy Samuels, Senior Managing Director and Chief Legal Officer of Countrywide Financial Corporation.
    If I seem a little nervous it is not just because this is my first time testifying before a House committee, my 16-year-old daughter is taking her driving test this morning. So I am a little nervous about that.
    We appreciate the opportunity to testify today on behalf of the Financial Services Roundtable's Housing Policy Council. In today's testimony we want to give the subcommittees a better picture of the non-prime borrowing market served by Countrywide and the member companies of the Housing Policy Council.
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    While the market knows us primarily as a prime lender, Countrywide entered the non-prime lending market in 1996 as a natural extension of our commitment to reach those outside of mainstream mortgage markets.
    Despite the industry's ongoing successes in expanding access to prime loans, the fact remains that a large segment of the borrowing public does not meet the eligibility criteria for prime loans.
    Two recent examples of actual Countrywide borrowers will illustrate this. Earlier this year, Countrywide made a non-prime loan to Mr. and Mrs. S. from Nicholasville, Kentucky, who were struggling to make ends meet.
    They had a high rate second mortgage at more than 14 percent. This and other consumer debts pushed their monthly debt service to over 50 percent of their $3,000 monthly income.
    Although the S's had an excellent credit score in excess of 700, the loan-to-value ratio necessary for them to consolidate their first and second mortgages exceeded the guidelines for a prime refinance loan.
    Our non-prime affiliate, Full Spectrum Lending, was able to make them a $94,000 loan at a loan-to-value ratio of 99 percent. The new loan had a 30-year fixed rate of 7 percent with points and lender fees totaling $2,500, and lowered the couple's monthly payments by more than $200.
    Their monthly debt-to-income ratio is now a much more manageable 43 percent. However, had Mr. and Mrs. S. lived in North Carolina or New Jersey their loan would have been considered a high cost loan and Countrywide, which does not make high-cost loans, would not have offered it at those terms.
    Our second example, Mr. C. from Clovis, California, had a 510 credit score and monthly mortgage and other debt payments that exceeded 60 percent of the income from the tanning salon he owned.
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    We helped Mr. C. consolidate his 7.75 fixed-rate mortgage, his adjustable-rate second mortgage and his other debts into a 30-year fixed rate first mortgage at 6.875 percent with total discount points and lender fees equal to 4 percent of the $264,000 loan amount.
    This loan lowered Mr. C's monthly payments by more than $1550 and reduced his monthly debt ratio to a much more manageable 43 percent of his income.
    Mr. C's low credit score precluded any rate reduction refinance or debt consolidation with a prime loan. Again both New Jersey and North Carolina law would consider this a high cost loan, and therefore, we would not have been able to make it at these terms.
    Let me share with you some of the broad demographics of Countrywide's prime and non-prime first mortgage borrowers based on our most recent three months of production through February of 2004.
    The average age of our non-prime borrower was 43, identical to the average age for our prime customers; 6 percent of our customers were over 60; 10 percent of our prime customers were over 60. Not surprisingly, the average FICO score of our non-prime borrowers was 608 compared to 715 for our prime borrowers.
    The average amount borrowed was virtually identical between prime and non-prime customers: $179,000 for non-prime, $182,000 for prime.
    Even the incomes between our prime and non-prime customers are remarkably similar: $69,000 for non-prime compared to $74,000 for our prime borrowers.
    The average note rate on a non-prime loan was 7.12 percent over the three-month period; the APR on our non-prime products for the period was 7.83 percent compared to 5.44 percent on our prime products.
    As illustrated in the additional borrower profiles in my written testimony, several elements, in addition to credit scores, can move a borrower from prime to non-prime status including the borrower's ability or willingness to document income, stability of borrower's income, lack of financial reserves, loan-to-value ratio on the mortgage property and the characteristics of the property that affect its collateral value.
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    Non-prime products give borrowers more choices and make credit more readily available because we, and other lenders, can price loans according to the level of risk.
    Before the advent of risk-based pricing, the mortgage banker's only other choice was to reject those borrowers who did not fit the prime lending standards.
    Of course, in taking more risk we find that credit problems leading to delinquency do occur more frequently in the non-prime market. However, our experience indicates that they occur for predominately the same reasons that they occur in the prime market: life disruptions that interfere with the borrower's ability to repay.
    Fortunately, responsible non-prime lending can be a second chance for individuals to get their economic houses in order and reestablish good credit.
    Just as these life disruptions represent temporary, not permanent setbacks of families, Countrywide's internal data show that non-prime status is a temporary condition for many of our borrowers.
    Of our non-prime customers who refinance with Countrywide approximately 45 percent graduate into prime products. This is compelling evidence that non-prime loans do indeed, provide a second chance for families who have experienced adverse life events.
    The industry recognizes that bad actors have taken advantage of vulnerable segments of our communities and they must be stopped.
    This is why the HPC supports congressional efforts to accomplish four main objectives: enactment of strong, uniform national standards to directly address these predatory practices; effective enforcement of those standards by both federal and state regulators; stronger financial literacy programs that begin in our school and reach to those who never got the chance to gain literacy skills in their formative years; and expanded access to high-quality home ownership and credit counseling for those who seek it and for those who need it.
    The industry supports a strong new federal standard, but this standard must not unduly increase costs, eliminate choices or reduce the availability of credit to the types of borrowers that I mentioned earlier my testimony.
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    Non-prime loans play a crucial role in promoting home ownership and providing financial options to customers outside of the main stream: a mission I know the members of these two subcommittees share.
    We look forward to working with the Congress to advance these mutual goals. Thank you very much for your attention and I would be pleased to answer any questions the committee may have.
    [The prepared statement of Sandor E. Samuels can be found on page 157 in the appendix.]
    Mr. BACHUS. I want to thank the witness for your testimony.
    Next we go on to Ms. Bryce.
    Ms. BRYCE. Good morning, Mr. Chairman and members of the committee.
    My name is Teresa Bryce and I am the general counsel of Nexstar Financial Corporation, a national mortgage lender and a mortgage loan processor for other financial institutions, both large and small.
    Today, I appear on behalf of the Mortgage Bankers Association as a member of its board of directors. Thank you for giving us the opportunity to share our views.
    Mr. Chairman, the mortgage banking industry is vital to the nation's economy. Today, more than two out of every three American families own their own home.
    This is a truly amazing historic achievement and MBA members continue to push for even greater availability of credit, especially in those communities that have traditionally lacked access to financial opportunities.
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    The so-called subprime market that we are exploring today serves a traditionally underserved group of borrowers that would otherwise have little or no access to credit because of blemished or other credit problems.
    We can make loans to these consumers through risk-based pricing and other innovative financing options that were not available 20 years ago.
    The future growth of the subprime market is however, confronting very serious hurdles. In the zeal to protect our more vulnerable consumers, State and local governments are passing far-reaching laws that are creating a confusing and fragmented mortgage market.
    As we have testified in the past, over the past 3 years close to 30 states have enacted different anti-predatory lending laws with more pending.
    We are beginning to see that this bewildering patchwork of State and local laws is forcing reputable lenders out of the market and deeply stifling the flow of capital to many deserving communities.
    Mr. Chairman, in my capacity as legal counsel, I have spent considerable time tracking and focusing on the issue of predatory lending.
    Even though over the years I have been very involved in promoting the expansion of credit to underserved communities I have advised my company to avoid operations in the subprime market.
    I am very disappointed to reach this conclusion, but it is a decision premised on the enormous legal risks that have evolved in this market segment.
    Risks that, in my opinion, very much outweigh any possible benefits that could be derived from subprime operations.
    Mortgage lending is subject to pervasive federal consumer protection and disclosure laws. On top of these strong federal regulations, the layer upon layer of state laws is making it increasingly impossible to ensure compliance and legal certainties.
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    Even lenders who concentrate on prime market loans have to spend much time and money in trying to navigate this maze of State and local anti-predatory laws.
    At Nexstar, we have purchased an expensive and sophisticated software package to evaluate each individual transaction subject to those laws to ensure that our loans do not trigger coverage.
    Notwithstanding these efforts, there is still no assurance of compliance because some of the tests imposed by these disparate laws are so complicated or subjective that they cannot be programmed into a software system.
    For instance, the Georgia reasonable tangible net benefits test worksheet is three pages long and still requires very subjective decision making that is always reviewable by a judge.
    Even using the best tools available in the market, there is no way for a mortgage company to proceed with certainty in knowing that it has successfully complied. This increasing legal disarray is a real albatross for small businesses.
    The penalties under these laws for even unintentional violations are often draconian and pose too much financial risk. These penalties are dreadful for large institutions, but they are potentially fatal for small businesses.
    Since these high cost laws impose assignee liability most investors simply refuse to fund them. Moreover, our investors are now requiring us to give strict representations and warranties that we are not selling them loans covered by these State and local laws.
    Again, this adds great cost and much risk and is a burden that falls especially hard on small lending institutions.
    In summary, the legal risk associated with subprime operations are so great and the liability so enormous that I cannot in good conscience recommend that my company enter this market.
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    Nexstar Financial originated over 17,000 loans last year. None of these loans were in the subprime market.
    It is truly regrettable that our company and other reputable lenders are opting to entirely forego this neediest segment of our mortgage market.
    We must act to remedy this situation because in the long run only true market competition among a large number of lenders will work to expand choice and lower costs for those communities that are most in need.
    Mr. Chairman, industry participants are in agreement: we need a single national standard so that we may bring order to the bewildering fragmentation of our mortgage market and thereby preserve competition in this segment.
    Thank you for the opportunity to appear before the committee. I look forward to answering your questions.
    [The prepared statement of Teresa Bryce can be found on page 109 in the appendix.]
    Mr. BACHUS. Thank you.
    Mr. Dana?
    Mr. DANA. Thank you.
    Chairman Bachus, my name is William M. Dana, president and CEO of Central Bank of Kansas City, Missouri.
    We are designated as a community development financial institution. I am pleased to testify on behalf of the American Bankers Association. I commend you for holding these hearings.
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    Subprime lending, or more precisely, lending to those with less-than-perfect credit ratings is an important category of lending that has helped better lives of many Americans.
    As with all lending, it must be done in a straightforward manner with all appropriate disclosures so borrowers understand the obligations they are undertaking.
    Subprime should not be confused with predatory lending which is characterized by practices that deceive or defraud consumers.
    Predatory lending has no place in our financial systems and there should be aggressive enforcement of laws and regulations designed to prevent such practices.
    Subprime lending is an extremely important part of my small bank's business.
    The community my bank serves has many individuals and families who are not wealthy and often lack a perfect credit score, who need credit and look to our bank to provide it. In many cases the loans for which they qualify are subprime.
    We provide full disclosure of all the terms of these loans and work hard to make sure our borrowers understand the obligations they are assuming.
    It does our bank no good and certainly our borrowers no good if they do not fully understand this important financial obligation.
    I would like to share some examples of the kinds of lending, subprime lending, my bank does and the impact on our community if we do not extend these loans.
    We have helped people who have been victims of predatory loans like a retired couple with a $19,000 annual income.
    They had taken a second mortgage against their home with a siding contractor paying 19 percent annual interest. My bank refinanced their mortgages on much better terms and eased their worry about losing their home.
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    My bank also helped new businesses get started like a loan to buy an accounting and tax service business targeted to Spanish-speaking immigrants.
    The applicant had a low credit score and her business partner had an even lower score. Nevertheless, Central Bank financed the acquisition at 8.5 percent using the business and a personal residence as collateral.
    Without our loan, these women would not be in business serving our large Hispanic population. They were both inviting targets for predatory lending by unscrupulous lenders, but instead they have a good loan at a fair price benefiting them and the customers they serve.
    We have also helped those in trouble in our community. A local church came to us when they had a church van repossessed and another lender had begun foreclosure proceedings against the church.
    The Pastor came to us and even though he had a troubled credit history, he agreed to guarantee a loan made by Central Bank. Working together we were able to help him save both the church and the van.
    Without Central Bank's participation in the subprime market, these borrowers, and many more like them, would not have these opportunities to help themselves and their communities. Instead they would likely have been targets for predators.
    A desire to do more to prevent predatory lending is understandable. It is important to note however, that the practices typically associated with predatory lending are already illegal. What is often lacking is proper enforcement.
    Laws that add additional requirements only raise the cost of these types of loans. Complying with many different State and local requirements adds a regulatory burden, impedes efficiency, raises costs and reduces the amount of credit available.
    In ABA's opinion, a national standard to prevent predatory lending may be desirable to ensure that all lenders, whether they are depository or non-depository, operate under the same requirements.
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    The ABA looks forward to working with the members of the Financial Services Committee to explore legislative options for a national standard to combat predatory lending.
    Thank you.
    [The prepared statement of William M. Dana can be found on page 141 in the appendix.]
    Mr. BACHUS. Want to thank the gentleman for his testimony.
    And Mr. Butts?
    Mr. BUTTS. Thank you.
    My name is George Butts and I am the program director of the ACORN Housing Corporation of Pennsylvania.
    Equal Housing has offices in 34 cities throughout the United States. We are one of the largest providers of housing counseling services in the country. We have put 52,791 people into homes.
    ACORN Housing works closely with our sister organization: ACORN, a leader in the fight-to-win economic justice for all.
    When we first started this fight it was about access. There wasn't any money coming into low-income neighborhoods. That is what creates a vacuum that subprime and predatory lenders rushed in to fill.
    Now the question is not access, but what kind of access. The fight is becoming making sure that the subprime market is cleansed of discrimination and predatory lending.
    Let us be clear: we are not against subprime lenders. They have a role to play in our marketplace; everybody is not going to qualify for an A loan.
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    But we also know that there is a lot of work to get to a well-functioning market in this industry. Recent steps taken because of public pressure are helping get us there.
    For example, in recent years Ameriquest, Household Financial, Citigroup, Fannie Mae and Freddie Mac have all made changes to help stop predatory lending.
    However, for every reformed household, there is an unrepenting Wells Fargo Financial and a dozen small subprime brokers who routinely engage in predatory practices.
    The subprime market is still an unregulated mess. These problems run deep, are systemic and occur to people from all backgrounds, but they are particularly targeted to elderly, low-income and minority homeowners.
    Let me start with a story of a family from Louisiana.
    James was a veteran of 25 years in the Marine Corps. He and his wife, Doris, bought a home through the G.I. Bill in 1994. Their mortgage had an interest rate of 8.5 percent.
    Wells Fargo Financial first contacted——
    Mr. BACHUS. Excuse me, Mr. Butts, if you could just speak up. Thank you. We want to make sure we get it. Thank you.
    Mr. BUTTS. Okay.
    Wells Fargo Financial first contacted them by sending live checks in the mail and they cashed one which resulted in a very high interest rate loan.
    Then Wells began pushing them to consolidate debts into their mortgage, promising lower monthly payments. In December 2001, Wells gave them a nine-year mortgage.
    The loan officer never told them that it included almost $11,000 in finance fees. This was over 11 percent of the amount financed compared to the typical 1 percent charged by banks.
    James and Doris already had insurance but were forced to finance in single-premium credit life and disability insurance, which stripped away another $6,400.
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    Instead of their current interest rate of 8.5 percent, Wells put James and Dorothy into a higher interest rate of 11.4 percent. The massive fees put the loan well over the house's appraised value.
    When the couple fell behind on payments, Wells convinced them to refinance, promising lower rates which added in thousands in new fees, an unnecessary insurance policy and a higher interest rate of 13 percent.
    James and Doris wanted to refinance to a lower rate, that is when they discovered that they had a five-year prepayment penalty which would add $10,000 to the cost of the loan.
    This is just one story among tens of thousands. Unfortunately, too many loan features that are totally legal are profoundly uncompetitive and non-transparent.
    Higher finance fees, prepayment penalties and yield-spread premiums are all easy to hide. Strip equity from borrowers and reward lenders and brokers for the number of transactions they complete rather than how many performing loans they set up.
    The annual study we released earlier this month, Separate and Unequal Predatory Lending in America, shows that African America and Latino homeowners are at least two times more likely to receive a subprime loan.
    What makes this especially troubling is a recent report in Inside B&C Lending indicating that nearly 83 percent of subprime loans went to customers with A-minus or better credit ratings. This happens particularly to people of color. This, itself, is a form of predatory lending.
    There is no reason to accept claims that fair regulation of subprime loans will lead to lenders leaving the market. In North Carolina, for example, the State was able to reduce predatory loans without hurting the subprime market.
    Other states have passed strong laws against predatory lending. Federal laws should not preempt this progress.
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    In my home state of Pennsylvania, Philadelphia's predatory lending law was preempted by the State's much weaker and ineffective law. On a federal level, the Community Reinvestment Act needs to be strengthened; banks should be given more credit for prime loans than subprime loans.
    By strengthening the CRA, we can help create a stronger market of good loans in underserved communities. This will help drive out the predators.
    This is going to be hard, but that is okay. As Frederick Douglass wrote, ''If there is no struggle, there is no progress. Power concedes nothing without demand. We have seen the system move before and it can move again.''
    Thank you for the opportunity to address you today and I will be happy to answer any questions that you may have.
    [The prepared statement of George Butts can be found on page 124 in the appendix.]
    Mr. BACHUS. Want to thank the gentleman for his testimony.
    Mr. Stein?
    Mr. STEIN. Thank you very much. I am Eric Stein with the Center for Responsible Lending, which is a research and policy non-profit.
    Thank you Chairman Ney and Chairman Bachus for the opportunity to testify; and Ranking Member Waters.
    The Center for Responsible Lending is affiliated with Self-Help, which is also a community development financial institution. And we have done $3 billion worth of financing across the country to 37,000 families for one purpose: and that is to make people build wealth through homeownership.
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    As a lender, starting in the late 1990s, we started seeing families come to us who had loans that were directly attacking our mission because they received loans but these were loans that put their homeownership at risk.
    I will just give one quick example.
    A woman who works for the Durham Public School System came to us with a loan from Green Tree Financial. A $99,000 loan, $16,000 of which were upfront fees, including single-premium credit insurance.
    She is an elderly African American woman. She had a very high interest rate, higher than her credit warranted and she had a prepayment penalty, which meant she couldn't get out of that loan.
    There was nothing we could do to help her. And everything that was wrong her loan was legal under state law and federal law at that time.
    We got together with industry groups in North Carolina, a really remarkable coalition: large banks, small banks, credit unions, mortgage bankers, mortgage brokers. We all negotiated on a bill, along with community groups and civil rights groups that really had one primary strategy: and that was to squeeze down on fees and allow interest rates to adjust.
    The reason that we thought to do this was that most of the subprime lending are refinance transactions. The reason that Mrs. V., it is the borrower that I mentioned, paid such high fees is that she didn't realize what she was doing.
    If you have a refinance loan and an unscrupulous lender wants to charge high fees, they tack it on to the loan balance. And all that does is decrease the equity available on the house.
    It is not like you are paying out cash at closing, like in a purchase transaction, but it is really an easy thing to do and the same thing happens on the back end as happened to her, in terms of a prepayment penalty: she would have had to pay that later and she didn't feel the pain when she signed the loan document.
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    So, in North Carolina, we wanted to squeeze fees, let interest rates adjust. We believe in risk-based pricing; we do risk-based pricing or we wouldn't still be in business.
    If the lender overcharges on interest rates, the best protector of that are responsible lenders who will come back later and refinance that borrower out and give them an appropriate interest rate.
    But, if a lender charges fees that are too large, there is nothing you can do once you sign those loan documents. That family wealth is gone forever; it is not there to pass on to future generations.
    That was the strategy that we all agreed to in North Carolina and the results 4.5 years later are in and the results are positive. Other states have taken the same strategy.
    First, what we found is that equity stripping is down; that stripping of wealth that we tried to address is down. University of North Carolina did a study that is the most comprehensive by far, and found that the number of refinanced loans with predatory aspects to it is down in North Carolina significantly after the law.
    Loans like Mrs. V.'s were flipping, which did not benefit the borrower. Those types of loans are now illegal, so those types of loans have decreased as well.
    Second, steering is the second predatory characteristic that has decreased in North Carolina.
    The UNC researchers found that loans-to-borrowers with credit scores above 660, those who are much more likely to be able to get lower cost conventional loans are down 28 percent in North Carolina, whereas conventional lending was up 40 percent in North Carolina.
    Which I think leads to an important point: in the next panel, you might hear that if the number of subprime loans decreases, that inherently means that the State law is a disaster. But what you need to do is to look what type of loans aren't being made, because it is not that credit is reduced, it is the number of subprime loans are down and that might be a good thing.
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    In North Carolina, the UNC research has found that it was a good thing that there were equity-stripping loans that were not being made and there were subprime loans that could go to conventional that weren't being made.
    The third problem in subprime that we addressed in North Carolina is foreclosures. There is going to be more discussion next panel. It is too early; we don't know what the research says about that in North Carolina.
    What we do know is there was a study in Louisville that a third of all the foreclosures there were due to subprime loans with predatory features, exactly those features that North Carolina made illegal and UNC found were reduced as a result. So we can be hopeful there.
    The other point I would like to make about North Carolina is that while the number of abusive subprime loans are down, credit is still widely available.
    UNC found that subprime purchase loans, the ones that actually buy a home and increase homeownership are up, faster than the national average.
    Subprime refinanced loans to borrowers who have no other options, who have credit scores below 580; they are up as well by 19 percent.
    The other point is that Inside B&C Lending found this, and UNC found it as well, if credit really were scarce in North Carolina, one would expect interest rates to increase because credit would have been rationed and the way to address that is by raising the price of it, which is interest rates.
