SPEAKERS CONTENTS INSERTS
Page 1 TOP OF DOC
PROMOTING HOME OWNERSHIP BY
ENSURING LIQUIDITY IN THE
SUBPRIME MORTGAGE MARKET
Wednesday, June 23, 2004
U.S. House of Representatives,
Subcommittee on Financial Institutions and
Consumer Credit, and
Subcommittee on 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 and Hon. Spencer Bachus [chairmen of the subcommittees] presiding.
Present: Representatives Bachus, Ney, Baker, Royce, Kelly, Biggert, Fossella, Gary G. Miller of California, Hart, Capito, Tiberi, Hensarling, Garrett, Kanjorski, Waters, Sanders, Maloney, Gutierrez, Velazquez, Watt, Ackerman, Sherman, Meeks, Lee, Lucas, Crowley, Israel, McCarthy, Miller of North Carolina, Scott, and Davis.
Chairman NEY. [Presiding.] Today, the two subcommittees meet to continue our look at the subprime market and its importance to consumers. Last year, Chairman Bachus and I began holding roundtables to discuss abusive lending practices in subprime lending and how we can assure credit availability for those who need and want it. We are pleased to also have Chairman Baker with us today who has a wealth of knowledge on this issue and has spent a long time looking at this issue.
Page 2 PREV PAGE TOP OF DOC
Last fall, we held our first joint hearing to examine abusive lending practices. This spring, we followed that by holding a hearing looking at the subprime lending market. For the first time in the predatory lending discussion, we looked at the growing class of subprime borrowers and their role in the mortgage marketplace. Today, we will look at another vital piece of the subprime market. The United States mortgage market is the deepest and most affordable in the world. Due to the evolution of unique funding structures for mortgages, Americans pay less for mortgages than almost anywhere else in the world. As a result, this country has the world's highest homeownership rate, although there is a lot more that can be done, especially in areas of minority homeownership.
However, the unique funding structure that has been long established for the prime mortgage market is far less mature for the subprime mortgage market. Only recently has it become common for a majority of subprime loans to be packaged and sold to investors. I believe that this evolution has led to lower and more uniform rates for subprime loans, saving consumers money while making credit more widely available. However, states and cities have begun passing laws that dramatically affect the availability of funds for subprime lenders.
In a well-intentioned attempt to end abuse of lending practices, some State and local governments passed laws extending liability for fraudulent origination practices to those in the secondary market that purchased the loan in a pool, but had no hand in actually writing the loan. These strict assignee liability laws threaten the availability of credit in the subprime market. I think we saw this most evident in Georgia at the time when it caused such a problem, people said, fine, we are just not going to do business. And of course, the legislature came back, there were some editorials, and they changed parts of that law. These strict assignee liability laws threaten the availability of credit, frankly, in the subprime market. Acting as a usury cap on mortgage lending, these laws effectively prevent people from receiving mortgages.
The recent case study on the problems with assignee liability, and I mention, of course, recent case studies in Georgia, where the State legislature passed an incredibly onerous law with strict assignee liability. That law led many secondary market players to withdraw from the Georgia market, drying up the credit for the borrowers. Of course, I mentioned the rest about the editorials that followed, and then the Georgia legislature passed a partial fix to the problem that provided some lending opportunities, but we still do not know what will be the lasting effect of these predatory lending statutes on the availability of credit.
Page 3 PREV PAGE TOP OF DOC
In order to better understand the impact of laws like Georgia's, this hearing will give our subcommittees a chance to hear from a distinguished group of witnesses on the availability of subprime mortgages. I think this hearing is timely and important to this committee's duty of ensuring access to credit for Americans. I also want to thank Congressman Lucas and a wide variety of other members on both sides of the aisle, Congressman Sherman and others, who have expressed interest in this issue. We appreciate it. I know it can be a controversial and tough issue, but I think it has to be looked at and dealt with. So I again appreciate members who have been willing to look at this.
With that, I will recognize Congressman Sherman.
[The prepared statement of Hon. Robert W. Ney can be found on page 52 in the appendix.]
Mr. SHERMAN. Thank you, Mr. Chairman.
The recent actions by the OCC have created an absurd situation where a certain class of lenders has the lowest common denominator of virtually no restrictions, and that will eventually lead to some bad actors, if it has not already, that will tarnish the image of all lenders and result in a backlash that will be harmful even to that subset of lenders, the national banks that think they enjoy the OCC's liberation from State regulation.
The answer is that Congress needs to take action. The most immediate action we should take is to get rid of what the OCC has done, which is to substitute itself for this committee and this Congress. It may be necessary for us to do that as part of a package where we establish real solid consumer protections, not lowest common denominator, and at the same time preempt this glowing plethora of state and even local regulation. We need good regulation for all Americans, and not a patchwork city-by-city, county-by-county, or even state-by-state.
We need the competition that comes from efficiency, which comes from offering a product nationwide. I hope that both sides in this debate will not grab onto their own definition of nirvana; that consumer groups will not say, well at least in Berkeley, we have every regulation we want; God forbid we should lose that paradigm. And some national bank should not say, well, we have the OCC for now; we do not have to worry about anything. And instead unite behind solid consumer protections that represent a middle ground.
Page 4 PREV PAGE TOP OF DOC
I hope these hearings lead to that result, and I yield back.
Chairman NEY. Thank you.
Mr. Chairman, Mr. Bachus?
Mr. BACHUS. Thank you, Mr. Ney.
First of all, I want to commend you for having this hearing of our two subcommittees. By way of review, this is the third hearing we have had on this matter. Our first hearing, we addressed ways to combat abusive lending practices in the nonprime or subprime area, and to address them without jeopardizing the availability of nonprime or subprime loans to those with less than perfect credit.
Our second hearing, we focused on looking at actually who the nonprime or subprime borrowers were, their profiles, and the advantages that nonprime and subprime mortgages, the benefits and advantages to those borrowers, and also some of the risks inherent in the nonprime or subprime market, and the risks posed by predatory lenders.
Today's hearing we are going to look at the secondary market, the role that it plays in adding liquidity to the subprime lending industry, and the benefits it provides of expanded homeowner opportunities.
The nonprime market, I think the most surprising thing to me is the explosive growth in nonprime or subprime lending. In 1994, there were $34 billion in subprime mortgages. By 2002, that was $200 billion, so you are talking about a five-fold increase in 8 years in nonprime loans. A lot of this increase in the number of loans is because of development of the secondary market where the originators are selling loans into the secondary market, rather than retaining them in their own portfolios. When they do this, we found that they create mortgage pools and as a result of this there have been assignee liability problems, where people who purchase these mortgage pools are held liable as assignee's.
I think maybe that will be part of the focus at this hearing today, to determine the fairness of assignee liability provisions that require purchasers of mortgage pools to determine as part of their due diligence whether the lender or mortgage broker involved in originating the individual loans that make up the portfolio misrepresented loans terms or engaged in other deceptive practices in dealing with the borrower.
Page 5 PREV PAGE TOP OF DOC
There is a question about the fairness of imposing liability on secondary market participants for violations, and I know we have someone here from Standard & Poor's that is going to be a witness. They have simply refused to rate mortgage-backed securities if they contained non-prime or subprime loans because of what sometimes is described as vague or open-ended assignee liability standards that some States have imposed. As a result of the assignee liability question, Congressman Ney and Congressman Ken Lucas introduced H.R. 833. What it does is it contains consumer protections in disclosures. It is intended to serve as a uniform national standard for combating abusive and predatory lending.
At the same time, it addresses this assignee liability by amending the Homeownership Equity Protection Act. The approach that their legislation takes, I am sure the witnesses are familiar with that and will address whether they think that is the right approach. It at least has the possibility, if it is a fair approach, of establishing some legal certainty to the secondary market, which is lacking in a lot of State and local anti-predatory lending laws.
With that, I will just close. Thank you for having this hearing. I am convinced that nonprime loans allow many people to participate in homeownership or to purchase a home that would otherwise be unavailable to them. I would like to allow us to find a way to preserve this market, preserve this opportunity that many middle-and low-income citizens need to have homeownership, and at the same time establish some legal certainty in a fair way concerning assignee liability, and to do it in a way that is fair to all parties.
I yield back the balance of my time.
[The prepared statement of Hon. Spencer Bachus can be found on page 54 in the appendix.]
Chairman NEY. I want to thank the gentleman, and I thank the gentleman for chairing this hearing today with us.
The gentlelady from California.
Page 6 PREV PAGE TOP OF DOC
Ms. WATERS. Thank you very much, Mr. Chairman.
I have a Statement that I am going to submit. I am here today to try and discover what the crisis is as indicated by this hearing. I think there is liquidity in the subprime market. I want to be clear. I am not opposed to subprime lending, and I know the difference between subprime lending and predatory lending. It does not have to be one and the same, but far too often it is. I am interested in making sure that in the subprime lending market, we do not have abusive practices, high interest rates and marketing techniques and practices that deceive and get people hooked into loans that they do not understand and cannot afford.
So I am very careful about making sure that that is understood; that subprime lending can be lending that can be helpful, but it is not always helpful and I think we find a disproportionate amount of the predatory lending in the subprime market. I am opposed to preemption. I do not know if you are aware that Los Angeles is one of the cities that has passed some local predatory lending laws. I want to be careful to do nothing that would preempt the kind of work that they are doing and some of the other states. I understand there are about 29 states and at least 18 municipalities that have enacted laws to address the problem of predatory lending.
So I am going to listen to the witnesses here today to see what they have to say. I do not know what the crisis is. Perhaps there will be some information here that can help me to understand exactly what is meant by the subject of this hearing. So with that, Mr. Chairman, I am just going to yield back the balance of my time.
[The prepared statement of Hon. Maxine Waters can be found on page 65 in the appendix.]
Chairman NEY. I thank the gentlelady.
Chairman Baker.
Mr. BAKER. Thank you, Mr. Chairman, for your leadership and interest in this matter, as well, of course, as Chairman Bachus. I know both of you have had longstanding concerns about this market issue. I understand the focus of the hearing today is the potential causes of liquidity impairment and abusive practices that may occur in the subprime mortgage market. I certainly agree with your interest in need for review, however I just want to make a very narrow observation about a concern I have today, which is that mentioned by Mr. Bachus as well, the potential imposition of liability on assignee's of mortgage loans.
Page 7 PREV PAGE TOP OF DOC
This imposition would, I think, place a burden on the secondary market participants that would affect and have a disruptive affect on the flow of legitimate credit to many underserved communities. The advent of securitization certainly has assisted in the liquidity of mortgage markets, lowered cost of credit, significantly increased the availability of subprime mortgage credit, and has resulted in benefits, not necessarily associated with that described as predatory lending. But the consequences of assignee liability would cause potential buyers to forego purchasing subprime or high-cost mortgage loans. Certainly if this were the case, with fewer buyers and less money, legitimate lenders would ultimately impair the ability of low-and moderate-income customers to participate in homeownership.
