[Senate Hearing 107-774]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 107-774
 
                      PREDATORY MORTGAGE LENDING:
                   THE PROBLEM, IMPACT, AND RESPONSES
=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             FIRST SESSION


                                   ON


         THE EXAMINATION OF THE PROBLEM, IMPACT, AND RESPONSES 
                OF PREDATORY MORTGAGE LENDING PRACTICES

                               __________

                          JULY 26 AND 27, 2001

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs







                           U.S. GOVERNMENT PRINTING OFFICE
82-969                          WASHINGTON : 2002
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut     PHIL GRAMM, Texas
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia                 CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware           RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan            JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey           MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii              JOHN ENSIGN, Nevada

           Steven B. Harris, Staff Director and Chief Counsel

             Wayne A. Abernathy, Republican Staff Director

                      Patience Singleton, Counsel

                  Jonathan Miller, Professional Staff

                    Daris Meeks, Republican Counsel

            Geoff Gray, Republican Senior Professional Staff

                Joseph Cwiklinski, Republican Economist

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)





                            C O N T E N T S

                              ----------                              

                        THURSDAY, JULY 26, 2001

                                                                   Page

Opening statement of Chairman Sarbanes...........................     1
    Prepared statement...........................................    51

Opening statements, comments, or prepared statements of:
    Senator Gramm................................................     2
    Senator Johnson..............................................     5
    Senator Reed.................................................     6
    Senator Schumer..............................................     6
    Senator Miller...............................................     7
    Senator Carper...............................................     8
    Senator Stabenow.............................................     9
    Senator Bennett..............................................    11
    Senator Dodd.................................................    12
    Senator Bayh.................................................    14
    Senator Allard...............................................    14
        Prepared statement.......................................    52
    Senator Corzine..............................................    20
    Senator Bunning..............................................    53

                               WITNESSES

Carol Mackey, of Rochester Hills, Michigan.......................    12
Paul Satriano, of Saint Paul, Minnesota..........................    14
Leroy Williams, of Philadelphia, Pennsylvania....................    17
Mary Ann Podelco, of Montgomery, West Virginia...................    18
Thomas J. Miller, Attorney General, of the State of Iowa.........    29
    Prepared statement...........................................    53
Stephen W. Prough, Chairman, Ameriquest Mortgage Company,
  Orange, California.............................................    31
Charles W. Calomiris, Paul M. Montrone Professor of Finance and 
  Economics,
  Graduate School of Business, Columbia University, New York, New 
    York.........................................................    35
    Original prepared statement..................................    81
    Revised prepared statement...................................   101
Martin Eakes, President and CEO, Self-Help Organization
  Durham, North Carolina.........................................    40
    Prepared statement...........................................   120

              Additional Materials Supplied for the Record

Letter to Senator Paul S. Sarbanes from Paul Satriano, dated 
  August 9, 2001.................................................   143
Statement of Elizabeth Goodell, Counsel, Community Legal Sevices 
  of Philadelphia, on behalf of Leroy Williams, dated July 26, 
  2001...........................................................   147
Statement of Daniel F. Hedges, Counsel, Mountain State Justice, 
  Inc., on behalf of Mary Podelco, dated July 26, 2001...........   147
Ameriquest Mortgage Company Retail Best Practices, submitted by 
  Stephen W. Prough..............................................   149
Statement of America's Community Bankers, dated July 26, 2001....   154
Letter to Senator Paul S. Sarbanes from Fred R. Becker, Jr., 
  President and CEO, National Association of Federal Credit 
  Unions, dated July 24, 2001....................................   163
Statement of Gale Cincotta, Executive Director, National Training 
  &
  Information Center, National Chairperson, National People's 
    Action,
  dated July 25, 2001............................................   166
Statement of Allen J. Fishbein, General Counsel, Center for 
  Community Change, dated July 26, 2001..........................   173

Letter to Senator Paul S. Sarbanes from Gary D. Gilmer, President 
  and CEO, Household International, Inc., dated July 26, 2001....   179

Letter to Senator Paul S. Sarbanes from Susan E. Johnson, 
  Executive
  Director, RESPRO', dated August 2, 2001.............   184

Letter to Senator Paul S. Sarbanes from Tom Jones, Managing 
  Director
  and Amy Randel, Director of Governmental Relations, Habitat for
  Humanity International, dated August 13, 2001..................   190

``A Prudent Approach To Preventing `Predatory' Lending'' by 
  Robert E. Litan................................................   193

Statement of Bruce Marks, Chief Executive Officer, Neighborhood 
  Assistance Corporation of America..............................   210

Letter to Senator Paul S. Sarbanes from Richard Mendenhall, 
  President, National Association of Realtors', July 
  25, 2001.......................................................   224

Letter to Senator Paul S. Sarbanes from Jeremy Nowak, President 
  and CEO, and Ira Goldstein, Director, Public Policy & Program 
  Assessment, The Reinvestment Fund..............................   226

Statement of Jeffrey Zeltzer, Executive Director, National Home 
  Equity Mortgage Association, dated July 26, 2001...............   232

                              ----------                              

                         FRIDAY, JULY 27, 2001

Opening statement of Chairman Sarbanes...........................   241
    Prepared statement...........................................   288

Opening statements, comments, or prepared statements of:
    Senator Miller...............................................   243
    Senator Stabenow.............................................   243
        Prepared statement.......................................   288
    Senator Corzine..............................................   244
    Senator Carpo................................................   254
    Senator Dodd.................................................   259
    Senator Carper...............................................   259
    Senator Santorum.............................................   267

                               WITNESSES

Wade Henderson, Executive Director, Leadership Conference on 
  Civil Rights...................................................   244
    Prepared statement...........................................   289

Judith A. Kennedy, President, The National Association of 
  Affordable
  Housing Lenders................................................   247
    Prepared statement...........................................   294
    Response to written questions of Senator Miller..............   416

Esther ``Tess'' Canja, President, American Association of Retired 
  Persons........................................................   249
    Prepared statement...........................................   296
    Response to written questions of Senator Miller..............   417

John A. Courson, Vice President, Mortgage Bankers Association of 
  America, President and CEO, Central Pacific Mortgage Company, 
  Folsom, California                                                250
    Prepared statement...........................................   311

Irv Ackelsberg, Managing Attorney, Community Legal Services, 
  Inc.,
  testifying on behalf of the National Consumer Law Center, the 
    Consumer
  Federation of America, the Consumer Union, the National 
    Association of
  Consumer Advocates, U.S. Public Interest Research Group........   252
    Prepared statement...........................................   317
    Response to written questions of Senator Miller..............   420

Neill A. Fendly, CMC, Immediate Past President, National 
  Association of
  Mortgage Brokers...............................................   254
    Prepared statement...........................................   340
    Response to written questions of Senator Miller..............   425

David Berenbaum, Senior Vice President, Program and Director of 
  Civil
  Rights, National Community Reinvestment Coalition..............   257
    Prepared statement...........................................   344
    Response to written questions of Senator Miller..............   428

George J. Wallace, Counsel, American Financial Services 
  Association....................................................   259
    Prepared statement...........................................   378

Lee Williams, Chairperson, State Issues Subcommittee, Credit 
  Union
  National Association, and President, Aviation Association 
    Credit Union,
  Wichita, Kansas................................................   262
    Prepared statement...........................................   384
    Response to written questions of Senator Miller..............   438

Mike Shea, Executive Director, ACORN Housing.....................   264
    Prepared statement...........................................   398

              Additional Materials Supplied for the Record

Statement of the American Land Title Association.................   440
Statement of the Consumer Bankers Association, dated July 27, 
  2001...........................................................   441
Statement of the Consumer Mortgage Coalition, dated July 27, 2001   445
Letter to Senator Paul S. Sarbanes from Brian A. Granville, 
  President
  Appraisal Institute, dated July 27, 2001.......................   468
Letter to Senator Paul S. Sarbanes from Maude Hurd, National 
  President, ACORN, dated August 9, 2001.........................   481
Statment of Richard Stallings, President, National Neighborhood 
  Housing Network................................................   489
Statement of Marian B. Tasco, Councilwoman, Ninth District, City 
  of Philadelphia, Pennsylvania..................................   492

                      PREDATORY MORTGAGE LENDING: 
                   THE PROBLEM, IMPACT, AND RESPONSES

                              ----------                              


                        THURSDAY, JULY 26, 2001

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:05 a.m., in room SD-538 of the 
Dirksen Senate Office Building, Senator Paul S. Sarbanes 
(Chairman of the Committee) presiding.

         OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

    Chairman Sarbanes. The hearing will come to order.
    Today is the first of two initial hearings on predatory 
mortgage lending: the problem, the impact, and the responses. 
This morning, we will first hear from a number of families that 
have been victimized by predatory lenders. Later this morning, 
and again tomorrow morning, an array of public interest and 
community advocates, industry representatives, and legal and 
academic experts will discuss the broader problem and the 
impact that predatory lending can have not only on families, 
but also on communities.
    Homeownership is the American Dream. It is the opportunity 
for all Americans to put down roots and start creating equity 
for themselves and their families. Homeownership has been the 
path to building wealth for generations of Americans. And in my 
view, it has been the key to ensuring stable communities, good 
schools, and safe streets.
    Predatory lenders play on these homes and dreams to 
cynically cheat people of their wealth. These lenders target 
lower income, minority, elderly, and often unsophisticated 
homeowners for their abusive practices.
    Let me briefly describe how predatory lenders and brokers 
operate. They target people with equity in their homes, many of 
whom may be feeling the pinch of consumer and credit card 
debts. They underwrite the property, often without regard to 
the ability of the borrower to pay the loan back. They do not 
use the normal underwriting standards. In fact, they ignore 
them altogether. They make their money by charging extremely 
high origination fees and by packing other products into the 
loan, including upfront premiums for credit life, disability, 
and unemployment insurance, and others, for which they get 
significant commissions right at the outset, but for which 
homeowners continue to pay for years since it is folded into 
the mortgage.
    The premiums for these products get financed into the loan, 
greatly increasing the loan's total balance amount. As a 
result, and because of the high interest rates being charged, 
the borrower is likely to find himself in extreme financial 
difficulty.
    As trouble mounts, the predatory lender will offer to 
refinance the loan. Unfortunately, another characteristic of 
these loans is that they have high prepayment penalties. So, by 
the time the refinancing occurs, with all of the fees repeated, 
the prepayment penalty included, the lender or broker makes a 
lot of money from the transaction and the owner finds that they 
are being increasingly stripped of their equity and, in the 
end, it may well be their home.
    Nearly every banking regulator, Federal and State, has 
recognized this as an increasing problem. And I believe, 
predatory lending really is an assault on homeowners all over 
America.
    Now I want to make one thing clear. These hearings are 
directed toward predatory lending practices. There are people 
who have credit problems who still need and can justify access 
to affordable mortgage credit. They may only be able to get 
mortgage loans in the subprime market, which charges higher 
interest rates. Clearly, to get the credit, they will have to 
pay somewhat higher rates because of the greater risk they 
represent.
    So, we make the distinction. We recognize that there is a 
subprime lending industry that is performing an important 
function. But we are concerned to get at those within that 
industry who are engaging in these abusive practices. Families 
should not be charged more than the increased risk justifies. 
Families should not be stripped of their home equity through 
financing of extremely high fees, credit insurance, or 
prepayment penalties. They should not be manipulated into 
constant refinancings, losing more and more of their equity and 
of their wealth that they have taken a lifetime to build up, 
but which is consumed by each set of new fees by each 
transaction. They should not be stripped of their legal rights 
by mandatory arbitration clauses that block their ability to 
appropriate legal redress.
    Some argue there is no such thing as predatory lending 
because it is a practice that is hard to define. Perhaps the 
best response to this was given by Federal Reserve Board 
Governor Edward Gramlich, who said earlier this year:

    Predatory lending takes its place alongside other concepts, 
none of which are terribly precise--safety and soundness, 
unfair and deceptive practices, patterns and practices of 
certain types of lending. The fact that we cannot get a precise 
definition should not stop us. It does not mean this is not a 
problem.

    Others, recognizing that abuses do exist, contend that they 
are already illegal. According to this reasoning, the proper 
response is improved enforcement.
    I support improved enforcement. The FTC, to its credit, has 
been active in bringing cases against predatory lenders for 
deceptive and misleading practices. However, because it is so 
difficult to bring such cases, the FTC further suggested last 
year a number of increased enforcement tools that would help to 
move against the predators. I hope that we will get an 
opportunity to discuss those proposals as these hearings 
progress.
    I also support actions by regulators to utilize the 
authority under existing law to expand protections against 
predatory lending. That is why I sent a letter signed by my 
colleagues on the Committee strongly supporting the Federal 
Reserve Board's proposed regulation to strengthen consumer 
protections under current law.
    Campaigns to increase financial literacy and efforts within 
the industry to engage in best practices are also important 
parts of any effort to combat this problem. Many industry 
groups have contributed time and resources to educational 
campaigns of this sort or developed practices and guidelines, 
and I welcome this as part of a comprehensive reform to the 
problem of predatory lending.
    Neither strong enforcement, nor literacy campaigns are 
enough. Too many of the practices we will hear outlined this 
morning and in tomorrow's hearings, while extremely harmful and 
abusive, are technically within the law. And while we must 
aggressively pursue financial education, we also recognize that 
education takes time to be effective.
    Again, I want to reiterate that subprime lending is an 
important part of the credit markets. But such lending needs to 
be consistent with and supportive of the efforts to increase 
homeownership, build wealth, and strengthen communities. And in 
the face of so much evidence of abuse and of so much pain, we 
must work together to address this crisis and that is what we 
are setting out to do by launching these hearings this morning.
    Senator Gramm.

                STATEMENT OF SENATOR PHIL GRAMM

    Senator Gramm. Mr. Chairman, thank you for holding these 
hearings.
    Let me say that one of the blessings of living in a strong 
economy, with a healthy savings rate that is made considerably 
better by the Federal Government running a surplus, is that for 
the first time in American history, we have an active outreach 
program by private lenders to lend to people who, under 
ordinary circum-
stances, would have a difficult time borrowing money, people 
who would end up borrowing from other sources such as, kinfolks 
or in the backstreet market where abuses would be substantial.
    Let me assure you, Mr. Chairman, that I am committed to 
cracking down on crooks and people who abuse the system and who 
abuse borrowers.
    I want to be absolutely certain that in trying to get at 
the bad guys we do not put into place policies that destroy a 
market that is serving an increasing number of people.
    We will hear later today that the default rate in some 
areas of subprime lending is as much as 23 percent. That is a 
massive default rate, the good news is that 77 percent of those 
borrowers did pay the loan back, and they, in doing so, 
established good credit.
    This is something that I feel very strongly about. Fifty-
two years ago, my momma bought a house. She had three children 
and no husband. She was a practical nurse who worked in a 
system that when your number came up, you got to take the job.
    And so, she did not have, for all practical purposes, a 
full-time job. She borrowed for a house that cost $9,200. She 
borrowed this money from a finance company, and she paid 50 
percent more than the market rate for that loan. Now some 
people would say, prima facia, that was an abusive loan, that 
it was predatory lending. I would beg to differ.
    First, my mother was the first person that I am aware of 
since Adam and Eve, in our branch of the human family, who ever 
owned the dwelling where she lived. She paid off that loan, and 
52 years later, her credit is golden. Any bank in Columbus, 
Georgia would lend my momma money because in all her 52 years 
of record there was never a time when she has ever borrowed a 
penny that she has not paid back.
    Now my point is the following. We have to be very careful 
in trying to deal with an abuse that exists so that we do not 
create a situation where credible lenders, non-abusive lenders, 
good lenders will get out of the subprime market.
    If we end up doing that, if we end up falling victim to 
this rule or law of unintended consequences, the problem will 
be that the 77 percent of the people that are now paying these 
loans back will not get the loans. People will end up being 
forced to borrow in a more informal market. People will not be 
able to buy their own homes, and I think that this is something 
that we have to measure. All good public policy is based on 
cost and benefits, the intended consequence versus the 
unintended. This is something that I am going to try to watch 
very carefully because, again, subprime lending I view as a 
very good thing.
    I never will forget when I was a Member of the House of 
Representatives, and someone came up to me and said, ``Do you 
think 6 percent is a fair interest rate?'' And I said, ``Fair 
to whom?''
    He said, ``Well, fair to the borrower and fair to the 
lender--Do you think we ought to have a law that says the 
interest rate is 6 percent?''
    Well, I said that would be great, but if the market did not 
produce more than a 6 percent interest rate, then you would 
have massive shortages of credit and you would disrupt the 
credit markets. In fact, I think zero interest would be a great 
rate. I would borrow a lot at it. But no one would lend me the 
money.
    We have to be sure that we know what we are doing, not just 
focusing on the evil we hope to drive out of the system, but 
also take care that the good is not driven out of the system.
    Finally, it is hard to define many things in the world, 
hard to define pornography, as they say, I agree with the old 
adage--I know it when I see it.
    But I think when you are making law it is important to try 
to define what you are doing. My guess is if you ask 100 people 
in America to define predatory lending, you are going to get 
100 different definitions.
    Many people define predatory lending as lending at above 
prime. I am sure what is predatory lending to one person is not 
the same thing to another.
    But it is important that we know what we are doing and that 
we know what we are trying to eliminate, and that we are aware 
of what the unintended consequences might be.
    And, again, I want to thank you, Mr. Chairman. I have a 
Finance mark-up, and then we have a big trucking dispute on the 
floor, as all my colleagues know. So, I will be in and out.
    But I am going to read the testimony that is given today. 
This is an area that I am very interested in, and I want to 
thank all of our witnesses for participating.
    Chairman Sarbanes. Thank you very much, Senator Gramm.
    Senator Johnson.

                STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. Well, thank you very much, Mr. Chairman I 
appreciate your leadership in calling today's hearing on 
predatory lending. I look forward to hearing from the witnesses 
who will come before this Committee both today and tomorrow.
    Today's testimony, I am sure, will be moving. Nobody likes 
to hear that vulnerable members of our society have been taken 
advantage of. No one should be preyed upon to borrow money they 
do not need on terms that they do not understand.
    We in Congress are in a unique position to shine some light 
on shady practices and to think through the best way that we 
can, in a constructive way, bring an end to those practices.
    At the same time, Mr. Chairman, I urge caution that we not 
generalize the practices of a subset of lenders to an entire 
sector.
    As we will hear today, predatory lending occurs in the 
subprime market. But as you wisely emphasized in your 
statement, only a fraction of subprime lending is predatory. 
Subprime is not, in and of itself, predatory lending. The 
subprime market provides a critical source of credit to many 
Americans who struggle to find economic opportunity in our 
country. To be sure, lenders can and do charge a higher rate to 
account for the higher risk associated with those borrowers. 
When it is done right, subprime lending gives people what they 
need, and that is more, not less, opportunity.
    I have been encouraged by some noteworthy improvements in 
the subprime marketplace in recent weeks. A number of key 
players have announced new practices which I hope will have a 
salutary effect on the subprime sector.
    We want to encourage lenders with household names who have 
every incentive in the world to protect their good reputations 
to remain in the subprime marketplace. We need to give their 
initiatives a chance to have an impact.
    So, I would offer a word of caution, that while we should 
be vigorous in our efforts to eliminate the ugly instances of 
predatory lending, that we take care not to institute a policy 
that is in fact counterproductive, that would increase the cost 
of credit and, indeed, cut off critical sources of credit to 
the very members of society who need it most.
    I look forward to today's hearing and hope that we can have 
a balanced and thoughtful discussion of how we can best 
accomplish our common goal of making credit available under 
fair terms to a broad segment of our society, keeping in mind 
that we have already a substantial level of law pertaining to 
these issues from HOEPA legislation to Truth-in-Lending to the 
Real Estate Settlement Procedures Act, to the Federal Trade 
Commission, and the Federal Credit Opportunity Act legislation.
    That is not to say that there is not room for further 
Federal legislative action. It is to say that there is a 
context that this has to fit into and that we need to, on the 
one hand, address the abuses, but on the other hand, make it 
very certain that we do not pursue public policy that in fact 
is counterproductive.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you, Senator Johnson.
    Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman.
    I want to commend you for holding this hearing. This 
hearing will shine a light on one of the dark corners of the 
financial markets. And in doing that, it will be helpful in and 
of itself.
    I hope when we do that, we can not only identify and point 
out to the American public abuses, but we also can identify 
those companies that have high standards that should be 
emulated by all their colleagues, and at the end of the day, we 
can move all companies to the best practices that we will find 
in the financial services industry.
    And in doing that, I think we can both allow for the 
continuation of credit for individuals that may have credit 
problems, and avoid the abuses that we will hear about today.
    I welcome the witnesses. Your testimony is vitally 
important because you put a human face on what can be a lot of 
numbers, graphs, and statistics.
    Again, let me thank you, Mr. Chairman, for holding this 
hearing and sending a very strong signal that we want to have a 
robust financial service industry, but one that certainly 
respects consumers and respects their clients.
    Thank you.
    Chairman Sarbanes. Thank you, Senator Reed.
    Senator Schumer.

            STATEMENT OF SENATOR CHARLES E. SCHUMER

    Senator Schumer. Well, thank you, Mr. Chairman. I want to 
add my voice in thanking you for making this an early topic in 
your Chairmanship.
    Our Committee is off to a great start under your leadership 
and we are doing a lot of good things. And this is at the top 
of the list. Thank you for that. I would like to make just 
three points.
    One--two are a little bit in counter to what my colleague 
and friend from Texas, Senator Gramm, said. It is easy to talk 
about this stuff in the abstract. I hope, and one of our goals 
should be that Senator Gramm not only reads your stories, but 
hears it and just goes through what some of us have gone 
through when we meet people who are victims of predatory 
lending, the horror of it.
    It is people who have lived by the American Dream. They are 
often people of color. They are often people who buying the 
home is the first time in their whole family that they have 
ever bought a home, and they live by the rules. They save their 
$25 and their $50 every month, did not serve meat on the table 
so they could achieve their piece of the American Dream and own 
a home.
    And some bottom crawler comes in and not only sells them at 
a higher interest rate--that is what subprime is--but says, I 
will get you the right appraiser, I will get you the right 
lawyer, I will get you the right this and that. And what are 
they left with?
    They end up buying a home where the boiler might break 
down, even though they were certified. Someone came in and 
said, this is a good boiler. Or the roof leaks the minute they 
move in.
    They end up often paying with a balloon payment they cannot 
pay off, or the interest rates goes from 4 percent the first 
year to 12 percent the second and they have to give up their 
home. And these people are crushed for the rest of their lives, 
most of them, because they played by the rules and scrounged 
and then nothing happened. I have sat in my State of New York 
and listened to these folks. That is what motivates us, and I 
believe it is really important to remember that.
    Second, also in reference to Senator Gramm and you, 
Chairman Sarbanes. You are both right to emphasize that the 
subprime market is a good market. And I know there is a 
tendency of people just to say anything above conventional 
mortgage is bad.
    Well, that is not true. We want to give people the ability 
to buy a home when their credit is not so good that they would 
get a conventionally rated loan. And I agree with Phil that the 
free market has to help govern here.
    There is a little statement that we make to remind 
ourselves of this. And that is, not all subprime loans are 
predatory, but all predatory loans are subprime.
    Why? How come no conventional loans are predatory? You 
could have the same practices at a lower interest rate.
    It is because we regulate the conventional market. And 
conventional lenders cannot get away with doing this. If 
someone tries to set up a little shady bank in the conventional 
way, regulators will come down on them.
    Regulation makes a big difference. And the idea that we 
should shy away from any regulation when it has been so 
successful at keeping the conventional market on the up and up, 
does not make sense to me.
    I want to commend some of the banks, for instance, that 
recently changed the way that they issued insurance on their 
own. They deserve credit. And all too often, I think many in 
the community lump everybody together and we have to separate 
the good ones from the bad ones. But we are not going to get 
rid of the bad ones unless we regulate. And just one quick 
final point.
    Part of this is created because there is a vacuum of 
conventional lending in the inner city. All I want to say is we 
can make a large difference today where we could not 20 years 
ago, in getting conventional mortgages into working-class and 
middle-class neighborhoods of people of color which we could 
not before.
    CRA has done that. Banks are eager to make those loans. But 
they do not have the ins. And we have to explore ways to get 
them the ins there. We are doing that in New York and I will 
share that with my colleagues later.
    Thank you, Mr. Chairman. Sorry I went on too long.
    Chairman Sarbanes. Thank you, Senator Schumer.
    Senator Miller.

