Held Up in Due Course: Predatory Lending, Securitization, and the Holder in Due Course Doctrine

Abstract

This second article of a two-article set analyzes the conjunction of the holder in due course doctrine, securitization of residential mortgages and predatory lending. Predatory and deceptive lending, widely documented in the media and in Congressional and regulatory hearings, is the practice by unscrupulous lenders of originating loans at above-market rates through deceptive practices or undue influence or by taking advantage of the ignorance, desperation, or susceptibility to fraud of borrowers. These lenders have been targeting primarily elderly, poor and minority borrowers throughout the country. Even worse, these practices have been funded by Wall Street. This article explains how predatory lending has its roots in the history of the holder in due course doctrine, which cuts off most borrower claims or defenses once a loan is transferred.

This aged doctrine has been transformed from its inception in the seventeenth century as a relatively benign, commercially useful doctrine, into a malignant one. Currently, the holder in due course doctrine promotes deception and aids unscrupulous lenders by protecting the buyers of residential loans even when the loans are the result of many forms of fraud. At the same time, the original purposes of the holder in due course doctrine, such as ensuring liquidity and transferability of notes, have been taken over by other and better means. Various federal, state and local efforts have been made to prevent predatory lending and some have done so by eliminating the holder in due course doctrine at least as to high price loans.

The article analyzes securitization, the process of pooling assets, in this case mortgages, and issuing securities based on the pooled assets. Unlike the praise by other academic commentators for securitization, this article shows how securitization creates holders in due course almost immediately as it allows relatively unregulated mortgage brokers with almost no capital to originate loans. Securitization thus provides an opportunity and safe haven for predatory lending, and worse yet, reduces lender discretion in resolving borrowers' difficulties once the borrowers discover they are the victims of deception. The article includes an economic analysis of the holder in due course doctrine and indicates that it increases the likelihood of fraud and other forms of predatory lending by putting the risk of fraud and unfair lending practices on the borrower, who often is virtually helpless to prevent them. The article concludes with a call for the abolition of the holder in due course doctrine in all cases where it would cut off the defenses of a residential borrower.

Keywords: mortgages, predatory lending, securitization, holder in due course, lending, negotiable instruments

JEL Classification: E43, F34, G22