The public policy challenge, I believe, is to strike a balance between limiting abusive lending practices, while ensuring the flow of credit to borrowers who cannot obtain loans in the primary market. Consumers obviously need to be protected from unscrupulous lenders, particularly those who are financially unsophisticated. I do believe there are sufficiently strong standards currently in existence and they should continually be reviewed to determine their adequacy of protection of the unsophisticated borrower.
Extension of these sanctions, however, to assignee's risks the future of our current market structure. To assure that assignee's are not made liable for abuses they cannot reasonably discover and correct, I have been at work for some time drafting my own approach to a remedy and I will be introducing later this week, that would recognize that commercially reasonable responsible actions called due diligence, which would not enable discovery, ought to be a sufficient defense. Sanctions such as class action civil liability, loan rescission, are matters which should be discussed. Assignees should be allowed to take some time to take corrective actions upon appropriate discovery of a compliance failure.
These are I believe important issues deserving of the committee's time, and I look forward to working with you, Mr. Chairman and Mr. Bachus, over the coming weeks as we move forward in trying to provide balance in a very important market that provides a service to many underserved consumers, and certainly a very important part of our overall economic recovery.
Page 8 PREV PAGE TOP OF DOC
I thank you, Mr. Chairman.
Chairman NEY. I want to thank the gentleman.
Mr. Sanders, the gentleman from Vermont.
Mr. SANDERS. Thank you, Mr. Chairman. I thank you and Chairman Bachus for holding this important hearing.
According to the Center for Responsible Lending, predatory lending is costing American families $9.1 billion every year. I am happy that Michael Calhoun from the Center is here with us today to talk about that study.
Mr. Chairman, in the richest country on earth, there is something wrong when so many foreclosures are taking place. Between 1980 and 1999, both the number and the rate of home foreclosures in the United States have skyrocketed by 277 percent. According to an article in the New York Times, over 130,000 homes were foreclosed in the spring of 2002, with another 400,000 in the pipeline. Many of these foreclosures are a direct result of predatory lending practices in the subprime mortgage market that must be put an end to immediately. According to the Mortgage Bankers Association, while subprime lenders account for 10 percent of the mortgage lending market, they account for 60 percent of the foreclosures.
Mr. Chairman, the title of this hearing is Promoting Homeownership by Ensuring Liquidity in the Subprime Mortgage Market. That is a very interesting title. The title seems to assume that there is a lack of liquidity in the subprime market that is somehow depressing homeownership in this country. But Mr. Chairman, according to figures compiled by the National Mortgage News, new subprime loans totaled $290 billion in 2003, more than double the total loan volume for 2000.
Mr. Chairman, we have a subprime industry which has more than doubled their loan volume over the past 3 years, but accounts for 60 percent of all foreclosures in this country. I have to ask, by providing even more liquidity in the subprime market, would we be promoting homeownership or would be promoting foreclosures? Everyone wants to promote homeownership. Homeownership is the American Dream. But having your home taken away from you because you cannot pay the bills charged by predatory lenders can quickly turn the American Dream in to the American Nightmare.
Page 9 PREV PAGE TOP OF DOC
Also in this discussion, importantly, let us not forget that predatory lending is being perpetrated by the likes of just not small-time operators, but by the likes of Citigroup and Household International. As a result of legal actions filed by the FTC, Citigroup agreed in September to reimburse consumers $215 million for predatory lending abuses which represents the largest consumer settlement in FTC history. Household International has agreed to pay $484 million to reimburse victims of predatory lending, representing the largest direct payment ever in a State or federal consumer case.
Mr. Chairman, when we are talking about predatory lending, we are not just talking about mortgage lending. Let us take finally a hard look at the abuse in credit cards, where many working people are paying 25, 28 percent a year in interest rates on credit cards, and as a result are going even further into debt. In my view, that is predatory lending as well.
Lastly, Mr. Chairman, I know there is an effort to preempt states and localities from passing strong anti-predatory lending laws. Mr. Chairman, the Republican Party has got to get its act right. Either they hate the big bad federal government or they love the big bad federal government. You cannot have it both ways. You cannot tell us how we love local government and State government. The word, Mr. Chairman, is laboratories of democracy. That is what it usually is, something like that, and then we preempt them every single day. Let's get our act together. Either the Republican Party wants to be the spokesman for the big strong federal government taking away power from local government or not, but let's be a little bit consistent in that area.
I yield.
Chairman NEY. I want to thank the gentleman for his kind comments.
[Laughter.]
Mr. Miller?
Page 10 PREV PAGE TOP OF DOC
Mr. GARY G. MILLER OF CALIFORNIA.Thank you, Mr. Chairman.
I want to commend you, Chairmen Ney and Bachus, for having this hearing. This is an extremely important issue in the subprime market out there. This is a very important issue particularly in the passage of State and local predatory lending laws which have assigned liability to the secondary market.
There is basically a housing crisis in this country, particularly in my State of California. The California homeownership rate is 56.9 percent in 2000. That lags the rest of the nation by over 10 percent. We also have the highest home prices in the nation. Housing finance is so vital to Americans and the overall health of our economy that the best public policy is for Congress to ensure that we have a fair workable uniform national lending standard. We must eliminate abusive lending practices, while preserving and promoting access to affordable housing credit.
There is no question that in some nonprime borrowers, they basically have been abused and we need to deal with abusive practices, but we should do everything we can at the same time to prevent them. There is also no question of the vast number of borrowers who are not victims of such practices can become victims by poorly crafted protective legislation that restricts nonprime credit availability and basically creates an unnecessary situation.
State and local anti-predatory lending laws are inconsistent and sometimes ineffective and nonexistent, and often arbitrary and unduly burdensome. This has been an effect of limiting nonprime credit availability. These laws have forced the mortgage industry to restrict access to credit or exit markets entirely. You cannot have a system whereby if you go one city, you have one requirement, and another city, you have another requirement. There is litigation on many of these ordinances that have passed locally that have not been implemented.
From what I am hearing, if they are implemented, that the impact is going to be disastrous to local economies. That is unfair. You should not be discriminated against because you want to buy a home in a certain area. If you are looking at the subprime market, if you eliminate that, people are really in serious trouble when it comes to financing homes in those areas. So you have to be very cautious. You have to understand that there is a need for subprime and the predators in that marketplace need to be eliminated.
Page 11 PREV PAGE TOP OF DOC
We need to do everything we can in this nation to give people an opportunity to own a home. It is becoming more and more difficult to provide housing for people in this nation as time goes on. We have to be proactive in this area. Sometimes you have to look at what happens at the local level. We do that in housing all the time. HUD is looking at eliminating local red tape that exists out there that precludes people from being able to build homes in certain areas. We have to be proactive in doing that. You cannot sit there and ignore local policies that are just absolutely abusive towards people wanting to buy homes.
You look at some of these areas, and the assessment against builders who want to build homes is so outrageous and generally passed on to homebuyers, that the federal government has to say this is wrong; that you are abusing people and perhaps federal policy has to establish certain guidelines that preclude some of these abusive policies. In subprime lending, we need to look at predatory. And when it is being abused, we need to move proactively
So Chairmen Ney and Bachus, I applaud both of you for your efforts on this and I look forward to hearing the testimony from our panel. I yield back.
[The prepared statement of Hon. Gary G. Miller can be found on page 63 in the appendix.]
Chairman NEY. I thank the gentleman.
The gentleman, Mr. Miller from North Carolina.
Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman.
I agree with those members who have said that it is vital that we make credit available for homeownership to those borrowers, those consumers who have less than perfect credit. It is also vital that they use the equity in their home, their life savings to provide against the contingencies of life. That is how they have saved for a rainy day.
But I strongly agree with those members who say that there are sufficient consumer protections now for what is happening to some of the most vulnerable consumers when they try to borrow money against the equity in their home to provide for life's rainy days. There is outrageous conduct going on. In the words of Woody Guthrie, they are being robbed with a fountain pen. There are lenders who steal their life savings, the equity in their homes, from the most vulnerable of consumers in the most difficult of circumstances. I certainly think that we can strike a balance between making credit available to those in that subprime market, including a liquid secondary market, and providing reasonable protections to those consumers.
Page 12 PREV PAGE TOP OF DOC
It is true that Standard & Poor's have said that the subprime loans coming out of some States require additional credit enhancements. North Carolina was the first State, and it is not our nature to be first in anything; we were the 12th of the 13 states to ratify the Constitution; I think we were among the last of the States to join the Confederacy. We did ratify the constitutional amendment guaranteeing women the right to vote. I think we did that in the 1980s. But we were the first with this, and our statute has held up pretty well.
There is readily available credit for the subprime market. Standard & Poor's has said that there is no enhancement required for North Carolina's subprime loans. I think it is perfectly possible to craft legislation here that will protect consumers against those outrageous practices that are occurring, and assure the continuous availability of credit.
I join Mr. Miller, the other Mr. Miller, in his opposition to poorly crafted legislation. I strongly oppose poorly crafted legislation. I may put that on my campaign literature this year. I am strongly opposed to poorly crafted legislation. But it is simply the case that we have legislation arising from the States that show us what can work.
Thank you, Mr. Chairman.
Chairman NEY. Mr. Royce.
Mr. ROYCE. Thank you, Chairman Ney. I would like to thank you, Mr. Chairman and Chairman Bachus for holding this very timely hearing on issues in the secondary mortgage market. I would like to also thank our distinguished witnesses for appearing today.
I think it goes without saying that the housing economy has been quite resilient for a number of years. I think this strength has occurred because of a number of factors, but one is asset allocation away from equities. Certainly, friendly government policies have helped, and low interest rates.
What concerns me is that problems in a sector can often be hidden or overcome in a boom cycle. All of that being said, I think that we need to start thinking about what happens when that housing market cools, because today we have Fed funds rate at 1 percent, but if we believe Wall Street economists, they say that the Fed fund rate will reach 4 percent by the end of 2005. If these predictions prove true, unless we have a very flat or inverted yield curve, mortgage rates are going to be much higher in the not too distant future. Higher interest rates are going to have a very adverse impact on the housing market.
Page 13 PREV PAGE TOP OF DOC
I do not know how much we can do about that possibility, but we can address structural issues that unnecessarily add costs to consumer mortgages. In my view, assignee liability is one issue that we should address. Congress should encourage more investment in the secondary mortgage market. Assignee liability provisions do just the opposite. Fixed income investors are not excited to become the next target for trial lawyers, and that is a big problem here in the United States. Until we act, billions of dollars of capital investment will likely stay away from the subprime market. That is going to harm the very people assignee liability laws are intended to help.
So once again, I thank Chairman Ney and I thank Chairman Bachus for having this hearing today, and I look forward to working with my colleagues on this very important issue. I yield back, Mr. Chairman.
Chairman NEY. I want to thank the gentleman.
The gentleman, Mr. Scott.
Mr. SCOTT. Thank you very much, Mr. Chairman.
I, too, am very much looking forward to this hearing. As the Congressman from Georgia who was very much involved in the predatory lending legislation in the State, going all the way back to the beginning with the Fleet Finance fiasco, our State has been a major player in this debacle.
