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 Mortgage Reform and Predatory Lending: Addressing the Challenges Treasury Assistant Secretary Sheila Bair Remarks to the Women in Housing and Finance Fall Symposium Willard Inter-Continental Hotel


Good morning and thank you for this opportunity to speak before you today about mortgage reform and predatory lending.

Innovations in mortgage finance have contributed to allowing many more Americans to achieve the dream of home ownership. From 1990 through 2000, the overall home ownership rate increased from 64.1 percent to 67.5 percent. The home ownership rate for minorities has shown an even greater increase over that time period, with the home ownership rate among African Americans increasing from 43.4 percent to 47.2 percent and the rate among Hispanics increasing from 42.4 percent to 46.3 percent.

Innovations in mortgage finance have also improved the ability of borrowers with credit problems to gain access to credit. As a percentage of all mortgage originations, the subprime market share increased from less than 5 percent in 1994 to almost 13 percent in 1999. In absolute terms, the subprime market grew from $125 billion in 1997 to $140 billion in 2000. The securitization of subprime loans has also grown dramatically, from $18.5 billion in 1995 to nearly $56 billion in 2000. This increased liquidity has contributed to the growth of the subprime market and to the increased rates of homeownership among low- and moderate-income individuals.

The growth in home ownership, together with increasing home values, has provided borrowers with an unprecedented amount of borrowing capacity. However, efforts to expand access to mortgage financing to the full spectrum of American citizens have been marred by abusing practices on the part of some lenders. Those American who lack experience and sophistication in dealing with financial service providers have been most vulnerable to the so-called "predatory lender."

Predatory lending is difficult to define. Hearings chaired by your feature speaker, Senator Sarbanes, last summer highlighted some of the more egregious cases. These hearings also underscored, however, the importance of distinguishing predatory lending from legitimate subprime lending.

Subprime lending serves an important function in providing credit to borrowers with impaired credit histories. Subprime lending has expanded credit availability to those low- and moderate-income individuals with the ability to repay, but who suffer from poor credit histories. Predatory lending simply preys on these people.

Contributing to the problem of predatory lending is the fact that the mortgage process is too complicated. Anyone who has taken out a mortgage knows that the process is flawed. The disclosures are complicated and difficult to comprehend quickly, even for people with legal or financial backgrounds.

Borrowers who do not understand the terms of their loans can be easily exploited. Some of this can be addressed through more effective borrower education. But part of the problem is also that the disclosures we are providing are complex and very difficult to understand.

Let me now briefly describe recent developments to address mortgage disclosure reform and predatory lending, and the Treasury Department's approach to these issues.

Mortgage Disclosure Reform

Effective disclosures are important because they provide borrowers with the ability to compare costs across lenders. An effective disclosure scheme requires that borrowers are able to clearly understand their mortgage's terms and conditions and that the information be reliable. On both counts our current disclosure scheme appears to be lacking.

Two acts - the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures (RESPA) - seek to ensure that consumers obtain timely and standardized information about the cost of credit and the cost of real estate settlement services. The Federal disclosures under RESPA and TILA comprise only 3-5 forms out of a much larger number of documents that are required by the lender or through state disclosure laws. Thus, it is very important given the large number of required documents, that those required under Federal law provide borrowers with useful information.

HUD issued a recent policy statement clarifying consumer rights under RESPA on three important consumer issues: yield spread premiums, broker fee disclosure, and unearned broker fees. In addition, the Federal Reserve is also in the process of improving disclosures under the Home Ownership and Equity Protection Act (HOEPA) and the Home Mortgage Disclosure Act (HMDA). HOEPA amends TILA to provide borrowers with enhanced protections for certain high-cost home loans and HMDA requires mortgage lenders to collect, report, and disclose information about mortgage lending. The Federal Reserve expects to promulgate final HOEPA regulations by the end of the year.

These positive actions must be followed with more far-reaching reforms if the mortgage process is to become truly consumer-friendly. Reaching a consensus among all of the interested parties on reforming our current mortgage disclosure scheme has, unfortunately, proven to be difficult.

Improving our disclosure regime is a key component in addressing the abusive lending practices associated with predatory lending. If borrowers have timely, clear, and accurate cost disclosures, they can provide a first line of defense against unscrupulous lenders. Both HUD and the Federal Reserve are to be commended for moving in this direction.