    In fact, that hasn't happened. Interest rates have not risen in North Carolina, compared to the rest of the country.
    The Banking Commissioner received tons of complaints about mortgage lending; not a single one by a borrower who couldn't get access to credit.
    The last point I would make is that the subprime industry increased this year compared to last year: 2003 over 2002 by 50 percent, to $332 billion. And it is not an industry that is in peril, is the point I would like to make.
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    [The prepared statement of Eric Stein can be found on page 190 in the appendix.]
    Mr. BACHUS. Thank you.
    And we will move on.
    Just to explain, the bells have rang, so we have two votes: one 15-minute, one five-minute vote.
    But we will go on with Mr. Theologides, his testimony. And then we will do the votes and members will come back for questions.
    Mr. THEOLOGIDES. Thank you, good morning.
    The Coalition for Fair and Affordable Lending and New Century Financial Corporation, the second largest non-prime lender, appreciate the opportunity to testify.
    I am Terry Theologides, executive vice president of Corporate Affairs for New Century, one of CFAL's founding members.
    We believe that in today's nationwide housing finance market, uniform, federal statutory standards for non-prime lending should be enacted to apply equally to all types of mortgage lenders and to provide strong protections to all Americans, while preserving access to affordable, non-prime mortgage credit.
    New Century and other CFAL members look forward to continuing to work with you to help craft legislation that can be passed with very broad bipartisan support.
    It is my honor to appear before you.
    Chairman Ney, Chairman Bachus, Congresswoman Waters, we commend you for holding today's hearing to further members' understanding of the non-prime market and the Americans who rely on it.
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    Non-prime mortgage lending originations were roughly $325 billion in 2003, representing 10.5 percent of all mortgage originations.
    The non-prime mortgage market's expansion since the early 1990s has significantly increased access to affordable credit for millions of Americans who historically have been unable to qualify for credit under so-called prime mortgage underwriting standards.
    We acknowledge that unfortunately, there have been unscrupulous lenders, who have engaged in abuses that are fraudulent, deceptive and illegal.
    Clearly, enhanced enforcement, together with more financial education and counseling opportunities are needed to help prevent these abuses from occurring.
    More importantly, however, we believe that it is imperative for Congress promptly to pass new federal standards to strengthen consumer protections while preserving access to affordable credit. We want to work with you to craft such a law.
    In my testimony this morning, I want to summarize four key points, which I addressed in much more detail in my written testimony.
    These are: what is the profile of a typical non-prime borrower; how do we ensure that non-prime borrowers we lend to have the ability to repay those loans; how do we determine the appropriate risk-based price for loans we make to our borrowers; and why don't these borrowers qualify for prime loans.
    The profile of the typical non-prime borrower is that they are middle-class, in their 40s and 50s and their racial and ethnic mix is representative of the U.S. population as a whole. They had an average income, in 2002, of $71,500.
    Before you and in my written testimony, we have several charts that summarize these demographic characteristics.
    When responsible non-prime lenders underwrite a mortgage loan, we look to assure ourselves that the borrower will have the ability to repay that loan.
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    In doing so, we recognize that borrowers who have more challenged credit profiles, or exhibit other higher risk loan characteristics represent a greater risk; therefore we analyze each loan carefully before we approve it.
    As a result, our industry has a 52 percent loan denial rate for non-prime loans, compared to a much lower denial rate of 13 percent for prime lenders.
    The pricing of loans in the non-prime mortgage market is very much a function of both competition and risk. As a result, the spread in the interest rates between prime and non-prime mortgages continues to compress and it now averages between 1.75 to 2 percent above today's typical prime mortgage rates.
    The handout accompanying my oral testimony and my written testimony demonstrate how our interest rates and points and fees track by risk grade. Our risk-based pricing starts with the categorization of applicants into one of six separate risk grades, based on a variety of factors.
    An automated computer program assigns our applicants' risk grades. Once an applicant is categorized into a risk grade, her interest rate depends on a variety of additional factors, including loan program, loan size, credit score band, loan-to-value ratio, income documentation, property type and a variety of other factors.
    Many Americans have difficulty qualifying under the more stringent prime mortgage underwriting guidelines.
    To help illustrate why our borrowers end up with a non-prime loan instead of a prime loan, we took our key underwriting guidelines and juxtaposed them to Fannie Mae guidelines. We then ran through our entire population of 2003 loans through these screening criteria.
    We found that 81 percent of our customers had a credit score below 660, which alone would have disqualified them from the prime market.
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    Moreover, when we dug further and looked into credit income documentation and other loan characteristics, we found that 96.5 percent of our borrowers had characteristics that would have precluded them from qualifying for a conforming mortgage, based on the published Fannie Mae guidelines.
    Of the 3.5 percent that could potentially have qualified for a conforming mortgage, they end up in our top credit grade and today, those rates are 5.5 to 6.5 percent.
    Mr. BACHUS. Not to interrupt the witness, but the time has expired.
    We are going to go to the vote, and so the committee will be recessed approximately 15 to 20 minutes.
    We will be back.
    Mr. THEOLOGIDES. Thank you, Mr. Chairman.
    Mr. BACHUS. Thank you.
    And then we can conclude.
    Mr. BACHUS. Members will be arriving in and out. We have a member, I am sorry. Four members. Five.
    Not that I am not paying attention to you, Mr. Clay, I just got back here and was a little unnerved over a close vote. How about that?
    Well, what we will do is we will go ahead and did you have any final comments, because the bells were ringing, Mr. Theologides?
    Mr. THEOLOGIDES. I did. Just a couple more comments.
    Should I start, Mr. Chairman?
    Mr. BACHUS. Real brief.
    Mr. THEOLOGIDES. Sure.
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    Before you all left for your vote, I was indicating that on credit, about 81 percent of our customers had credit scores below the level that is used by regulators and many financial institutions to demark where is a prime and where is a non-prime loan.
    And that looking at other characteristics, you actually get down to about 3.5 percent of our borrowers that maybe would have qualified for a prime loan. And they receive very attractive rates from us in the 5.5 to 6.5 percent range.
    We recognize there are some bad lenders and brokers who take unfair advantage of borrowers.
    We accordingly support strengthening current federal law, as well as enhancing enforcement in consumer financial education opportunities.
    We also understand that many State and local legislators who have stepped in to try to fill the gaps in the federal HOEPA law had been well-intended; however, the irrational patchwork of State and local anti-predatory lending laws that is developing is not workable.
    New Century and CFAL strongly support prompt congressional action to provide clear, effective, and workable uniform national fair lending standards for non-prime mortgage loans.
    Thank you.
    [The prepared statement of Stergios Theologides can be found on page 222 in the appendix.]
    Mr. BACHUS. Thank you.
    One of the ideas that has been proposed or bandied about was to prohibit charging separate points and fees on a subprime loan, and I guess you would call it front-loaded or put into the interest rate.
    Do you have any comment on that? Or anybody on the panel? I am sorry.
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    Mr. THEOLOGIDES. I would be happy to comment on that, Mr. Chairman.
    Certainly, if people are being charged points and fees that are not disclosed to them that is not proper. And certainly that is characterized appropriately as an abusive practice.
    But forcing everything into the rate does have its downside.
    Many borrowers cannot afford the monthly payment if the compensation is packed into the rate. So, offering them an option of electing either to take some points and fees upfront to buy down the rate and lower that payment gives them a choice.
    And certainly, that is our position. Our rate sheet, which is included with our testimony, shows that trade-off. If you want to pay a little bit more in points or a little bit less in points, the rate can adjust accordingly.
    Mr. BACHUS. You would also, wouldn't you have to look at the longevity of the loan and the cost if you put it into the interest rate versus outright payment?
    Mr. THEOLOGIDES. That is right.
    Mr. BACHUS. Or if anybody has calculations or examples of that, I would be interested in that too.
    What it would cost versus——
    Mr. THEOLOGIDES. Right. The paying additional points can lower the interest rate 50 basis points or more for each point. Which again, on an average loan, can mean $100, $200 in difference in payment.
    And so, just as in the prime world, people are making that trade-off, we are concerned that if everything is driven into the rate, that works well for someone who can has the extra cash and can put it into the rate, but it removes some choice from a borrower who may want to make that well-informed choice to buy down their rate, sir.
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    Mr. BACHUS. Anyone else like to comment on that? No?
    Mr. STEIN. I would like to make one point, if I could.
    As I mentioned in my testimony, the North Carolina law's goal is not to get rid of points and fees, but to squeeze them a little bit, because that is where most of the abuse occurs.
    And you are still allowing five points, which is five times the points and fees paid on a conventional mortgage. It is not like they go away, but it is just favored.
    High-cost loans can still be made, but again, there are more protections in place because that is how equity is stripped.
    Mr. BACHUS. Thank you.
    Mr. SAMUELS. Mr. Chairman?
    Mr. BACHUS. Yes?
    Mr. SAMUELS. One of the issues that we are confronting is trying to make as many loans available to people who have the ability to qualify and to afford the loans.
    And one of the things that we are discussing is where should the appropriate lines be on these triggers, as to what constitutes a high-cost loan, where should they be drawn? The lower they are drawn, the more people are going to be cut out of the credit market.
    Certainly, there are abuses that have been talked about, bad practices that are legal that need to be addressed, such as: people who are made loans without the ability to repay them; people who are made loans who derive no benefit from them; people who are steered to subprime if they could qualify for prime.
    Those things, I think, if they are addressed in the legislation, I think that drawing an appropriate line for high-cost triggers that allows people choice, that gives people the opportunity either to finance their points and fees up to a certain level, or to pay them upfront, I think is something that we want to be able to do because it will expand the opportunity for people to get credit.
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    Mr. BACHUS. Well, thank you.
    Go ahead.
    Ms. BRYCE. I would just add that is what we have seen in the marketplace is that in the purchase market, in particular, there has been difficulty with consumers being able to come up with the amount of money they need for closing costs and down payment, even on prime loans.
    So as a result, I think you need to leave the option of doing either one because they may need to finance in some of their points and fees in order to be able to get the loan.
    Mr. BACHUS. Thank you.
    One question I have, Ms. Bryce, is you talked about the patchwork of state laws, and some of the complications that arise over that.
    I wonder if you could just give us an example.
    And I am going to finish my questioning in the back and forth here, and we will have some additional time.
    But very quickly, if you can give me one example of a complication of state laws; different patchwork, but also, I also I would even take it a step further, I guess, as we go on here, of municipalities.
    I mean dealing with the State is one thing, but I can tell you in municipalities, and I know in Ohio, I think it is been unfair to people.
    If you are in Cleveland it is going to be a different story for you than maybe if you are in Dayton or somewhere else and defined of the State law by the locals, so you have a hodgepodge of laws all over our state.
    But right now, if you could just tell me about a complication involving state laws.
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    Ms. BRYCE. Sure.
    I would echo what your comment is about Cleveland, because with——
    Mr. BACHUS. Not to become Cleveland, but——
    Ms. BRYCE.—but for instance, a good example is in the State of Illinois, with the City of Chicago.
    Where you already have the federal HOEPA laws, but the Department of Financial Institutions of Illinois also has issued a set of regulations on mortgage loans.
    Cook County has also passed an ordinance related to these practices, as has the City of Chicago, in addition to the already expansive mortgage lending laws that cover our lending practices.
    So in fact, in the City of Chicago, you are subject to at least four sets of laws, not including the federal law.
    Mr. BACHUS. Thank you.
    And my final question, and then I will move on to other members, would be for Mr. Butts.
    In the separate and unequal study, I think it is asserted that a large number of the current subprime borrowers actually qualify for prime loans, I think is what it said.
    Now, I think if you have a credit score below 660 you can't receive prime credit. So, how can that study say that 35 to 50 percent of the subprime borrowers qualify for prime rates when about 80 percent of those individuals have credit scores below 660, which would be a cutoff rate?
    Mr. BUTTS. Because in a lot of cases a lot of mainstream banks have products that are not just based on credit scores, but they are based on the credit report and what the credit report says.
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    And people who come to counseling agencies like us, because we have things to help mitigate the risk. So, our rate right now for a fleet loan with a credit score of 580 is 5 percent.
    And a lot of people——
    Mr. BACHUS. Sorry, 580 is 5 percent?
    Mr. BUTTS. Five percent.
    So, people can qualify. And I mean that is one of the reasons that we put that statement at the beginning, where we say what really needs to happen is that the mainstream financial institutions need to work harder at providing alternative products to what the predators are doing.
    I mean this is some of the things that are happening in Philadelphia right now, with our Mini-PHIL and PHIL-Plus programs.
    That was a consortium of banks and counseling agencies, and the city, where we all put together and got a product that directly addresses what the predators were doing, which was going after people with home improvement loans and giving them high interest rates.
    Now they can come to a regular mainstream bank with a credit score, for some institutions, as low as 550, and get a regular home improvement loan and not have to go to the predatory loans.
    Mr. BACHUS. Can I ask the lender? I just haven't heard of below 550 at 5 percent.
    Mr. DANA. Mr. Chairman, maybe I can address a little bit from our experience, as a community development bank.
    We typically make loans regularly on credit scores that would not qualify as what you would consider a prime rate. Most of our clientele that we deal with have had some type of credit experience or difficulty with credit in the past.
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    So, basically it becomes an issue of working with those borrowers on a one-on-one basis regardless of what their credit score is to get them a product that will accomplish what they are looking for, which is in most cases, wealth-building of some type.
    Mr. BACHUS. So it can happen with 580 and you can get 5 percent? Statistically, you know what percentage of individuals can do that?
    Mr. DANA. I can't quote statistics, I can just speak to what happens in our individual institution, but if there are statistics like that, we could see if we could find some and get back to you.
    Mr. BACHUS. Mr. Theologides?
    Mr. THEOLOGIDES. We are the second-largest non-prime lender, so we are working with programs that can be offered, sort of, nationwide.
    And for a 580 borrower a 5.5 percent interest rate is probably not impossible, but it is pretty tough. It has to fit into a lot of other parameters. But that borrower would today get in the sixes or in the sevens.
    And again, we have grown to be the second-largest in this industry not charging more than everybody else. We have been among the most competitive.
    So, I think while there might be some specialized programs——
    Mr. BACHUS. Because not a down payment might be a factor also, I suppose?
    Mr. THEOLOGIDES. Amount of down payment, loan-to-value rates——
    Mr. BACHUS. If they have a lower credit score, but they have a certain amount of holdings or assets?
    Mr. THEOLOGIDES. Absolutely.
    What I would illustrate is, and what we have put in our testimony is there are lots of variables; it is not a black box. You look at the different variables of what the credit is, what the loan-to-value is, what the assets are, and it is available on our Website.
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    It is not mystery pricing, it is looking at all of these variables and how they affect the risk to the lender and everyone. We are competing vigorously against Mr. Samuel's company and when his rates go down in the morning, I hear it from my people in the afternoon.
    We are always struggling to try to compress how we can balance the risk, the increased risk, but at the same time maintain competition in this segment of the market.
    Mr. BUTTS. I also think the key to mitigating that risk ha been loan counseling.
    We do a lot of what we call character lending, where we are actually looking at the circumstances and we are suggesting. And a lot of times we have access to the underwriters who are actually drafting, approving these loans.
    And we are making the case that based on this set of factors we think you should make this loan. And more often than not, because of the parameters that we have set up with them, we are able to do that.
    Mr. BACHUS. Now in some cases, when you are talking about the 580 or below, is the CDFI subsidizing, well, giving the full-faith backing?
    Community Development Finance——
    Mr. DANA. I can speak to that.
    We are a CDFI, and on an individual loan-by-loan basis, the CDFI does not grant grants based upon individual loans. They do it on the overall picture based upon your increase in lending into distressed communities.
    Mr. BACHUS. Not a grant, but I mean a subsidation.
    Ms. BRYCE. I think you do have to look at certain bank programs because some of them are created for CRA purposes and they are a negotiated program.
    And sometimes they are essentially unprofitable programs for the banks, but they decide to do those programs at any rate.
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    So, I think you have to know what you are looking at and how it compares to what else is available in marketplace.
    Mr. BACHUS. Well, in a generic basis, a broad-brush basis, are these loans exceptions to the rule or it happens a certain amount of time, or it happens a lot, to put it kind of in layman's terms because we don't know statistics.
    Are these exceptions to the rule, the below 580 credit score at 5 percent or do they have them with certain frequency or?
    Mr. DANA. Yes, Mr. Chairman, I would agree with Terry, that it is an unusual situation. You would have to look at the circumstance.
    Certainly, you can buy down the rate to very, very low, but with 580——
    Mr. BACHUS. Not to interrupt you, but let me put this caveat in there.
    Let us just talk about market-based loans; no CDFI, no type of special, first-time homebuyer rates, market-based loans. Are a lot of people getting these loans below 580?
    Mr. SAMUELS. I mean one of the things I mentioned in my testimony is that our average rate for the last three months ended in February, was just a little over 7 percent for our non-prime borrowers. That is the interest rate.
    The APR would be in the high sevens. So, a 5.5 percent rate for someone who is clearly in the subprime category, which somebody of 580 or below credit score would be, that would be unusual. But again, we would have to take a look at the circumstances.
    Mr. BACHUS. I apologize; I have run way over my time.
    Ms. Velasquez? Mr. Watt?
    Mr. WATT. Thank you, Mr. Chairman.
    Let me just say first of all, since this is the first hearing or opportunity since H.R. 3974, the bill that Mr. Miller and I dropped, let me make a couple of comments.
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    I know this is about subprime lending, but most everybody has talked about predatory lending and is sometimes difficult to know where the line is between subprime and predatory lending.
    So, what I wanted to ask each of the panelists, and maybe other people in the audience, to do is now that the bill has been dropped, essentially reflecting what the North Carolina standard is, in as many respects as the North Carolina standard fit at the federal level.
    There were some respects where we had to make some adjustments just because it was not a perfect fit at the federal level.
    I want to invite comments and feedback from those participants in the industry who understand this dynamic and want to emphasize that as North Carolina's purpose was not to drive lenders out of the market, neither was Representative Miller, and my purpose to drive any lender out of the market.
    And we are trying to find what the appropriate balance is. We think our balance is better on balance than the Ney-Lucas bill, I would have to say.
    Mr. BACHUS. You always have time to reflect and maybe change your mind.
    Mr. WATT. But we also understand that reasonable minds can differ on a number of the issues, and so this is the stage at which feedback is welcome.
    We couldn't get feedback from everybody before we dropped the bill, but that is the purpose of dropping a bill, that is the purpose of having hearings and hopefully through a series of hearings we will get to a bill that is an appropriate standard.
    Having said that, we know that there are and have been specific benefits that have resulted from the North Carolina law, and since Mr. Stein is here from North Carolina, perhaps I would give him the opportunity to put some of those benefits into the record as we start to build this record.
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    Mr. Stein?
    Mr. STEIN. Thank you Mr. Watt.
    You probably won't be surprised to hear that I think your bill is an excellent one.
    I think based as it is on the North Carolina law, which was negotiated by industry and consumer groups, I did mention a lot of the benefits, and going back to the previous question about are people getting the appropriate loan, and I think for people in North Carolina that is increasingly the case.
    Since borrowers with credit scores above 660, again, there are fewer of those in North Carolina getting subprime loans, they are getting conventional loans.
    There is less equity stripping because fees are squeezed into a five-point bucket, which isn't squeezing so far again, that is five times the amount of fees in conventional, but UNC found that abusive equity stripping loans are gone from the market, and yet credit is still widely available.
    I think it has been a pretty unqualified success in North Carolina as a result of the law.
    Mr. WATT. Perhaps we could get a copy of the study that was actually done.
    And Mr. Chairman, I might ask unanimous consent to make that University of North Carolina study a part of the record of this hearing so that everybody would have the benefit of it.
    [The following information can be found on page 273 in the appendix.]
    Mr. BACHUS. Without objection.
    Mr. WATT. I think my time is about up.
    I wanted to go a little bit further into this issue that the chairman raised about the interplay between points on the one hand and interest rates on the other hand. But I think we will have opportunity to do that over time.
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    So trying to keep within the spirit and the letter of the five-minute rule, Mr. Chairman, I will yield back.
    Mr. BACHUS. I want to thank the gentlemen.
    Mr. Hensarling?
    Mr.HENSARLING. Thank you, Mr. Chairman.
    I certainly appreciate the serious nature of this hearing and the serious legislation that has been drafted to attempt to address it.
    But there is a great challenge for the committee because, as I listen to the testimony very closely and listen to the opening statements, as we are dealing with the issue of subprime lending, and I guess it is evil cousin predatory lending, there doesn't seem to be an acceptable definition of what constitutes predatory lending.
    If so, it is going to be very difficult for us to legislate against something that we are having a little trouble defining in the first place.
    I, for one, believe that absent any compelling evidence of force or fraud, I am loathe to outlaw a commercial transaction between consenting adults.
    When we are dealing with the issue of fraud, obviously these subprime loans are subject to a number of disclosure regulations already, so the first question I will place to a couple of members of the panel.
    What disclosures are presently missing from HOEPA that you would like to see in legislation? What is not being disclosed to the consumer in the offering of this credit?
    Why don't we start with you, Mr. Samuels?
    Mr. SAMUELS. Thank you, Mr. Hensarling.
    First of all, I want to thank you for your leadership in Plano, Texas, where we have a large facility and we appreciate all your help in moving a lot of employees over to Plano.