                STATEMENT OF SENATOR ZELL MILLER

    Senator Miller. I will take only a minute.
    Thank you very much, Mr. Chairman, for holding this 
hearing. This is a very serious matter. This is an important 
topic and I commend you for holding this hearing. And I want to 
welcome all of the witnesses here this morning. I look forward 
to hearing from you. I look forward to listening to the debate 
on this issue.
    In the State of Georgia, we just got through a debate that 
raged for a long time and very heatedly, in the State 
legislature, where a predatory lending law was passed in the 
State Senate, but then died in the house.
    So, this is a topic that I am very interested in hearing 
from the witnesses on, and I thank you for holding this 
hearing.
    Chairman Sarbanes. Senator Miller, thank you. We have had 
some good discussions between ourselves about this issue and I 
appreciate that very much.
    Senator Carper.

             STATEMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. Mr. Chairman, thank you.
    To our witnesses, I want to echo the words of welcome from 
Senator Zell Miller. We are glad that you are here. Thank you 
for taking time out of your lives to share this part of your 
day with us.
    Mr. Chairman, and my colleagues, I am struck sometimes by 
how helpful simply scheduling a hearing on a particular subject 
can be.
    [Laughter.]
    I just want to point to a couple of examples.
    One, I serve on the Energy Committee where Chairman 
Bingaman invited folks who serve on the Federal Energy 
Regulatory Commission to come and testify earlier this month. 
Two or 3 days before they testified, they took some remarkably 
positive steps to help alleviate the energy crisis in 
California.
    Just yesterday, Chairman Joesph Lieberman held a hearing on 
legislation that he and others have sponsored dealing with the 
entertainment industry and questions about the quality of the 
entertainment that is provided to us from the music industry, 
the video game industry, the television industry, and the movie 
industry.
    I found the comments from some of the industry 
representatives, talking about things that they had done 
voluntarily, were willing to do even more and better 
voluntarily, coming out of that hearing were encouraging.
    Others of my colleagues have spoken here today about some 
of the very positive steps that some who are represented in 
this room have taken to make sure that some of the questionable 
practices they were involved in have been stopped or will be 
stopped. I join my colleagues in applauding those of you who 
have taken those steps or will take those steps.
    I read an interesting piece by Robert Litan, whom some of 
you may recall. He used to be the number-two guy at OMB when 
Alice Rivlin was the head of OMB, and he is now over at the 
Brookings Institution. He has a very thoughtful piece that some 
of you may have seen. It is too long for me to go into at any 
length, but I think the points that he makes are good. They 
reflect the concerns that we have already heard that we want to 
make sure that the steps that we take here in this Committee 
and in this body, that we do no harm, that we make sure that 
those who are riskier borrowers still have access to credit, 
but they are not exposed to the kind of predatory practices 
which in many cases are already illegal.
    And as we face this challenge and listen to our witnesses, 
we have to be smart enough and thoughtful enough to come up 
with ways to better ensure, one, that the laws that already 
make these predatory practices illegal are actually enforced, 
at the Federal, the State, and the local level.
    Two, I think there is a lot to be said for embarrassing 
publicly those financial institutions who are actually 
violating the law and to put them under a spotlight and glare 
that they will not enjoy and will help to ensure that they and 
others cease those practices.
    Three, we have an obligation to work with the private 
sector and others to better ensure that consumers are educated 
and know full well what is legal and what is not, and that they 
are better able to police those who are offering credit in ways 
that are inappropriate or illegal.
    And last, I understand in reading this piece by Robert 
Litan that the Federal Reserve has undertaken the gathering of 
a fair amount of data that deserve to be studied, scrutinized, 
analyzed, as we prepare to take any action here in the Senate.
    So let me conclude where I started, Mr. Chairman. Thanks 
for bringing us together today. And to those who have joined us 
to testify, both in this panel and other panels, we appreciate 
very much your presence and your testimony.
    Thank you.
    Chairman Sarbanes. Well, thank you, Senator Carper.
    Senator Stabenow.
    And let me acknowledge Senator Stabenow's tremendous help 
and support in helping to put these hearings together and 
moving this issue forward and ensuring that it is high on our 
priority list and our agenda.

              STATEMENT OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Well, thank you, Mr. Chairman very much 
for holding this hearing and for the witnesses that are here 
today. This is an incredibly important issue and I hope that we 
can come together and put forward a positive solution.
    I know that there are literally thousands of horror stories 
around the country and I have heard many of them personally 
from my constituents in Michigan. Unfortunately, we do have 
unscrupulous lenders that are in the subprime market, while we 
also have ethical and responsible lenders in that market as 
well. But I have been pleased to invite one of our panelists 
today, Carol Mackey.
    Carol Mackey is from Rochester Hills in the metro Detroit 
area. She came to a hearing that I held in May on this very 
issue, where I learned of her own difficult and tragic 
experience. Ms. Mackey, I am very appreciative that you are 
here with us today to share your experiences and help us to 
learn from what happened to you.
    Mr. Chairman, I also, would like to recognize a very 
special friend and guest of mine who I have asked to attend 
this hearing today--Rev. Wendell Anthony, who is the President 
of the Detroit NAACP chapter, which I might brag is the largest 
chapter in the United States.
    Under the leadership of Rev. Anthony and the NAACP, they 
have been working very hard to raise awareness and to combat 
the issues of predatory lending, as well as increase affordable 
housing.
    There was a very successful hearing and conference that was 
held on June 9 that I was pleased to be a part of in Detroit 
under Rev. Anthony's leadership. He informed me last evening 
there was a second follow-up meeting on issues of access to 
affordable housing and predatory lending issues, where on just 
a few days' notice, they invited people to come, expected 100 
people and had 500 people show up. This is an example of how 
important issues of affordable housing and fair lending 
practices are, I believe, to the people that we represent.
    I think, as this hearing gets underway, I would like to 
underscore, Mr. Chairman, something that I said earlier that 
many of my colleagues have said. And that is, subprime lending 
is not predatory lending. In fact, subprime lending serves a 
legitimate purpose in providing credit to consumers with risky 
credit histories. We know that. A thriving subprime market can 
serve higher credit risk communities well.
    Our challenge is to focus on the bad actors, if you will, 
without giving the entire industry a bad name. And I think that 
is our challenge. And what we do not want to do is dry up 
capital in the subprime market. We do want to stop predatory 
lending practices.
    I hope we are going to sort out these issues, and to 
increase educational outreach, that we are going to make sure 
that existing laws are enforced. I also hope we also will pass 
new legislation that will make illegal what is now unethical.
    I do not believe it is enough just to promote education and 
enforcement without new legislation. Frankly, I think it is 
extremely important, given the fact that we are talking about 
thousands of dollars that have been taken from hard-working 
Americans, as well as their dreams--the dream of homeownership, 
the opportunity to build a secure future for themselves and 
their families. And that is why this practice is absolutely 
outrageous.
    Again, Mr. Chairman, I want to thank you for your 
leadership in calling this hearing. I want to thank Ms. Mackey 
for being here, and Rev. Anthony for his leadership. I am very 
anxious to move forward in a way that allows us to be 
constructive and address what I believe is a very serious issue 
for our families.
    Senator Carper. Would the Senator yield for just a moment, 
please?
    Senator Stabenow. Yes, I would be happy to yield.
    Senator Carper. Mr. Chairman, I misspoke earlier. I 
mentioned the hearings involving the Federal Energy Regulatory 
Commission and I gave the credit to the Energy Committee for 
holding them. Those were actually hearings called by Senator 
Lieberman, also, before the Governmental Affairs Committee. He 
held the hearings on the entertainment industry yesterday, the 
Federal Energy Regulatory Commission a week or two earlier.
    He is probably going to have hearings now on predatory 
lending. I do not know what he is running for, but----
    [Laughter.]
    --he is a busy boy. But I want to give him the credit for 
it, and his staff.
    Thank you.
    Senator Stabenow. Thank you, Mr. Chairman.
    Chairman Sarbanes. Senator Bennett.