Addressing Predatory Lending

While improved mortgage disclosure should help reduce the abusive lending practices associated with predatory lending, it likely will not solve the problem entirely.

We must do more to educate borrowers so they are in a better position to protect themselves. To better prepare consumers for this task, the Federal government should take a leadership role in educational efforts. My office is working with others in the Administration and with industry, education, and non-profit groups to enhance financial literacy. In addition, the Community Development Financial Institutions Fund - also a part of my office - is increasingly building financial literacy programs into its award-making process. Though not a panacea, greater financial literacy among homebuyers should help reduce the incidence of abusive lending. I know Dina Ellis, my Deputy Assistant Secretary for Consumer Policy, will be discussing our financial literacy efforts in more detail with you this afternoon.

Second, increased enforcement efforts should be a top priority. The Justice Department and the Federal Trade Commission (FTC) have taken aggressive steps in recent years to crack down on abusive lending. You will hear more about enforcement against deceptive and illegal lending abuses from Joel Winston of the Federal Trade Commission (FTC) shortly. The FTC has undertaken several high profile cases that could mean broad redress for many consumers. The FTC also devotes resources to consumer education and the Commission goes on record with its views on legislative and regulatory proposals in this field. The Commission, in other words, is covering its bases for the American consumer.

Finally, and most importantly, the Federal government should take a leadership role in encouraging private sector efforts to eliminate abusive lending practices. One possible approach is to encourage the development of a set of industry best practices for subprime lending.

Many key players in the prime and subprime mortgage industry have already announced mortgage purchase guidelines.. Last spring, Fannie Mae issued guidance to its lenders prohibiting steering to subprime loans, requiring that borrowers have a reasonable ability of paying the loan, limiting points and fees to 5% of the loan amount, prohibiting single-premium credit life, and limiting prepayment penalties. Similarly, Washington Mutual recently announced its own best practices, which includes not selling single premium credit life insurance; not originating HOEPA mortgages in excess of $20,000; and not offering subprime loans with compulsory negative amortization, balloon payments, or non-default call provisions. In addition, the Mortgage Bankers Association of America has endorsed best practices that include not only statutory compliance and training, but also consumer education and counseling. Individual firms have also developed guidelines

We applaud these very constructive efforts and believe that an industry set of best practices makes appropriate use of market forces and still provides the Federal government with an enforcement role. For my part, I would like to explore whether the Treasury Department can play a leadership role in developing a set of national best practices for the subprime lending community. For regulated depository institutions, such practices could be incorporated into bank supervisory standards and enforced through the supervisory process. For lenders not subject to federal bank regulation, the FTC would have enforcement authority. If for example, the lender agreed to abide by a published set of industry best practices, but was later found not to have followed those practices, the FTC could bring an enforcement action based on unfair and deceptive practices.

The development of an industry set of best practices could help promote consistency and uniformity among state and local predatory lending laws. By setting national standards for good lending practices, a set of industry best practices might provide a good model for the efforts of state and local leaders in this area.

A code of best practices could also help consumers navigate the complex mortgage financing process by giving them some assurance that the lender with whom they are dealing adheres to certain core standards for which there are federal enforcement mechanisms.

It is in the interest of industry and consumer groups to work together in developing a set of industry best practices. In fact, many of the current subprime mortgage guidelines put in place by mortgage companies were developed in conjunction with consumer groups. By working together, I believe the Treasury Department, in partnership with lenders and consumer groups could strike an appropriate balance in terms of assuring widespread access to credit while protecting consumers from predatory practices. We must be aggressive and vigilant in our efforts to crack down on abuses. On the other hand, unnecessary or unduly cumbersome requirements on legitimate subprime lending will only cause mainstream lenders to withdraw from providing credit to those who need it most and are otherwise creditworthy.

In exploring the feasibility of a federal government role in developing a code of best practices for subprime lenders, I would greatly appreciate the thoughts and input of the members of this well-respected organization. There is a tremendous amount of expertise in this room, and I look forward to the opportunity to work with you in tackling this important issue.

In closing, let me thank the Women in Housing and Finance for its efforts in organizing this symposium.

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