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 predatory lending practices and gives incentives to liberally approve loans to individuals who cannot afford a loan. Advocates from consumer advocates and subprime lenders both would like to see the creation of a national predatory lending law, and I certainly commend the leadership of our financial services committee for moving in that direction.
Page 14 PREV PAGE TOP OF DOC
As a former member of the Georgia General Assembly as a State Senator, I can speak of the impact that an overly strong regulatory measure can have on a housing market. For a little bit of history, the Georgia Fair Lending Act had several provisions, including assigning liability to secondary markets, which caused financial companies to pull out of our State and withdraw some lending products. The Georgia legislature had to revisit the law last year to prevent additional companies from leaving the State.
In an effort to stop unscrupulous lending practices, the Fair Lending Act caused hardship to legitimate lenders. It triggered an immediate reaction from both mortgage lenders and secondary market entities. Once that Act extended assignee liability to potentially thousands of covered loans, with interest rates approximately 4 percentage points below the HOEPA interest trigger. Major mortgage lenders announced their plans to stop making both the high-cost loans and cover loans in Georgia. Standard & Poor's announced it would not rate mortgages covered by the law, and both Fannie Mae and Freddie Mac indicated they would not purchase mortgages that qualify as high-cost loans under the Act.
Assignee liability, then, presents us with quite a challenge. The central question, of course, is what is the effect of making assignee liability for the predatory lending practice of originators? Should assignee's be required to bear the responsibility for the predatory practices of those from whom they purchase loans?
One side of the argument is that it is clear that if the liability is broad and does not provide solid safe harbors and limits on liabilities, lenders will refrain from purchasing a broad category of loans. This is because the risk of acquiring the loan has become too great, not because of each of the loans in that category may be predatory. This means that many lenders will not originate high-cost loans and purchasers will not purchase them. They will not be securitized and the secondary market will not produce the liquidity that fuels additional lending in the high-cost loan market.
Page 15 PREV PAGE TOP OF DOC
Yet, assignee liability is critical to successful efforts to address predatory lending. It helps to protect responsible investors from misperceived risk and provides incentives for the market to police itself, curbing market inefficiencies. The argument is, without assignee liability an unscrupulous lender can increase the value of the loans it sells by engaging in predatory practices, and packing the loan with unnecessary fees, excessive interest rates and large prepayment penalties. The lack of assignee liability provides little incentives to purchasers of such loans to determine if the loans were originated illegally or are so out of line with market norms that they present a substantial likelihood of abuse.
What a dilemma; what an issue. How do we resolve it? How do we get an end to predatory lending? That is on our plate today and I look forward to an excellent meal.
Thank you.
Chairman NEY. I want to thank the gentleman.
Mr. Hensarling from Texas.
Mr. HENSARLING. Thank you, Mr. Chairman, and thank you and Chairman Bachus for holding this hearing.
Since coming to Congress, I have heard a lot of bad ideas, but assigning strict liability to assignee's of mortgages in the secondary market—strict liability—strikes me as one of the worse. I mean, where those who purchase the mortgage do not even have any knowledge of a potential underlying violation strikes me as a truly, truly bad idea.
One thing we have consensus on in this committee is that we all believe that predatory lending is a problem. Unfortunately, we cannot seem to come to any consensus on what predatory lending is or is not. I hope that we as a committee do not conclude that predatory lending is tantamount to a commercial transaction between consenting adults with full disclosure, but because we do not like the terms, we decide in our infinite wisdom that we should outlaw these transactions.
Page 16 PREV PAGE TOP OF DOC
Now, as we debated the Fair Credit Reporting Act, we heard testimony after testimony that we in America enjoy the most accessible, lowest-cost credit in the world. I think it is undisputed we have the highest rate of homeownership in the entire history of our nation, and that includes homeownership opportunities for low-income individuals and those who have either poor credit records or no credit records.
If we do not legislate properly, we risk all of this. I certainly found the comments from my colleague Mr. Scott of Georgia very instructional, very enlightening. To some extent, it seems to me we have a case study of what happened in Georgia and I look forward to hearing some testimony from the witnesses on this. But what I saw happen in Georgia was that Ameriquest, Chase, City Financial, Fannie Mae, GMAC, National City, Option One, Freddie Mac, Wachovia, the list goes on and on and on, all pulled out of the market because of uncertainties with respect to the liability.
If we want to be pro-consumer on this committee, I would suggest that we work hard to make sure that we increase market competitiveness and not sow the seeds of the market's destruction. It is critical that we figure out what predatory lending is, that we agree on the definition and we isolate it from those reasonable players in the commercial market who are making homeownership opportunities available to low-income Americans.
I yield back the balance of my time.
Chairman NEY. The gentlelady from New York, Ms. Velazquez.
Ms. VELAZQUEZ. I ask that my statement be included in the record.
Chairman NEY. The gentlelady asks for unanimous consent. I would note for all members, unanimous consent if there is no objection for their statements to be entered into the record.
Mr. Lucas.
Page 17 PREV PAGE TOP OF DOC
[The prepared statement of Hon. Nydia M. Velázquez can be found on page 64 in the appendix.]
Mr. LUCAS. Mr. Chairman, in the interest of time, I would like to associate myself with the remarks of my colleagues across the aisle, Mr. Miller of California and Mr. Royce, and also with Mr. Scott of Georgia. Thank you.
Chairman NEY. I thank the gentleman.
The gentleman, Mr. Garrett.
Mr. GARRETT. Thank you, Mr. Chairman.
Just very briefly, first of all, I thank you for holding the hearing today. I think for both sides of the aisle, we are concerned about the same thing, and that is the victims, whether they be defined as some us are concerned, the victims of abusive practices, or also those people who are the victims of good intentions.
I come from the State of New Jersey where the victims in that case are the victims of good intentions of the State legislature who, as in Georgia as well, had the best of intentions, I am sure, to look after those folks who may be victims of abusive lending practices. But at the end of it, they become victims themselves, whether they are those who no longer are able to enter into the subprime market, the families involved who are no longer able to get those loans; and finally those legitimate lenders who are now precluded from being in that marketplace because of the actions that the State legislature took.
I am also mindful of the Ranking Member's comment at the outset of these discussions with regard to a Statement saying we have to get our act together here. Would that be true, that we get there, and make a decision from either side of the aisle as to where the appropriate responsibility lies, whether it is on these areas of State concern or federal concern.
I think at the end of the day, the hearings that we hold here at the very least should shine the light of day both on the abusive practices, but also on the very debilitating effect that the State legislative actions in several States have already taken, and fortunately they have begun to take remedial actions on these various facets.
Page 18 PREV PAGE TOP OF DOC
Mr. Chairman, again I appreciate your holding these hearings and I yield back the balance of my time.
Chairman NEY. Thank you.
The gentleman from New York, Mr. Israel.
Mr. ISRAEL. Thank you, Mr. Chairman.
I will take less than a minute. There is an old saying here in Washington that we cannot define pornography, but we know it when we see it. The same rule cannot be applied to predatory lending and below-prime lending. It clearly means different things to different people. I have a community in my congressional district that has been tragically undermined by predatory lenders. The fact of the matter is that bad actors in predatory lending are negatively defining reputable below-prime lenders.
I have a very simple bottom line, Mr. Chairman, and that is that I believe that we need to work on a bipartisan basis to create an appropriately regulated federal marketplace that allows the subprime industry to give more people access to homeownership, while completely shutting down the bad actors. I look forward to working with my colleagues towards that end.
Thank you, Mr. Chairman. I yield back.
Chairman NEY. Thank you.
Mr. Davis of Alabama.
Mr. DAVIS. Thank you, Mr. Chairman. Let me also thank the Ranking Member for her comments at the beginning.
I will not take anywhere near the full 5 minutes, but I want to define the problem from my perspective. On both sides of the aisle, we have a very strong commitment to a free market in this country. That is a bipartisan commitment that we have. The challenge of predatory lending and excessive subprime lending is that it distorts the market. I have to consider a market to be distorted when upper-income African Americans and upper-income Hispanic Americans with good credit are finding themselves pushed into the subprime market. That is a distortion of the way the market should be working in this country. It is a distortion that limits homeownership opportunities. It is a distortion that locks people into a vise from which they often cannot escape.
Page 19 PREV PAGE TOP OF DOC
We are struggling for a solution. I think a number of us would like to see a national standard, but it has to be a national standard that has some teeth to it. It is a reality that the efforts of the Department of Treasury, the efforts of the Office of Comptroller of the Currency have frankly not made any real headway. One of the reasons why some of us on this side of the aisle are troubled by the OCC's efforts at preemption several months ago is because the efforts of HUD, the efforts of OCC in the last several years have not made any significant dent, as Chairman Bachus said at the outset, in the incidence of subprime lending. I think illegitimate subprime lending is only continuing to rise in this country.
The short of it is that we have to find a strategy to address this serious market distortion and we have to rise above anecdote. What we often hear is that, well, we have made progress in Baltimore; we have made progress in L.A.; we have made progress in New York. Nobody ever wants to quantify this problem. Nobody wants to find a way to really, number one, identify what practices are illegitimate lending and what we can do about it.
So I hope the focus of this hearing will lead us toward some consensus on what an across-the-board approach ought to look like, but I hope that we do not leave here without a genuine recognition that this is a market distortion and it is something that ought to concern both sides of the aisle.
I yield back the balance of my time.
Chairman NEY. I thank the gentleman.
With that, I want to thank also the witnesses and the members for their opening statements. We will move on to the panel. Our first witness is Micah Green, who is president of the Bond Market Association, an association representing approximately 220 securities firms and banks that underwrite, trade and sell debt securities. Mr. Green joined the association in 1987, having previously served as the staff director and general counsel with the House Subcommittee on Human Resources of the Committee on Post Office and Civil Service.
Page 20 PREV PAGE TOP OF DOC
Frank Raiter is a managing director of Standard & Poor's Credit Market Services, a division of the McGraw-Hill Companies. The company assigns credit ratings to financial institutions such as loan guarantees, bank loans and mortgage-and asset-backed securities.
I will defer at this point to Mr. Miller of North Carolina to introduce the next witness.
Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman. I am very pleased to introduce Mike Calhoun to this committee. Mr. Calhoun is the general counsel and vice president of the Center for Responsible Lending. They are headquartered in Durham, which adjoins my district, and I believe Mr. Calhoun lives in Durham as well. The Center for Responsible Lending is an affiliate of Self-Help, and Mr. Calhoun is also a general counsel of Self-Help.
I am very proud of the work that Self-Help has done in making credit available, providing financial services generally to low-income consumers, and has done it on reasonable terms. Their approach is, how to provide a product at a reasonable price, taking risk into account, and make a fair, reasonable profit off of the transaction, as opposed to when a consumer walks in their offices, taking the approach of just how much money can we they make off that consumer. Self-Help has grown dramatically and has done great things for folks in North Carolina.
Mr. Calhoun has practiced consumer law for more than 25 years. He is a graduate of the law school at the University of North Carolina at Chapel Hill, an outstanding academic institution. I understand that Mr. Calhoun also has a college degree.
Chairman NEY. Thank you.