             COMMENTS OF SENATOR ROBERT F. BENNETT

    Senator Bennett. Thank you, Mr. Chairman. I do not have an 
opening statement, but I have read through the statements of 
the witnesses here and appreciate their willingness to come 
share their experiences with us.
    I know it has to be a painful experience to come before the 
public and admit that you have gone through something like this 
and that you have been taken advantage of. Many people would 
prefer to simply hide and live with the sense of outrage that 
comes. We are very grateful to you for your willingness to 
expose yourselves to the lights and the heat of this kind of a 
circumstance because your information is very helpful. Once 
again, my gratitude to you. Thank you, Mr. Chairman
    Chairman Sarbanes. Thank you, Senator Bennett.
    Our first panel consists of four individuals who have 
suffered from predatory lending practices. I am very quickly 
going to touch on each of the witnesses before I recognize 
them.
    Carol Mackey is a retired substitute teacher who, as 
Senator Stabenow indicated, lives in Rochester Hills, Michigan. 
Her monthly mortgage payment doubled after she was encouraged 
to refinance her mortgage to pay off debt and undertake repairs 
to her condominium. And we will hear more about that in some 
detail.
    Paul Satriano is a retired steel worker from St. Paul, 
Minnesota. He was solicited for a loan with high points and 
excessive fees, including single premium credit life insurance 
and prepayment penalties as well.
    Leroy Williams is a retired shoe store assistant manager 
from Philadelphia, Pennsylvania. Mr. Williams received three 
mortgages, including two refinancings by three separate lenders 
over a 15 month period and he is currently fighting off a 
foreclosure.
    And Mary Ann Podelco is a widow who resides in Montgomery, 
West Virginia. Mrs. Podelco's home was foreclosed upon in 1997, 
after her mortgage was refinanced seven times in 16 months by 
four separate lenders.
    Let me say before we turn to you for your testimony, I want 
to express my appreciation to all of you, as Senator Bennett 
has just done, for your willingness to leave your homes and to 
come to Washington and to speak publicly about what you have 
been through. I know it must be very difficult for each of you. 
But I hope you appreciate and understand and take some pride in 
the fact that you will be contributing to a process that I 
trust will lead to action to put an end to the kind of 
practices that have caused each of you such heartache and such 
trouble.
    I hope you will draw some strength and comfort from 
understanding that you are an important part of this process 
that we are undertaking here to try to correct this situation 
and to ensure that others do not go through the same experience 
which each of you have suffered. And so we are deeply 
appreciative to you for coming to be with us today.
    Now Ms. Mackey, before I start with you, Senator Dodd has 
joined us. I do not know what his schedule is, but I will yield 
to him for just a moment for a statement.

            STATEMENT OF SENATOR CHRISTOPHER J. DODD

    Senator Dodd. Thank you, Mr. Chairman. I will be very 
brief. I apologize to my colleagues and the witnesses.
    First, I want to underscore the comments just made by 
Chairman Sarbanes. The admiration I have for people who step 
out of private lives before a bank of microphones and cameras 
to talk about very personal matters deserves a special 
commendation. All of us are deeply appreciative of your 
willingness to do this. I want to thank Senator Sarbanes for 
holding this hearing. It is important.
    But I think all of us up here, I hope, anyway, feel very 
strongly that predatory lending is a cancer. There is no other 
way to describe it in my view. Its causes should be catalogued, 
its manifestations should be carefully studied, its victims 
should be treated and made whole, and these practices should be 
cut from the body of healthy mortgage lending so that more 
people in our Nation can enjoy the American Dream of 
homeownership.
    This hearing is going to go a long way to help us do that. 
We are already seeing reaction by the banking industry in this 
country, responding to it. So, if nothing else happens, just 
merely having these hearings has already had salutary effects. 
And a great deal of credit for that goes to the Chairman of 
this Committee, Senator Sarbanes, for insisting upon these 
hearings, that they be held.
    And so, I thank you, Mr. Chairman, for doing so, and I 
thank our witnesses for your courage to be here with us this 
morning.
    Chairman Sarbanes. Thank you very much, Senator Dodd.
    Ms. Mackey, we would be happy to hear from you now.

                   STATEMENT OF CAROL MACKEY

                  OF ROCHESTER HILLS, MICHIGAN

    Ms. Mackey. My name is Carol Mackey. I am from Rochester 
Hills, Michigan. I am a senior citizen and I am working. I was 
substitute teaching. That was really my calling. But because of 
retirement ages for teachers, I am now working as a secretary, 
which I find to be an interesting and challenging occupation as 
well.
    I appreciate the opportunity to share my experience as a 
victim of what I believe to be predatory lending practices of 
American Equity Mortgage. I have been a stay-at-home mom most 
of my life. I just recently in the last 12 years had to go back 
to work full time.
    I first heard about American Equity Mortgage in August 
2000, from an advertisement on WJR radio in Detroit. Ray 
Vincent, the President of American Equity Mortgage, was on 
every morning as I was getting ready for work. I had been 
considering a home equity loan so I called the Southfield 
office of American Equity Mortgage and spoke with a loan 
officer. I told him that I wanted to get a home equity loan to 
pay off my debts and make some minor improvements to my condo.
    According to the loan officer at American Equity Mortgage, 
even though I wanted a home equity loan to pay off some bills 
and do some minor home improvements, it was in my best interest 
to do a consolidation, which meant refinancing my old mortgage 
loan.
    The mortgage loan officer of American Equity Mortgage 
explained that it was best for me because I would only have to 
make one payment instead of two, it would all be tax 
deductible, and with my bills paid off, I should be able to 
handle the new payment. In addition, he implied that I would 
have difficulty getting a second mortgage because of my credit 
history. Not being a financial whiz, I relied on his expertise.
    My old mortgage loan had a remaining balance of about 
$74,000, an interest rate of about 7.5 percent, and a monthly 
payment of about $510. Based on the State Equalized Value used 
for tax purposes, my home is worth about $151,000.
    My new mortgage is for $100,750, has an interest rate of 
12.85, an APR of 13.929 percent, a monthly payment of $1,103, 
and a prepayment penalty of 1 percent.
    The $100,750, new mortgage was comprised of the $74,000 
payoff of the old mortgage, $18,645, in additional funds to pay 
off bills and perform the minor improvements to my home, and 
points and fees totaling $8,105.
    I did not understand the full cost of the additional money 
I received until several weeks later when I finally discussed 
the situation with one of my sons. Based on my son's 
calculations, American Equity Mortgage and their loan officer 
thought it was in my best interest:
    To pay $8,105 in points and fees to receive $18,645 in 
additional funds; to pay an effective interest rate of 44 
percent on the $18,645 in additional funds; to pay an extra 
$593 a month for the $18,645 in additional funds; and to pay an 
additional $201,608 in interest over the life of the loan for 
the $18,645 in additional funds.
    After funds were disbursed to pay off some of my bills I 
ended up with just over $9,000 to spruce up my condo, but I had 
to pay off a credit card debt of $1,200 out of that, leaving me 
with $7,800. Since closing last September, I have had to dip 
into the $7,800 
to make the mortgage payments that American Equity Mortgage 
arranged for me.
    When my son and I discussed the outrageous cost of my 
attempt to get a home equity loan, it was apparent to us both 
that I had been victimized by a predatory lender.
    My son contacted American Equity Mortgage on my behalf, and 
was directed to the General Counsel of the company. He 
explained to the General Counsel that he believed that I had 
been a victim of predatory lending practices by American Equity 
Mortgage.
    Through a series of conversations, he discussed the facts 
of the situation as I have outlined them here today, and 
requested that American Equity Mortgage cancel the new mortgage 
and replace it with a revised mortgage that reflected the 
interest rate of my original mortgage, blended with what a 
reasonable interest rate on a second mortgage would have been.
    American Equity Mortgage refused, on the basis that the 
mortgage loan officer stated that I had wanted to refinance my 
original mortgage from the outset. That is absolutely false. 
Why would I want to lose a perfectly good 7.5 percent mortgage?
    If I had been able to get a home equity loan for $20,000, 
as I had sought, all of my debts would have been paid and I 
would still have the $10,000 that I wanted to spruce up my 
home. And I most assuredly would not be paying more than double 
what my mortgage payment was before this all started. All I 
needed was $20,000.
    I am sharing my bad experience because I believe that I 
have been victimized. That American Equity Mortgage has 
perpetrated a fraud and that they should be held accountable 
for their actions. I hope that by sharing my experience, other 
homeowners can recognize and avoid the predatory practices that 
I fell victim to. Moreover, I hope that appropriate laws can be 
put into place, at both the State and Federal level, to protect 
homeowners from being victimized and to punish lenders engaging 
in predatory practices.
    Chairman Sarbanes. Let me interject to be clear. This is 
the new mortgage the loan officer said that you should 
consolidate.
    Ms. Mackey. Yes.
    Chairman Sarbanes. And when you sought an equity loan for 
$20,000, just to pay the debts and fix up your condo, he 
suggested, no, what you should do is consolidate that with your 
old mortgage. So you, in effect, would get a new mortgage.
    Ms. Mackey. Well, what he suggested was a consolidation, 
yes.
    Chairman Sarbanes. Right. And so, this new mortgage is the 
result of that consolidation.
    Ms. Mackey. That is correct. And the new mortgage is for 
$100,750.
    Chairman Sarbanes. Yes.
    Ms. Mackey. The interest rate is 12.85 percent, with an APR 
of 13.929 percent, and a monthly payment of $1,103, with a 
prepayment penalty of 1 percent.
    The new mortgage, which is $100,750, was comprised of 
$74,000 that paid off the old mortgage, $18,645 in additional 
funds to pay off the bills and do the spruce-up on my condo, 
and points and fees totalling $8,105. I think I have everything 
in there now.
    Chairman Sarbanes. Well, thank you very much.
    Ms. Mackey. Thank you. And I especially thank you for 
asking me to testify. And Senator Stabenow, thank you so much 
for taking an interest in my case. I appreciate that.
    Chairman Sarbanes. Mr. Satriano, just before I turn to you, 
we have been joined by Senator Bayh and Senator Allard. I do 
not know whether either has a statement they may wish to make.