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    Let me address what predatory lending is, and then we will get to the disclosures.
    I think that predatory lending can be defined in a number of ways, and we are talking about bad practices, including fraud, including making loans to someone who cannot repay, including making a loan to someone where there is no benefit to that individual.
    And I think that those are the areas that we really need to focus on in crafting good, solid, uniform federal legislation, preemptive federal legislation that can really address directly the issues that we are talking about.
    In addition, however, in direct response to your question, we have a number of disclosures that Countrywide uses to help people understand what the nature of the loan is.
    For example, there is been a lot of talk about prepayment penalties.
    One of the things that we do is we provide our borrowers with a choice between a loan with a prepayment penalty and a loan without a prepayment penalty.
    And we have a disclosure form that very clearly sets forth what the loan looks like with a prepayment penalty and what the same loan would look like without a prepayment penalty, and what benefit would be gained from taking a prepayment penalty, and what the amount of the prepayment penalty would be, to give people a good idea of whether it would make sense for their particular circumstance to take a loan with a prepayment penalty.
    If they take the loan with the prepayment penalty, they will get a benefit on the price of the loan. You see? So we have that disclosure.
    We are also creating a disclosure that I have talked to several of your colleagues about. That is, a summary of loan terms, because as you know, we have a very thick stack of documents at closing.
    What we want to do is to take the summary of loan terms and we call it, ''Understanding Your Loan,'' that basically says, ''Here is what your loan is. Here is the interest rate, here is the monthly payment.''
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    ''Is it a 30-fixed? Is it an ARM?'' All of the basic and important terms of the loan, so that somebody could see that before they sign on the bottom line.
    Also, they would be able to use that document if they decided they wanted some counseling and they wanted somebody to look at that loan, the counselor would not have to pour through hundreds and hundreds of pages, they would have a document that says, ''This is what the loan looks like, is it a good idea or not''.
    Those kinds of disclosures. We have broker disclosures, having our borrowers understand what the role of a broker is, and how a broker is compensated.
    So we have a number of things that we do to try to help the borrower understand the loan process.
    Mr. HENSARLING. Thank you.
    Mr. Samuels, the time passes quickly, I see my time is about to run out.
    No pun intended, but I was hoping on giving Mr. Butts a chance to rebut.
    I notice in your testimony you mention that a predatory, if I am reading this correctly, that you cite prepayment penalties as a predatory feature, yet Mr. Samuels says there can be a rate differential, based on prepayment penalty.
    So, it seems to me that if we are taking away consumer options, how is this helpful to the consumer? And why is a prepayment penalty, per se, a predatory lending practice, Mr. Butts?
    Mr. BUTTS. Well, like financed fees it is so easy to hide prepayment penalties.
    I think the problem that we have with them, generally speaking, is that one: they are too long, two: that they are not really fairly disclosed to people.
    That you understand that you can't, if you take this loan with this prepayment penalty, you are, sort of, stuck in this loan for a certain period of time, and you need to know that upfront before you sign the paperwork.
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    And the fact that there is no real disclosure about it a lot of times; I know because I have had loans like that before.
    God has a wonderful sense of humor; most of the stuff that we have been through, my wife and I, is stuff that we talk about all the time.
    So, I saw the paperwork that said prepayment penalty when we sign for a loan that we got, and we said, ''Well, why do we have to?''
    Well, at the time there at settlement, we had to sign the paperwork, whatever the terms were that they were giving us, we still had to sign it because our circumstances with such that we were told, ''Well, you have to. The loan is going to be this much interest rate and we have got the table with a different interest rate that said, well, you can finance down later on. Just take the loan now.''
    Those are the kinds of things we hear all the time. And the prepayment penalty was just another part of the process, and another thing they told us not to worry about when we had to sign the papers, because you had to sign it because otherwise you wouldn't get the loan to get out of the mess that you were in.
    Mr. HENSARLING. I see my time is up Mr. Chairman.
    Mr. BACHUS. Thank you.
    Gentlelady from California?
    Ms. WATERS. Thank you very much. There are a couple of questions I would like to raise.
    First, I am just curious how many lenders represented here today support preemption. Do you support preemption Mr. Samuels, do you support?
    Mr. SAMUELS. Yes ma'am.
    A federal preemptive bill.
    Ms. WATERS. And what about you, Miss——
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    Ms. BRYCE. Yes, we do.
    Mr. DANA. Speaking on behalf of our bank, we are a state nonmember bank, so we are not regulated by the OCC. So, it would be difficult for us to speak to that issue, but the ABA can get back to you on that.
    Ms. WATERS. All right.
    Let me ask about mandatory arbitration. Can a borrower be refused the ability to get the mortgage, rather, if they disagree with mandatory arbitration? Can you be turned down and turned away?
    Ms. BRYCE. Well, there are a lot of mortgage products, or a lot of mortgages in the marketplace today that don't require that don't require mandatory arbitration.
    So, I think there is certainly availability of those products without mandatory arbitration.
    Ms. WATERS. Now, let me back up.
    I personally have been looking at properties and went to escrow in one and talk with realtors about others, and talk with bankers, talk with everybody, and it seems that this is almost a standard practice now to have these mandatory arbitration clauses.
    Ms. BRYCE. I can only speak to our company. We do not have a mandatory arbitration clause.
    Ms. WATERS. Oh, good.
    Ms. BRYCE. And we have discussed that issue, because frankly, having been in the mortgage industry for quite some time now, I have seen a lot of class actions.
    And unfortunately, a lot of them have not been because there has been any real damage to the borrower, if any, but rather, because the class-action lawyer was looking for fees.
    And so, the whole issue of mandatory arbitration came up in the industry as a way to really have a way to address disputes with a particular borrower.
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    They really had an issue and have a forum, an alternative way to deal with that, in lieu of finding the industry involved in a lot of class actions.
    Ms. WATERS. Yes, I know the reason for it.
    What is represented, but I guess the question becomes: Can a customer, can a consumer be denied simply because they disagree with the mandatory arbitration?
    Mr. DANA. We do have mandatory arbitration, Congresswoman Waters. And it is one of the required documents that we ask a borrower to sign.
    We have worked very hard to make sure that our arbitration agreement is extremely fair.
    Ms. WATERS. But could you turn somebody down because they disagree?
    Mr. DANA. You mean if they refuse to——
    Ms. WATERS. Yes, if they refuse to sign that? Just that one; that is the only thing they have an issue with in there?
    Mr. DANA. But it could happen. It could happen, yes madam.
    Mr. THEOLOGIDES. If I could comment on that as well, Congressman Waters?
    Ms. WATERS. Yes?
    Mr. THEOLOGIDES. We have not made a loan ever with mandatory arbitration; it is not in our standard package. But we, CFAL, group Coalition Repair and Affordable Lending, believe this is an area, again, for appropriate federal regulation.
    Now, the Countrywide arbitration clause, from what I have heard, is a pretty fair one and they bear all the fees, but there are abusive arbitration——
    Ms. WATERS. General standards.
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    Ms. WATERS. What I am told is you don't know who will be selected to be the arbiters; you don't know whether or not you have to travel long distances to get involved.
    And there are no standards, so what one company could call fair, well, everybody could call theirs fair, but it is all different. There are no standards, is that right?
    Mr. THEOLOGIDES. Well, New York adopted some pretty good standards about what goes into a fair, as opposed to an abusive, arbitration clause.
    So that is something that this committee should discuss, as it is evaluating how to regulate non-prime lending, to the extent lenders have some standards about what is a fair.
    What are the rules; how is the arbitrator selected; who pays; it doesn't seem fair for the borrower to have to write a check just to pursue their rights about a potential dispute.
    Ms. WATERS. Why isn't it voluntary?
    Mr. SAMUELS. I am sorry?
    Ms. WATERS. Why isn't it voluntary? Why can't the consumer have a choice?
    Mr. SAMUELS. Frankly, because at the time of the dispute, when the lawyer gets involved, they will always want to get to the jury lottery, and they will not choose the arbitration.
    And by the way, I agree with you in terms of standards, and we think that one of the things that a good piece of legislation ought to have are standards so that the venue is in the place where the property is located or where the borrower lives.
    Ms. WATERS. Would you accept preemption if a mandatory arbitration was eliminated altogether?
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    Mr. SAMUELS. Would I accept preemption? That is a difficult question.
    What I would do——
    Ms. WATERS. You support it now?
    Mr. SAMUELS. I would——
    Ms. WATERS. And if it had everything in it you wanted except mandatory arbitration would you support it?
    Mr. SAMUELS. It is a negotiation process, I would say, and I would say that that would be part of the negotiation.
    And if we got everything that industry wanted, I think that that might be something that we would be able to certainly discuss.
    Ms. WATERS. Yes, sir.
    Mr. THEOLOGIDES. If I could comment on that?
    Ms. WATERS. Okay, yes.
    Mr. THEOLOGIDES. One of the reasons that many companies elect to have arbitration clauses is this concern about lawsuits. One way to address that might be to provide a meaningful right to cure.
    I know that responsible companies, you make a mistake. We had 160,000 loans last year; you are going to make a mistake. If you are a responsible company, you want to hop on that, address it, fix it.
    Right now, in the federal HOEPA, there is not, we feel, an adequate right to cure. So if you have made a mistake, God help you.
    And so that, as a result, lenders respond to that saying, ''Well, I lost my ability to fix it, now I need to defend,'' and be concerned about that.
    So I think many, not speaking for Countrywide, but I think many lenders philosophically, if they had a right to fix their errors, may be more receptive to constraints on mandatory arbitration because then you don't have to worry about it.
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    Look, I will clean up. If one of my people made a mistake, it is my job to fix it, give me that chance for 30 or 60 days, upon proper notice, and then shame on me if I haven't fixed my mess.
    Ms. WATERS. Would you agree with that, Mr. Samuels?
    Mr. SAMUELS. Yes ma'am.
    Ms. WATERS. Thank you.
    I yield back.
    Mr. BACHUS. Thank you.
    The gentleman from Vermont: Mr. Sanders.
    Mr. SANDERS. Thank you very much, Mr. Chairman.
    Before I ask a few questions, I do want to point out that I always am amazed that conservatives, who often tell us how bad the big mammoth federal government is, now want to preempt those little old states where democracy flourishes.
    So, I always find that interesting.
    I maybe think that what we need is a very strong federal floor, in terms of predatory lending, but we have to allow states to address their own needs, and if they want to go further than the federal government, I think that they should be very clearly allowed to do that.
    Let me ask Mr. Stein a few questions, if I might.
    Mr. Stein, how has North Carolina's subprime mortgage market changed since the enactment of the 1999 anti-predatory lending law?
    Mr. STEIN. The market has changed by limiting upfront fees that borrowers pay, which has eliminated a lot of the equity stripping abuses that have happened.
    It has also changed in the sense that borrowers, who qualify for conventional loans, are actually getting conventional loans more than they are getting subprime loans.
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    So, both of those factors mean that there are fewer subprime refinanced loans that are happening in the State, but that is not the same thing as saying credit is not widely available, it is just the fact that the borrowers can go to the conventional market and get a loan.
    And I think that the market has improved significantly.
    Mr. SANDERS. So, you have touched on this.
    My second question and that is, Has North Carolina's anti-predatory lending law hurt Self-Help's ability to make subprime home loans?
    Mr. STEIN. No.
    This is a national statistic, but we made $3 billion worth of loans nationally. In North Carolina it is probably $1.25 billion worth of loans.
    And the interesting thing about the North Carolina law is that it was the representatives of the large banks, of the community banks, of credit unions, and when those are agreeing to actually voluntarily be regulated, then that is something to take notice of.
    North Carolina is not a hotbed of government regulations, and they were supporting a bill that imposed regulations on them. They haven't asked to be preempted from it.
    And so all of us have been able to make responsible loans in North Carolina following the implementation of the law.
    Mr. SANDERS. Has anyone ever brought to your attention a prospective borrower who could not get a mortgage loan because of North Carolina's laws, provisions?
    Mr. STEIN. No. We have never seen such a borrower.
    We have seen a ton of them who receive loans that they shouldn't have received because there is no benefit to the borrower.
    The Banking Commissioner is the one who probably would have heard the complaints more than us.
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    Seventy-5 percent of all the Banking Commissioner of North Carolina's complaints are due to mortgage lending.
    Not a single one has ever been from a borrower who couldn't get access to credit, and we haven't seen that borrower either.
    Mr. SANDERS. There are contradicting studies of the effects of the North Carolina law.
    Could you briefly tell us why you think the University of North Carolina study gives a better picture of North Carolina's subprime market than the study conducted by the Credit Research Center?
    Mr. STEIN. Sure.
    UNC has the most recent and far-reaching study. They used a loan database called Loan Performance, which is the only one that actually looks at the terms of the loans that were happening in North Carolina.
    They looked at seven quarters before the law was implemented, and seven quarters after the law was fully implemented, and compared those two, compared it with the country.
    The Credit Research Center, their research ended the day before the law became fully implemented. You can't really learn much there.
    And all they could do is say that credit had decreased a little bit.
    But what UNC did is they took it a step further.
    What subprime loans were not made because to say that subprime loans were not made could be a good thing; could be a bad thing.
    And what they found was that the loans that weren't being made were the ones that the law intended to prohibit, which are equity-stripping or abusive loans.
    So, they used a much more comprehensive database, they looked at the terms, and they used a longer time period.
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    Also, it is a publicly accessible database, as opposed to Credit Research Centers which is proprietary with anonymous lenders.
    Mr. SANDERS. Okay.
    My last question is how does the North Carolina law prevent the flipping of subprime home loans?
    Has the provision helped curb abuses?
    Has the tangible net benefit under all the circumstances created problems for responsible lenders?
    Mr. STEIN. That was a very controversial provision when it was placed in there and we have had a lot of discussions about what should the standard be.
    And it is kind of like obscenity, in the sense that it is hard to put an exact definition to it.
    And what we said was if anybody could think of a better standard we are happy to implement it. And nobody could, and so nobody loved it, but everybody lived with it.
    And I think it is had as much impact as the rest of the law. The important thing about it: I agree on class actions, in this case.
    This is not something where you can really do a class action because it is the individual circumstances of the borrower looking at their new loan, looking at their old loan, looking at all their circumstances.
    So, there is been very little litigation in North Carolina about it. I think that provision is largely responsible for the fact that North Carolina borrowers who are eligible for conventional loans are getting those instead of subprime loans.
    Mr. SANDERS. Okay.
    Thank you very much, Mr. Chairman.
    Thank you.
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    Mr. BACHUS. Thank you.
    Ms. Velazquez?
    Ms. VELAZQUEZ. Thank you, Mr. Chairman.
    We all know, or we all heard that they are hanging on their sub-default on foreclosures in the subprime market.
    And the numbers are, unfortunately, skyrocketing in some low-income communities, like my district in New York.
    It has been brought to my attention that some lenders and loan servicers have developed relationships with large housing counseling agencies, in which they contact the housing counselor when one of their borrowers becomes delinquent. Then the counselor contacts the family to offer assistance.
    Can any of the lenders and consumer groups comment on this type of relationship and whether you think it would be helpful in preventing recipients of subprime loans from going into foreclosure?
    Mr. STEIN. May I respond?
    We think that is a wonderful idea, and frankly we are working with the 3-1-1 program in Chicago, where that is one of the features of the loss mitigation tools.
    Our biggest challenge in helping people avoid foreclosures is getting people to call us.
    That is the biggest challenge that we have, because when we can talk to someone, we more often than not, and way more often than not, can do a workout with them. You see?
    Our company loses on average $30,000 for each foreclosure. It is not in our interest, it is not in our investor's interest, and it sure isn't in the borrower's interest to go through a foreclosure.
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    And we spend a lot of time and effort and resources to mitigate these losses.
    We have a very large Loss Mitigation Unit, and we would be delighted to work with housing agencies or counseling agencies.
    Ms. VELAZQUEZ. Okay.
    Mr. STEIN. There are privacy considerations, but they can be overcome, and we can develop those kinds of arrangements.
    Ms. VELAZQUEZ. Yes?
    Mr. BUTTS. When we initially bring people in for counseling, one of the forms that they sign is a disclosure form, stating that it is okay for the lender to get back in touch with the counseling agency if the loan goes to 30 days late, or even 15 days late in some cases, so that we can intercede on the lender's behalf to try to see if there is something we can work out.
    A lot of times, what we have been finding especially lately, with the high foreclosure rate in Philadelphia, is that a lot of people haven't been driven to us to get that help in the first place.
    The sheriff's department had a record 1,000, over 1,000 foreclosures last month and it worried everybody to such an extent that everybody in the area got together: the lenders, the city, the counseling agencies, everybody.
    And we held this big symposium on the 18th, where we had people who were about to lose their homes, the sheriff's sale, come in and try to get work outs and everything done.
    They had to sign disclosures saying that it was okay. But it was the unification of will, I think, that sort of helped get that done.
    And what we are finding, looking at a lot of these cases now, that people are starting to come in from the sheriff's sale, is that a lot of them, when you look below the surface, had bad loans to begin with.
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    They had servicing problems with the servicers that caused defaults. They had problems with the lawyers. Then the banks wanted to work out an agreement, but they couldn't because the lawyers wanted their money upfront.
    And there wasn't enough money there to solve the default and pay the lawyers. All kinds of wild and unusual problems that are showing up here that are causing these defaults and foreclosures.
    Ms. VELAZQUEZ. Thank you.
    Many borrowers who may qualify for prime mortgage credit are paying higher costs for subprime loans.
    What role do you think consumer education can play in ensuring that families that qualify for the prime mortgage do not end up with higher costs of a subprime loan?
    Yes Ms. Bryce?
    Ms. BRYCE. Well, I think with consumer education there is an opportunity there to let people know that they have so many options.
    And that is why it is so important to promote competition in the marketplace.
    It is important for people to know that they should shop for a loan. We have encouraged that, the whole disclosure scheme that we have is designed around trying to shop, but in fact, a lot of——
    Ms. VELAZQUEZ. But that is part of education.
    Ms. BRYCE. Right. A lot of people don't do that, and so we need to promote that.
    Ms. VELAZQUEZ. Okay.
    On the other side, we have many borrowers who are not financially prepared to purchase a home that are targeted for subprime loans and are a greater risk of default and foreclosure.
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    Do you think requiring subprime lenders to advise families to seek housing counseling before purchasing a subprime loan will help mitigate the effects of predatory lending?
    Mr. BUTTS. I think that is absolutely true, that that would be one of the things that we would actually need.
    I mean in some ways, education is the easiest part of this to fix, because everybody is out there doing education.
    It is the systemic problems that are in a lot of the industry that we really need to fix, because we can't get at that if people going door-to-door talking people into getting loans that they can't afford.
    Ms. VELAZQUEZ. Can we hear from the lenders side?
    Ms. BRYCE. It is also an opportunity to deal with fraud and misrepresentation.
    I think that has come out in a couple of situations and discussions here, and those are the kinds of practices that you can only get to through some type of counseling to understand that that is going on.
    Those are already practices that are illegal, but identifying them up front would help then move a borrower into another situation.
    Mr. SAMUELS. Right, we very much encourage people, if they wish it and seek it, to get counseling, and we provide the 800-number for the HUD counseling services.
    We believe if there is an educated borrower, we win.
    Ms. VELAZQUEZ. But you don't have any problem if that is a requirement?
    Mr. SAMUELS. A requirement, you mean mandatory counseling?
    The problem is the expansiveness of the requirement. There are people who need it, certainly, but there are people who really feel that they don't need it.
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    And a lot of these people feel very insulted and actually discriminated against. That is what our experience has been.
    We had a HUD required counseling program. Many people were very upset about it. We think that counseling programs need to be available; people need to know about them; they need to have an 800-number that they can easily access; and we should encourage people who feel that they need that to access it.
    A mandatory counseling program, however, you are talking about, you know, millions of counseling sessions.
    Mr. BACHUS. Time has expired.
    Ms. VELAZQUEZ. Yes.
    Mr. BACHUS. Go ahead, if you want to finalize it.
    Mr. THEOLOGIDES. Well, I would concur with Mr. Samuels.
    That every borrower within three days of application gets the 800-number from us of a counselor. Some elect, many do not.
    We think borrowers should have the choice, should they feel they need it, but making it mandatory for two or three million loans is a lot of counselors that today don't exist.
    And so we would be concerned about making it mandatory, because it would slow down the ability of people to re-fi or buy a home.
    Ms. VELAZQUEZ. Thank you, Mr. Chairman.
    Mr. BACHUS. Excuse me.
    Thank you.
    Mr. Miller?
    Mr. GARY G. MILLER OF CALIFORNIA.Thank you, Mr. Chairman.
    I have been in the development industry for over 30 years, and I agree with what you are saying.
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    Most people come in, they want to know what their down payment is going to be, their closing costs, and what interest rate, and that is it.
    You want to try to steer them to the proper people, but mandatory could make it very, very difficult.
    And like we were discussing RESPA reform, and putting a reform measure out there that really made it very difficult for mortgage brokers to stay in the business really bothered me, because a lot of people will go to a lender who don't have time to go out and worry about a person's credit report, and they will get turned down, because they don't qualify for prime.
    And they will go to a mortgage broker, and they will work with them and find a way to help them with their credit report, look for a lender who makes the subprime loan and get them into a home where they might not otherwise be able to do that.
    I am not putting lenders down, don't get me wrong, it is not intended to do that, but it is a difficult, complicated marketplace. It is like a puzzle, anytime you impact part of it, you impact the whole.
