The Legal Infrastructure of Subprime and Nontraditional Home Mortgages

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.

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