                  COMMENT OF SENATOR EVAN BAYH

    Senator Bayh. Thank you, Mr. Chairman. I do not want to 
interrupt our witnesses.
    Thank you for the offer.

                COMMENT OF SENATOR WAYNE ALLARD

    Senator Allard. Mr. Chairman, I do have a statement.
    I would just ask that it be made a part of the record. I 
would agree that we go on and hear the testimony from the 
witnesses.
    Chairman Sarbanes. Fine. Of course, it will be included in 
the record.
    Mr. Satriano, we would be happy to hear from you.

                   STATEMENT OF PAUL SATRIANO

                    OF SAINT PAUL, MINNESOTA

    Mr. Satriano. Thank you very much. Good morning. My name is 
Paul Satriano and I am a member of Minnesota ACORN. Last 
November, I got a terrible home loan from Beneficial, which is 
part of Household, and over the last few months I have become 
active in ACORN's campaign against predatory lending, so that I 
can help make sure that more people do not have the same 
problems that I do now.
    For the last 8 years, I have been working as an auditor for 
Holiday Inn, and before that, I was working for the steel 
workers. I was also a member of the U.S. Air Force and I am a 
disabled vet. My wife, Mary Lee, works as a customer service 
representative for Road Runner Delivery Service and we have a 
daughter and two children that live with us in our house.
    My father-in-law built our house in 1947. Four years ago, 
after my wife's mother passed away, we took out a mortgage to 
buy the house. Interest rates were falling, so we refinanced 
the following year. And then we found out that the windows, 
which were original, had to be replaced, so we took out a 
second mortgage for them. Our monthly payments were $791 on the 
first mortgage and $166 on the second, and we never had a 
problem with these loans, were never late on any payments.
    A few years ago we dealt with Beneficial for the first 
time. They refinanced our car loan. They were very friendly at 
that time. Then they started sending letter after letter 
telling us how we can get up to $35,000 in cash. We had some 
credit card bills totalling $7,000, so we called and figured we 
are take care of them. Once they have you calling back, they 
had us. We were hooked.
    We told the Beneficial representative that we just wanted 
to pay off our credit card bills. She convinced us that we 
should do that at the same time that we consolidate our first 
and second mortgages with them.
    But the loan they ended up giving us only paid off $1,200 
of our credit card bills. To do that cost us $10,000 in fees, 
plus almost $5,000 in credit insurance, and left us with a 
higher total interest rate and a couple of hundred dollars more 
each month to pay on our debts. We lost $15,000 in equity in 
our home and now we are locked into the higher rate in 
payments, both because the loan has a 5 year prepayment penalty 
for about $6,000, and because we now owe much more on our house 
than it is worth, and it is going to be harder to refinance it. 
Let me tell you how it happened.
    A few hours before we were supposed to go to the signing 
for the closing papers, Beneficial faxed us the first written 
information we ever received about the loan. The paper they 
sent said the house was worth $106,000, and that would be the 
maximum amount of the loan. They laid out what the $106,000 
would go to and none of it was for points or fees to 
Beneficial.
    When my wife and I went in for the closing, they went 
through all the paperwork so fast, it was like a barker in a 
circus--they just keep talking, you put your money down, and 
you try to find the two-headed boy and you never saw one. It 
was over in less than a half hour.
    During the closing, the branch manager said they could not 
pay off all our credit cards with this loan. But because you 
have a car loan with us and you are such a good person and you 
paid every month, that we can get you more money on that and we 
will pay off the credit cards. So, we thought that was okay.
    When we got home later, we found out that there was a 
letter in our mailbox that the change in our car loan to 
include the credit card debt had been denied.
    Beneficial implied that if we did not take our credit 
insurance, we would not get the loan. So, they added $4,900 to 
our loan amount for that. After talking with ACORN, I realized 
that we could ask for a refund on this $4,900. With what we got 
back, we paid off some of our credit card loans. But we are 
going to be paying the $4,900 for the rest of the loan, so it 
really does not matter at this point.
    Also, the offer sheet Household sent us said our payments 
would be $1,168 a month, which was already more than we were 
paying before. But now we are paying them $1,222 a month, plus 
we are paying another $49 a month on the bills the Beneficial 
offer sheet said would be paid off, but were not. And despite 
our history of not a single late mortgage payment, Beneficial 
charged us an interest rate of nearly 12 percent. Standard bank 
`A' rates were below 8 percent at the time.
    Although we did not realize it, the fees and credit 
insurance put our loan amount over $119,000. Even without the 
prepayment penalty, the fact we owe more than the value of our 
house means we might be stuck in this loan for a while. ACORN 
was the one that really let us know that there was a prepayment 
penalty. We did not even know that there was a prepayment 
penalty.
    Beneficial had also charged us 7.4 percent of the loan 
amount as discount points, and that is close to $8,900 on top 
of the $1,100 that they took out for third-party fees. Our loan 
also contains a mandatory arbitration clause which says, we 
cannot take Household to court.
    After we sent in a complaint to the Minnesota Commerce 
Department, we eventually got a district manager from Household 
on the phone. But he told us everything was fine with our 
paperwork and that he could not do anything and he sent all the 
paperwork to the Commerce Department.
    So, we are left with a loan amount much higher than the 
value of our home, higher payments, more debt staked against 
our house, a higher interest rate than before, and they paid 
off only a fraction of our credit card debt, which had been the 
original reason to refinance. Plus a prepayment penalty and 
Beneficial is protected from legal action by the mandatory 
arbitration clause.
    My wife and I have faced some difficult times this year, 
and the financial stress caused by this loan has made things 
worse. In January, my sister died and I had to travel out to 
New Jersey, and I had to drive because my one sister could not 
fly. On the way back, our brakes went out and I had to pay $500 
to get new brakes. Three weeks ago, my daughter-in-law died, 
and now my son and three children are going to need help.
    This is not Beneficial's fault. But if we would have had 
the right kind of loan, we would have been in a better position 
to help these people now. Even without a predatory loan, we 
would be in a tough spot. Now we have higher payments on our 
debts each month and we owe more against our house. For the 
first time, this month, we were not able to make our mortgage 
payment.
    What surprised me most in all of this is that I am not 
alone in getting a predatory loan. In the last few months I 
have heard from a lot of people who have also been hurt by bad 
loans, from Household and from other lenders.
    The basic problem is that when you sit down at that closing 
table, the lender knows more than you do. You expect honest 
dealings, like you have had on past loans. And with predatory 
loans, that is just not what happens. That is why we are 
counting on our Senators to support strong protection for 
borrowers against abusive loan terms. And to say I am pissed is 
an understatement.
    Thank you.
    Chairman Sarbanes. Thank you, Mr. Satriano.
    Mr. Williams.

