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.
Striking back, probably even before most people, even industry insiders have
even heard of the suitability issue, the MBA published a report
titled Suitability - Don't Turn Back the Clock on Fair Lending and Homeownership
which argues that the mortgage industry should not be subject to
restraints similar to those that have long been in place for securities dealers.
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
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
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
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."