Center for Responsible Lending (CRL) has released a report on the recent
financial crisis and its impact on consumers.
The State of Lending in America and its Impact on U.S. Households
assesses the impact of the financial crisis on American families and their
financial security and looks at a range of current lending practices and their
report, written by Debbie Bocian, Delvin Davis, Sonia Garrison, and Bill
Sermons, looks at the financial products that American households use for everyday
transactions, to acquire major assets, and build savings and wealth and the
ways in which predatory lending has sometimes corrupted traditional financial
products and undermined their worth. State of Lending is organized into three
separate reports, the first two covering a spectrum of consumer loans, the
third abusive debt collection, mortgage loan collection, and servicing
will summarize the extensive portion of the report that deals with mortgage
lending in two parts. The first reviews the role of various market players
and the changes that have been made to the traditional lending model. A subsequent article will summarize CRL's
words about the impact of the housing crisis on individuals, communities, and
the economy and on the challenges that must be met in the future.
authors conclude there are two trends.
First, families were already struggling financially even before the
crisis hit; managing the gap between stagnant family incomes and growing
expenses by increasing their debt which in turn left them with less spendable
income and often with long-term financial distress, foreclosures and crushing
are reaping benefits from the recovery and the rising stock market and
improving job opportunities but millions have lost their homes and millions
more may yet do so; one-fifth of mortgaged homeowners are underwater. The impact was even greater on families of
color who were three times more likely to be targeted with abusive subprime
loans as other borrowers with similar credit records.
authors say that, despite the housing crisis Americans put a high value on
homeownership, associating it with the
American Dream and Americans' idea of how to acquire wealth. Although not without risks, homeownership
provides the opportunity to build equity both through appreciation of housing
prices and paying down debt. When
traditional mortgages are used, homeownership provides a "forced savings"
mechanism for households.
Homeownership has long been a key
source of economic mobility and financial security. Home equity can be tapped to start a new
business, pay for higher education, secure retirement and provide a financial
cushion against unexpected hardships and ownership bestows a host of
non-financial benefits on individuals, families, and communities.
The federal government has long
been involved in the mortgage markets. It worked to stem the tide of
foreclosures during the Great Depression, addressed discriminatory redlining in
the 1970s, and worked for decades to expand access to homeownership. Many agencies within the government deal with
housing and home ownership and government has long guaranteed mortgages for
underserved communities through FHA and VA loans and now through explicit GSE
Mortgages were once relatively
simple transactions between lenders and borrowers. However, in recent decades,
the mortgage market has become larger and complex and involves more
participants. Today the main players are:
federal government which in addition to guarantees offers preferential tax
treatment of mortgage interest, property taxes, and capital gains on
owner-occupied homes. It provides
capital liquidity and credit enhancements, and oversees mortgage-market
GSEs also increase liquidity though their role in driving the secondary market
without which private lenders would be able to extend far fewer mortgages.
lenders fund almost all U.S. mortgages and fall into two basic categories,
portfolio lenders and mortgage companies.
Portfolio lenders use bank deposits to fund and hold loans in investment
portfolios. Mortgage companies or banks
rely on investments to finance their mortgages and on the sale of their
mortgages to the secondary market to finance payments to investors.
and Private Securitizers together have fundamentally altered the mortgage
market over the last few decades. First,
by relying on third-party originators (mortgage brokers) lenders could lower
their fixed costs and expand operations into new markets without increasing
staff or office space or invest heavily in consumer marketing. In 2005 half of
all mortgage originations and 71% of subprime originations were brokered. Second, Wall Street financial companies, by
issuing their own mortgage-backed securities (MBS) and selling these directly
to investors, could avoid meeting loan standards set by the GSE regulators. As
a result, the growth in the private-label securities market was heavily driven
by subprime loans, which the GSEs could not purchase directly.
servicers collect and track mortgage payments from borrowers, manage escrow
accounts, and remit payments from those accounts. They also manage delinquent loans and some
provide foreclosure services and manage foreclosed properties. Although some
lenders service the mortgages they originate, others sell the servicing rights
to other lenders or independent servicers. The fundamental responsibility of a
servicer is to "manage the relationship among the borrower, the servicer, the
guarantor, and the investor/trustee of a given loan," however the specific guidelines
that servicers must follow in each of their activities vary depending their contractual
agreements with lenders.