    And oftentimes we start debating subprime and predatory, and we blur the distinction between the two.
    And we need not do that. I mean I have been very concerned with looking at what we have done in about 30 states and municipalities, especially Oakland in California and Los Angeles.
    Things they have done on the Georgia line really, really bother me because there is a lot of people out there who have credit ratings that are not quite what they would like them to be, and what some lenders in the prime marketplace have to look and categorize as less than prime.
    And if you start allowing the direction I think they went in Georgia and Oakland in California, you start eliminating the option for many people who otherwise would be able to buy a house, you put them in a position where they have to be renters.
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    And above all, we want to avoid that because we look at the major opportunity for people to acquire private wealth, it is owning your home.
    I voiced today the issue of, you know, section 8 vouchers. They are fine temporarily, but we have to do something to have a move up market, where people can get out of the section 8 into a home of their own.
    And I guess I would like you to, Ms. Bryce, maybe you could answer this one: could you please expand on how the additionally newly passed and soon-to-be effective laws that are very similar provisions to the Georgia law, how those really impact people who want to borrow money to get in a home?
    Yes, madam? And anybody on the panel who would like to address that.
    Ms. BRYCE. Well, I think what happens is as each one of these laws comes down, and there is almost not a day that goes by that I don't get an e-mail about something new that is pending, we are having to step back and look at what the ramifications are in that particular marketplace and decide whether that is something where we have to pull back in that marketplace.
    And that is something that we are just not accustomed to having to deal with.
    And so, I think that what it does is it reduces the amount of competition because that means there is less availability of credit in that marketplace, and competition is really what is going to drive better terms in the subprime market.
    And I think what we want to do is balance what we do to protect consumers who have been preyed on and still preserve that competition and in fact, increase that competition in the marketplace.
    Mr. SAMUELS. Some of these laws and regulations at the local level and the State level have created difficulty for the secondary market.
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    I think it is reasonable to say that if within the loan documents and the loan papers that a secondary lender looks at them, if they can understand that this is a predatory loan they should back off, but if the secondary marketplace reviews the loan documents and goes through the normal recourse, and there is no information in the report that shows, in any way, that that is a predatory loan.
    Some of these local ordinances and laws have put a secondary marketplace where they are liable regardless. What detriment do you think that is going to have if we don't clarify this in the law?
    Ms. BRYCE. Well, I think we have already seen some of the rating agencies come back and say that they are not going to rate pools of loans for mortgage-backed securities that include loans in some of these jurisdictions.
    And that essentially creates a situation where the lender doesn't even have a choice because if you are someone like us, we don't have a portfolio, so we have to sell our loans into the secondary market.
    And so, if the rating agencies say, ''We won't rate them,'' then essentially everybody pulls back.
    And I think it is important, whatever standards there are, they need to be clear so that each of us knows as we go about doing our business what the rules are so that we can comply with those rules and not have a situation where later someone is going to second-guess whether it was right or wrong.
    Mr. SAMUELS. I mean I have watched and listened to the debate at the local level, city council in passing ordinance on this, and they are well-intended. I don't argue that they have the wrong goal in mind, but the consequence is disastrous to people who want to own a home.
    And you often look and say, ''Well, states should have rights to make certain laws and requirements and ordinances that people should comply with,'' but don't you think it is time for a national standard on this?
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    Because why should people in one part of the country or one specific city be a jeopardy of the concept of owning a home just because an unintended consequence occurred by a local ordinance or a state rule?
    Don't you think at this time we have enough information that we can clearly define predatory and subprime and come up with a national standard to comply with?
    Ms. BRYCE. Well, I think certainly the federal government has the resources to come up with a good national standard.
    Mr. SAMUELS. I believe we do too, but don't you think it is time that that happened?
    Ms. BRYCE. I think it is definitely time that we need to do that.
    And frankly, I don't see why for a consumer who is sitting in Washington D.C. that there are different rules if you decide to buy in Washington D.C., Maryland or Virginia.
    And there are a lot of places that are the same for those people who live in St. Louis who might decide to live in Illinois or people in the New York metro area.
    I think if you have one standard then it is also much easier to educate consumers so that they know what their rights are, and they know how to identify the practices that are illegal.
    Mr. SAMUELS. Would anybody else like to respond?
    Mr. STEIN. And one other benefit is our ability to lower the costs of homeownership, because if we have one standard as opposed to having this patchwork quilts, where our compliance costs are just going through the roof, if we are able to do it at all.
    From a macro level we have to decide whether we are going to stay in a jurisdiction or pull out of a jurisdiction, or restrict our lending in a jurisdiction.
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    And from a micro level, looking at the borrowers that I described in my testimony earlier, these people would not be able to get their loans.
    And so, you can look at it from the business standpoint, we also need to look at it from the consumer standpoint and what the benefits of these types of laws——
    Mr. BACHUS. Time has expired.
    Mr. SAMUELS. In closing, Mr. Chairman, we need to have a standard that is transparent, that it is not vague and ambiguous, leaving the secondary market at risk for an unintentional act on their part trying to do well.
    Thank you, Mr. Chairman.
    Mr. BACHUS. Mr. Lucas?
    Mr. LUCAS OF OKLAHOMA. Mr. Chairman, on behalf of the Ney-Lucas bill, I think that certainly, the North Carolina standard has done a lot of good.
    And as Mr. Watts and Mr. Miller have some legislation out there, but I think the testimony and comments have been very enlightening here today, and it is very beneficial to me.
    But I think all we are really trying to accomplish here is to come up with some good public policy where it is a win-win situation: where the law of unintended consequences isn't over burdensome.
    Certainly, Mr. Butts, the case you talked about, with the Marine veteran for 25 years and what happened to him was very egregious, and those things should never happen.
    But I think we have got to be careful when we come up with new standards that they aren't overly burdensome. We are never going to come up with anything perfect.
    I guess what I would like to hear from anyone on the dais that would comment is is there anyone who would speak against a uniform national standard; a state standard, Mr. Stein?
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    Mr. STEIN. I think if, for example, the Miller-Watt bill were passed, and that is inherently preemptive in the sense that it overrules anything that directly conflicts with it.
    Plus, it is a strong standard, so there would be no incentive for states to pass another law because it will be an ineffective one.
    I think Mr. Miller's point really goes to the question of federalism.
    Should states be allowed to make rules on what happens within their state? There is an interesting article by the American Enterprise Institute that talks about if you have something that is a local activity, where the commercial actors there can exit, they can leave if they don't like what the politicians do, then that is something that should be left to the State.
    If Georgia goes too far in seeking assignee liability, which they did, then the rating agency is totally within its rights to say, ''I am not going to rate any loans there.'' And lenders then can't make loans there.
    But what happened was the General Assembly realized that, and they quickly corrected that problem. That was federalism at work.
    If HOEPA preempted back in 1994, North Carolina never would have been able to say that single premium credit insurance is an abusive product.
    The question is does Congress have, while, there is a lot of wisdom in Congress, are they necessarily going to get it right?
    A state has much greater ability to change on the fly when there are abuses or when there are loopholes. Debt cancellation agreements are a supplement to single premium. States can fix that, and it is much more difficult for Congress to do so.
    So I think you can have a national standard, but it should be a floor, and I think that floor will govern most of the country, but if North Carolina realizes that there is a single premium credit insurance problem, it should be able to correct that problem.
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    And the last point I would like to make is that it is not like the subprime industry has been driven into the ground by state laws. I mean it increased by 50 percent last year.
    How many industries increased by 50 percent in one year? I think that the subprime industry is very strong and vigorous, as it should be, but if states see an abuse, they should be able to fix it and protect their citizens.
    Mr. BACHUS. Okay. Others?
    Mr. Butts, comments?
    Mr. THEOLOGIDES. If I could figure out my microphone. There we go.
    The comment on that last point, I mean we do feel that there needs to be a national standard, that a lot of states don't have protections comparable to some of the leading states at this point.
    But in so doing, we have to take greater about how that standard is designed. And although I say we learned a lot from the North Carolina experience, and we, New Century, are lending there, and I think we learned a lot of good lessons from North Carolina about how to structure it.
    There are also a negative consequences, and you know, in the two of our top 20 states, the two states where we have the highest interest rates, are North Carolina and New Jersey.
    Why is that? Not because our rate sheet is automatically higher for those states, but because we are not able to use all of the different tools that we have in the toolkit that can offer a borrower a chance to lower their payment.
    And so more gets driven into the rate, and in those states the rates are slightly higher. Now, many of the borrowers can make that adjustment, but there are some borrowers who can qualify at that $1200 a month payment, but they can't at the $1400.
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    And if we take away the tool, whether it is a prepayment charge or the ability to finance some points and fees, to bring them down to that $1200, those borrowers are not getting credit.
    And that is our belief that at the margin, in the lower credit grades and in the smaller loan amounts, that are the most sensitive to those variations that borrowers today in New Jersey, in Georgia and North Carolina, are not getting access to credit that their neighbors in neighboring states can get today.
    Mr. BACHUS. Good point.
    Any other comments?
    Ms. BRYCE. I would just add that I think the numbers are telling, in that MBA, our estimate, is that about 6,000 lenders are out there nationwide and about 150 of them are in the subprime market.
    And I think this is a driver of why that number is so low.
    Mr. BACHUS. Time has expired.
    Go ahead if you would like to.
    Mr. BUTTS. The aim here should be to have a good floor.
    I think the experience in Philadelphia is instructive here, because what we did in Philly was pass one of the strongest predatory lending bills in the country, and it got preempted by the State legislature and replaced with a much weaker, ineffective bill.
    And we wouldn't have had a problem with the Philadelphia law being preempted if that law was going to be strong and address the issues that we need to protect our constituents.
    But that didn't happen in Pennsylvania's case. And so we want the same thing here, if there will be a federal preemption law, that it would be a strong protection in it for our constituents.
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    Mr. BACHUS. Well, gentlemen, I also want to thank the gentleman from Kentucky for his hard work on this bill and support throughout the whole process.
    Mr. Miller, from North Carolina?
    Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman.
    Mr. Samuels?
    Mr. SAMUELS. Yes, sir?
    Mr. MILLER OF NORTH CAROLINA. I had a question or two about the examples that you gave on page seven of your testimony.
    Mr. and Mrs. S, $94,000 loan, lend-to-buy ratio 99 percent, 30-year fixed rate of 7 percent, points in lender fees totaling $2,500; and you say that that could not have been done under North Carolina law.
    What is the provision in North Carolina law that would prohibit that loan?
    Mr. SAMUELS. It was the points and fees trigger, sir.
    Mr. MILLER OF NORTH CAROLINA. Well, that is $2,500 on a $94,000 loan that is 3.65 percent.
    Mr. SAMUELS. There is also a prepayment penalty involved in this, and that would have been also included in the points and fees trigger.
    Mr. MILLER OF NORTH CAROLINA. That is not listed in the hypothetical. There is no mention of that in the hypothetical.
    Mr. SAMUELS. No, no.
    And in the second hypothetical——
    Mr. SAMUELS. The reason I took it out, frankly, was to try to get it under 5 minutes. But anyway, that is——
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    But the only thing that made it illegal was the only thing, was what you took out to shorten your testimony?
    Mr. SAMUELS. I am sorry?
    Mr. MILLER OF NORTH CAROLINA. The only thing in the description of this loan that would have prohibited it, under North Carolina law, is what you took out to shorten your testimony? I visualized a prepayment penalty.
    Mr. SAMUELS. I know it was a prepayment penalty.
    Yes, the prepaids plus the points and fees put it over the limit.
    Mr. MILLER OF NORTH CAROLINA. Okay. Prepayment is not listed in the facts that you set forth.
    Mr. SAMUELS. Correct.
    Mr. MILLER OF NORTH CAROLINA. And what you set forth is 3.65 percent of the mortgage.
    In the second example, again, there is a fairly long description. It sounds like a good loan: 30-year fixed rate, less than 7 percent. Four percent upfront, discount points, lender fees.
    Some language in here about why he needed to borrow the money; it all sounds like good reasons. And again, the only thing in this real case, is the prepayment penalty, is that right?
    Mr. SAMUELS. Well, there are four points here.
    Mr. SAMUELS. Another issue that is of concern, that is also not here, again because of the time, has to do with affiliate fees. These are fees that are paid to our affiliates for closing costs, appraisals, things like that.
    Mr. MILLER OF NORTH CAROLINA. Is that in the——
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    Mr. SAMUELS. It is not in the testimony, no sir.
    Mr. MILLER OF NORTH CAROLINA. Okay. All right.
    And in the last example that you gave, that would in fact, well, apparently——
    Mr. SAMUELS. Yes, in the written testimony, that would have qualified.
    Mr. MILLER OF NORTH CAROLINA. Okay. Thank you.
    Mr. Dana?
    Mr. DANA. Yes, sir?
    Mr. MILLER OF NORTH CAROLINA. How are you, sir?
    Mr. DANA. Fine.
    Mr. MILLER OF NORTH CAROLINA. Ms. Waters asked earlier if everyone here agreed with the preemption. I think that you said that you couldn't really state the ABA's position on that, and then Mr. Stein, I think, leaned forward and whispered in your ear. Was he telling you that, yes, the ABA does support preemption?
    Mr. DANA. Yes, a preemptive national standard would be supported by the ABA.
    Mr. MILLER OF NORTH CAROLINA. That is what I thought he was telling you.
    Mr. Dana, your testimony says, ''Concerns about predatory lending should be addressed through a unified national standard and you will recommend that Congress actively consider proposals for such an approach to predatory lending.''
    Have you heard the phrase, ''It takes an act of Congress''?
    Mr. DANA. Yes.
    Mr. MILLER OF NORTH CAROLINA. Okay. What does that mean to you?
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    Mr. DANA. Lots of red tape and regulation in order to get it done.
    Mr. MILLER OF NORTH CAROLINA. It is really hard.
    Mr. DANA. Yes.
    Mr. MILLER OF NORTH CAROLINA. That is what it means to me, too.
    It used to be just a phrase and in the last year it is taken a real meaning.
    And when I am asked to describe what it is like to serve in Congress, nimble is not one of the words that comes to my mind.
    HOEPA was passed in 1994. I think almost none of the practices we are talking about were addressed by HOEPA because they weren't really prevalent or even existing at that time.
    If we pass a law that lifts certain practices and prohibits them, and then says no State or local government can do anything else, when new practices come along that we haven't thought of, it is going to take an act of Congress, isn't it?
    Mr. DANA. Well, I think one of the things we have to remember is that we are interested in making our communities better.
    We want asset building, we want wealth accumulation, we want folks to be able to own housing when they are able to qualify for it.
    Mr. MILLER OF NORTH CAROLINA. How are we going to get at new abusive practices?
    Yes sir, I would like an answer.
    Mr. THEOLOGIDES. I believe we have certainly learned a lot over the last 10 years, and in the first cut we should knock out the abusive practices that have been identified today, but accompany that legislation with some authority federally to provide some means to regulate and provide, again, a federal standard that would be uniform nationwide to address those abuses.
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    I mean we do see responses in the various agencies to abuses, and usually they can get their faster than the legislature can, but right now, there is no mechanism in most of the non-prime lenders, like ourselves.
    We have 50 different state licenses and so if there could be a single approach or mechanism to deal with those abuses, again, folks that are in it for the long haul want those abusive practices out of the industry.
    And we do want people to be nimble to respond to it, but we would prefer to have one really good response that covered everybody instead of 100 different ones, some of which might be effective and some of which might not be.
    Mr. BACHUS. Thank you.
    Mr. Sherman, then Mr. Clay, and then Mr. Scott and Mr. Davis.
    Mr. SHERMAN. For the first time in the history of this committee we have two Brads in a row.
    I would like to address Brad's concern that the federal government is not terribly nimble with a couple of things.
    First, whatever law we pass should give substantial authority to whichever regulatory agency we empower because it takes an act of Congress is a big deal, it takes a regulation of an agency is a smaller deal.
    And I think that a regulatory agency with expertise might be about as fast as at least my state legislature.
    I would point out also that while the States may look nimble, if one or two or three states can act quickly, there are many States that right now don't prohibit any of these practices.
    And so, we shouldn't judge the federal government against the most nimble, we should try for most nimble for the most Americans.
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    And that a federal regulator might be as nimble as the average State and might be even more nimble than my state.
    While talking on federalism, I would also point out that perhaps we would want to have in our federal law something that says a state could embrace plan A or plan B.
    I don't think you folks can deal with 400 different municipalities, but you may be able to deal with one or two different approaches.
    I also want to address Ms. Maloney of New York's concerns for assignee liability.
    Assignee liability I think kills the secondary market, and the secondary market is critical.
    At the same time, what we want is really solid assignor liability. And the problem Ms. Maloney brings up is your assignor may be a fly-by-night or an undercapitalized operation.
    What I will be proposing in the legislation is that we have a bond or an insurance requirement. Now, if the assignor is very solid, the insurance company should sell the insurance very cheaply. If the assignor is, in the belief of the insurance company, a risky operation, then they should charge a lot for it.
    But I would think that if an assignee is buying a portfolio, where the assignor is liable and that liability has some insurance behind it, that that ought to be enough to ensure it protection.
    I have a question for every member of the panel, and that is, Could you identify one, two or three states that you think has a good law that Congress ought to use as one of the models for drafting federal law?
    I guess I will start with Mr. Theologides, as I believe he is the most anxious to respond.
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    Mr. THEOLOGIDES. Right, well, you know, I figured I might run out of states.
    Mr. SHERMAN. Well, no, you are allowed to name the same states.
    Mr. THEOLOGIDES. Okay. I would say——
    Mr. SHERMAN. In fact, if you all agree that one state is the best model you will make our life a lot easier. Go ahead.
    Mr. THEOLOGIDES. Well, I think there are elements, there is no silver bullet, but there are elements, certainly, of California, New York, and North Carolina that I think this process needs to consider very carefully, and elements of those laws have been very effective.
    Mr. SHERMAN. Mr. Stein?
    Mr. STEIN. Yes, I think North Carolina, New Mexico and New Jersey, and I would say that North Carolina does have assignee liability, as long as damages are is bounded to secondary markets the rating agencies can rate the loans and the lending can continue, and the borrowers have a chance to save their house, as opposed to suing a lender and perhaps collecting money five years later.
    Mr. SHERMAN. Yes?
    Mr. BUTTS. North Carolina and California——
    Mr. SHERMAN. You like California?
    Mr. BUTTS. Oh, it is all right.
    Mr. SHERMAN. It is a beautiful state.
    Mr. BUTTS. I would say North Carolina and New Mexico.
    Mr. SHERMAN. So you are naming California, New Mexico, and North Carolina?
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    Mr. DANA. Congressman, we feel at the ABA that we will work with the committee to get the right combination of whichever laws are most prevalent.
    Mr. SHERMAN. Next?
    Ms. BRYCE. Perhaps Indiana, but also I would echo that we would be looking at what the best practices are amongst the laws that are out there in crafting a federal standard.
    Mr. SHERMAN. You have to start somewhere. And my fellow Californian?
    Mr. SAMUELS. Right, well, since I'm your fellow Californian, I will start with California, with a few modifications. Also New York.
    I agree pretty much with what Terry said.
    Mr. SHERMAN. Okay.
    If time permits, I will ask a question of Mr. Theologides, and that is what does New Century do to ensure that it brokers do not engage in predatory lending?
    Mr. THEOLOGIDES. Well, most mortgages today originate through brokers, and in our case, 90 percent of our loans come through brokers.
    And the fact that we have grown to be the second-largest lender in the non-prime world without a major incident or class action or anything shows that the broker business can be done well. It is blocking and tackling, it is background checks, it is a licensing process, it is monitoring the loans, both the data and the individual files, it is listening to your borrower complaints. It is putting the bad brokers on a watch list or getting rid of them, and in extreme cases, even referring them to law enforcement.
    Where we struggle is, again, there is not a national repository or database of the list of bad brokers. There are a few state databases and there are some states that don't regulate brokers at all.
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    So one thing we did like about the Ney-Lucas bill is it provides us a place where we can make sure the broker we just cut off didn't just change his name and moved to the neighboring state.
    I think that is another area where a national registry would be helpful to us.
    Mr. BACHUS. Time has expired.
    Mr. SHERMAN. And as part of that registry——
    If I can have just 10 more seconds, is we ought to include those who have been in other financial areas under the jurisdiction of the committee, in particular, who have a bad record in stock brokerage shouldn't then just be able to move over to real estate.
    And I yield back.
    Mr. BACHUS. Thank you.
    Next is Mr. Clay.
    Mr. CLAY. Oh, thank you, Mr. Chairman.
    And let me think the panel for being here today. Ms. Bryce, welcome to the committee, good to see you.
    Let me ask you, when a borrower applies for a loan with your subprime unit but has the credit to qualify for a prime, do you have procedures in place to ensure the borrower receives a prime loan and should not subprime lenders have a policy in place to make sure that each borrower gets the best loans that they qualify for?
    Ms. BRYCE. Well, actually Congressman Clay, we don't have a subprime unit, so that wouldn't apply to our company.
    However, in a previous company that I worked with we did have procedures for making sure that if a prime borrower was identified that there was a process for trying to move them into the prime area of the company.
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    Mr. CLAY. Mr. Dana, would you like to address it?
    Mr. DANA. Well, all of our borrowers get the same treatment, whether they are subprime or prime borrowers.
