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Abstract:
Predatory lending - the practice of making exploitative high-cost loans to naive borrowers - has spurred policy-makers, activists, lenders and scholars to debate whether intervention is warranted and, if so, what type of intervention is appropriate. The solution requires understanding the incentives in the home mortgage market that have fueled predatory lending. Recent changes in the credit market have created new possibilities for lenders to profit by exploiting information asymmetries to the detriment of unsophisticated borrowers. As a result, a new, predatory lending market has emerged alongside the legitimate prime and subprime home mortgage markets. Neither market forces nor existing legal remedies are sufficient to correct predatory lending. Instead, government intervention is needed. The authors propose a new, narrowly tailored remedy - suitability - that would require predatory lenders to internalize the costs of the harm they cause.

Predatory lending, subprime mortgages, lending discrimination

Abstract:
Today, Wall Street finances up to eighty percent of subprime home loans through securitization. The subprime sector, which is designed for borrowers with blemished credit, has been dogged by predatory lending charges, many of which have been substantiated. As subprime securitization has grown, so have charges that securitization turns a blind eye to financing abusive loans. In this paper, we examine why secondary market discipline has failed to halt the securitization of predatory loans.

When investors buy securities backed by predatory loans, they face a classic lemons problem in the form of credit risk, prepayment risk, and litigation risk. Securitization exacerbates all three risks by unbundling the mortgage process, giving rise to adverse selection. In theory, the lemons problem should cause investors to flee the market for subprime mortgage-backed securities or demand a risk premium commensurate with the worst quality loans. Instead, securitization allays adverse selection concerns by structuring transactions so that risk-averse investors receive their agreed-upon return without needing to screen out predatory loans. In addition to pricing, the secondary market uses structured finance and deal terms, instead of filtering, to manage credit, prepayment, and litigation risk. Furthermore, structured finance provides incentives to securitize predatory loans. Voluntary due diligence could help ameliorate the problem, but those efforts remain sparse. To alter this perverse incentive structure, we propose legislation to impose a duty on secondary market assignees of subprime home loans to investigate and police predatory lenders.

subprime, predatory lending, securitization, lemons problem

Abstract:
Subprime mortgage lending has grown rapidly in recent years and with it, so have concerns about predatory lending. In response to evidence of predatory lending, most states have enacted new laws or expanded existing laws to address abuses in the subprime home loan market. The effect of these statutes is a matter of debate. This paper seeks to improve the understanding of this increasingly important issue and pays particular attention to the role that legal enforcement mechanisms play in this context. Our results are consistent with the view that anti-predatory lending laws influence subprime lending markets and that disaggregating the details of the overall legal framework into its component parts is essential for understanding subprime market dynamics. The restrictions, coverage, and enforcement components all have significant relationships with subprime market outcomes, with the coverage relationship found to be broadly consistent with the reverse lemons hypothesis put forward by Ho and Pennington-Cross (2007). The results also suggest that the newer mini-HOEPA laws have had an impact on the subprime market above and beyond the older preexisting laws, particularly for subprime originations. Broader coverage through these new laws is associated with higher origination likelihoods, while increased restrictions through the mini-HOEPA laws are associated with lower origination propensities.

Subprime lending, enforcement mechanisms, predatory lending, anti-predatory lending laws, mortgage lending, homeownership

Abstract:
Without regulation, securitization allowed mortgage industry actors to gain fees and to put off risks. During the housing boom, the ability to pass off risk allowed lenders and securitizers to compete for market share by lowering their lending standards, which activated more borrowing. Lenders who did not join in the easing of lending standards were crowded out of the market. Artificially low risk premia caused the asset price of houses to go up, leading to an asset bubble and breeding fraud. The consequences of lax lending were thereby covered up.

The market might have corrected this problem if investors had been able to express their negative views by short selling mortgage-backed securities, thereby allowing fundamental market value to be achieved. However, the one instrument that could have been used to short sell mortgage-backed securities - the credit default swap - was also infected with underpricing due to lack of minimum capital requirements and regulation to facilitate transparent pricing. As a result, there was no opportunity for short selling in the private-label securitization market. The authors propose countercyclical regulation to prevent a race to the bottom at the height of the business cycle.

