Saturday July 19, 2008

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MBA Urges Regulators To Avoid Invoking Suitability Standards

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The Mortgage Bankers Association (MBA) recently made a preemptive strike against what it obviously perceives as the next threat against the mortgage industry - "suitability standards."

It is suggested by some consumer advocacy organizations that such standards should be imposed on the lending industry to insure that borrowers are obtaining mortgages that are in their best financial interests.

The driving force behind any demands that may be made by consumer groups is, of course, the proliferation of "exotic" mortgages such as interest only loans and option arms of which we have written frequently. Consumer groups are apparently seeking regulatory oversight of underwriting standards to insure that borrowers are only given mortgages suitable to their financial situation.

The association points to the increased availability and affordability of mortgages and homeownership and states that the greatest gains have been among minority and first-time homeowners. The report claims that these opportunities have been made possible because of fair lending and anti-redlining laws such as the Equal Credit Opportunity Act, the Fair Housing Act, and the Community Reinvestment Act.

Thus, the Association states the debate is no longer about whether credit is sufficiently accessible to borrowers but whether loans are in specific consumers' best interests. "While a specific proposal for a suitability standard...is not yet fully formed, a variety of approaches have been suggested." MBA maintains that most of these approaches would require more "rigid, prescribed underwriting standards, a duty of fair dealing at the inception of the loan, a subjective evaluation by the lender whether a product is best suited for that borrower, the establishment of a fiduciary obligation by the lender to the borrower, and a private right of action to redress any violations." There is also a suggestion, the association states, that a regulator be empowered to specifically outline such requirements.

Rigid underwriting standards would result in some borrowers being denied credit. If a subjective suitability standard is put in place a lender might find himself caught between a suitability standard and longstanding requirements of equal credit laws and/or community investment rules. Even if the lender complies with all of these, he could be accused by a borrower who later gets into trouble with his loan of failing to follow suitability standards.

The risks of these competing requirements may force lenders to leave the business or protect themselves against increased liability; this could impact competition, ration credit, and increase prices.

The report asserts that product choices are not the primary cause of defaults, instead it is "life events" such a job loss, a medical crises or family problems that most often lead to bankruptcy and/or foreclosure.

The report reviews various Securities and Exchange Commission rules and regulations which impute a suitability requirement to securities market professionals. The requirement results from an agency theory that such professionals act as agents on behalf of the customer and thus should be "expected to only recommend securities that are suitable to the customer's financial means and investing goals." Brokerage houses typically do this by requiring new customers to submit financial statements and indicate their investment goals. While this usually seems to be a pro forma adherence to the regs, some companies do refuse to allow certain customers to invest in commodities, options, or other more risky markets.

MBA argues that mortgage lending is not analogous to the securities industry, primarily because securities dealers function as intermediaries between the customer and the market and represent themselves as investment consultants. Mortgage lenders conversely represent the investors and companies which provide mortgage funds and thus do not have a fiduciary responsibility to borrowers; in fact they probably cannot have a fiduciary relationship with a borrower because one already exists with their investors. Also, investors in securities usually develop a long-term relationship with their investment advisors but borrowers tend to shop among many brokers for the best deal. MBA also speculates that the suitability standard may not be working well in the securities industries as evidenced by the "magnitude of claims brought against brokers based upon suitability."

Instead of suitability requirements, the report states that it is to the benefit of all parties, consumers, advocacy organizations, regulators, and mortgage lenders that borrowers obtain loans they can repay but that the goal should be to make the lending process understandable and abuse-free and that Congress should resist pressure to enact a suitability standards that would remove the current "arms length" model in the mortgage industry. Congress, federal regulators, industry and consumer organizations should work to "create a uniform national lending standard, improving financial literacy and licensing, simplifying the mortgage process, streamlining disclosures, and establishing clear, objective restrictions to step lending abuses without destroying the market's ability to innovate for the benefit of consumers."