    The qualifications of the borrower indicate which rate they will be charged at. The higher risk credits may indeed require a higher rate.
    Mr. CLAY. Now, you know I am going to follow up with that one.
    You know, why is it that African Americans are steered at five times the rate of white Americans to subprime loans when they qualify for prime loans?
    Mr. DANA. In our institution, which is the experience that I can talk to, our rates are the same regardless of gender and race.
    Mr. CLAY. Excuse me. These costs hundreds of thousands of dollars over time to people, who are steered, who actually qualify, have the same background and qualifications as the next person.
    Have you been reading these recent studies lately?
    Mr. DANA. Well, we don't discriminate because of race or ethnic background. Our responsibility is to make our community as good as it can be. So, we will take in an application and price it accordingly, regardless of race.
    Mr. CLAY. Does this not qualify as economic injustice?
    Mr. DANA. Well, the fact that we are making these loans to regardless of what their race is, is not an economic injustice.
    Mr. CLAY. Mr. Samuels, perhaps you could tackle it.
    Mr. SAMUELS. Yes, sir.
    We do have a process. Everybody who comes in through our non-prime unit is run through artificial intelligence underwriting.
    If somebody looks like he or she can qualify for a prime loan, that person is flagged and goes to a separate underwriting unit, and we try to make that person a prime loan.
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    We do a very good job of making sure that we do not steer people who could qualify for prime loans to non-prime. It is probably the thing that we are most proud of because we know what a big issue it is.
    Mr. CLAY. Thank you. It sounds like it should be standard practice for the industry.
    Mr. Theologides, would you like to add something?
    Mr. THEOLOGIDES. Yes. Earlier in my testimony I did note that it has not been our experience that we are seeing borrowers in significant numbers who would qualify for prime and who are being steered to non-prime.
    But having said that, I agree that if someone qualifies for prime, they ought to be able to get a prime product or the best product they qualify for.
    Having said that, I think one reason that you see a higher concentration of lower income people in non-prime, and Americans of color, is that with lower incomes or lower wealth, it may be more difficult.
    We do see in a prime world there are higher denial rates unfortunately for certain segments of our community. So that may be why there is the appearance that there is a higher concentration in non-prime, although if you look at it loan by loan, we are not making non-prime loans to borrowers of any color that would qualify for prime.
    Mr. CLAY. Okay.
    I am going to come back to you.
    Go ahead, Mr. Stein.
    Mr. STEIN. I was just going to support your point.
    Harvard Joint Center for Housing Studies just released a report where they looked at the question, ''If people living in African American neighborhoods get subprime loans at five times the rate of white neighborhoods, 49 percent versus 9 percent, is that based on risk or is it based on some other factor?''
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    And they said it was not based on risk. I think that the companies that you are talking to here do a good job of making sure that they are not doing that, but in the wider subprime arena, it is clearly happening.
    Mr. BUTTS. I think it is also speaks to my earlier point, that there aren't branches in our neighborhoods for people to go to, so the choices they get are with the subprimes or the creditors.
    And they get targeted that way, that is true, and there is racism involved here too, and that is true. But the fact still remains that there aren't a lot of branches in mainstream financial institutions in our neighborhood. And I think that is one of the reasons for this.
    Mr. CLAY. One more question, Mr. Chairman, for Mr. Theologides.
    What credit grade do most of your borrowers, especially those who are minorities, fall into? And are you charging mostly of your borrowers your highest rates?
    Mr. THEOLOGIDES. Our borrowers, of whatever color, are run through our same automated engine and they fall into our full credit spectrum.
    Most of our loans are in the higher subprime grades, so those people are people that maybe have a few dings on the credit but haven't had a recent bankruptcy or a serious impairment.
    And our average interest rate right now is under 7 percent, and for the folks in our top credit grades, they are getting interest rates closer to the low sixes, so we do price according to the risk.
    And I think you have hit on, obviously, a very important point that needs to be the subject of this committee's deliberation, is how best to deal with the fact that there are always going to be some borrowers that walk into a branch that maybe doesn't have the right product for them.
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    And maybe one idea is that to the extent it is a New Century, well, we are a niche player, we are not Wal-Mart, we focus on one thing.
    We certainly wouldn't object if a borrower met certain basic criteria that it looks like they might qualify for prime. Let us give them a notice or something saying, ''You might want to talk to another institution, they might offer a lower rate than what we would offer.''
    Mr. CLAY. You all also offer financial education and financial literacy, I understand.
    How does that work?
    Mr. THEOLOGIDES. We have partnered with both national and local organizations. To offer financial education nationally, we have partnered with NCRC and Southern Christian Leadership Conference, the Congressional Black Caucus Institute, WOW, and the Hispanic Caucus Housing Initiative.
    Again, we concur with all the panelists that an educated borrower is in the best position to make an informed choice and avoid being victimized. That goes without saying.
    Mr. CLAY. I thank you for your responses. I thank the panel.
    Thank you, Mr. Chairman.
    Chairman NEY. [Presiding.] Thank you.
    Mr. Scott?
    Mr. SCOTT. Thank you very much.
    Mr. Chairman, the essential question we are here to deal with is how do we combat predatory lending without damaging the subprime market?
    I take it that everyone sitting at the panel agrees that we need a national federal anti-predatory lending law. It is clear.
    There are 44 State and local anti-predatory lending laws. What lessons have we learned from the experiment of these predatory lending laws at the State level; number one on that question.
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    And number two: what recommendations would you make to us here in Congress in fashioning a federal anti-predatory lending law that would stress what we should avoid doing?
    Mr. STEIN. Congressman, let me start with the second question first, as to what should be avoided.
    And what I think you have heard pretty much a chorus from the lenders is that while we do want to stop the bad guys, and believe me we do, because it is in all of our interests to do that, we don't want to do it in such a way as to dry up credit or to eliminate choices and opportunities for people, who can qualify, should be able to qualify, to obtain credit.
    That is a big concern of ours, and you know one of the things we have talked about is that there is been a proliferation of credit in all the States, and that is true. We have experienced historically low interest rate.
    These are 40-year lows, and so everybody has been working seven days a week, 24 hours a day to keep up with the business.
    The law of physics is what goes down must come up. And so, ultimately the interest rates are going to rise, and we have to take a look at these laws and what the triggers are that we are going to be imposing.
    How are they going to operate when interest rates are not at 5, 6, 7, 8 percent but they are at 7, 8, 9, 10 and above?
    And we have to make sure that what we do is to preserve the ability for people to have choices in how they manage their financial affairs, while at the same time targeting the bad abuses.
    Chairman NEY. Okay. Thank you.
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    Ms. BRYCE. I would suggest that one of the things we need to avoid are subjective standards, and I think we have seen that in a number of the laws that have passed such that lenders can't really know how to comply with the law, or be sure that they are complying with the law.
    So, I think that is something that we definitely need to avoid in putting together a national standard and really look at how do we promote a situation where more lenders are willing to come into the subprime market to enhance competition?
    Chairman NEY. Thank you.
    Mr. DANA. I would agree with Ms. Bryce that we have to make sure that our standards should be clear and not vague in nature.
    The last thing we want to do is restrict the flow of credit to deserving individuals.
    Chairman NEY. Mr. Bachus?
    Mr. BACHUS. I am very interested in what you have to say Mr. Butts, because you referenced your comments by saying you want a strong law.
    Mr. BUTTS. Right. We had negotiations with Ameriquest around subprime lending and we yelled and screamed at them and fussed at them and called them predators and did all kinds of nasty stuff to them and they finally——
    Mr. BACHUS. I am sorry, if you can talk into the microphone.
    Mr. BUTTS. All right.
    —and we finally settled down and we talked to them and what we asked from them was to become the gold standard of what a subprime loan should look like.
    And, we believe that our agreement with them sort of accomplished that. So, you can get a subprime loan from Ameriquest right now with a $550 fee and that is it; no points and none of that stuff.
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    No pre-payment penalties, none of the really nasty stuff that is in these bills. And they feel that they can market their products to everybody, and so we know it can happen.
    I think it is just the collective will that everybody wants to really understand what that standard should be. And it should be a standard that suits the marketplace that we are going after.
    Mr. BACHUS. Okay.
    Mr. STEIN. I tell you, in North Carolina we learned a couple of things that were important.
    The first is that while disclosure and counseling are both important, on their own they are not going to be enough.
    I don't know if you saw this recent GAO study that addressed that question, but it concluded that disclosure and counseling will not significantly address predatory lending. If you have someone in a refinance transaction, they might have learned something a year ago, 2 years ago, six months ago, but it is not like they are going to remember it every second of the day.
    And so that is not going to be enough and you are talking about a lot of the borrowers are less sophisticated. What if they have 75 sheets of paper then each one?
    The other thing is that subprime lending is actually more complicated than conventional lending, so to expect disclosures and people understanding all the different loan terms as opposed to structuring the market in a fair way is to expect too much.
    I think in North Carolina, as I mentioned before, what we try to do is structure the market so lenders compete primarily on price. They can charge five points a fee; they can charge pre-payment penalties within that. They can't do single premium credit insurance.
    But, limit the amount of fees because that is where borrowers spend their wealth, that they don't realize they are spending, and let interest rates adjust up and down a little bit on a floating basis.
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    North Carolina didn't cap interest rates any more than federal HOEPA does, but federal HOEPA law's interest rate trigger hasn't caused a problem.
    Mr. SCOTT. Yes, okay.
    Mr. THEOLOGIDES. Two things.
    One: we learned from the Georgia experience on assignee liability that we need to tread lightly in that area to recognize that if unlimited assignee liability is combined with vague standards to cap points and fees, leaders will flee the market and Americans will be unable to get credit.
    The second thing is: we also need to tread lightly in figuring out what that right balance is in limiting points, fees, and what we count in points and fees: prepayment penalties, payments to brokers.
    That in so doing we may unwittingly eliminate the ability of a borrower to lower their payment and today in a low interest rate environment that is not as big of a deal, but believe me, when rates move up a 100 basis points, 200 basis points, people are going to want to have every tool in the tool chest to be able to pick a product that allows them to have a lower payment and still either refinance their home or buy that home.
    Mr. SCOTT. Right.
    Let me ask you this one quick question, because in Georgia, which is my home state, and we had a good law, I felt very concerned about the assignee liability to the secondary market.
    In grappling with that, would you say one solution might be that we assign the liability to the secondary market only for those lending violations that can be detected from a review of the regular loan documents?
    Mr. THEOLOGIDES. I think you are on the right track. Clearly, you don't want people turning a blind eye, they have it within their powers staring it in their face. You want them to look at that loan and if it is abusive, push it back.
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    But we also need to recognize that, well, my company is in the mortgage business, we can do that, but the teachers' pension fund that buys our AAA-rated mortgage backed securities really is not in a position to evaluate those loans and the assignee liability shouldn't extend that far down the chain.
    Mr. SCOTT. So, and in a federal law, if we did that, if we just assign it to those that we review those regular loan documents; you feel that would answer the bond market's problem?
    Mr. THEOLOGIDES. I can't speak for them, but I believe if there is some clear standard about when you have done enough due diligence, what the degree of diligence is appropriate to make sure that if one loan gets through you don't have an Armageddon scenario.
    I think they can work within those parameters, is our experience as a lender because they are doing diligence in our shop every week. They are looking at loan files. So we see it on the receiving end.
    I think it is the being held accountable for something that they can't possibly detect, or that would require them to review every page of every single loan of the hundreds of thousands of loans they buy that becomes just very difficult for them to deal with in it.
    And the way they deal with it is essentially, ''We are not going to buy your Georgia loans, let us buy them from the other 49 states.''
    Mr. SCOTT. I think he wanted to comment. One more point, Mr. Chairman.
    Chairman NEY. That was your fourth ''one more point, Mr. Chairman.''
    Mr. SCOTT. This one is very important, Mr. Chairman.
    Chairman NEY. Well then, we had better hear it.
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    Mr. SCOTT. All right. I hope it lives up to that billing.
    Mr. SAMUELS. In Georgia assignee liability clearly went too far. The images were potentially unlimited, but then the State senate passed a bill, which still provided for assignee liability, it just bounded that. It said it wouldn't be greater if somebody tried not to buy a high-cost loan.
    It wouldn't be greater than the amount of the loan outstanding and some fees. And it didn't limit it just to what is written on the loan document.
    Problem is, if you do that, what you are saying to an innocent home buyer is, ''You have a predatory loan and we are so sorry that in this case the lender sold the loan but we are going to foreclose on you, you are going to lose your house, you are going to lose all your wealth. Three, 4, 5 years later perhaps, because there is not mandatory arbitration, you might be able to sue against the lender, if they are still there, if they still have money. And get some money, but you have a destroyed credit rating.''
    So you need assignee liability. You can have it, but these rating agencies are going to rate loans if it is bounded and you can't have class actions when it is small. And that is what Georgia passed in their state senate and that worked fine.
    But the person in the pension funds who buys the mortgage-backed security, they are never going to face assignee liabilities. The trust is perhaps going to face it.
    So you can't limit it to just to what is on the document. It sounds good, but if you have an innocent homebuyer who was victimized, you have an innocent secondary market purchaser, that innocent secondary market purchaser can price for that risk and it is minuscule because it is limited to the amount of the loan and there aren't going to be many cases that get through there.
    Mr. SCOTT. All right.
    My final 15 seconds, Mr. Chairman, was this point that I just had to respond to.
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    Earlier, my colleague, Mr. Clay, mentioned about the peculiar emphasis unfortunately of predatory lending on the African American community. I think it is very, very important that we make sure we get the record straight on this that race is unfortunately a real reason why we have predatory lending. African American communities are targeted.
    They are purposely targeted. They are just not targeted at low income, they are targeted up and down the strata and they are targeted precisely because they are African American communities.
    A lot of that has to do with the low savings rate, another part of financial literacy. I bring this point up because myself, Chairman Ney and some other members of this committee have been very, very strong on the application of the two-way toll-free number.
    And it is very critical in that community because when they are targeted, folks come, they leave a card. And if we have a 1-800 number, we have a way of lassoing in and being preemptive and getting a hold of some of these predators before the damage is done.
    And I would think that if I get an assessment for you all just to give us your feelings on the value of that 1-800 number and providing that two-way dialogue and that two-way help.
    Would that be a help as we move forward in that predatory lending?
    Wonderful. Thank you. I got everybody shaking their head.
    Thank you, Mr. Chairman.
    Mr. BACHUS. Thank you.
    And one problem we do have with the five-minute rule is it does very much limit substantive discussion and particularly when you have a member like Mr. Scott who is knowledgeable on the subject, who had participated in legislation when he was a member of the Georgia legislature, so I am glad to give the extra time to my colleague.
    Mr. SCOTT. Thank you very much, Mr. Chairman. I appreciate that and God bless you.
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    Mr. BACHUS. Thank you.
    Now your partner to the right there, Mr. Davis, not right by political parties but in direction, he on the other hand, since he has been elected he and I share the Birmingham newspaper.
    And he has totally preempted any publicity that I was able to get in that newspaper. I am going to yield to him 30 seconds.
    The gentleman from Alabama has five minutes.
    Mr. DAVIS. Thank you, Mr. Bachus.
    And by the way, we have been keeping time today; 30 seconds would be about five minutes.
    For a minute I thought Mr. Scott was running for the Senate from Georgia, too.
    Let me, if I can go back to the questions that Mr. Clay was getting at earlier and try to get a little bit more specificity from all of you.
    I understand that no one sitting on this panel is going to acknowledge that any of your institutions are engaged in predatory lending, so that is not the question I am posing to you.
    Do any of you disagree with the statistics that Mr. Clay cited? And let me hone in on just one part of those specifics.
    I understand that you are going to have a higher rate of African American subprime loans, in part because you have a wealth gap. I understand, as I suspect Mr. Clay understands that.
    What is more striking though is that as Mr. Scott just alluded you have a significant amount of subprime lending and most likely predatory lending as well that goes on in the upper income black community.
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    In fact, the statistics that I have seen are that you are twice as likely to find a subprime loan in affluent black neighborhoods than in low-income white neighborhoods.
    Now, first of all, that appears to be a complete deviation from any kind of market reality. Obviously, there is no reason one would think at all that you would have subprime loans in a fairly high income market.
    It is typically subprime loans, as I understand them, are intended for low-income individuals with credit problems, recognizing some people may make a bad choice to get in the market, there is no question that is who they are intended for.
    So, let me ask you this question. Why is this happening? Because as I understand that everyone says my bank is not doing it, my institution is not doing it, but can someone grapple with just this question?
    What set of practices are happening in this country that are leading to such a high subprime rate in affluent black neighborhoods?
    Yes sir?
    Mr. THEOLOGIDES. It is a very difficult question to answer, but let me take a cut at it.
    Two things. One: most of our borrowers contrary to popular belief are not low-income.
    So, white or any color, our loans are actually not concentrated in the low-income area, although they do share a common element of presenting a higher risk for credit or for other reasons.
    Two: even across income strata, our data, our lending data do show that even in the higher income grades our African American applicants are falling into a lower credit grades when run through our automated scoring engine. And believe me; we spend a lot of time trying to figure out why that is.
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    Based on our initial analysis, it is not necessarily income, it may be wealth, it may be credit, it may be in the case of the Hispanic community, there are high self-employment rates that we see, too.
    And no doubt there is some element clearly of the predators have targeted communities of color and the elderly. I mean, that is some element.
    Mr. DAVIS. Let me ask you this question. I have touched off; let me ask you this question.
    Do any of you have any data on the degree of subprime lending in African American communities that have good credit histories? Has anybody looked at that very narrow question?
    Mr. THEOLOGIDES. Yes, we did look at that narrowly. We ran through all of our borrowers through Fannie and Freddie proxy to see how many and of our African-American borrowers, 2 percent of them could potentially have met those guidelines.
    So, 98 percent of them are squarely in need of a non-prime product to hopefully migrate up into that market.
    But, again I think more analysis needs to be done. I think the studies that look at income oftentimes are looking at income by census tract, so we are not comparing $100,000 high-income white to necessarily $100,000 high-income minority.
    Mr. DAVIS. Mr. Butts, do you agree with that? Because you have been the person on the panel who is been most direct about the prevalence of subprime on the black community and presumably part of your argument is that it is not just a low-income, high credit risk areas, but that it pervades into categories of lenders or borrowers, frankly, who don't need subprime at all.
    Are you the same way that this gentleman is about this issue?
    Mr. BUTTS. No, I think this is probably going to sound politic of me, but I think part of what is going on here is this way.
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    What is instructive is I had a conversation with somebody one time, a subprime marketer, and what he told me was that they want to be number one the bank of opportunity when somebody needs money and they want to market that way.
    And the other part is that they start at yes, where everybody else starts at no then the risk is later according to what things accept at yes.
    And a lot of times when people are marketing to our community and are talking to us around those terms that are already set, that they are not going to give us this loan.
    And I know I can't qualify for it, because this happened to me or that happened to me or whatever, and then when somebody comes along and says yes, you can have this loan, it is just you are going to have to pay through the nose to get it, but you can have this loan, that makes it easier to be marketed to that way and I think maybe that is partly one of the things that they understand in a really going after that market because of that.
    I mean, they make it easy.
    Mr. DAVIS. Let me try to quickly——
    Chairman NEY. Let me interrupt just a second.
    Mr. Dana you have a flight?
    Mr. DANA. Yes, I do.
    Chairman NEY. So we are going to excuse you at this time.
    Mr. DANA. Thank you very much.
    Chairman NEY. Thank you.
    Mr. DAVIS. Let me just ask one question on a slightly different topic since Mr. Dana is leaving I might direct this to you, Ms. Bryce.
    Let me shift to a different area altogether.
    All of you have embraced the idea of having a national standard, and I recognize there is some disagreement about what the substance and content of that standard would be.
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    Is it your position, Ms. Bryce, the national standard would be a floor or a ceiling?
    Would it be in effect the minimum that states would have to do or the minimum that rather lenders would have to observe or would you suggest leaving any leeway for the States to add their own set of regulations?
    Ms. BRYCE. Well, I think our position is that a national standard should include federal preemption. So that it is clear, many of us are national lenders and it would allow us to have one standard to work from in all jurisdictions.
    It would mean that people who live in sort of multi-jurisdictional areas, whether it is in D.C. and you are looking at whether you want to be in Maryland or Virginia or D.C. that there is one standard that would allow for consumer education across the board with one standard.
    So we are really looking at it from the point of view of saying one standard will enhance competition will allow for better consumer education but that should be the standard nationwide.
    Mr. DAVIS. And let me ask one quick question before I turn my time back.
    Mr. Miller was making a point earlier that I want at least one of you to respond to, which is that obviously sometimes Congress has a glacial pace; it takes a while for things to happen around here. State legislatures often have the ability to get things done at a much quicker pace.
    Mr. Miller's observation was why should we restrict or prohibit the States from being innovative, from doing some things that frankly might be illustrative to us sitting here in Washington?
    Why not give the States some capacity to at least experiment in some of these areas?
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    That strikes me as a fairly reasonable proposition on his part. I recognize the counter argument that you want uniformity but I think everybody on this panel recognizes that a whole host of legal areas we don't have uniformity.
    And that all the many areas in which we don't have uniformity certainly cost somebody somewhere and they produce litigation costs, et cetera, et cetera. But yet we still tolerate that in our legal system.
    So can any of you, before I turn my time back, speak to Mr. Miller's observation that the States have some capacity to innovate, and to be laboratories in this area?