Securitization, credit default swap, subprime, mortgage, asset bubble

Abstract:
In response to subprime loan abuses, it is common for policymakers to exhort consumers to comparison-shop for residential mortgages. This policy prescription ignores the fact that price revelation works differently in the prime and subprime markets, impeding search in subprime. In the prime market, lenders reveal firm prices for free, without requiring consumers to first submit loan applications. This dynamic, combined with Truth-in-Lending Act (TILA) disclosures that standardize prices, make it easy to comparison-shop for prime mortgages. In contrast, in the subprime market featuring risk-based pricing, consumers must reveal their creditworthiness before lenders can determine loan prices, which allows lenders to delay price revelation until after taking loan applications. In numerous cases, subprime borrowers do not learn firm prices until closing, due to a lack of lock-in commitments and behind-the-scenes negotiations over broker compensation. As a result, the subprime market is a pay-to-play market where customers must often pay several hundred dollars in application and appraisal fees (and wait until closing) to discover actual prices. This process makes meaningful comparison-shopping prohibitively expensive and promotes oligopolistic pricing in the subprime market.

The same price revelation dynamics cause Truth-in-Lending Act disclosures to break down for subprime loans. TILA allows subprime lenders to advertise their best rates alone, misleading customers with weaker credit. In addition, TILA does not require lenders to reveal binding prices until closing (except for high-cost refinance home mortgages). Finally, TILA disclosures for traditional adjustable-rate mortgages, interest-only mortgages, and option ARMs are hopelessly complex. The article concludes by proposing reforms to federal disclosure laws to permit meaningful comparison-shopping and promote price competition in the subprime mortgage market.

subprime, predatory lending, risk-based pricing, disclosures, Truth in Lending Act

Abstract:
Traditionally, policymakers, communities, and industry have regarded the Community Reinvestment Act ("CRA") as a positive mandate for banks and thrifts to do good by increasing investment in low- and moderate-income ("LMI") neighborhoods. When Congress enacted CRA, it was inconceivable that LMI neighborhoods might eventually receive too much credit in the form of abusive mortgages. However, by the late 1990s, predatory mortgages- exploitative high-cost loans to gullible borrowers-were ravaging the inner cities.

We address the question: given the surge in predatory lending, how should CRA respond? CRA and federal subsidies to regulated lenders can create perverse incentives for lenders to engage in predatory lending. For this reason, regulators should administer CRA with the goal of curbing predatory lending. In particular, federal bank regulators should use CRA to sanction behavior that could further predatory lending. Regulators should deny both satisfactory and outstanding CRA ratings to banks and thrifts that fail to satisfy specific loan eligibility criteria designed to counteract predatory lending when originating or brokering subprime mortgages. Similarly, CRA ratings should drop where banks or thrifts finance subprime lenders-either through letters of credit or working capital loans, or purchases of subprime mortgages or interests in subprime securitizations- without instituting adequate due diligence and monitoring safeguards against predatory lending.

Conversely, CRA should be used to reward beneficial conduct by banks and thrifts that is designed to reduce predatory lending. For example, increased CRA credit for legitimate subprime lending by insured depository institutions could inject badly needed healthy competition into the subprime market. CRA credit should also be used to reward banks and thrifts for refinancing predatory loans with legitimate loans. Special marketing programs designed to offer legitimate credit to groups targeted by predatory lenders likewise deserve CRA credit, as do innovative underwriting guidelines for LMI borrowers. Finally, we advise against extending CRA examinations and ratings to non-bank subprime lenders, whether they are affiliated with insured depository institutions.

CRA, Community Reinvestment Act, predatory lending, subprime lending

Abstract:
For decades, cities have invested in decaying neighborhoods, leading to increases in home values and home equity. As a result, these neighborhoods have become ready targets for predatory lenders, who market their abusive loans to financially unsophisticated homeowners with home equity and no relationships with traditional lenders. Some borrowers lose their homes; others forsake home repairs to avoid default and foreclosure. Neighborhoods that once were stable become littered with abandoned and neglected homes, resulting in increased crime, falling home values, rising demands for social services, and lower tax revenues.

In the wake of the devastation done by predatory lenders, the question for policymakers is: what can be done? This paper seeks to answer this question. The paper opens by defining predatory lending. Next, the paper describes how the rise of securitization, deregulation of price terms, affordable lending incentives, bank closings, and historical credit discrimination together fueled the rise and institutionalization of predatory lending in the 1990s. Lastly, the paper evaluates different possible approaches to redressing predatory lending, including industry self-regulation, consumer education and counseling, Community Reinvestment Act oversight, criminal enforcement, existing private causes of action, and a suitability proposal.

predatory lending, community development, Community Reinvestment Act

Abstract:
Mounting foreclosures and recent disclosures of abusive lending practices have led many states to adopt new anti-predatory lending laws. Researchers have examined the impact of such laws on credit flows and the cost of credit. This research extends the literature by examining if the market responded to these laws by substituting different mortgage products for those restricted by anti-predatory lending provisions. The evidence indicates that the new laws were effective in restricting loans with targeted characteristics and that the market substituted other product types to maintain affordability in the face of these restrictions.