                  STATEMENT OF LEROY WILLIAMS

                 OF PHILADELPHIA, PENNSYLVANIA

    Mr. Williams. Good morning. And thank you for inviting me.
    My name is Leroy Williams. I am 64 years old. I live at 
5617 Larchwood Avenue, Philadelphia, Pennsylvania. My income 
from Social Security is $826 a month.
    I bought my home in 1975 for $10,000. I had a mortgage with 
payments of about $150 a month. The payments included my taxes 
and insurance. I finished paying my mortgage in 1996, and I 
retired the same year as an assistant manager of a shoe store.
    Between October 1998 and January 2000, I ended up with 
three different mortgages on my home. My taxes and insurance 
were not included in the payments on any of the three loans.
    In 1998, I was having trouble paying my gas bill. I was 
behind in the payments and I did not want the city to dig up 
the gas line in front of my home and turn off the gas. I saw an 
ad in the paper about loans to pay off your bills and I called. 
A man came out to my home and talked to me about getting a 
loan. He brought loan papers to my home for me to sign. The 
loan was with EquiCredit. The payments ended up being $215 a 
month. The payments were higher than my gas bill had been and I 
still had a high gas bill every month in the winter. My Social 
Security income when I got the EquiCredit loan was $779 a 
month.
    The date I signed the loan was October 2, 1998. The loan 
from EquiCredit was $19,000. They gave me $3,000 in cash that I 
did not ask for. I used the $3,000 to pay the gas bill and 
other bills and help my sister. Her husband had just died and I 
used some of the money to go to the funeral in North Carolina 
and to help pay some of the expenses and to help my sister in 
general. I do not remember where the rest of the loan money 
went, just that they told me that the loan had to pay all my 
bills.
    As far as I remember, I was making the EquiCredit payments 
okay. I do not remember just how I got into the next loan, with 
New Jersey Mortgage. There was a broker named Joe, but I do not 
remember his last name or what company he worked for. I threw 
out the papers from that loan because I was so mad about it. I 
had to take a bus outside the city to go sign for the loan. The 
date I signed for the loan was October 6, 1999, about 1 year 
after the EquiCredit loan.
    The loan from New Jersey Mortgage was $26,160. I do not 
remember what all the loan paid for, but I think I received 
$400. The payments ended up being $320 a month. I did not want 
payments that high, so I cancelled the loan. But they called me 
and told me I had to make payments or I was in jeopardy of 
losing my home. I kept telling them that I cancelled the loan.
    Right after I signed the loan from New Jersey Mortgage, I 
got a card in the mail from someone named Keeler. The card said 
I could get a better deal on my mortgage. I called Keeler and 
he told me not to send payments to New Jersey Mortgage and he 
would get me a better deal. Then it took a long time for him to 
set up the loan, and I kept getting calls from New Jersey 
Mortgage.
    Keeler drove me to an office in New Jersey to sign for the 
loan. He would not come into the office with me. He told me he 
had to go get gas. The loan Keeler set up was from Option One. 
The date was January 3, 2000. The loan was for $32,435. The 
payments are $315, but I know now the payments can go up to 
$348 or higher after 3 years because the interest rate will 
change.
    I signed for the Option One loan because I thought I was 
going to lose my home if I did not, even though I told Mr. 
Keeler that I needed payments around $240 a month. I tried to 
make the payments at first, but I had too many bills to pay and 
it was so hard. And it was making me more and more angry, so I 
stopped making the payments.
    I know now that Option One paid New Jersey Mortgage around 
$2,300 more than the amount of the New Jersey Mortgage loan--
because of interest and a penalty of 5 percent of the loan if I 
paid it off early. I have also learned that the New Jersey 
Mortgage loan had a balloon payment. I understand now that 
means I could have paid $320 every month for 15 years and still 
owe most of the loan.
    When you are a certain age and you have lived in a place 
for 20 years, you just want to dwell there until your time 
comes, but I do not have any peace because of all this.
    Thank you again for inviting me to talk with you.
    Chairman Sarbanes. Thank you very much, Mr. Williams.
    Mrs. Podelco.

                   STATEMENT OF MARY PODELCO

                  OF MONTGOMERY, WEST VIRGINIA

    Ms. Podelco. Mr. Chairman, thank you for the invitation to 
speak here today. My name is Mary Podelco and I live in 
Montgomery, West Virginia. I grew up in West Virginia and went 
through the 6th grade. I moved to Indiana where my husband and 
I worked in factories. I had four children with my husband of 
19 years and was widowed for the first time in 1967. After I 
was widowed the first time, I moved back to West Virginia and 
worked as a waitress, paid all my bills and rent in cash. When 
I remarried in 1987, my husband Richard and I were very proud 
that we were finally able to purchase our own small home. He 
worked as a maintenance worker and passed away in June 1994. I 
became the sole owner. In July 1994, I paid off the $19,000 
owed on the home from the insurance from my husband's death. 
Before my husband's death, I had never had a checking account 
or a credit card. I had always paid my bills in cash and tried 
to be an upstanding, responsible citizen. I do not drive and 
never owned a car.
    In 1995, I received a letter from Beneficial Finance 
offering to lend me money to do home improvements. I thought it 
was a good idea to put some new windows and a new heating 
system in my home. I signed a loan with Beneficial in May 1995. 
This was the beginning of my troubles. My monthly income at 
that time was $458 from Social Security and my payments were 
more than half of this. They took a loan on my house of about 
$11,921. The very next month, Beneficial talked me into 
refinancing the home loan for $16,256. I did not understand 
that every time I did a new loan, I was being charged a bunch 
of fees.
    I began getting calls from people trying to refinance my 
mortgage all hours of the day and night. I received a letter 
from United Companies Lending telling me that I could save 
money by paying off the Beneficial loan. On September 28, 1995, 
I signed papers in their office. More fees were added and the 
loan went to $24,300, at an interest rate of 13.5 percent.
    Just a few months later, I received a letter from 
Beneficial telling me I could save money by paying off United 
and going back to Beneficial. The loan was about $26,000. On 
December 14, 1995, according to the papers, Beneficial paid off 
United again, charging me more fees and costs.
    In February 1996, Beneficial advised me that it was time 
for me to refinance again. The loan papers show that I was 
charged a finance charge of $18,192 plus other fees and an 
interest rate of 14 percent. By the end of February, I had five 
different loans in 10 months. I did not understand that they 
were adding a lot of charges each time.
    After that I was called by Equity One by telephone to 
refinance the loan. On May 28, 1996, I signed papers with 
Equity One in Beckley, West Virginia. The new loan paid off the 
Beneficial loan--which was for 60 months--and replaced it with 
a loan for $28,850 for 180 months which I understand increased 
my total loan from $45,000 to over $64,000. I got $21.70 cash 
out of the loan. My monthly payments were $355.58. They charged 
me closing costs of over $1,100. Then on June 13, Equity One 
suggested that I needed another loan to pay off a side debt and 
they loaned me $1,960, at over 26 percent interest. Monthly 
payments were $79. This loan brought my monthly payments to 
Equity One to over $434 a month. My monthly income at that time 
was $470. I really could not make the payments. My 
granddaughter had a monthly income from SSI, but by law, I 
cannot use her money for my benefit.
    Then on August 13, Equity One started me on another loan. I 
was later told that Equity One was acting as a broker for an 
out-of-state lender--Cityscape. This new loan was all arranged 
through the Equity One office to help me by lowering my 
payments. This loan included $2,770 in new fees and costs. 
There were a whole lot of papers with this Cityscape loan that 
I did not understand. The payments were still too much.
    I missed my first payment when my brother died in December 
1996. Cityscape said they would not take a late payment from me 
unless I made up for the missed payment. I could not do it. 
Later in 1997, I lost my home to foreclosure by Cityscape. I 
now understand that these lenders pushed me into loans I could 
not pay. Adding all of these fees and costs each time caused me 
to lose my home, one I owned free and clear shortly after my 
husband died.
    Thank you.
    Chairman Sarbanes. We thank all the witnesses.
    We have been joined by Senator Corzine from New Jersey.
    Jon, I do not know if you have an opening statement.