The next witness is Pamela Kogut, who is the Assistant Attorney General in the Office of Massachusetts Attorney General Thomas F. Reilly; and Richard DeMong is the Virginia Bankers professor of bank management at the McIntire School of Commerce at the University of Virginia, where he taught since 1977. Dr. DeMong is a registered investment adviser and has lectured extensively on issues relating to equity evaluation of subprime loans and financial analysis.
Page 21 PREV PAGE TOP OF DOC
I want to welcome all the witnesses today. We will start with Mr. Green.
STATEMENT OF MICAH S. GREEN, PRESIDENT, THE BOND MARKET ASSOCIATION
Mr. GREEN. Thank you very much, Chairman Ney. I really appreciate your kind introduction. I congratulate you and Chairman Bachus and Ranking Members Waters and Sanders for your leadership and continuing your review of this important issue. I also would thank Chairman Baker for his constructive work on this issue.
Let me just say, too, to the entire subcommittees, I know typically a hearing is when those of us who are witnesses impale ourselves to you about what we think needs to be done. I will tell you, I just sat through 20 opening statements of people who have thought about this issue, people who understand this issue, people who have strong feelings on this issue. We have heard from you. I think I can speak for my other panelists. We know what we have to do now. We know that we have to be responsible on this issue. We cannot understate the problem of predatory lending, nor should we overstate the market issues.
We also need to be very careful to be very clear about what the problem is with assignee liability, and we need to make sure that we fully understand and together define clearly what a good subprime marketplace is all about and what bad predatory lending is all about, and agree that we have to stop predatory lending, but not at the cost of people who need access to capital just merely because they have had a tough lot in recent years and their credit rating may not be stellar.
So I will tell you as a witness at this hearing, I have heard your Statements and I will take them back to our community to make sure that we take the charge very seriously, to come together constructively on something that can hopefully advance the ball here.
But there is a problem. There is a problem, and to pick up on Congressman Sanders's point about the States being a laboratory the States have, in fact, been a laboratory. The States have been an excellent laboratory. States have tried to deal with this issue in ways they sincerely knew and felt that they could best deal with this issue. And they learned that there was a problem. There was a problem that if you go too far, it can have a cost to people who need legitimate capital at the most affordable cost.
Page 22 PREV PAGE TOP OF DOC
Keep in mind, all these statistics about the growth of the subprime market have been at a time when interest rates have been very low. The subprime market has grown just as the other mortgage market has grown tremendously, both the refinancing market and the original issue market for home purchases. We are about to enter a period of rising interest rates. We are also about to enter a period where people who may have been out of work during a recession may be coming back to work. What happens when people are out of work? Their credit rating, their own personal credit quality could go down during that period of stress in their life.
So they may now be back at work and need to access capital for the purchase of a home or for whatever reason, and because of a blemish on their record may need to access the subprime market at the most affordable level. If a viable secondary market is not working well to help reduce the cost of that subprime marketplace, real people will be hurt, not by a loss of liquidity, which is a favorite term of art in the marketplace, but by higher costs. The way liquidity translates itself to the average person is a higher cost of that borrowing, a higher cost of that mortgage. So we are at a time where this issue has grown in importance because of a potential rising interest rate environment, as Congressman Royce indicated.
But I will say that the real problem with the laboratory experiment in the States has been not only any one particular state experience, like what happened in Georgia or New Jersey or any one of numerous states, but the fact that we have a patchwork quilt of various types of state regulations and state requirements. Some of them are clear and objective. Some of them are vague and uncertain.
The marketplace is a national marketplace. In order to quantify the risks, you need clarity and objectivity. Imprecision and unclearness results in the inability to value those risks and quantify those risks. That is why when a very objective observer like S&P looks at this issue, they say it is difficult for them to quantify the credit-worthiness, as you will hear from S&P.
Page 23 PREV PAGE TOP OF DOC
So we come here today wanting to be a partner. We want to work with these committees to try to arrive at a solution. In a perfect world, no assignee liability would probably be the ideal, but we recognize, as Congressman Scott said, that you need some way to enforce these rules in a way that will get at the predatory lender. So we would support clear objective assignee liability, because at the end of the day if it is clear and objective, it can be implemented in a precise and less costly way.
So we would look forward to working with this committee to try to figure out where that line is, but clearly the status quo, particularly at this stage of the market cycle, is not a good place to be.
So I thank you, Mr. Chairman and members of the committee, and I look forward to answering your questions.
[The prepared statement of Micah S. Green can be found on page 98 in the appendix.]
Chairman NEY. I thank the gentleman.
Mr. Raiter.
STATEMENT OF FRANK RAITER, MANAGING DIRECTOR, STANDARD & POOR'S CREDIT MARKET SERVICES
Mr. RAITER. Good morning, Chairman Ney, Chairman Bachus and members of the subcommittees.
As an independent and objective commentator on credit risks, Standard & Poor's generally does not take a position on questions of public policy. Thus, while Standard & Poor's strongly supports efforts to combat predatory lending and other abusive practices by lenders, it does not take a position on what legislative or regulatory actions would best accomplish that goal.
Nevertheless, Standard & Poor's has been closely following legislative and regulatory initiatives designed to combat predatory lending in order to determine how those laws might affect its ability to rate securities backed by residential mortgage loans. Standard & Poor's appreciates the opportunity to discuss the factors that it considers when evaluating the impact of anti-predatory lending laws on rated transactions and in particular the issue of assignee liability.
Page 24 PREV PAGE TOP OF DOC
Increased access to mortgage loans has led to increased homeownership across the United States. While this growth in homeownership is positive, it has become evident that some of this increase has unfortunately occurred simultaneously with the rise in predatory lending practices. Among others, these predatory practices include the following: charging excessive interest or fees; making a loan to a borrower that is beyond the borrower's financial ability to repay; charging excessive prepayment penalties; encouraging a borrower to refinance a loan notwithstanding the lack of benefit to the borrower; and increasing rates upon default.
Anti-predatory lending laws are designed to protect borrowers from these unfair, abusive and deceptive lending practices, and Standard & Poor's strongly supports efforts to eliminate predatory lending. However, in its role as a provider of opinions on credit risk, Standard and Poor's must evaluate the impact of these laws on the return to investors in mortgage-backed securities.
Indeed, given the expansion of individual investment in securities through various retirement and pension plans, these investors might actually be the same borrowers the laws are intended to protect. Standard & Poor's has determined that some of these laws may have the negative affect of reducing the availability of funds to pay these investors. This reduction could occur if an anti-predatory lending law imposes liabilities on purchasers or assignee's of mortgage loans simply because they hold the loans that violate a law, even if they did not themselves engage in predatory lending practices.
In performing its evaluation of anti-predatory lending laws, the two most important factors that Standard & Poor's considers are whether an anti-predatory lending law provides for this assignee liability, and if so what penalties the law imposes on assignee's for holding predatory loans. If Standard & Poor's determines that there is no assignee liability, Standard & Poor's will generally permit loans covered by the law to be included in rated transactions without any further considerations or restrictions.
Page 25 PREV PAGE TOP OF DOC
If on the other hand, a law does permit assignee liability, Standard & Poor's will evaluate the penalties under the law. If damages imposed on purchasers are not limited to a determinable dollar amount, that is the damages are not capped, Standard & Poor's will not be able to size the potential liability into its credit analysis. Therefore, these loans cannot be included in rated transactions.
If on the other hand, monetary damages are capped, Standard & Poor's will be able to size in its credit analysis the potential monetary impact of violations of the law. Standard & Poor's looks at all types of potential monetary damages, including statutory, actual, and punitive damages. It should be noted, however, that even if capped damages can be sized, it may not be economical for a lender to make such loans if the credit support that Standard & Poor's would require equals or exceeds the monetary value of the loan. For example, if a law provides for punitive damages, even if these damages are capped, the amount of the damages may well exceed the loan value.
In making these determinations, above all Standard & Poor's looks for clarity in the law. Specifically, Standard & Poor's looks for statutory language that clearly sets forth what constitutes a violation, which parties may be liable under the law, and as noted, whether any monetary liability is limited to a determinable dollar amount. Absent clarity on these issues, in order to best protect investors in rated securities, Standard & Poor's may adopt a conservative interpretation of an anti-predatory lending law and may, in instances where liability is not clearly limited, exclude mortgage loans from transactions it rates.
In offering these comments today, Standard & Poor's reiterates to the honorable members of the subcommittee that as a public policy matter, Standard & Poor's supports legislation that attempts to curb predatory and abusive lending practices. Standard & Poor's also notes, however, that its role is to evaluate the credit risk to investors associated with anti-predatory lending legislation, and not to recommend public policy.
Page 26 PREV PAGE TOP OF DOC
This concludes my testimony. I will be happy to answer any questions. Thank you.
[The prepared statement of Frank Raiter can be found on page 111 in the appendix.]
Mr. BACHUS. [Presiding.] Mr. Calhoun.
STATEMENT OF MICHAEL D. CALHOUN, GENERAL COUNSEL, CENTER FOR RESPONSIBLE LENDING
Mr. CALHOUN. Chairmen and members of the committee, I appreciate the opportunity to testify today, and I thank Congressman Miller for his kind introduction and his respect for his college rival, Duke University.
Self-Help has provided over $3 billion of financing for first-time homebuyers across this country. We regularly purchase, securitize and hold loans in the secondary market. Our mission is to help families create financial net worth. In the late 1990s, we found that many of our borrowers that we had helped put into homes were being solicited to refinance into predatory loans. We also found that many loan applicants had already been trapped in predatory loans and were unable to qualify for a loan to help them.
We and other lenders and many other groups worked together in 1999 when North Carolina enacted the country's first predatory lending law. It has worked very well both protecting consumers and maintaining access to credit. I was one of the principal drafters of the law and I also serve as general counsel for Self-Help in its lending programs, and have previously directed Self-Help's secondary market program.
I will address three points this morning. First, assignee liability is presently a part of our national mortgage market and a necessary part. It is not something new. Second, the North Carolina law which has substantial assignee liability has worked very well. And finally, I will address the impact of the subprime market on homeownership.
Page 27 PREV PAGE TOP OF DOC
Today, it is a fact that most home loans are sold. You end up making your payments to somebody totally different from whomever you took the loan out with. Assignee liability simply means if the loan is illegal, can those violations of law be enforced against the party collecting or even foreclosing on your loan?
Assignee liability is commonplace in mortgage transactions presently under a number of State and federal laws. It is the general rule in many consumer transactions, such as car purchases, furniture purchases that are regularly securitized, that paper is securitized. At the most critical point, with a family facing the threat of foreclosure, the absence of assignee liability means that the purchaser of the illegal loan can foreclose and evict the family and force them to try and find the original lender and seek redress against a party that may be gone or bankrupt. We will hear examples of that today from other witnesses. In short, significant assignee liability is central to protect families and protect the integrity of our mortgage market.