Real estate, mortgages, housing, abusive lending, predatory lending, mortgage products, product substitution, adjustment to prohibition

Abstract:
The testimony proposes transferring consumer protection responsibilities for consumer credit from federal banking regulators to a single, dedicated agency whose sole mission is consumer protection. During the housing bubble, the U.S. system of fragmented regulation drove lenders to shop for the easiest legal regime. The ability of lenders to switch charters put pressure on banking regulators - both state and federal - to relax credit standards. The result was regulatory failure, in which federal banking regulators sacrificed prudent lending standards and consumer protection for the short-term profitability of banks. Creating one, dedicated consumer credit regulator charged with consumer protection would establish uniform standards and enforcement for all lenders and help prevent another collapse in credit underwriting. The testimony closes by proposing vesting states with concurrent enforcement authority.

consumer protection, subprime, regulatory failure, bank regulation

Abstract:
This paper provides a critical analysis of the legal landscape of residential mortgage lending and explains how federal law abdicated regulation of the subprime market. First, the paper presents the historical backdrop to government oversight of mortgage lending and identifies the changes to and innovations in the lending process that contributed to the recent transformation of the residential mortgage market. We then describe recent attempts at the state and federal level to re-regulate and the backlash initiated by the federal banking agencies to thwart regulation of their constituent banks through preemption, resulting in parallel universes of regulation. Next, the article discusses the consequences of deregulation and preemption on state governments, lending business models, the rule of law, and enforcement of law by consumers and supervisory agencies. Finally, we connect the legal structure of the capital markets and the complexities created by funding agreements, including loan servicing contracts, to direct adverse impacts upon distressed homeowners. Where their loans were securitized - as were the vast majority of loans - the antiquated legal doctrines surrounding securitization strip those borrowers of most claims and defenses in foreclosure actions brought by securitized trusts. The dialectic of federal deregulation, state re-regulation, and federal preemption has produced a dual system of regulation in which increasing numbers of aggrieved borrowers are stripped of defenses to foreclosure. This same dialectic explains why major lenders have flocked to federal preemption under the national bank and federal savings association umbrellas.

mortgage, subprime, nontraditional mortgage, preemption, consumer credit, servicing, banking regulators, adjustable-rate mortgage

Abstract:
This article describes the provisions of the federal Home Mortgage Disclosure Act (HMDA), tracing its legal evolution since 1989, when Congress expanded HMDA to require reporting of home mortgage lending by ethnicity and race. HMDA requires most lenders to report the demographic makeup and geographic distribution of home mortgages to the federal government. The 1989 amendments and later developments transformed HMDA from a law exclusively concerned with geographic disinvestment to one concerned with lending disparities by ethnicity and race. In the process, HMDA evolved from an obscure reporting statute to a flashpoint for debates over lending discrimination and subprime lending.

Home Mortgage Disclosure Act, HMDA, mortgage lending, home loans

Abstract:
Years of discriminatory behavior against minority households have damaged their ability to build wealth. One of the most financially destructive practices endured by minority households is the excessive overpayment to finance a home purchase or access accumulated equity in a home. The market conditions that position blacks, and to a lesser extent, Latino households, to be the principal targets of predatory mortgage lending have their roots in decades of legally sanctioned housing market discrimination. Some minority households lack the financial knowledge or awareness to protect themselves. In other cases, years of discriminatory financial practices have contributed to rendering them ineligible to access low-cost financing. And, finally, vestiges of discrimination continue today with minority consumers convenient targets of unscrupulous lending behavior.

Starting in the early 1990s, federal antipoverty policies placed new emphasis on asset creation for low- and moderate-income people, especially the working poor. While federal policy embraced wealth creation as the new antidote to poverty, it failed to anticipate threats to preserving home equity once it has been created, including rising consumer debt and predatory lending. To date, the federal government has failed to combat predatory lending consistently and effectively. The failure to curb predatory lending has spawned high levels of home loan foreclosures across the U.S. and threatens the largest asset of many minority households, i.e., their homes. This paper proposes policies to improve the sustainability of minority homeownership.

homeownership sustainability, lending discrimination, subprime, predatory lending