    Yes, sir.
    Mr. SAMUELS. One of the things that we can't lose sight of is that we have the best home finance system in the world. Countrywide has an operation in the U.K. and we see the difference between what we have here and what they have overseas.
    It is really the envy of the entire world and one of the reasons that we have that is because of the national system that we have. Somebody can buy a house in Oregon and the financing for that will probably come from Florida or even from Japan.
    Mr. DAVIS. Has the North Carolina innovations somehow dramatically undermined the market in that state?
    Mr. SAMUELS. Well, in our view I think one of the issues that we have been talking about is there has been a broad increase in lending but there is a group sort of at the top end that should be able to qualify for a loan that should be able to have a choice as to how to reduce their monthly payments, but because of where the triggers are set, they cannot.
    And that is the concern that we have. Our view is that we should have those triggers set at a more reasonable place, and at the same time one thing I want to address is we talked about, you know, some people want stronger laws.
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    We want strong laws, too, and that is very important but we want the strength of those laws directed at the bad acts, at somebody taking a woman who has a social security payment and giving her a loan with a monthly payment equal to her social security payment.
    That is a bad act. But to say that we need a strong law to cut off a group of people who could qualify for the loan under any of our underwriting standards because we set the trigger at too low a level, I think is the wrong approach.
    I think we need to target the bad acts with very strong legislation while at the same time preserving that choice and accessibility to credit.
    Mr. DAVIS. Thank you, Mr. Chairman.
    Chairman NEY. Thank you. Mr. Crowley, do you have a question?
    Mr. CROWLEY. Thank you, Chairman.
    First let me thank you, Mr. Chairman, for holding this hearing on this issue. As I have stated before in committee, I believe that this is a very, very important issue and deserves the hearings that are scheduled to take place, and it is good to see the panel before us come from all angles on this issue.
    I for one believe that the non-prime and subprime market is actually afforded opportunities for wealth where in the past that opportunity had been denied because of a lack of capital access.
    My constituencies in New York City, and especially in the southern part of the Bronx, where I have seen people who had nothing because of subprime be able to afford a moderately priced home 15 or 20 years ago now have seen a great deal of wealth created because of their ability to access that capital in the first place.
    So I think this really is for many an inner city issue. And therefore I am very, very concerned about how we walk and how we tread on this issue so as not to diminish the opportunity for capital where in the past it had been denied.
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    But I do want to follow up. My friend from Alabama and I am working on some legislation to address some of the issues that he was raising before and that is because of what I believe is disturbing an issue that was highlighted and I believe by ACORN and the separate and equal predatory lending in America report.
    And that is when its happening reportedly between ten and 35 percent, and I have heard numbers much lower than that, of A-minus subprime borrowers actually qualify for prime rate receive subprime loans that are more expensive and especially as it pertains to the African-American community and apparently may be the target oftentimes of that practice.
    Let me just ask the lenders if they could talk about the data as they perceive it and how it was put together and how we address it. And then also maybe the consumer groups as to how they compile that information.
    Mr. Theologides, maybe you can address that and what they think can be done to address it as well.
    Mr. THEOLOGIDES. I would be happy to start. I mean, again, that is a very important issue and believe me we in the industry are reading those reports very carefully and I think that is absolutely appropriate for this committee to try to address both analyze that and figure out a way to address the issue that sometimes referred to as steering borrowers who would qualify for prime being steered into a higher cost subprime or non-prime product.
    Mr. CROWLEY. Do you think that 10 to 35 percent of the A-minus is an accurate figure?
    Mr. THEOLOGIDES. I do not think that is an accurate figure; I think that is from 1996 from a Freddie number.
    In my written testimony, sir, we analyzed our data and we think we are representative of the industry; we are the second largest; we are 8 percent of the market. And that number was closer to 3 to 3.5 on paper could potentially have qualified for it.
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    Now for Countrywide, they offer a full range of products. We are a niche player and we specialize at being a low cost provider in non-primes. To address your question, one solution might be that to the extent a lender doesn't offer a full array of products that a borrower appears on paper to have the characteristics that might qualify for prime let them know.
    And give them information either whether it is to an 800 number, like Congressman Scott was saying, or through some form of notice because, again, I think that is something that we can grapple with through a national legislative approach to address that issue and clearly part of it is people preying on someone that might not be as familiar with the process and part of it is just luck of the draw.
    There aren't as many prime branches today in the inner cities. And so I think absolutely that is something that ought to be dealt with in the context of this national standard.
    It is my understanding that this data came from the data. And that is how we came up with it; analyzing the metropolitan area. That is where we got the figures.
    Mr. STEIN. That is one of the issues, having complete data because if all you look at is income that does not tell the whole story.
    Our situation is different than New Century's because as was mentioned we do have a full pantheon of products.
    Everybody who enters our company through a non-prime channel is put through artificial underwriting and processing and if it looks like they can qualify for a prime loan, they are flat and they go to a certain underwriting group that tries to get them a prime loan.
    Now, oftentimes what happens is the borrower says no I don't want to provide this documentation or I need a higher loan to value ratio or I want to take more cash out of my home than Freddie guidelines would allow.
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    So that even though they could qualify for a prime loan, in fact they are a non-prime borrower and the loan that they end up choosing is a non-prime borrower and they understand that because of the characteristic that they have chosen that they may not qualify under the underwriting standards that Fannie and Freddie and the secondary markets you know has implemented.
    But we do a pretty good job of making sure that people who can qualify under the prime standards are given the opportunity of a prime loan.
    Mr. CROWLEY. Ms. Bryce.
    Ms. BRYCE. I do think it is an issue to just focus any study on the HMDA data by itself without looking at credit scores for various groups and also looking at debt to income ratios and other underwriting factors.
    Our economists have been looking at some of those studies and we could certainly provide their comments after the hearing. There are some other studies that are in development, as I understand it.
    Professor Bostic, who is at the University of Southern California, has been looking at the credit scores of different African American sorts of groups of economic groups and one of the interesting things that seems to be coming out of his study is that the credit scores of African Americans with high school educations appear to be higher than those with college educations.
    I don't know what the reasons for that will be or if he will have a reason for that, but those are kind of interesting studies that we are tracking to try to get a better understanding of what might be going on in the marketplace.
    But I think you have to look at those underwriting factors in order to really evaluate the issue and figure out what that percentage really is.
    Chairman NEY. Time is up, Mr. Crowley.
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    Ms. BRYCE. I think she is right that you need to look at risks; you can't just look at income.
    In fact, there is an affiliate of the Mortgage Bankers Association, the Research Housing Institute I think it was called, that did a study that looked at home purchase subprime loans, and it had access to credits, and it compared African Americans and whites and found that for the exact same risks the chances of an African American borrower getting a subprime loan were a third higher.
    And so this steering, as you were mentioning clearly goes on. It is hard to quantify in some companies the ones here do a much better job at not doing that. But it is a clearly significant problem.
    The other study that looks at risk as opposed to just income is the UNP study of North Carolina and what they found was after the law was in effect, the percentage of loans to borrowers above 660 credit scores who could potentially get a conventional loan decreased by 28 percent, while conventional lending in the State increased by 40 percent.
    So, what you found in North Carolina after the law was set for very good standards, I think was that there was less of this steering that went on.
    And I think the New York law has been very effective too. Your banking commissioner said that the rates are down but that credit access is still widely available. I think that also has a lot to commend it.
    Chairman NEY. Okay, thank you.
    I am going to forego my question, because we have a second panel, but if anybody has looked at any statistical trends of more individuals going into subprime. It didn't matter if the neighborhood was white or black or Asian or you know any——
    I don't want to take a lot of time.
    Mr. THEOLOGIDES. Well we at CFAL did commission a nationally recognized firm to analyze this issue, because we recognized the potential for this and we will be issuing that shortly.
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    I have seen sort of the preliminary data, yes. I think that will be informative and advance the discussion for all of us panelists here.
    Chairman NEY. Well, I thank the panel for all of your time and a second panel for waiting, so we will move on.
    I want to thank the first panel for your time here in the Capitol. Thank you.
    Move on to panel two. Thank you we will start with panel two.
    Panelists testifying, there is Charles W. Calomiris.
    He is a seasoned professor and author who has written and published numerous books in American Economic Review, articles detailing the experience of the U.S. and international financial markets.
    He currently serves as the Henry Kaufman professor of financial institutions at the Columbia University Graduate School of Business, also the professor at Columbia's School of International Public Affairs.
    Mr. Calomiris is the recipient of several research grants, and serves as the co-director of the project on financial deregulation at the American Enterprise Institute and as the chairman of the board of the Greater Atlantic Financial Corporation of Publicly Traded Banks based here in Washington.
    I want to welcome you.
    Anthony Yezer is a member of the Department of Economics at George Washington University where he directs the Center for Economic Research.
    His research interests include the measurement and determinants of credit risk and lending, the effects of regulations on credit supply, and models of the demand supply of credit to households.
    His articles have appeared in the Journal of Finance, the Journal of Real Estate Finance and Economics and Journal of Law and Economics, just to name a few.
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    He currently serves on the editorial boards of five journals, and is editor of the American Real Estate and Urban Economics, association monograph series.
    Norma Garcia is a senior attorney at the West Coast regional office of Consumer's Union, a non-profit publisher of Consumer's Report magazine.
    Her specialty at Consumer's Union is as an advocate on behalf of low-income consumers, especially in the areas of credit and finance.
    She is a published author of ''Dirty Deeds, Abuses and Fraudulent Practices in California's Own Equity Market'' and ''The Hard Sell: Combating Home Equity Lending Fraud in California'' and ''Fighting Home Equity Lending Fraud and Abuse in California.''
    She was Consumer Union's principle lobbyist for the passage of S.B. 2045 and A.B. 489, legislation adopting a statewide anti-predatory lending law.
    Mr. Geoff Smith is the project director at the Woodstock Institute. Woodstock is a 30-year-old Chicago-based non-profit organization that works locally and nationally to promote reinvestment and economic development to lower income and minority communities.
    Mr. Smith received his Master's in geography from the University of Wisconsin, Madison, in July of 2000. Prior to becoming project director, he served as a research project associate at the Woodstock Institute, where he worked on community development issues.
    Dr. Michael E. Staten is a distinguished professor and director of the Credit Research Center at the McDonough School of Business at Georgetown University.
    Mr. Staten has designed and conducted projects on a wide range of policy issues involving markets for consumer credit and financial services.
    He is an expert witness on credit and insurance issues and has published numerous articles in various journals, including the American Economic Review, the Journal of Law and Economics, and the Journal of Health and Economics, just to name a few.
    I want to thank all of you. We will begin with you, Mr. Calomiris.
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    Mr. CALOMIRIS. Thank you, Mr. Chairman. It is a pleasure to be here today.
    With your permission, I would actually like to depart from my written comments, which I would like to have entered into the record.
    Chairman NEY. Without objection.
    Mr. CALOMIRIS. But, having sat through the first panel, I thought that it would be useful to follow up on an excellent discussion on regulatory measures, which is really not the focus of my prepared statement, because I didn't think that was the focus of our discussion today.
    But I do want to talk about it a little bit.
    I just would preface my remarks by saying that I think everyone understands there has been remarkable progress and growth in subprime lending.
    Access to credit markets for minorities, for low income people, but also more broadly, more flexibility for everyone, and subprime is not just about credit to the poor, not just about credit to minorities, it is more flexible credit for everyone.
    And I think that everyone is in agreement that this is a very valuable resource in our economy, and I think also people understand that the technological improvements that have helped that to happen are really two kinds: they are statistical scoring models that have permitted the quantification of risk, the pricing of risks rather than the yes or no of risks.
    And, secondly, it has been the development of securitization markets that have added to the low financing costs in this market, and also the competition in this market. That is why there is so much competition right now. And that is why we have a national market because of those securities markets that are standing behind the developments in this area.
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    So consumer finance, mortgage finance, has become a boom to the American consumer, particularly in the last decade, because of those two major innovations having to do with the way it is financed ultimately in the capital markets and the way it is scored.
    And those two, of course, are closely related. And I think that we all, I hope, share a goal that we want to see a continuation of a national mortgage market. National in its competitive scope, national in its opportunities for everyone.
    And so we want to balance that goal with the goal of avoiding predatory practices. So I just want to suggest a few ideas that I think could be very helpful and that I have been suggesting for a few years, which I think might be useful as you are considering any bill.
    First of all, as the first panel made clear, what good lenders want is safe harbor. They want to know that if they act appropriately that there isn't some hidden liability hiding out there that is going to come back and bite them.
    So I think that clear rules that establish safe harbors so that if they know that if they go through a set of very specific practices that they are going to actually not be treated unfairly themselves.
    I think that is important. A second principle has to do with disclosure. Everyone I think recognizes we have a massive amount of disclosure in the mortgage market right now.
    We probably need less disclosure in the sense of volume of paper. I think anyone who has been through a mortgage, as I have been sees that it becomes trivialized. You stop paying attention to the paper, because there is just too much of it.
    What we need is meaningful disclosure. And I think we need disclosure that particularly addresses Mr. Clay's question.
    How do we create disclosure that helps someone who is not a sophisticated borrower at the time of the mortgage signing know that he or she is being overcharged?
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    I have a very specific concrete suggestion that I have been making for a few years and I haven't been able to get much response on it. Here is my suggestion.
    Suppose that we had a common statistical sample of borrowers and so if you know what your credit score is, if you know your credit score, and you know your loan to value ratio, there would be one piece of paper that would tell you, the borrower, that people with that credit score and that loan to value ratio on average get the following interest rate, the following points, the following pre-payment penalty, for a mortgage of that term.
    Chairman NEY. I don't want to interrupt you, but it seems as a good roll that you are on, and it is good but my——
    Mr. CALOMIRIS. Am I going over time?
    Chairman NEY. No, no, I think it is fascinating. But I just wanted to ask would this, also. We had talked earlier about whether you had a subsidy of type or CRA or whatever. Would this be just for everything market-based?
    Mr. CALOMIRIS. This is for the population. What I have in mind, whether it be some sort of measure coming from some kind of overall market data base and, of course, the particular borrower may be getting better terms if it is a CRA-related loan where there is some subsidy.
    Or the borrower may be getting worse terms because the borrower's credit is really worse than the credit score reflects.
    But, nonetheless, you wouldn't have the opportunity for the egregious kinds of violations that Mr. Clay and others have been talking about.
    If you simply as a borrower were able to see what on average people of your credit score and your loan to value ratio were getting in the market.
    To me, that is one page and it would be an extremely meaningful disclosure and it is not beyond our ability to do it.
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    And I think that it is much more effective than what I call in my testimony stealth usury laws. Laws that have the undesired consequence that many of the first panelists were talking about, which is to effectively deny credit access to people who need to pay very high interest rates, that denial happens because the costs imposed by the State laws, like North Carolina's.
    The costs of compliance basically have a chilling effect on the supply of credit to high cost mortgage lenders and so, for high cost lending, people simply withdraw from that little niche.
    So, I think that we want to have more and better kinds of disclosure, maybe less volume of disclosure and I think we want to avoid stealth usury laws, which I think have been very adverse in their consequences for certain small niches of borrowers.
    I also want to talk a little bit as an economist and as someone who has done, probably with all due modesty, more statistical research than anybody who has been before you today, about the quality of the statistical research that has been described which is, to put it mildly, highly uneven.
    Many of these studies are not controlling properly for all the variables one would want to control for. And they also define predatory lending in different ways.
    So, studies that tend to be cited by people who like what I described as stealth usury laws, States' laws that have a very negative effect on supply of credit to certain niches, those people tend to cite studies that really define as predatory loans that are expensive.
    They describe them as equity-stripping.
    These are highly judgmental categories, and I think that part of the problem here is when we get these different views of the statistical evidence it is really not different statistics, it is different interpretations, different definitions and different standards for adequate control.
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    So I really caution you not to take those discussions too seriously. I also caution you not to think that it is a good idea to be too prohibitive of pre-payment penalties.
    Pre-payment penalties can reduce the cost of borrowing because pre-payment risk in the mortgage market in fact on average is of a greater size and of a greater consequence for lenders than default risk.
    And so pre-payment risk is mitigated by pre-payment penalties and reduces borrowing costs. Be very careful about the arguments of people who tell you that they want to get rid of pre-payment penalties or sharply limit them. That can hurt borrowers.
    I think another set of rules that I think are worth exploring are not just counseling on a voluntary basis, which I agree with, but also budgeting more money for testers.
    If you are going to establish standards, it makes sense to actually also budget for people to go out and see if they are being complied with. If you want to find the bad lenders, a great way to do it is by sending people out as testers and I think we should do more of that.
    I don't want to go over my time; I know it is late in the day, so I will pretty much stop on that point except I want to make one final comment about federalism.
    Dual banking has served the United States well for 140 years.
    I do see the advantage to allowing the finance companies who are not themselves under the OCC to enjoy a uniform national standard and I haven't made up my mind on this issue, but I do want to point out that there is an advantage, as Congressman Sanders mentioned, of some kind of federalism.
    The way we have done that for the last 140 years in the United States is that we have federally-chartered institutions that are under a uniform national standard.
    And that is what I think the Comptroller in particular has insured with his, I think, quite proper preemptions. But we have also allowed the States to regulate non-federally chartered institutions.
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    So it seems to me that there may be some regulations or some standards that we want to put into fair lending laws for the whole nation but that some of the regulations of the lenders might want to be different between the federally regulated lenders and the others.
    Thank you very much.
    [The prepared statement of Charles W. Calomiris can be found on page 134 in the appendix.]
    Chairman NEY. Thank you.
    Mr. Yezer?
    Mr. YEZER. Sorry.
    Chairman NEY. Whenever you are ready.
    Mr. YEZER. I would like to thank the——
    Chairman NEY. If you could move the mike a little closer.
    Mr. YEZER. I would like to thank the chairman and the committee for inviting me to make these comments.
    My colleague here, my written testimony, I certainly stand behind, but in view of the discussion this morning and my enhanced knowledge of the committee's task, I want to part from those comments.
    I was reminded as I heard the discussion of my involvement as an expert on the credit practices rule. Now this is a Federal Trade Commission rule.
    It goes back to when we started studying it in about 1978 and the notion of the credit practices rule was that there were abusive practices in credit remedies applied to consumer credit and the notion was that the Federal Trade Commission should seek to regulate these.
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    Now, as an expert economist testifying for the commission, I was given a wonderful data set which was a stratified random sample of the laws around the country for loans from around the country and their experience and of lenders.
    And I could see the variation and regulations across the States and I could find which limits on credit or remedies appeared to have little or no effect on the availability of credit and which ones really affected the supply: the notion being that you could restrict lots of credit or remedies that had very little effect on the cost of credit, but you didn't want to restrict ones that would substantially raise the cost of credit.
    I did that with my colleagues, the GW when most of our recommendations were adopted. By the way, the papers are also published in academic journals so the academic folks liked it.
    And while there were lots of screenings from both sides about our recommendations, I think overall the trade regulation rule worked out pretty well. So this is a sort of background.
    Now we come to——
    Chairman NEY. I am sorry. The recommendations were in which article?
    You talk about the recommendations——
    Mr. YEZER. Okay. Well, the Credit Practices Rule, which was adopted in 1981 by the Federal Trade Commission governing creditor remedies. The two papers that have most of it in; I could give you the citations.
    Chairman NEY. Okay. Yes, if we could get that.
    Mr. YEZER. And plus, we had a huge volume of testimony.
    So, now we turn to subprime lending and subprime lending I sort of defined in my testimony as something that is about 125 basis points or more above prime. And then we look at statements about that market and my first comment is we have no clue.
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    We don't know how much subprime lending there is. If you look at property records, you will see the name of the mortgagee.
    When you look at actual property records and look at names of mortgagees, especially in inner city areas of large cities, you find an awful lot of brand X mortgagees.
    These are not covered by anything, they are not reporting to anybody. They are not in any data set. We don't know what is happening there, but I have my suspicions, okay?
    Other data sets are really problematic. HMDA clearly gives false impressions of the growth of subprime lending because HMDA keeps adding lenders and not only that existing lenders lend through HMDA who are recently added report larger and larger volumes of loans simply because they are computerizing their databases.
    So all the entrances based on HMDA are sort of a statistical artifact of the sampling procedure. Other databases are also partial.
    Now, could we expand HMDA? Well the problem with expanding HMDA and getting more reporting publicly like that is there is already a big disclosure problem in HMDA.
    I can go to property transfer records and I can match up a loan amount on the census tract with the name of a lender and HMDA and I can identify the mortgages in the individual HMDA records of half the members of Congress.
    And probably 60 percent of the public because I have done that. Okay?
    So if you expand HMDA the more and more small lenders there is just no privacy in the disclosure at all.
    Now, in addition, you are still not going to get to the brand X people so we don't know how much lending there is and we don't know what its characteristics are and the worst of it is probably opaque.
    To the extent there has been some testing and I recently along with my statement, edited a two volume special issue of the Journal of Real Estate Finance and Economics where we have about 11 scholarly papers on subprime lending that have passed the peer referee process and will be published, and that particular exercise did demonstrate that economists can make some inferences about what is going on in the subprime market.
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    We have two independent studies; by the way of North Carolina that indicate insofar as we can test indirectly the regulations there significantly reduce the availability of credit.
    These are in a peer referee journal, as opposed to the papers that were referred to previously, and I share my colleague's comments on their academic merit.