The North Carolina law did not contain a separate assignee liability provision because assignee liability for certain mortgage violations was already part of existing North Carolina law. North Carolina's subprime market has remained strong, growing more than 50 percent under the law. A UNC Business School study of the law's impact found no reduction in subprime home purchase loans in North Carolina under the law. It found the effect on refinancing loans was overwhelming on those loans with predatory features. It concluded the law was having its precise purpose and was working well. New Jersey and several other States have even more limited assignee liability than North Carolina and we expect that there will be positive experiences there as well.
As noted by the Chairman and several other members, the subprime market has been exploding in volume. It is important to remember, though, the subprime market when we look at its impact on homeownership is overwhelmingly a refinance market. Over three-fourths of these loans are refinancings of existing mortgages where somebody is already in a home, not loans to purchase a home. Foreclosure in the subprime market, as noted, is exploding at a rate 10 times that of the prime market. As we sit here today, fully 5 percent of all subprime loans are in foreclosure right now.
Page 28 PREV PAGE TOP OF DOC
Moreover, these loans tend to refinance repeatedly and have an average life of only 3 to 4 years. If a lender charges five up-front points or more and/or a 5 percent prepayment penalty, with each loan and each refinancing, quickly a family's long-earned home equity is gone. This has a very disparate impact on minority families. While the reasons can be debated, it is a fact that minority families are much more likely to have and be affected by subprime loans than other families.
Moreover, the loss of home equity is even more devastating. There is a tremendous equity gap in the United States today, with African American families having only one-tenth the net median wealth of majority families. That is currently about $10,000.
The continuation of unchecked predatory loan practices gravely threatens homeownership and equity of families. I urge this committee to enact effective federal protections like those in North Carolina. These federal protections should be a floor, not a ceiling so that the States and Congress can work together to protect American families.
Thank you.
[The prepared statement of Michael D. Calhoun can be found on page 67 in the appendix.]
Mr. BACHUS. I appreciate that.
Assistant Attorney General Kogut.
STATEMENT OF PAMELA KOGUT, ASSISTANT ATTORNEY GENERAL, OFFICE OF THE ATTORNEY GENERAL, COMMONWEALTH OF MASSACHUSETTS
Ms. KOGUT. Thank you, Mr. Chairman and members of this committee. I am so pleased to be here today to present the views of Massachusetts Attorney General Tom Reilly and our office's work concerning subprime mortgage lending cases. I bring to this hearing the perspective of a law enforcement office which has a long history of bringing cases against mortgage lenders that have engaged in unlawful practices, including cases against subprime mortgage lenders.
Page 29 PREV PAGE TOP OF DOC
I am going to highlight a recent case which our office brought against, First Alliance Mortgage Company. This case illustrates that even when we have reasonably strong consumer protection laws on the books, in straightforward egregious violations of the law, consumers may not be made whole by a lawsuit at the end of the day unless the laws are made stronger and the secondary market entities are held accountable. If the secondary market entities are not held accountable, at the end of the day the consumers are going to be left holding the bag, and the bag will be empty. That is what our experience has shown us.
So to focus on the First Alliance Mortgage Company case, this Irvine, California-based lender obtained a license from our Division of Banks to do business in Massachusetts in 1997. After a routine examination a year into their license, our Division of Banks found that this lender was routinely charging borrowers 20 points and more for mortgage loans. Our Division of Banks was concerned and referred the matter to our office for enforcement. We filed a lawsuit fairly soon after the case was referred to us. We filed a lawsuit in October of 1998. We focused on a State regulation that prohibits mortgage lenders from making mortgage loans with terms which significantly deviate from industry-wide standards or which are otherwise unconscionable.
The focus of the lawsuit was intended to focus really cleanly and swiftly on the points overcharges which were clearly unconscionable by Massachusetts standards. We expected that this was a lawsuit that would be wrapped up quickly. This turned out not to be the case at all. A little more than a year-and-a-half after the case was brought, First Alliance Mortgage Company filed for bankruptcy protection in California, which extended the litigation in our case by years. The case did not end up getting resolved until 2002. At the end of the bankruptcy case, the Massachusetts consumer saw only cents on the dollar.
Here is what we learned about First Alliance Mortgage Company's practices. During the year when they made loans in Massachusetts, and after we filed our lawsuit and obtained a preliminary injunction against first alliance which limited them to charging no more than five points per loan, they closed up shop in Massachusetts and left. So they only did business in Massachusetts for one year, making 299 loans. Of these, more than 35 percent of the loans contained points charges in excess of 20; two of our borrowers paid more than 30 points.
Page 30 PREV PAGE TOP OF DOC
Although First Alliance characterized itself as a subprime lender, of the 299 loans made, 20 percent were made to borrowers whose credit ratings were A or A-minus according to FAMCO's own standards. What does this mean in practice? This means that for example one of our borrowers, a woman aged 61, borrowed the sum of $47,000, a little more than that. She had an adjustable rate note that had an initial rate of interest of 9.49 percent, and she paid more than 25 points, or more than $11,000 in points for her loan, but she was rated as an A borrower, that is, a consumer whose credit history and debt-to-income ratio should have qualified her for a conventional conforming mortgage loan with competitive rates and costs. She was a middle-class borrower who lived in a good community outside of Boston, and she paid more than 25 points for a mortgage loan.
Twenty-eight of our borrowers had their loans flipped which means that within about a year after they obtained their original refinanced loan from FAMCO, they got another FAMCO loan and paid the same level of points the second time around. For example, one couple in their 60s paid more than $15,000 in points, or as it turned out, more than 20 points for the first loan they got with First Alliance Mortgage Company, and just 14 months later got a second loan from First Alliance Mortgage Company and were required to pay more than $15,000 in points the second time around. There is no reason for that level of points payment, obviously.
We learned that FAMCO telemarketers were taught to urge consumers to get new FAMCO loans at every opportunity. So if a consumer called this mortgage lender to get a loan payoff figure, the telemarketers tried to sell them a new loan. If they were late making one payment, telemarketers tried to get them to get a new FAMCO loan. Our Massachusetts consumers did not seek out this lender. They were solicited. They ended up with this loan not having needed it or looked for it in the first place.
We also learned that this lender got its loan originators to memorize and follow a deceptive sales pitch called the loan officer track. Without going into the details, this was basically a handbook on deception and specifically taught the loan originators to deflect questions about points charges. We learned that this lender did not hire experienced mortgage loan originators. They drew from car sales people who had proven track records in car sales. It is significantly that they were not taught about mortgage lending laws when they were trained. They were only taught to memorize this deceptive program.
Page 31 PREV PAGE TOP OF DOC
Ultimately, after First Alliance filed for bankruptcy protection, the Massachusetts AG's office was joined by a number of other AG offices, Minnesota, Illinois, Florida, California and Arizona, and the New York State Banking Department, as well as the FTC and private class actions, and we worked in a coordinated fashion to get a result in bankruptcy court. The result was very good: 18,000 borrowers got consumer redress. The consumer redress fund was ultimately approximately $85 million, but still this was not enough money to go around at the end of the day. Massachusetts at the time that this lawsuit was filed did not have assignee liability and the First Alliance Mortgage Company entity did not have enough money at the end of the day to make our consumers whole.
One last point is that the coordinated plaintiffs in this case did make an important decision to sue Lehman Brothers, the investment firm that had securitized FAMCO's loans and a jury did fine Lehman Brothers was liable for aiding and abetting FAMCO in its fraudulent scheme, and was ordered to pay the sum of $5.1 million.
The point that we come here to make is that this is a lender that engaged in egregious violations of law. We had a clear law in Massachusetts, but we did not have assignee liability. The secondary market entities did not contribute sufficiently and consumers were not made whole. Our consumers at the end of the day were seriously harmed and there was nothing we could do to protect them.
Thank you.
[The prepared statement of Pamela Kogut can be found on page 104 in the appendix.]
Mr. BACHUS. Thank you.
Professor DeMong.
STATEMENT OF RICHARD F. DEMONG, VIRGINIA BANKERS PROFESSOR OF BANK MANAGEMENT, MCINTIRE SCHOOL OF COMMERCE, UNIVERSITY OF VIRGINIA
Page 32 PREV PAGE TOP OF DOC
Mr. DEMONG. Thank you, Mr. Chairman and members.
The nonprime mortgage lending has increased dramatically in recent years, providing billions of relatively low-cost loans to millions of borrowers whose risk profiles prevent them from qualifying for so-called ''conventional'' or ''prime'' loans that offer somewhat lower rates. Without the availability of nonprime loans, most of these borrowers would not be able to obtain credit to buy a home or to utilize some of their home equity for a variety of important financial needs.
The continued availability of critically important consumer credit is highly dependent on retaining a healthy and efficient securitization market for nonprime mortgages. Liquidity can be lessened significantly, especially for higher-risk borrowers, by unclear, overly restrictive and conflicting laws, particularly when purchasers or assignee's of nonprime loans are subjected to broad liability for errors that may have been made by loan originators While it is now generally recognized that additional legislative safeguards are needed to protect nonprime borrowers from certain potentially abusive lending practices, it is critical that such legislation does not have the effect of reducing credit availability.
This is an extremely important issue for millions of Americans, and I therefore commend Chairman Ney and Chairman Bachus for their continued leadership in scheduling this hearing to help address it. I also commend Representative Baker, who has voiced special concerns over preserving nonprime lenders's access to the capital markets, and Representatives Lucas, Watt, Miller, Kanjorski and others for seeking to develop workable legislative proposals.
The origination of nonprime mortgages in 2003 was estimated to be $325 billion, representing about 10.5 percent of all mortgage originations. Just as is true with the prime mortgage market, the nonprime mortgage market has become national as the large national institutional lenders have replaced banks and small finance companies as the primary source of funds.
Page 33 PREV PAGE TOP OF DOC
Loan originators no longer need to hold a mortgage loan until maturity or sell whole loans to other financial institutions. With the development of the mortgage securities and an active secondary markets, lenders can sell entire pools of loans to a diverse set of investors such as pension funds, mutual funds, life insurance companies or individuals. By bringing new investors to the market, securitization has dramatically increased funding for housing finance, reduced margins, lowered costs and interest rates, and increased access to credit across the country. Two-thirds of nonprime mortgage loans are now securitized in the secondary market.
To be most efficient, investors that are the source of funding for mortgage debt desire reliable risk analysis of the potential borrower, good reputations of all those involved in the mortgage lending process, transparency of the process, standardization of the process, and clarity in the laws.
Just as prime mortgage interest rate spreads dropped in the 1980s after the development of securitization, as well as the continued active secondary market, so have nonprime interest rate spreads dropped over the last 6 years, especially during the last 2 years. I have two exhibits. Exhibit one shows the subprime interest rate spread between nonprime loans and the 10-year constant maturity treasury rate, and you see the dramatic drop in the last 2 years. The second chart shows the difference between B credit and the 30-year FHA-insured FRM, the fixed-rate mortgage. Both of them show the shrinking spreads.
As economic theory suggests, nonprime interest rate margins for the lenders have decreased with growing efficiency, which partially came from the standardization, and competitiveness in the market. Borrowing rates have therefore decreased for consumers.