Under a "traditional" lending
model-where lenders both originated and held their mortgages-lenders had a
vested interest in ensuring that borrowers could repay their loans. In the more
recent "originate-to-securitize" system, the compensation of brokers, lenders,
and securitizers was based on transaction volume, not loan performance. This led to aggressive marketing and
origination, lax evaluation of the borrowers' ability to repay, and to a new
breed of dangerous mortgages often made with scant underwriting and marketed
without regard to their suitability for the borrowers.
The growth in private-label
securitization not only removed GSE standards from the equation but Wall Street
encouraged riskier loan products by paying a higher premium for non-conforming
loans. Subprime lenders targeted many of the same borrowers who had traditionally
used the FHA and VA programs, saddling these borrowers with much riskier debt
than those government programs, for which many could have qualified. Then the agencies charged with rating the
quality of mortgage-backed investments were assigning high ratings to
securities backed by these dangerous and unsustainable loans leading investors
to believe those products were safe.
Not all communities were targeted
equally by sub-prime lenders. Borrowers of color were 30% more likely to
receive higher-rate subprime loans than similarly situated white borrowers and
borrowers in non-white neighborhoods were more likely to receive higher-cost
loans with risky features such as prepayment penalties. In the early years of the subprime market,
flipping was common in the subprime market.
Each time refinancing occurred, fees and closing were rolled into the
loan, stripping equity. Loan terms were
complex and prevented easy comparison shopping and mandatory arbitration
clauses kept borrowers from pursuing legal remedies for illegal or abusive
terms. One of the early abuses in the subprime market was single-premium credit
insurance, which charged a high up-front fee to insure mortgage payments if the
borrower couldn't make them.
The abusive practices that led to
the mortgage crisis were enabled by an out-of-date and fractured federal
regulation failed to adapt to the increasingly complex mortgage market and many
participants were virtually unregulated at the federal level.
- Authority for
interpreting and enforcing consumer protections was fractured among several
agencies, none of which had protecting borrowers as its primary mission. Federal regulators hindered state level
consumer protection by ruling they could not enforce strong state lending laws
against nationally chartered institutions.
- When agencies
did focus on consumer protection, they tended to rely on disclosure rules and
nonbinding "guidance" over hard and fast rules. Consumer groups and borrowers
were raising concerns over lending in 2000 but only in July 2008 did the
Federal Reserve implement any rules about abusive, unfair, or deceptive
Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 explicitly outlined new rules for mortgage
lending in order to prevent specific types of market abuses and it established
the CFPB as a new consumer protection agency.
Dodd-Frank mortgage provisions are designed to reorient the market back
to well-underwritten, sensible mortgages and disfavors the loan terms common to
the private-label securities market.
Among the most important aspects
of Dodd-Frank is the establishment of an "Ability-to-Repay" standard which
requires originators to make a "reasonable and good faith determination based
on verified and documented information that the consumer has a reasonable
ability to repay the loan and pay housing expenses. Dodd-Frank creates a preference against risky
loan terms through a category of safe loans called "Qualified Mortgages" (QMs)
giving litigation protection to lenders who conform to the ability-to-repay
provision and a number of other QM requirements. Dodd-Frank also banned single-premium credit
insurance and mandatory arbitration, required escrows of taxes and insurance
for higher-priced mortgages; and documentation of borrowers' income.
Importantly, Dodd-Frank created
the CFPB as an independent consumer watchdog agency to ensure that financial
transactions, including mortgages, are fair and transparent and empowered it to
enforce existing consumer protection laws and regulations and respond to new
abuses as they emerge. The CFPB consolidates the functions of a number of
agencies and will be able to regulate the practices of all mortgage-market
participants, including banks, non-banks, brokers, and servicers. Also, by leaving funding outside the
appropriations process, Congress protected the agency from lobbying efforts to
weaken the resources available for supervision and enforcement.
A lot of blame for the recent crisis has
been laid on the Community Reinvestment Act (CRA) and the affordable housing goals
of the GSEs for encouraging loans to unqualified borrowers. The facts do not support these claims. CRA has been around for 30 years while the
problem loans began within the last ten.
Only six percent of subprime loans were extended by CRA-obligated lenders
to lower-income borrowers and those loans appear to have performed better than
other subprime loans. GSE could not purchase or securitize subprime mortgages directly. The share of subprime MBS purchased by the
GSEs as investments from Wall Street firms was a fraction of that of the private
sector. Most of the GSEs losses, in
fact, were from loans to higher income families, were tied to Alt-A rather than
subprime loans, and did not count toward affordable housing targets.