    Okay, now, in terms of subprime lending, what can we infer even if the data was imperfect? Well the first thing is it sort of looks like the markets we teach our freshmen in economics.
    That is, people with better credit scores tend to pay less. People with worse credit scores pay more. Some prime lenders are particularly profitable and there appears to be an active competition in subprime lending. All of that looks good.
    And by the way, in addition to response to lending appears to be to withdraw from the markets. So all that looks like just what we teach our freshmen.
    There are some strange features of the subprime markets but some of them you can understand with a little bit of economic theory like the fact that subprime lenders have a higher rejection rate and a higher interest rate. But, you can actually work that out and you can see why that is the case.
    So, a lot of features of the subprime market sort of look okay as a market. I have two concerns. The first one hasn't been mentioned: that is a home equity trap and the demand for subprime mortgages.
    We encourage Americans to mortgage themselves up to their eyeballs and then spend the next 20 years pre-paying their mortgage and building up all sorts of wealth in their home.
    What happens if you lose your spouse, lose your job or lose your health? Well, guess what? You have all that equity in the home; you don't qualify for prime credit any more. So you have to go to the subprime market. Part of what is happening is a sort of got you.
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    Because we have got a lot of households in America who have bought the home equity lie. They shouldn't be maximizing home equity. They do it at their peril. It is not liquid and you can easily get in a home equity trap and there is a lot of tragic stories there.
    [The prepared statement of Anthony M. Yezer can be found on page 267 in the appendix.]
    Chairman NEY. You ran over the time.
    We will move on to other witnesses then we will come back and I want to pick up that thought about I might be in that equity trap so I want to ask you about that.
    Ms. Garcia.
    Ms. GARCIA. Good afternoon, Mr. Chairman, members of the staff.
    My name is Norma Garcia. I am a senior attorney with Consumer's Union's West Coast office in San Francisco, California.
    Consumer's Union believes that home ownership is a critical priority for our country and that protecting the equity that citizens have accumulated in their homes is critical to every state's prosperity and well being.
    People who own their homes and have built up equity in their homes have a real financial stake in their communities. They are the glue, oftentimes, that holds communities together and it is their home equity that often forms the greatest source of their personal wealth.
    It is no secret that families in America have a lot of equity built up in their homes. As the previous witness just said, that equity for many represents the greatest wealth they will ever know.
    It is very significant for all homeowners with 45.2 percent net worth as a figure that home equity represents for the average homeowner and for Latino and African American families home ownership is even more vital as it represents approximately 60 percent of net worth for people from those communities.
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    So the nation as a whole home equity accounted for 44 percent of the nation's total net worth. That is a lot of money of our economy tied up in home equity.
    And it is for this reason that Consumer's Union is very concerned with protecting home equity. There is been a lot of discussion today about the subprime lending market being available to help homeowners get into homes, and that is a fine thing.
    To the extent that homeowners aren't paying more for their mortgages than they should, definitely the subprime market is serving a need.
    But there is a bigger concern here that no one has really made a distinction about, and that has to do with how does the subprime lending market effect the existing equity that homeowners have built up over the years.
    And it is for this reason after asking this question that we looked at the question of what does the growth in the subprime market mean to preserving home equity and to preserving home ownership.
    You have heard statistics today that have told you about how large this market has grown nationally, and I want to focus in on a couple of states that Consumer's Union actively works in. We have advocacy offices in Texas and in California.
    In the State of Texas, the subprime and refinancing market has grown substantially. In 1997, there were 2512 subprime refinance loans made in Texas. In the year 2000, there were 23,353 loans made.
    In California we have seen a similar growth in the subprime lending market. In 1998 it is estimated there were approximately $18 billion in subprime loans made in California. In 2002 that number has ballooned to over $62 billion.
    A recent study by the UCLA Advanced Policy Institute established that the number of refinance loan applications received by subprime lenders in California increased at an average annual rate of 27 percent from 1993 to the year 2000. That is comparable to 4 percent for prime lenders.
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    Our Texas office took a closer look at who are the subprime borrowers in Texas. And our Texas office looked at publicly available data available through HMDA and available through the census bureau.
    This is information that is readily available and subject to peer review; it is information that anyone can access, it is not proprietary and it is useful in terms of discerning certain trends in the marketplace.
    Our office in Texas found that income is a factor that predicts when someone is likely to get a subprime loan in a particular neighborhood, but even when controlling for other factors, the number of elderly people in a neighborhood and a borrower's rate can be key to determining who gets a subprime loan.
    In Texas, the older residents in an area predict the greater likelihood of subprime lending in that area and that is consistent with the findings established by AAARP.
    HMDA data for Texas also demonstrates that the growth of the subprime refinance market has increased overall statewide but that the percentage of loans to African-Americans and to Latinos that are made through subprime lenders has also increased
    Those numbers are substantial. In 1997, 7.6 percent of all refinanced loans sought by Latinos were subprime. In 2002 that number jumped up——
    Chairman NEY. I am sorry, did you say 70 percent?
    Ms. GARCIA. Seven point 6 percent.
    Chairman NEY. Oh, I am sorry. Okay.
    Ms. GARCIA. In 2002 that number jumped up to 39.7 percent. For the African American community, those numbers are in 1997, 19 percent of all refinanced loans for African Americans were subprimed.
    In the year 2002, that number jumped to 57 percent.
    In California, cities have confirmed that subprime refinance lending is concentrated, highly concentrated in Latino and African American communities. And this is of great significance.
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    I heard a comment earlier that perhaps this is just an urban problem but it is not just an urban problem, it is also a rural problem.
    In California, we had a few of the largest subprime growth areas that are actually in rural counties, so we know it is growing substantially in cities but it is also growing in fast-growing rural counties.
    Subprime lending can reduce or eliminate home equity. This is one of the reasons why we are extremely concerned about the growth in the subprime market to the extent that that also triggers a growth in predatory lending and everyone has heard the discussion today about what would be considered predatory.
    To the extent that it contributes to that growth, there is a lot at stake here. There is a lot of home equity at stake, there are a lot of communities at stake and there is a lot of home equity that could be easily siphoned off.
    Chairman NEY. I would note that time is expiring; we can move on to the last two witnesses and Mr. Clay may have some questions.
    Ms. GARCIA. Thank you.
    [The prepared statement of Norma Garcia can be found on page 150 in the appendix.]
    Chairman NEY. Then we will come back. I am going to let you go before me. I just thought I would point that out to you.
    Mr. SMITH. Thank you for the invitation to testify before this hearing. My name is Geoff Smith and I am project director at the Woodstock Institute.
    The Woodstock Institute is a 30-year-old Chicago based non-profit organization that works locally and nationally to promote reinvestment and economic development in lower income and minority communities.
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    With that we have been extremely active in the area of subprime and predatory lending policy, conducting research that illustrates the scope and impact of predatory lending and working to develop and promote local, State and federal policy that addresses this problem.
    My testimony today will focus on the findings of the research report recently released by Woodstock Institute that quantifies the relationship between skyrocketing neighborhood foreclosures and increased levels of subprime lending in preceding years.
    The results indicate that subprime lending was the dominant force in the increased and highly concentrated levels of neighborhood foreclosure.
    In Chicago, a foreclosure led to staggering problems and the regions leading housing issue for local government and area community development organizations.
    From 1995 to 2002, Chicago-area foreclosure starts increased by 238 percent.
    Traditionally, FHA loans have been primarily associated with troubling foreclosure rates and lower income and minority communities. Over the course of the late 90s conventional foreclosures skyrocketed to take over this role.
    Between 1995 and 2002, FHA-related foreclosures increased 105 percent. Over the same period, conventional foreclosures starts increased by 350 percent, three times the rate of FHAs.
    These increased conventional foreclosures are not distributed evenly across the Chicago region, however. Rather, they are spatially concentrated in highly minority communities.
    Neighborhoods greater than 90 percent saw an increase in financial foreclosure starts of 215 percent, while neighborhoods with 90 percent or greater minority populations experienced an increase of 544 percent.
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    Neighborhoods 90 percent or more minority residents accounted for 40 percent of the 1995 to 2002 increase in conventional foreclosure starts and tracked the 50 percent or greater minority populations accounting for more than 61 percent of the increase in foreclosure starts.
    Neighborhoods of 90 percent or more minority residents in 2000 accounted for 37 percent of 2002 area conventional foreclosure starts, but these same communities only accounted for 9.2 percent of owner-occupied housing in the region.
    The above illustrates that conventional foreclosures rapidly increased in the Chicago area from1995 to 2002 and that a disproportionate share of this growth occurred in highly minority communities.
    The question we asked is ''What factors drove these increases?''
    What we found is that after controlling for changes in neighborhoods of economic and demographic conditions, subprime lending was the dominant factor of increased neighborhood foreclosure levels.
    Our results show if every 100 additional subprime loans and under occupied properties made in the neighborhood from 1996 to 2001 that resulted in additional nine foreclosure starts in the community in 2002 considering that the average tract in Chicago had about 11 foreclosure starts in 2002 this represents a 76 percent increase in foreclosure levels.
    Breaking down lending at loan purpose, we found that a tract with 100 additional prime home purchase loans from 1996 to 2001 could be expected to have about .3 additional foreclosures in 2002.
    All tracts at 100 additional subprime home purchase loans are expected to have almost nine additional foreclosures. Thus, the contribution of subprime home purchase loans in the neighborhood foreclosures is 28 times that of prime home purchase loans.
    In the case of refinance loans, the higher number of owner occupied prime loans actually leads to a reduced incidence of foreclosure levels.
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    A tract of 200 more owner-occupied prime refinanced loans from 1996 to 2001 is expected to have one fewer foreclosure than 2002.
    Conversely, a tract with 200 additional subprime refinance loans can be expected to have 16 additional foreclosures.
    The findings of our study clearly indicate that subprime lending is a dominant drive where the increase in highly concentrated neighborhood foreclosure levels of recent years, while responsible subprime lending may bring important benefits to families that have difficulty obtaining credit elsewhere, the cost associated with a lightly regulated subprime lending industry are too high to go unnoticed.
    These economic, social and emotional costs accrue not just individual borrowers but also to modest income neighborhoods fighting for success and stability and cities struggling to provide public services and balanced budget deficits.
    Neighborhoods and cities external to the foreclosure transactions lose hundreds of millions of dollars every year in decreased property values, lost tax revenue and increased service burdens.
    The findings of our study indicate significant economic and social costs associated with portions of the subprime lending industry and the need for stronger controls at the federal and state levels. Thank you.
    [The prepared statement of Geoff Smith can be found on page 209 in the appendix.]
    Chairman NEY. We have our last witness. Mr. Staten.
    Mr. STATEN. Thank you, Mr. Chairman.
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    I appreciate the committee's efforts to gather information that will better describe the operation of subprime mortgage markets.
    It is a daunting task, and those of us who are professional researchers and economists, as three of us on the panel are, have been spending some time over the last 3 years trying to do this very thing.
    Part of the reason it is a daunting task is because there really is no comprehensive database of subprime loan activity.
    I have submitted for the written record empirical evidence that we put together at the Credit Research Center using a large and unique database of about three million subprime loans made over the last 7 or 8 years.
    And I will let that evidence stand for the written record. But let me just step back and talk at a 30,000-foot level about what data say and what they don't say and how it pays to be careful about the interpretations you make from these databases.
    For example, we have heard time and time again this morning apparent alarm at the fact that there is a disparity in the incidence of subprime lending across certain geographic neighborhoods, in particular a higher incidence of subprime activity relative to prime in minority neighborhoods.
    On the surface of it, that doesn't particularly alarm me. And that shouldn't shock you to hear that.
    Because it may just be the case that this is symptomatic of greater access to credit. I understood from one witness this morning the primary problem we confronted 25 years ago. Now all of a sudden there is a flood of access to credit.
    And so, perhaps the greater activity that we are seeing in terms of mortgage originations in traditionally less served neighborhoods, minority neighborhoods, lower income neighborhoods have is simply a reflection of the fact that the markets taken notice and are making credit available.
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    What you really should be asking of the databases that you examine is whether the price that is being offered to borrowers in those areas is appropriate to their risk. And it is not just the borrower's personal risk, it is also the whole package of risks embedded in the loan application, as we heard from our corporate representatives this morning.
    Without that information you can't tell whether borrowers are being abused, whether they are being unfairly targeted and unfairly priced or gouged, however you want to phrase it.
    The most commonly used database of all the studies that have been cited this morning is the HMDA data and the HMDA database is singularly unsuited for addressing that question.
    The HMDA database is very good at telling you where the loans are made and the race of the person to whom they are being made. That is precisely what it was exactly designed to do.
    But it doesn't tell you anything at all about the risk profile of the person getting the loan and it doesn't have any information about price.
    That is a serious shortcoming in the entire discussion of subprime lending and whether activity is appropriate or not.
    You can't begin to understand how the market is functioning in terms of matching loan and borrower risks to loan pricing and features unless you have that information.
    Now that is going to change; it is going to change in 15 months because part of the additional disclosure requirements put on mortgage lenders, is to start providing information on price.
    But that information won't be available to researchers until mid-2005 and until then all we have are the same HMDA data that we have been living with and trying to analyze subprime for the last 10 or 12 years.
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    And it is simply not up to the task. Not up to the task, not up to the task of addressing the questions that ought to be addressed, by this committee and any committee that is contemplating trying to legislate for the entire market based on basically the anecdotes and the horror stories that we don't deny are out there but don't give us any indication of how frequently those are occurring.
    So what I have submitted for my written record is some discussion of the limits of the databases that are out there and a good deal of information about analysis of one database that is a large database comparable in size to what HMDA claims is the subprime component and also contains price information and borrower risk information that begins to allow you to assess whether the market is behaving as my colleague, Professor Yezer suggested, pretty much as we would expect a competitive market to behave as we teach it in introductory economics.
    Thank you very much.
    [The prepared statement of Michael Staten can be found on page 174 in the appendix.]
    Chairman NEY. I want to thank the entire panel. I think you are a wonderful panel and have given great testimony.
    Mr. Clay?
    Mr. CLAY. I thank you, Mr. Chairman, I appreciate your indulgence.
    Let me quote for the entire panel the comptroller of the currency made the point and I quote: ''There is a danger that broad-based laws, however well-intentioned, may have an unintended adverse impact on the availability of non-predatory subprime credit.''
    This view was supported by other studies and for that and evidence subprime lending has declined in states and localities following adoption of predatory lending legislation.
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    From your research, can you determine if the flight of the business is because of the loss of exorbitant profits, from predatory laws, or other reasons? And I will just start here.
    Please elaborate for me if you would please.
    Mr. CALOMIRIS. Well, actually, I am going to be very brief because I think that Mr. Staten has done more empirical research on this but I have read empirical research on it.
    What I would say is that I am convinced that the research that I have seen shows that certain high-cost subprime lending has declined. Now, there are two different interpretations of that decline.
    One of them is that lenders are finding the legal risks and the transactions costs of meeting these State or local laws so onerous that they have decided to withdraw and that therefore some people who would like to borrow and can only borrow at very high rates are finding that there is not the opportunity.
    Another interpretation is that the market wasn't functioning properly in advance and that those rates never should have happened and that those kinds of loan terms are almost by definition predatory.
    That is basically why you can get two different views of this. My own view is it probably is a mix of the two.
    Mr. CLAY. But sir, I only get five minutes of questioning and——
    Mr. CALOMIRIS. My answer would be it is a mix of the two.
    Mr. CLAY. Okay, thank you.
    Mr. Yezer?
    Mr. YEZER. Yes, let me put this is another context. When in consumer credit we have had experience with usury regulation and other regulation. Part of the problem with usury regulation is that there are always loan sharks.
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    There is always another resource. Now in the case of any credit market regulation, the group that we are not observing is the Brand X lender who may very well move in when other credit is restricted.
    So, I would want to test that carefully before I passed a regulation.
    Mr. CLAY. Thank you.
    Ms. Garcia?
    Ms. GARCIA. Yes, there is an assumption here when people talk about the restriction of credit that more credit is better? This isn't about more is better; it is about quality credit for communities that need it.
    And so to the extent that some of the laws, local and state laws, have resulted in fewer subprime loans being made, we look at that as an indication that the law is working.
    And there has been a lot of discussion about terms being onerous. I have had lenders come up to me and say, in the City of Oakland, ''Well if such and such lender isn't going to lend here, I am more than happy to move in because I realize there is a viable market here that I want to tap into.''
    Now, maybe that is competition at work. Maybe that is the kind of competition that needs to be stimulated by these types of laws.
    Mr. CLAY. I thank you for that response.
    Mr. Smith?
    Mr. SMITH. As I see it, laws are passed in states because abuse is identified in the lending market and by passing those laws you are addressing those abuses thus you would expect some sort of decline in lending related to those types of loans and it is to be expected, I think.
    And I think that over time you would see the market adjust.
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    Mr. CLAY. Before you answer, Mr. Staten, I know I would like to add a caveat to that question for you.
    You brought out the fact about the market takes notice and that is why credit becomes available and of course you are right the market is 48 percent of African Americans own their own homes compared to 68 percent of the rest of the population. So, you talk about the price of appropriate risk.
    Now, we are still talking about a house, a structure, right? I mean perhaps you can elaborate on what you mean by appropriate to the price to the risk.
    You say a house is worth $100,000 or it is worth $200,000 or whatever. I mean, where does it stop where somebody receives some economic chances or just plain fairness?
    Mr. STATEN. I am not sure I follow all of your question. What I referred to by pricing appropriate to risk is simply when a lender takes a look at a loan application walking through the door; a lender is trying to decide what is the likelihood that this loan is going to be repaid?
    And what are the costs associated if it doesn't?
    Part of the determinate of risk is the collateral value, part of it is how much the borrower puts down in terms of equity, part of it is the borrower's personal risk is reflected in FICO scores and other risk attributes.
    Part of it is the apparent stability of the borrower's income. All of those things roll together. And those borrowers who have good track records in the past, have good equity in the home, good stable income, should get a lower price in a competitive market.
    Mr. CLAY. How does that account for the fact that African Americans are five times more likely to be steered to the subprime market?
    Mr. STATEN. Well I don't know what you mean by steered. What you are probably saying is that in some jurisdictions they are five times more likely to be taking subprime loans than prime loans.
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    Mr. CLAY. Yes.
    Mr. STATEN. Okay. Do we know that that is not appropriate for the risk that they present?
    Mr. CLAY. Well, it tells they have very similar payment histories, credit histories, backgrounds, what have you.
    Mr. STATEN. Yes, which studies are those?
    Mr. CLAY. Harvard just released one this week, I have not, I don't have it in front of me, but would like to share it with you.
    Mr. STATEN. I would be happy to look at it.
    Mr. CLAY. What is your response, because doesn't that number stick out? That African Americans are five times more likely?
    Mr. STATEN. I don't think that is true everywhere.
    Mr. CLAY. This is a national study.
    Mr. STATEN. Are you representing that to be a national figure?
    Mr. CLAY. Yes.
    Mr. STATEN. I would have to take a closer look.
    Mr. CLAY. We will get you that study, share it with you. I would love to talk more to you about it. I thank you, Mr. Chairman for the time.
    Chairman NEY. Thank you and if you also, Mr. Clay, if you would like on the last couple of questions if you would like to ask some more it would be fine with me, too. It just depends on your time.
    I wanted to start with 00; I don't know where to start but I think it is a fascinating conversation also from the point of view of looking at it statistically and academically.
    I think Mr. Calomiris you had made a statement about statistics and they weren't accurate and statistically it hasn't been looked into with preciseness in a lot of cases, the studies that are out there.
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    Mr. CALOMIRIS. Well, I was referring to a few different things, two different kinds of problems. Because we are seeing a lot of discussion of studies here today, I was here for the whole first panel and listened to the discussion of studies that control for income which is not a sufficient statistic for an individual's risk.
    And so some of the studies that were cited earlier really are just controlling for income, and that is not good enough. So some of the issues have to do with whether you are controlling for all the things you would want to control for.
    FICO scores and loan to value ratios are the two most important things but they are not the only things.
    I am not here as a banker, I am here as an academic but I am a banker.
    And I can tell you that the FICO score is the beginning, not the end of risk analysis along with loan to value ratio, so part of it is that the studies are using data that are not complete but part of it too is that there may be what we call in statistical jargon cross sectional unobserved heterogeneity.
    Okay, what does that translate into? That translates into the fact that there may be a variable left out that you can't observe that is correlated with a variable that you can observe. In that case, it could be race.
    And so race may be picking up statistically things that just aren't in your data set and that may be correlated with the thing you are not observing. So you have to be careful.
    That is not saying that that is the answer that is just saying you have to be careful when you are looking at these studies to make sure they are being done in a good and objective way.
    Chairman NEY. You touched on information I think you are correct. You know I have recently done some financing last year and I sat there and I am trying to like get on with it and she is going through it and I always ask do I have a pre-payment penalty?
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    It is too much money, things I have been taught over the years. But I do like to get on with it.
    And what I am getting to the mail on the information from the credit card companies that they are now required, under the law to send out is being discarded as most people discard three to four to five sheets.
    I kind of like it simplified so I think we have probably informationed people to death to the point where I doubt they are sitting down and looking through things. I think that would be definitely simplified a lot.
    I just want to throw out a couple of statements to anybody. More than free to answer. All I want is one thing: your comment about equity. I am sorry. First, I think that Dr. Yezer had a comment about equity and——
    Mr. YEZER. If you take a class in economics or if you look at economic research you will conclude American homeowners are holding far too much equity. And that the current mortgage interest instruments are 30-year fixed rates self-advertising instrument is a dinosaur and a disaster for American households.