The investors evaluate all investments on a risk-adjusted basis. If an investment becomes uncertain or risky, investors will find other more certain and less risky investments. They demand a higher return for increased risks. All the financial markets crave certainty and similarity. A law that is not clear or certain may cause nonprime market liquidity to drop dramatically. An example of that is a study that I did in New Jersey after it implemented the New Jersey Home Ownership and Security Act of 2002, for the 2 months after the implementation of the law, as compared to the 2 months prior to it. Lending to subprimes dropped by over 60 percent. Any vagueness in the law will disrupt funding sources.
Page 34 PREV PAGE TOP OF DOC
So as Congress evaluates a uniform nonprime lending standard, there are lessons from the development of the prime mortgage securitizaton market. The success of the conforming securitization market depends on standardization of the legal framework, including preemption of state usury laws; and predictable and limited risks for the ultimate investors in the securities, in other words, no broad assignee liability.
In closing, I urge Congress to pass a well-crafted federal law that prevents undesirable lending practices, while at the same time preventing disruptions to nonprime lending. That is, a law with clear, reasonable, and objective uniform national standards to prevent improper lending practices, and one that does not impose broad liability on assignee's. Such a federal law will not only protect borrowers, but will help promote continued liquidity in the nonprime mortgage lending market
Thank you for this opportunity to testify. I would be pleased to respond to any questions members may have.
[The prepared statement of Richard F. DeMong can be found on page 90 in the appendix.]
Mr. BACHUS. I thank the witnesses. For the record, without objection your entire written, statement, prepared statement will be made a part of the record.
The committee has established a procedure where members are called on to question the witnesses in the order that they arrived at the hearing. Therefore, Mr. Garrett is the first member to be recognized.
Mr. GARRETT. Thank you, Mr. Chairman.
Just a couple of questions, first, in line with the most recent testimony from the professor, can you delve into a little bit more with my home state, New Jersey, your findings after the two-month period, and were you able to do anytime after that? Because as you have heard testimony here and elsewhere, there is no impact, and the impact has only been a negligible one or positive as far as the legislative actions in New Jersey, but the findings that you have just indicated seem to go counter to that.
Page 35 PREV PAGE TOP OF DOC
Mr. DEMONG. Thank you, Mr. Congressman. I have not done a follow-up study. I am collecting data to do that right as we speak. You are exactly right. The greatest impact is going to be immediately after the law is passed until the market sorts it out and figures out whether additional costs are necessary or additional fees are necessary or interest rates or anything else. It will be interesting to see the results.
However, I should point out that the legislature in New Jersey is presently amending the law, which may very well change the whole study dramatically. I guess I was trying to use the study just to illustrate that a State law could, and did in this case, have dramatic effect immediately, and that is why I would argue for a very thoughtful national standard which would prevent disruptions in the market as investors search for more certain and less risky investments.
Mr. CALHOUN. If I may, briefly, there was a special circumstance in New Jersey immediately following the passage of the act, and that was that the rating agencies had not yet had time to evaluate the act. So while they were undertaking that evaluation, they announced that they would not rate mortgages from New Jersey. They subsequently completed that evaluation and decided that for the overwhelming majority of loans, there was not a problem and that they would rate those loans. As you noted, as to the final category of loans, New Jersey created this intermediate threshold of covered loans. As to that final category, the legislature is debating now whether it should remove that category, as they did in Congressman Scott's State of Georgia. They tried that category. It turned out to be a major problem and they quickly removed it.
Mr. GARRETT. Yes, but that is exactly the point. The rating agency said that for everything outside of what the intention of the Act was going to cover, in essence they are still okay. It is for exactly what the legislature was aiming at that they still had the question as to what should we be doing with that area.
Page 36 PREV PAGE TOP OF DOC
Mr. CALHOUN. Under the Homeowners Equity Protection Act, HOEPA, there is full assignee liability on high-cost loans and the rating agencies for the last 10 years have taken the position generally that they do not rate those loans. So that is not different from what we have had previously, the New Jersey approach.
Mr. GARRETT. Okay. Professor?
Mr. DEMONG. The study that I did was actually after Standard & Poor's had decided how to rate the New Jersey paper. So the 2 months I did were December 2003 and January 2004, as compared to September and October of 2003. So it was after Standard & Poor's had decided that it would rate paper from New Jersey. The markets were reacting to the implementation of the law. A rating agency action is just one more disruption, and that is the type of thing that I would urge Congress to look for and come up with a national standard so you would not have a State-by-state disruption.
Mr. GARRETT. I know Mr. Green wants to answer that, then I have a question for the Deputy Attorney General.
Mr. GREEN. I was just going to supplement that one of the elements in the New Jersey law is that the borrower enjoy a net tangible benefit from the transaction, but it is ill-defined. I think one of the things that the New Jersey legislature is looking at is that area, because again getting back to the need for clear and objective standards, an ill-defined or even undefined net tangible benefit analysis will be impossible to do. It simply increases the risk that the assignee's liability will have a real-world effect on the ability to purchase that mortgage and make it part of the pool, which has the effect on the overall pool.
Mr. RAITER. If I could just add, having been at Standard & Poor's at the time, the reason that upon initial review of the New Jersey Act, there were some incredibly vague language that implied that any use of proceeds from a refinancing that went into home improvement would open up the investor to a liability that was undefined or capped. There was no way to in fact determine at the time that someone refinanced the house and took cash out that they may or may not engage in home improvements. Therefore, we could not rate any refinanced loan in New Jersey until we got clarity on exactly what the intent was.
Page 37 PREV PAGE TOP OF DOC
Mr. GARRETT. I thank you. I did have another question. I will not do the questions as my time is allotted. I just will say that I have met with used car salesmen over literally the last past week and they are looking for some prime lenders to come into the industry. I am just kidding.
[Laughter.]
Mr. BACHUS. I thank the gentleman from New Jersey.
I have just been informed that Mr. Sanders will not be back. I am trying to cope with that loss.
[Laughter.]
I am going to recognize the gentleman from Illinois, Mr. Gutierrez.
Mr. GUTIERREZ. Thank you.
I guess my first question is to Mr. Raiter. The OCC keeps saying that national banks are not predatory lenders. You indicate in your testimony that you can easily rate subprime loans and make allowances, and that you can do this despite, although I just heard you say that you had a little difficulty in New Jersey, that you can easily rate these loans despite different state laws governing them.
If you can in your agencies as you have testified, can rate these loans and therefore assess risk on these loans, do you see a need for the OCC to issue a predatory lending rule at all, with the claim that it was crucial to avoid a crisis in liquidity? In other words, the OCC came here and said, we are going to have a crisis in liquidity if we do not issue these preemptive laws on predatory lending. But I read your testimony and listened to you, and it sounds like you figured out a way to rate those loans, so if you can rate them, then investors can know the risk. So what is the issue of liquidity if there is one?
Mr. RAITER. When we analyze a loan and include it in a rated security, as I think I indicated in the testimony, in some cases the risks to the investor exceeds the value of the loan. So if you lend somebody a dollar, but you have to put up $1.50 in order to get your dollar back, you are very likely not going to be lending a dollar.
Page 38 PREV PAGE TOP OF DOC
Mr. GUTIERREZ. I guess, Mr. Raiter, but you have been able to figure that out.
Mr. RAITER. Correct.
Mr. GUTIERREZ. My question is not whether there is a lot of risk to the loan. You are answering my question. You have been able to tell the market, hey, listen, this loan for a dollar could cost you $1.25 or $1.50 in the end.
Mr. RAITER. Right.
Mr. GUTIERREZ. I am just trying to see if I understood your testimony correctly, and that is you have been able to assess risk. If you are able to assess risk, could you tell me how that could affect liquidity then because I guess everybody knows what the risk is?
Mr. RAITER. The way it has affected liquidity, if ''liquidity'' is the term that you all want to use, is those loans are not getting made. Those borrowers are not receiving the loans under those terms that would put them in a category of a high-cost or a covered loan.
I might just add that we are getting reps and warranties from everyone that uses S&P's mortgage ratings desk that provides that they are not making high-cost loans under any jurisdiction in which they are operating. So the loans that are covered by the law are at this point not being financed in the secondary market. If they are making the loans, they are putting them in a portfolio.
As to your point on the OCC, and I am not a government regulatory expert, but I do believe their issue is with leveling the playing field for financial institutions that they regulate from one jurisdiction to another, not necessarily liquidity.
Mr. GUTIERREZ. I am sorry. You were not here, as you state, for the hearing and you are not a government official and not a member of this committee, so you would not be knowledgeable on the point. We are, as they have come to testify before us. So I think the record is pretty clear that they said we have a crisis of liquidity.
Page 39 PREV PAGE TOP OF DOC
As a matter of fact, since you are an agency that wants to bring clarity, the OCC did not only do that, they did it in a rushed manner. They did it in the stealth of night. They did it under cover of congressional recess. We asked them, we said, OCC, do not issue the rule until Congress comes back to session, and 2 weeks before we got here, they issued the rule. So you can imagine how we might be suspect after we have written them letters. As a matter of fact, this committee, Republican and Democrat, passed an amendment on the budget that basically is saying that the OCC does not have jurisdiction to do this.
So I understand and maybe I asked the wrong person, but it is just that when I read your testimony about being able to rate things, I figure, well, people will know what to buy and not to buy. From my perspective, that is a good thing. People know, a pension fund, do not buy these loans. Maybe they should not buy them because they are bad loans, because you at Standard & Poor's have assessed such a risk to those loans that maybe you have assessed that risk to those loans because they should not have been made in the first place.
I do not think we should get into the kind of argument of, well, they did not issue the loans. Well, maybe they should not have issued the loans. Maybe they were bad loans and we should not just have a system that says, we are going to have rules that allow all kinds of loans, and then in the end kind of see where those loans fit. Because as I have heard testimony here this morning that in the predatory lending, it is 10 times as high; the foreclosure rate. That is a lot of people that are going to suffer. I mean, it is not like a small mistake. Ten times higher than conventional mortgages? That is a lot. That is a lot of people that are going to suffer.
So if it was a small calculation in the market, maybe we could take a look at it, but I think that we should really be careful when the rate is 10 times as high. I think you have answered my question. You can rate these loans. So the marketplace has a reliable place they can go to before they buy or sell loans, because you can rate them. That basically was my question.
Page 40 PREV PAGE TOP OF DOC
Mr. BACHUS. Mr. Gutierrez, you are over 1 minute, but if you would like another.
Mr. GUTIERREZ. Thank you so much. In the absence of Mr. Sanders, I am trying to fill in a little bit for him.
[Laughter.]
Mr. BACHUS. Okay. I have learned some things. I did not realize the OCC issued that thing late at night under the cover of darkness.
[Laughter.]
Mr. GUTIERREZ. Maybe you have not read the letters from your side of the aisle asking them. And since the gentlelady from New York is here on your side of the aisle, and she and others wrote them the letter.
Mr. BACHUS. Was it 2 or 3 at night? What time was it? I am just kidding with you. Please go ahead.
Mr. GUTIERREZ. We can laugh and we can be silly about this experience all we want. The fact is that people, we have had testimony here today that people are losing their livelihoods, and that is a very serious issue. When we have an Assistant Attorney General from Massachusetts who says that she is a law enforcement officer of the State of Massachusetts, elected directly by the people of Massachusetts, and we have a philosophy being groomed here in Congress that at the local level they do it best, and that Washington, D.C. does not necessarily have all the answers.
And we have had Mr. Green come and testify about how wonderful all these laboratories are at the different state levels, I just think that it is a serious thing, because if you lose your house and you are getting ripped off, it is a crime. What we are discussing here are not dollars and cents. We are discussing crimes against people, and I think that is a very serious thing. So I characterized it that way, and I do not know that we should impugn my interpretation in that way, but that is the way that I see it. That is what I will submit for the record.
Page 41 PREV PAGE TOP OF DOC
Mr. BACHUS. I appreciate your wrapping up. I will say that the institutions that the testimony has been about, none of them are federally insured under the regulations of OCC, at least according to OCC.
Mr. GUTIERREZ. Mr. Chairman, if I could ask the Attorney General a question, maybe we can clear this up, because we have had testimony here that when the New York Attorney General, elected by the people of New York, attempted to engage a nationally chartered bank, that nationally chartered bank told the Attorney General, a law enforcement officer in New York, we do not have to deal with you; we are going to talk to the OCC. And Mr. Chairman, you know, the OCC is only open from 9 to 4, Monday through Thursday.
Mr. BACHUS. Mr. Gutierrez, what I am saying is the institution that we have heard testimony about today was not regulated by the OCC. Thank you.
Ms. Capito?
Mrs. CAPITO. I do not have any questions. Thank you.
Mr. GUTIERREZ. Thank you, Mr. Chairman. I can see this committee who it is being run by and for.
Mr. BACHUS. Ms. Kelly?
Mrs. KELLY. Thank you, Mr. Chairman. I have no questions.
Mr. BACHUS. My first question is for Mr. Green. Mr. Green, you have heard testimony from the Assistant Attorney General and from Mr. Calhoun and others that there is a situation where there is a predatory or abusive practice or tactics employed that harms consumers, and the lender or the broker is, as in the case of Massachusetts, was bankrupt, so they are not really subject to legal recourse. You have a situation where you either have a, let's say, innocent assignee or innocent victim. At least in the case of predatory lending, wouldn't it be better to hold the assignee liable than the innocent victim, in that the assignee at least should have been in a position to know?
Page 42 PREV PAGE TOP OF DOC
Mr. GREEN. I think it is a great question because that is precisely why we have come to the conclusion, after looking at all of what is going on in the marketplace now, after looking at what the various States have done, to that a national standard—one that provides clear and objective assignee liability that can be identified.
And picking up on the gentleman from S&P, focusing on the damages side, that if you had a national standard that accomplished that in an objective and clear way, in fact there ought to be assignee liability and that assignee liability ought to be enforceable. But when it is not clear, when it is a patchwork quilt around the country, it makes it very difficult to operate in an efficient, cost-effective, or even just-effective way.
Mr. BACHUS. I guess what you are saying is as long as they are able to price the liability risk?
Mr. GREEN. If liability is going to be accepted, you have to know what is going to impose it, and that clear and objective standard makes that doable.
Mr. BACHUS. And as long as there are clear standards as to what the liability would be?
Mr. GREEN. Yes, we would support and look forward to working with you. I know there are several pieces of legislation in the works just among this committee, Congressman Ney, Congressman Watt, and Congressman Baker today. We would look forward to working with all of you to try and find what that right definition is.
Mr. BACHUS. Okay. The GAO found in a study they released earlier this year that by separating ownership of a loan from its originator, the secondary market for subprime loans may in some instances undermine efforts to combat predatory lending. I am going to quote from the GAO report, ''The existence of a market that allows originating lenders to quickly re-sell subprime loans may reduce the incentive these lenders have to ensure that borrowers can repay.'' How do you respond to the GAO suggestions that the secondary market may, at least in some instances, facilitate predatory lending?
Page 43 PREV PAGE TOP OF DOC
Mr. GREEN. The analogy that comes to mind, if that was a question for me, is a way of reducing car accidents is to prohibit driving. The fact is there is a big market for people who need credit, who need access to capital, and they may not have pristine, clean track records. The subprime markets provide them access to credit.
It should not be surprising to anyone that the foreclosure rate is higher in the subprime market. They are riskier loans. That is why they are made in the way they are made. That is why they do pay a higher interest rate because they are a riskier credit, and riskier credits do have a higher risk of failure, so the fact is that there is a higher foreclosure in that category of loans. But if the foreclosure rate, which I heard earlier is 5 percent, that means 95 percent are people who needed credit are not facing foreclosure. Without that deep liquid secondary market, they may not have the same access to credit that they currently have to be able to reach their own life's dream.
So I would say that while the GAO may be technically correct, it is losing the forest for the trees. The important thing is you want to create access to capital for those who want it and deserve it and need it, and you have to deal with the problem of predatory lending more straight-on.
Mr. BACHUS. What about the North Carolina law? Do you all find that to be a fair law? I would ask you, Mr. Green.
Mr. GREEN. I guess we have found that the North Carolina law, specifically on predatory lending, has less vagueness in the assignee liability and frankly the body of their specific predatory lending stays away, as the previous witness said, from assignee liability specifically. So it has been a law that most of the marketplace has perceived to be a more workable standard than what we found in other states.
Mr. BACHUS. So you found that the North Carolina model at least does not inhibit the mortgage capital?
Page 44 PREV PAGE TOP OF DOC
Mr. GREEN. I never say never.
Mr. BACHUS. It does not appear to be. I mean, we have experience with it now.
Mr. GREEN. Right. But I think it would be a good standard as this committee furthers its look at potential legislation. It would be a good standard to look at.
Mr. BACHUS. Okay.
Mr. CALHOUN. Mr. Chairman, may I clarify two things? First of all, Mr. Green was referring to the 5 percent foreclosure figure. I want to make it clear, that is 5 percent of subprime loans which are currently in foreclosure. That is this year. Next year, there are going to be more loans. It is not that 95 percent of these loans are going to stay out of foreclosure. It is this year, 5 percent are in foreclosure. Given the average span of a foreclosure process, which is in the range of a year, next year we are going to get another 5 percent of them. We are talking about huge numbers of families losing their homes in this market.
The other one point is, on the North Carolina model, I want to be clear. North Carolina was the State that developed the prohibition against flipping, that there has to be a net tangible benefit. That applies to all loans in North Carolina. We also have a couple of safeguards. You have to prove that it was an intentional violation by the lender, and some other safeguards. We went through a lot of time trying to come up with a very specific standard. Both lenders and consumer advocates found that all of those standards were over-or under-inclusive.
Mr. BACHUS. Let me ask you this, my time has run out, I think what Mr. Green is saying is that the industry can live with the North Carolina law.
Mr. GREEN. I am saying it is a good starting place to look because their approach——
Mr. BACHUS. Has it limited liquidity to any great extent? I am not trying to put you on the spot.
Page 45 PREV PAGE TOP OF DOC
Mr. GREEN. You are doing a good job.
[Laughter.]
I would say that the North Carolina law has examples in it that the industry does feel are more precise and objective than what we have experienced in other states.
Mr. BACHUS. Okay.
Mr. GREEN. The right place to be on a national standard is probably not going to be exactly where the North Carolina law is.
Mr. BACHUS. I understand. I am just saying it is workable. I think Mr. Calhoun is saying, at least what I hear, is that it is protecting consumers.
Mr. CALHOUN. That is correct, Mr. Chairman.
Mr. BACHUS. Maybe I am oversimplifying this process, but that is sort of what I am hearing.
Ms. Waters?
Ms. WATERS. Thank you very much.
I think it must be understood that those of us who fight so hard against preemption appreciate the fact that some States work very, very hard to get rid of predatory lending. When we move to so-called definitions at the national level, all of that is going to be weakened. The whole idea, I have discovered, of wanting to preempt state laws not only as it relates to predatory lending, but in some other things, is basically to weaken the laws of States that have strong laws to protect their consumers.
I want to ask Mr. Calhoun because we keep hearing how much folks care about folks with bad credit being able to have access to credit and to get these mortgages. I am very grateful for that, that people care so much about people being able to have access to credit. As I said when I first started to speak, I do not mind subprime lending that is fair, but there are some other details that we have to look at with this subprime lending. I want you to discuss for me two or three other things that make subprime loans bad, that turn them into predatory lending.
Page 46 PREV PAGE TOP OF DOC
For example, you talked about loan flipping. I want to tell you, we see a lot of loan flipping. I want to hear something about late payments. I want to hear about some of the other things that turn subprime lending into bad loans. We are not opposed to somebody getting a percentage point more for a loan because someone has shaky credit.
Now, if the credit is too bad, then I do not care who it is, they should not have a loan because they are not going to be able to pay it back. If you know that they do not have the income by which to make these payments and they are going to get in trouble because they simply cannot afford the loan, then it is sinful, it is shameful to advance that loan because you are simply going to cause people to lose a lot of money.
Also, Mr. Calhoun, I have had so many complaints, people coming to my office. These loans are sold so many times they do not know who they are paying. This is one of the tricks. Folks do not know who the payment should go to because it has changed hands so many times, and that is how they get caught, getting late and getting behind trying to track down who this payment is to go to, because the loans has been sold three or four times.
Help me to understand and this committee to understand some of the other factors that go into predatory lending, so that people do not get the idea that we are just railing against subprime lending.
Mr. CALHOUN. I think one of the most important lessons that has come from the homeowner protection act that this Congress enacted 10 years ago, and the experience in North Carolina, is that unscrupulous lenders will simply change tactics unless you have comprehensive protections.
The North Carolina law is actually pretty modest. It sets a threshold for high-cost loans at 5 percent lender fees. So we are talking a $100,000 loan, $5,000 of lender fees, excluding things like appraiser, attorneys fees, et cetera. We want to make it clear, that is not a benchmark for a good loan. I do not think many of us would be happy with a loan like that or happy if our parents or our family received a loan like that.
Page 47 PREV PAGE TOP OF DOC
It is meant to be a generous threshold so that it does not restrict access to credit. But the important thing is that it includes all of the fees. We leave the flexibility to the lender and the borrower how they want to structure the loan. Do they want to have small up-front fees but a big prepayment penalty? Do they want to have a large origination fee and then not many other fees? If you do not include all the fees, the lenders' experience has been under the federal act simply change the name of the fees or restructure the loan to evade the law's protections.
We see that under your current federal law, HOEPA, in for example prepayment penalties which are perhaps the biggest looming problem in the subprime market. There are virtually no prepayment penalties in the prime market. They have now developed to be on the majority, almost 80 percent of subprime loans, and they are often as much as 5 to 10 percent of the loan amount. So when you go in to pay off $100,000 loan, they take another $5,000 or $10,000 out of the equity.