    And basically we encourage people and unfortunately in the African-American community it is all too common if you look at the numbers, they are just going to pay off the mortgage, right? And they are holding no, you know, they are holding a little bit of government guaranteed assets, usually bank accounts.
    And they have got home equity. They have got no stock or bonds, mutual funds, no accountant or broker dealer. And again if something bad happens in their lives they initially max out their credit cards and then they want to tap their home equity and it is got you.
    They are not going to get in the prime market. They are going to go subprime and they are going to pay really high rates of interest despite the fact that they have built up all this equity.
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    If instead of course they had an interest only mortgage or they had a mortgage instrument, which automatically swept out equity, which we could do, in modern design into a mutual fund.
    By the way, they have initiated them in the U.K. Then if something bad happens, they could tap those funds.
    And they wouldn't have to go through all the cost and trouble of refinancing and being thrown through a major got you into the subprime market. This is a major problem for American households.
    Chairman NEY. What do you think about home equity loans?
    Mr. YEZER. Home equity loans are one way, especially to the extent that people are getting around some of this problem. But remember those are largely for the people who have good credit risks and for whom the got you has not been too bad.
    If you are a lower income person, generally speaking, and/or less knowledgeable about the use of credit, then you are much more likely to fall into the home equity trap. And it is very unfortunate.
    Again, we are sitting here. We are the leader in financial economics in the world. The rest of the world comes here to study.
    You take our classes, and we tell you how a household ought to manage their balance sheet. We tell you that the 30-year fixed rate self-advertising mortgage is a dinosaur. Right?
    And then you go out and look what the government recommends and they recommend all the wrong things.
    So it is kind of frustrating. But you know if efficiency broke out in the U.S. economy you wouldn't need economists so that is what we rely on.
    Ms. GARCIA. Well I think that it is probably true that homeowners shouldn't accumulate all their wealth in their home equity.
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    The fact is that they do and we know that there are cultural considerations at play here that merit a deeper understanding but I can testify from first-hand experience that in the Latino community, at least if you have ever come from a Latin American country you understand there is no such thing as a mortgage.
    And you don't own your house until you pay for the whole thing. And so to the extent that that practice is prevalent in the Latino community it is definitely culturally based.
    I don't think that that eliminates our incentive here to protect against practices that siphon off equity unnecessarily. I think it informs the discussion and is something that we should consider when we talk about what we need to do here today.
    Chairman NEY. I was chairman of insurance and banking committee. Because there was insurance companies, the banks, and the savings and loans at the time.
    And none ever mixed. And the huge food fight we had which was tremendous was its unbelievable concept that the State of Ohio would ever enter into interstate banking was something that just wouldn't happen because interstate banking was going to destroy our state.
    Because if you got a loan you went to you know Bank One or the Huntington Bank and that was all there was to it.
    And of course years before that, the government said well you can have one of those drive through or branch banks. But it is got to be kind of close to the main bank.
    But I just think back and it brings my point to a national standard. I don't even call it preemption any more. It is a national standard.
    And I think now it, the OCC was what they are looking at in their ruling will create a two-tier system and people will be under that rule but this whole group of financial institutions that aren't national and so therefore you are going to have a two-tier process.
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    But, and I was always opposing the rule and if you would have asked me years ago about interstate banking at the time it would be the fact that we have to have armed protection in our State and we can't intermingle.
    If you asked me about preemption we wouldn't dare with Ohio's home rule thinking pre-empt something. But all of a sudden everything changed and those also were the days where you didn't link up to a computer and have ditech.com or whatever you know you either went right into your State or you didn't.
    There wasn't the technology so I think all of that has changed to where you know it is time to talk about a national standard otherwise you know you will have inequities for people across this county and we could say, ''Well, look, Georgia had a mess down there and then it came back and we straighten part of it out because people were actually kicked out of the subprime market.''
    And Georgia? What does it have to do with Ohio? Or California? Well it does these days. It is different.
    You know money is moving and money is money so I just think that you know if somebody would have asked me would I be offering this bill 15 years ago, I would have said no. Absolutely not.
    But times have changed and technology has changed, which makes it interesting about Mr. Calomiris' comment about you have been wanting to say about this kind of wait and solve it with a chart. Which may be so simplistic but look at that and see if that does it. It spells I think a lot of things out.
    The one question I wanted to ask you Ms. Garcia is the one statement you made was sort of on the basis that maybe we ought to look at the quality and but not have some people in subprime because it is too costly.
    Something to that effect, I think. Is it a bad thing or a good thing and I think we have to look too at the person that is out there and they can because of risk factors they can only get into the subprime and if you ask them they think they can pay that mortgage, they are going to want to be in there versus us telling them for the good of the order you know it is kind of better to start your house for a while.
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    And that is because maybe they have had a credit problem. So that is been the intent of in my opinion this bill is standardized some issues to protect some consumers.
    You know, look, there is a lot of things that ought to be spelled out and we have got Mr. Scott and Ms. Velazquez the counseling issues because I think people have to be educated.
    Those are just a few of the thoughts I had about national standard and why I think we should embark on it.
    If you don't have a national standard then you do have you know the State of Ohio and then Cleveland and then Cambridge has its own and Dayton, Ohio and then Toledo and it just keeps going to where people can't get into the market and they have got bad credit and subprime in Cleveland, Ohio but if you move to Toledo maybe you can.
    And I just——
    Ms. GARCIA. May I respond to that?
    Chairman NEY. Yes. Sure I am just throwing this out there.
    Ms. GARCIA. Well we think a national standard is a good thing but we also believe that it is important for states to have some flexibility to legislate where the national standard doesn't meet the needs of people in particular states.
    We think the national standard sets the floor, not the ceiling of what should happen with respect to how subprime lending is regulated in this country.
    There has been a lot of discussion about local ordinances in Oakland and in Los Angeles and I would be happy to comment about that since I have been involved with both those processes as well as with the establishment of the State law in California and I can tell you that the State law in California was in response to holes seen in the federal law and it was also response to the severity of predatory mortgage lending in California.
    I don't know that every state shared that experience but that has been our experience and that is what motivated the impetus for a statewide law in California.
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    Now, we looked a local ordinances and what is that all about? You know why if we have a state law in California why would local governments want to come in and do something else?
    Well, the fact is that the local governments analyzed the State law and realized that people in their jurisdiction needed more protection.
    The City of Oakland proceeded very carefully with their ordinance and I have heard a lot of discussion here about the Oakland ordinance and how it might impact upon the purchase money market but I want to mention also that no one mentioned that one of the triggers for the Oakland ordinances, the triggers are different for purchase money loans versus refinance loans.
    Recognizing that there is a benefit to subprime lending in the purchase money market, there is also been an attempt by the city attorney's office; it is an ongoing discussion that they are having with the ratings bureaus about the assignee liability issue. And no one mentioned that.
    There are some distinctions to be looked at here. I think one of the things we need to think about is what drives the State movement, what drives local ordinance movement and it is the gaps.
    And unless and until the federal law can address those gaps you are going to have local governments interested in being more protective.
    Chairman NEY. So you would support a national standard?
    Ms. GARCIA. I would support a national standard as a floor to what needs to happen——
    Chairman NEY. Of course that limit was a floor.
    Ms. GARCIA. And you know there are a lot of good things in HOEPA, but 10 years later, we still have problems.
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    Chairman NEY. I mean, in one way I mean one of the witnesses previous I think would support a national standard if it was one they liked. I mean, if it did certain things.
    I just think taking since things have changed as I said earlier and taking an objective look at it. The other thing I will tell you and I am not saying that by any stretch of the imagination the U.S. House is void of politics but when I was in the State senate I used to do the usury amendment.
    Nobody ever wanted to do it and we had Democrat and Republicans, it is not a partisan statement stand up on the floor and says let us make usury 4 percent in Ohio.
    Knowing of course that in those days major companies could just bomb us out in Michigan and take 3,000 jobs and still you could go get your credit with them at a higher interest rate.
    Or the fact that some of the federated change would in fact just cut people off of credit.
    Now, nobody likes these bills that make usury at 17 or 21 percent but we would have these emotional gimmick amendments to make it 4 percent.
    One day I said, ''We ought to just pass one of those and watch the people that introduced it pass out.''
    And I think that nationally there are a lot of good people all over. I applaud people who run for office but I think also nationally there is a lot of emotion to this, a lot of politics.
    You stand up on the floor of a council, maybe it hasn't been looked at in some aspects and you do an amendment that is just going to kill people with kindness you know and keep them in apartments.
    I think that is a potential and you have them all over the country, so I think just take another look at it. I mean when we even dared to do this bill a few years ago, it was like it was almost something criminal to even talk about predatory lending, but I think Georgia and the problems came to the forefront and that is why I think we are having a decent discussion by the way about this issue, I really do.
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    Of people from all sides but I think, too, out in the hinterlands you had a lot of emotion on this issue and it would tend to do a lot of politics, and some people in certain towns aren't going to have the ability of what they should.
    But, again, you have to get down also to the root of real predatory practices of terrible things that are done to people and I use the Cleveland example where they mandated predatory lending counseling, which is great.
    And this poor guy thought his mortgage was $447; it was $600 and some. And the counselor who was hired under this law created in Cleveland, as I read in ''The Plain Dealer'' said I stayed $79 bucks, I sat down with the guy.
    And, so, you know you do counseling a certain way in Cleveland and a certain way in Des Moines, Iowa and you know I just think some national standards even on that I think would be a healthier idea when people send for it.
    Ms. GARCIA. Well, one other thing that I wanted to mention also that was not stated about Oakland and Los Angeles is that those ordinances do not prohibit high cost lending or borrowing. They only provide for certain protections for the borrowers of the highest cost loans.
    And so, to that extent they are not limiting lending and many of the provisions of those ordinances are some of the things that we have been talking about here today, and there have been a number of statements made about the value of counseling and the value of an informed borrower.
    Well, those ordinances have provisions that require counseling for borrowers who are taking out the highest cost loans. And that benefits everyone, it benefits the lender, it benefits the borrower.
    Chairman NEY. I wanted to ask, because we are running out of time, regulated mortgages that are priced too high would probably, I assume, likely prevent high risk borrowers from getting loans.
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    Because those high-risk borrowers are the most likely to default on their loans, do you see any positives in essentially barring the high-risk borrowers?
    Do you see any positives in that or——
    Mr. SMITH. I think that that is a good point. I mean, I think that there is been this perception that everyone in some ways everyone should have access to credit and I think that sounds bad.
    I think that there are borrowers out there that are too risky for certain mortgages and I think that that is manifested in these high foreclosure levels.
    Something had to be driving the increases in foreclosures of 544 percent in predominantly minority communities and it is not——
    Chairman NEY. Can I ask you has anybody factored any credit cards and——
    Mr. SMITH. Well, we didn't consider other consumer debt in our research. That data just given the nature of the data it is not available at the level that we use for analysis.
    Mr. STATEN. I just want to jump in here to say I am imagining a different world. I am imagining that we are sitting here today and that we are all complaining at how inefficient the market was because all these people pay such high interest rates on subprime loans but the foreclosure experience was the same as on prime loans.
    And they obviously were cheated, right?
    Because they weren't so risky after all but they paid really high interest rates and so we are not here with that discussion, we are here with a different discussion, an unsurprising discussion which is that when we had an enormous boom in subprime lending with very high interest rates being charged because most subprime loans are riskier, we got more risk.
    What a surprise.
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    Mr. SMITH. Well I don't think that it is a surprise necessarily that higher risk loans default and foreclose at higher levels than prime loans but the magnitude of the relationship I think is what I would categorize as surprising and I just think that that is what is really significant not just that subprime loans lead to higher rates of foreclosure than prime loans.
    That is to be expected. But that they lead to higher rates of foreclosure 28 times prime loans. I think that is unacceptable.
    Mr. DAVIS. Well let me just say because I talked to Standard & Poors in my Senate testimony of 4 years ago I asked them to tell me what their estimates were of what the foreclosure rates would be. And they estimated they would be 23 times in some categories, 1,000 times and I think the average was for subprime relative to prime about 24 times.
    That was an anti-estimate. So it sounds like we priced them based on an ex-anti-estimate that looks a lot like the ex-post experience. What is surprising here?
    Mr. SMITH. Well perhaps it is not surprising then but I think it is unfortunate then that that is an acceptable risk. If seeing foreclosures increase by 544 percent is an acceptable risk then that is too much risk.
    Mr. DAVIS. Now we have really come to the heart of the issue.
    The heart of the issue is whether and this is why I call these self-usury laws. The heart of the issue is whether some grandmother who is sitting on a house, has a lot of home equity and her grandchild would like to go to an expensive college and she is trying to decide whether to get a subprime loan because she can't qualify for a prime loan to basically take some of the equity out of her house and finance that education.
    It is going to be really expensive and there is a significant chance that she is going to actually not be able to make it and there is going to be a foreclosure.
    Now the question is do you want to stop her from doing it or do you want to let her do it? And I will tell you where I stand on that. I think I am going to let her do it. And he wants to stop her.
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    Chairman NEY. Well, if are you stopping grandma? Why don't you comment on that?
    Mr. SMITH. If grandma is going to foreclose, then yes I would stop her. I mean, I think one of the things that we are also missing on this quick discussion is that subprime loans aren't evenly distributed across space; they are concentrated in highly minority communities——
    Chairman NEY. How do we know that she is going to foreclose, though, just because it is a higher? How do we know that? I am just curious.
    Mr. SMITH. Well we don't know that she is going to foreclose but if we——
    Chairman NEY. I can have a low rate and hey I go out and you do this and you spend that and I run up credit cards and you know et cetera and all of a sudden I just I lost my home so my imagine so hey let us do a background profile on the bar because that person gambles or might gamble or makes that investment.
    I am just saying, if it is a couple of points higher on interest we say well, you know they are for sure going to default down the road.
    Mr. SMITH. It depends on how much risk you are willing to tolerate. You can make a loan that is 99 percent likely to go into foreclosure and there is that 1 percent there that maybe she can make it and if you are willing to tolerate that risk then that is okay.
    I mean that is acceptable risk then fine but I think that there has to be a threshold where we say that is too much risk and the impact that foreclosures have on communities not just individual borrowers but cities and neighborhoods is too much to accept.
    Chairman NEY. I know Mr. Staten also talked about calculating risk I think earlier in your testimony if you want to jump in.
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    Mr. STATEN. I Just want to make one point and that is that she can sell the house, okay, because that is what she would be forced to do if she really wants her grandchild to go to college, so she can sell the house.
    You know that is an option and so do we want to force her to do that? The other option of course it there is lots of other sources of credit. As I said, there is all these Brand X mortgages out there.
    We don't even know who these people are; they probably are the most abusive lenders and you guys aren't regulating them or talking about regulating them and nothing you do will regulate them.
    Is that clear in my testimony? Okay, is it clear?
    I can get financing without going to a home brokerage lender or a regulated lender, okay? So the real question is what do we want the person to do? Sell the house, go to a subprime lender or go to Brand X lender.
    Chairman NEY. You know one of the issues is I think that the average lender that is out there is not going to sit and say okay well first of all you are going to have to go to subprime and you see that they make $1,000 a month.
    I don't think your average lender is going to walk in there and say well let us make payments $800 a month and finance you $800 a month knowing they are going to default and popular thinking is everybody wants to get that house and I have found; at least I have seen statistically a lot of places don't like to mess with that because they got to go in, clean the house up, have somebody manage it, try to sell it.
    Now I am not saying that there aren't people out there that haven't today that don't do those practices. I am sure some people sit there and they might say we know this person is going to fail we are going to try and take this house.
    But I just don't think a lot of the reputable ones will do that so therefore let us try to find the ones that aren't reputable and weed them out.
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    I just don't think a lot of people in the business are going to sit there and say, ''Okay. Now let us bring them all in and manage all this property.''
    Some people would do that, I am not saying that that doesn't happen in the country and we have got to correct that.
    Mr. SMITH. It doesn't have to be doomed to fail to trip these high cost thresholds. Let us just talk through an example.
    Suppose that you are talking about a pretty small mortgage like a $50,000 mortgage and there is only a 10 percent chance there is going to be a foreclosure, okay? A 10 percent chance, but my foreclosure costs are going to be $20,000 as a banker.
    If my foreclosure costs are $20,000 then that means that I might not get back $30,000 let us say on that house. So I might charge a 15 percent interest rate or 20 percent interest rate on a small mortgage even if there is only a 10 percent default probability and that might be the fair interest rate to charge.
    And so in my grandmother example, grandma may say there is a 90 percent I am not going to get foreclosed.
    And my point is that that kind of a loan will trigger the effective stealth usury triggers that are no longer these state laws and so its nuts talking about the 99 percent chance of foreclosure that seems so obvious or the example we had in the previous panel where somebody unscrupulously had a loan payment that is equal to the social security payment.
    Those are clear cases that we don't want to see but my case is a tough one. You can't just back off from that case because that is realistic.
    A lot of people are paying high interest rates that aren't going to get access to credit and a foreclosure might only be 10 or 20 percent. High, significant but you have to decide, are you going to make their decision for them?
    Some people are willing to do that. I am not.
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    Chairman NEY. Yes.
    Mr. SMITH. Let me give you another example that is part of the home equity trap that indicates how insidious it really is.
    Okay, I am employed in the town; there is a major industry in the town, major industry declines. I am laid off. I have got all my money in home equity. I can't get a prime mortgage so what do I do?
    Well, I can sell my house at the very time in which the housing market is in the toilet and everybody else wants to sell?
    Oh, good I am in great shape then. Or I can get a subprime mortgage and hope the industry rebounds or I can get a job someplace else.
    The subprime mortgages come back very fast if that person does get a job or if the community revives they are going to refinance back into a prime mortgage just as soon as their FICO score improves.
    That is what we see; by the way, subprime refinancing is very, very high and has no relationship to interest rates particularly at all.
    When folks have a bad experience because they were caught in the home equity trap and then they temporarily can only get this credit or they have to sell their house in a declining market or an unsatisfactory situation and after a short period of time, a year or 2, they cure this situation they can refinance back into the prime market.
    Now what is wrong with that? This is the way we teach our kids in freshman economics. You have to be careful.
    I agree there may be all sorts of provisions just with credit practices that you can say, this is a bad thing. And get rid of it.
    But you need to have solid research by good economists before you go out and do those things and try to regulate. Charles posed a disclosure notion.
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    I actually am so old that I actually advised on the APR regulations, but anyway, that is how bad it is. I look a lot younger of course.
    But before you pass these, one of my colleagues also worked on the Susan B. Anthony half-dollar.
    So one of the things I know is you have to have solid research before you decide what you can regulate and what would be a practice that someone abusive would use and someone who was not abusive wouldn't want. And then go after it.
    Chairman NEY. So you feel the home equity loans are something that should be suffered together?
    Mr. SMITH. No. I think what has happened with home equity is a substitute for what is going into the subprime market and trying to attach as equity. I talk to the mortgage bankers and I tell them you know you are all one in done business.
    I mean, it is mortgage bankers, brain surgeons and morticians. The one and done consumer model. They should be providing people with financial services for a lifetime.
    Okay, that is what they should be doing. And there should be, if there were different kinds of mortgage instruments that were really being pushed and the American people were being told that in fact they should get into equity market.
    I mean Australia is upside down but they still have a mortgage, which is selling which allows you to miss the payment each year. This is we just want to maximize our home equity, this is entirely wrong.
    And as I say but if we are going to do that, then we need a liquid market so that people can bail themselves out when the local economy goes in the toilet, because otherwise they are really in trouble.
    Chairman NEY. I am sorry we are out of time but I could go on. Fascinating panelists each and every one of you.
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    One statement I did want to touch on was that what you said about freshman economics and I just think that I am a teacher by degree and some of my teaching colleagues would be upset with everything is laid on the school systems. I think too much, you know, in a lot of ways.
    That happens to be moms and dads and you know helping with the family things that should be done at home but that is the way life is.
    But somewhere along the line I think at an earlier age across this country if we could teach some kind of basic this is how a checking account happens, if you go buy a $1,000 worth of clothes and you have that credit card. And by the way and it is only $10 a month it is going to take you 10 years to pay it off.
    Somewhere along the line you could get some basic life reasoning, even if it is a two-week course in eighth grade or whatever.
    I think honestly it would help at a younger age to give a little bit of education so people would. Because, when we passed the mandatory seatbelt law in the State of Ohio and I mean if you want to hear people you know screaming to high heaven about it and people are still upset about it but the young kids are raised with it?
    And they buckle up, it is no problem, there are no problems; they are not offended by it.
    But people are still debating it to this day 12 or 15 years later. And I think if we can get into the somehow education system and that would be a remarkable way, whichever side of the issue you all are on or anybody.
    It would be a remarkable way early on counseling and warning and dangers of predatory lending and not having been able to have them become bank closing and finance officers or counselors but some kind of basic knowledge I just think would be so helpful at a younger age.
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    All the way around.
    I want to thank you. You have just been a magnificent panel. Thank you very much.
    The chair knows that some member may have additional questions for the panel, which they may wish to submit in writing.
    Without objection the hearing record will remain open for 30 days for members to submit written questions to these witnesses in place to response to the record.
    The hearing is adjourned.
    [Whereupon, at 3:27 p.m., the subcommittee was adjourned.]