Under the federal law, the size and presence of prepayment penalties are not considered at all in determining whether it is a high-cost loan. Today, a loan with a 20 percent prepayment penalty is not a high-cost loan under the federal Act. If you leave a fee like that excluded from determining whether it is a high-cost loan, then the bill will just simply require people to change how they structure the loans, change the names of the fees, but will not end up at the end of the day protecting borrowers. That is one of the most important lessons.
The other is that you need a flipping standard applying to all loans. As we heard from the Assistant Attorney General, virtually all of these lenders make money by refinances. They collect a new set of fees and their loan officers are trained and pushed to try and get a refinancing at every chance. Repeated refinancings are what see currently under HOEPA, where a lot of the lenders charge 7.99 points to stay under the 8 point threshold for high-cost loans under your federal law. If you repeatedly refinance at 7.99 points, it does not take very long to take away all of the home equity.
Page 48 PREV PAGE TOP OF DOC
Again, that is totally legal under your current federal law, and we have seen examples where people have been refinanced three or four times in a year at 7.99 points. That is not a high-cost loan. It is not a violation of any of the federal protections at this time.
Ms. WATERS. Are those the major kind of items that you have covered in your North Carolina laws dealing with predatory lending and that you would want to have covered in any federal preemption? If there is going to be one, and I hope not, are those the major concerns?
Mr. CALHOUN. Yes, Congresswoman. To emphasize, the high-cost loan threshold does not bar high-cost loans. There are HOEPA loans made today by some lenders who specialize in that, and there are some high-cost loans being made in North Carolina. But again, under current standards for a high-cost loan, you are talking about a loan with more than five points up front, or interest rates in today's market of more than 13 percent. We feel like, and the experience in North Carolina has been, that credit is readily available for almost all borrowers within those constraints.
Ms. WATERS. What about late payments?
Mr. CALHOUN. Most States have some provision to protect consumers in both mortgage transactions and other transactions, on late payments. There are some lenders who try abusive practices where they will extract one late payment and make all your subsequent payments declared therefore late. Or they use late payments as a wedge to try and force a refinancing and a flip. So that is an important area to have protections.
Ms. WATERS. Mr. Chairman, I am going to yield back the balance of my time, but I would really like if at all possible for Mr. Green to give me his ideal. You know a lot about this subject. You have worked it quite some time. If you were going to advance a federal law, a change, an improvement to deal with predatory lending in the subprime market, what would you advise us to do? What is acceptable to you? You kind of nodded your head on Mr. Calhoun's North Carolina law, but you did not quite say you support it. What do you support?
Page 49 PREV PAGE TOP OF DOC
Mr. GREEN. At the end of the day, the specific criteria for what is a predatory loan is something that the originators of the loans and this committee and others need to figure out, what are the best identifying criteria. From the secondary market perspective, what criteria are utilized is less important than the precision with which those criteria can be identified.
Many of the criteria that are looked at in the North Carolina law carry with them objective standards. It is when the criteria becomes more vague and esoteric and theoretical and less precise that it becomes much more difficult to value and to identify a loan in a pool of hundreds, maybe thousands of loans as to whether or not it meets that standard. Even if you could identify it, you have no way to control whether or not you have met that standard.
So to hold someone liable and assign them liability for something they cannot identify and cannot control is where the problem in the marketplace arises. If the criteria can be identified and is objective, you can begin to implement something. That is why we suggest a national standard. I do not want to use the ''preemption'' word. I guess there is no way around it if you are going to use ''national standard.'' I think everyone agrees that this is a national problem. The marketplace that you are focusing on is a national market, and we have had experiences in the laboratory of state legislatures where it has been difficult to establish that enforceable, quantifiable objective standard.
Ms. WATERS. I respect that, but let me just tell you, bankers know how to count and they know junk when they see it. Prior to coming up with ways by which to make money in the subprime market and with predatory lending, they use the same eye to tell people no, you cannot have credit because you do not look like you can pay this back. You look like you are a bad risk.
So they know it. They understand it. And when they are protected and they can roll the dice on it and they can make a lot of money with high interest rates and other kinds of fees et cetera, and they have no liability, they will take a chance. So I am not at all impressed with the fact that they just do not know bad paper when they see it. They know it quickly and surely.
Page 50 PREV PAGE TOP OF DOC
Chairman NEY. [Presiding.] The time has expired. I would note, Mr. Green, I believe, does have to leave, so if you have a question.
Mr. Fossella of New York.
Mr. FOSSELLA. Yes, to follow-up on that. Thank you, Mr. Chairman.
Mr. Green, you talk about subjective triggers. ''Unintended consequences'' is perhaps a phrase that comes to mind in our efforts to curtail abusive practices, which I think we all agree with, should be curtailed and ultimately eliminated.
But can you be more specific as to why a national standard is necessary by quantifying perhaps how some people are ultimately shut out of the market, if that is a conclusion from all these nebulous, esoteric standards, as you in your testimony call them, subjective triggers to assign liability? How are people actually shut out by limiting access to capital and the folks who are actually purchasing these loans?
Mr. GREEN. At the end of the day, the secondary market succeeds because people pay their loans back. It is not in anyone's interest to have loans in a portfolio that are not going to perform. Now, there is a risk of nonperformance in any loan, even the highest-rated credit has a risk of nonperformance. But in higher and riskier borrowers, that risk is higher.
In order to make sure that they are in compliance with the law of a particular state, they will take certain actions. That will have an effect on their ability to accept loans that extend credit to that higher-risk category. If they do not accept those loans, those loans are never made.
Now, where the line is between loans that should be made and should not be made is a difficult public policy question, because you do not want to draw the line so that nobody gets loans because there are lots of people that deserve them. But the viability of the secondary market ultimately defines the extension of credit. If we can come up with tangible, identifiable objective standards that can be enforced on a national level, you can make the marketplace work much better than the current situation allows us to have happen.
Page 51 PREV PAGE TOP OF DOC
Mr. FOSSELLA. So is it safe to say that ultimately if this were to be left unaddressed that there are going to be people who fit subprime criteria that would ultimately be shut out of the market?
Mr. GREEN. I think as Mr. Raiter indicated that the risks that are in the marketplace when you can or cannot get a rating have an effect on whether or not credit is extended in the first place. So the answer is yes. I dare say I think that the risk of that is greater in a rising interest rate environment when credit itself, by virtue of its cost, is less accessible.
Mr. FOSSELLA. So to Mr. Raiter, are there situations, and you may have said it in your testimony, forgive me because I was not here, are there situations in which at the State level laws were passed and ultimately you in your testimony indicate that you support these measures, but at the same time recognize again these unintended consequences that result? Did you notice a pushback in some States that are considering legislation that would be inconsistent or at odds with the federal standards right now?
Mr. RAITER. At odds with the federal standard?
Mr. FOSSELLA. Are there laws that have taken root in the States where as a result of this liability imposed on the purchasers, States have had to modify and change, and what, if any, has been the impact in other states that have been considering similar legislation?
Mr. RAITER. I can comment on the changes that were made in Georgia.
Mr. FOSSELLA. Yes, specifically yes.
Mr. RAITER. And the changes that were contemplated in New Jersey, and after the original law was promulgated and enacted, there was an Attorney General opinion on how it would be interpreted that had an impact on how loans would be treated when they came in for ratings out of the New Jersey markets. What other jurisdictions may be doing when they see the impact of changes in those two jurisdictions, we have not tracked. We have looked at the individual laws as they become enacted.
Page 52 PREV PAGE TOP OF DOC
I think the other answer to the first part of the question is the high-cost loan categories in all the jurisdictions that have gone into effect are not showing up. If they are being made, they are not being financed in the secondary market with transactions that are rated by Standard & Poor's, which may be exactly the intent of these various laws and statutes, that those loans are undesirable. Whether they are predatory or not would depend again on whether we could identify exactly what the requirements for falling into a violation were under the statutes.
If it was clear and defined and we could size the risk, then we would put a number on it. If it was not clear and defined and we could not tell whether a loan was or was not really predatory, then they would have to be excluded. So if it is the intent to basically prevent these types of loans from being financed in the secondary, then it would behoove the legislators to be as specific as they can in identifying what is a violation and what the penalty is, and the loans will not make it to the secondary market because it will not be economically feasible, as they are not making it now.
We do not have any issuers that are checking the blocks and telling us that they are including high-cost loans. They are giving us a warrant that if in fact they inadvertently acquired a high-cost loan, they will immediately buy it back.
Mr. FOSSELLA. This will be my last question. Are you prepared to say whether it is a better public policy to ensure that as many loans are allowed to flow into the secondary market as possible, or are you neutral on that?
Mr. RAITER. We are neutral on public policy, but you all should be quite aware that where you draw the line, it is likely that the loans that fall above that line probably will not be made.
Mr. FOSSELLA. All right. Thank you, Mr. Chairman.
Mr. DEMONG. Congressman, can I add to that?
Page 53 PREV PAGE TOP OF DOC
Mr. FOSSELLA. If you like.
Mr. DEMONG. The study that I did in New Jersey showed an absolute drop in certain subprime loans, including cash-out refinancing, probably at least a 60 percent drop in the first 2 months after the Act. But to go directly to your question, can you quantify the folks that do not get the loan; you are not going to hear from them. It is tough to measure that folks that do not get a loan. So we can see a change in lending based on a law, and I would argue that we are better off with a national standard because it is a nationally funding market.
But to address the second part of your question, yes it does matter if a law affects the secondary market, affects securitization, in that there are going to be less funds available for potential borrowers in that state or in that region. So there will be a direct impact if the secondary market securitization market is cut off.
Mr. CALHOUN. If I may add one thing, I think there is a very important distinction here. This is a dynamic market. What the experience has been under the federal law and under the State laws, it is not that people stop making these loans. Rather, the loans are restructured so they do not have the predatory impact on the borrowers.
The main predatory feature of loans has been fees that strip equity. So simply what a lender can do is structure the loan with a higher interest rate, because for example the North Carolina law follows the federal interest rate trigger, but takes less money out of the fees. It is these high up-front fees and high prepayment penalties that have encouraged all of the equity stripping, the repeated refinancing.
It is important. In North Carolina, we advocated strongly, do not change the interest rate threshold from the federal standard. Allow plenty of room for these loans to be made. Remember, for most subprime borrowers, hopefully these are bridge loans so that they can improve their credit and move to a better or a prime or closer to prime loan. If the loan is loaded up with large up-front fees and prepayment penalties, the borrower is blocked from doing that, from doing what I would hope we would want to encourage these borrowers to do. If instead the loan has more in the interest rate, the lender can still make a fair profit, which they have to do, but the borrower is not trapped long term in a predatory loan.
Page 54 PREV PAGE TOP OF DOC
Mr. FOSSELLA. Thank you.
Chairman NEY. Mr. Miller of North Carolina.
Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman.
Mr. Raiter, Mr. Green I think praised North Carolina's law, but I think by faint damnation, and said it was not as imprecise; the prohibitions were not as vague; not as subjective as some other states. But in rating subprime loans coming out of various states, you did not rate North Carolina's loans. I do not want to talk you into doing that, but could you tell me what was different about North Carolina? Did you do that based on the provisions of North Carolina's law? Or did you do t