               COMMENT OF SENATOR JON S. CORZINE

    Senator Corzine. I just appreciate very much your holding 
this hearing, Mr. Chairman, and to all of the witnesses, I 
respect and admire your willingness to speak out on this issue.
    Chairman Sarbanes. Thank you very much. I am going to be 
very brief, but I just want to--Ms. Mackey, I would like to go 
through your situation because you skipped over a part and then 
you put it at the end and I want to try to do it in sequence so 
that we get a very clear picture on what happened.
    As I understand it, before you responded to this radio ad 
that you heard because they were advertising that you could get 
a home equity loan and you wanted to do some fixing up of your 
condo and also pay off some other debts, you had a mortgage 
loan of $74,000, before you went to them.
    Ms. Mackey. Before I went to the home equity loan, yes.
    Chairman Sarbanes. $74,000, at an interest rate of 7\1/2\ 
percent, and you were making a monthly payment of about $510.
    Now, as I understand it, they said to you that, to get this 
home equity loan, it would be in your best interest to do a 
consolidation, which meant refinancing your old mortgage loan 
and then having a new loan included therein. And you went ahead 
and that is what you did. Is that correct?
    Ms. Mackey. Yes, that is correct.
    Chairman Sarbanes. All right. Now the new mortgage that 
resulted out of all of this was for just over $100,000, instead 
of $74,000.
    Ms. Mackey. That is right, $100,750.
    Chairman Sarbanes. That mortgage had an interest rate of 
12.85 percent.
    Ms. Mackey. That is correct.
    Chairman Sarbanes. The old mortgage had 7\1/2\ percent. 
Correct?
    Ms. Mackey. That is correct.
    Chairman Sarbanes. 12.85 percent. Your monthly payment 
jumped to $1,103, and there was a prepayment penalty included 
of 1 percent.
    Ms. Mackey. That is correct.
    Chairman Sarbanes. Okay. This meant you got this $100,750 
new mortgage, $74,000 of that to pay off the old mortgage.
    Ms. Mackey. Right.
    Chairman Sarbanes. There were points and fees of $8,105.
    Ms. Mackey. That is right.
    Chairman Sarbanes. And then that left you with $18,645, in 
additional funds to pay off bills and do the improvements.
    Ms. Mackey. Yes.
    Chairman Sarbanes. So that is how you arrive at this point 
that to get the $18,645 additional, you paid $8,105 in points 
and fees.
    Ms. Mackey. That is right.
    Chairman Sarbanes. Actually, you went to an interest rate 
on the new mortgage of 12.85 percent for all of it, whereas 
before, you had an interest rate of 7\1/2\ percent on the 
$74,000 mortgage. You now ended up paying an extra $593 a month 
in monthly payments. That jumped from $510 to $1,103. And you 
will pay over a couple hundred thousand dollars in interest 
over the life of the loan.
    Ms. Mackey. Yes.
    Chairman Sarbanes. Well, that is a pretty dramatic example 
of what we are trying to address here today and I very much 
appreciate your coming and telling us that story.
    Now, Ms. Podelco, in the time that is left to me, because I 
explained to the panel, we do 5 minute periods amongst the 
Members and then we move on to the next Member. I am not going 
to go all the way through this, but I want to explain it.
    When your second husband died, you and your second husband 
had finally purchased a small home of your own. Correct?
    Ms. Podelco. Yes.
    Chairman Sarbanes. Then he passed away. You became the sole 
owner. You received an insurance policy payment after his 
death.
    Ms. Podelco. Yes, that is right.
    Chairman Sarbanes. And you took $19,000 of that insurance 
policy payment to pay off the mortgage on your home. Correct?
    Ms. Podelco. Yes, so that I would have a home.
    Chairman Sarbanes. That is right. And you had a home free 
and clear of any debt. Correct?
    Ms. Podelco. Yes, at that time.
    Chairman Sarbanes. That is right. And then you got this 
letter about doing home improvements and you thought, you 
needed some new windows. You needed a new heating system and so 
forth.
    Ms. Podelco. Yes.
    Chairman Sarbanes. So, you went and signed a loan just 
under $12,000--$11,921. Right? To begin with.
    Ms. Podelco. Yes.
    Chairman Sarbanes. Okay. At that time, your income was $458 
a month from Social Security and the payments on this loan 
would be more than half of that.
    Ms. Podelco. I know.
    Chairman Sarbanes. Of course, that is a dramatic 
illustration of the fact that these predatory loans are made 
without relationship to the borrower's ability in terms of 
their income to repay the loan. It is completely geared to the 
equity in the home, which is one of the points that we are 
trying to stress.
    And then what happened over time, one or another company 
kept coming to you to get you to refinance your loan. And 
unfortunately, you proceeded to do that. Of course, they 
charged you fees and everything each time they did it. So the 
amount of mortgage on your home and the monthly payment you had 
to make kept going up. Is that correct?
    Ms. Podelco. Yes.
    Chairman Sarbanes. In fact, it went up to the point--well, 
the last figure I have here--of course, there were some add-ons 
after that. It reached over $64,000, the mortgage.
    The total loan went over $64,000. And of course, your 
monthly payments escalated as well. And in the end, you were 
not able to meet the payments. Is that correct?
    Ms. Podelco. That is correct.
    Chairman Sarbanes. And you lost your home.
    Ms. Podelco. Yes.
    Chairman Sarbanes. I believe that is a very dramatic 
example. I just say to my colleagues, we have really have to 
pinpoint this thing and do something about it.
    Here is someone who worked all their lives, bought a home, 
took the insurance policy money on their husband's death in 
order to pay off the remaining mortgage on a home to own the 
home free and clear, and then was manipulated over a period of 
time, successively, by these operators, until finally they ran 
the mortgage loan way up, ran the monthly payments way up. In 
effect, they stripped the equity out of the home, when they 
foreclosed and took it away.
    Thank you very much for coming and being with us.
    Ms. Podelco. You are welcome.
    Chairman Sarbanes. Thank you all.
    Senator Johnson.
    Senator Johnson. Mr. Chairman, I thought the testimony here 
was extraordinary and I am appreciative of your calling this 
panel. I do not have any questions of my own here, other than 
simply to say thank you to all four members of this panel. I 
think that you have contributed in a very meaningful way to the 
overall debate on this very difficult issue.
    Chairman Sarbanes. Senator Reed.
    Senator Reed. Well, Mr. Chairman, the testimony is 
disturbing, shocking, to think that, as you so aptly 
characterized it, people work all their lives and then have 
their homes taken from them through manipulation, through a 
pattern of deceit and dissembling, is despicable. I do not 
think there is any other word for it.
    I do not know what I can add in terms of questioning, but 
it struck me when I was listening to Mr. Satriano and reading 
his testimony, that because of an arbitration clause in your 
own mortgage, you could not even go to court. Is that correct?
    Mr. Satriano. That is right, sir.
    Senator Reed. And I wonder, Ms. Mackey, did you ever 
address some type of court filing?
    Ms. Mackey. I have spoken with the Legal Aid Society of 
Oakland County. They referred me to an attorney who never 
returned my calls. I am going to pursue it. It is just not 
fair.
    Senator Reed. And Ms. Podelco, when you were in your 
dilemma, did you try to get any legal assistance to try to 
upset the contract?
    Ms. Podelco. No, that is where I made my mistake, until I 
realized that they were ready to foreclose.
    Senator Reed. The other thing I should point out, Mr. 
Chairman which I find disturbing is that, when we have had our 
debate upon the bankruptcy bill, and we have had companies come 
in and argue about how we have to reform the bankruptcy laws 
because they are being taken advantage of.
    And we now have stripped away many basic rights that 
previously people had to protect themselves. And you find out 
that--and I would not suggest the linkage between specific 
companies, but you find out that within the same financial 
services operations, there is a great deal of shenanigans going 
on. And yet, we are hearing that we should not take any action. 
We cannot do anything. That it is the market.
    But certainly, when it comes to the bankruptcy bill, we 
were implored that we had to take action. It just seems to me 
unfair.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. I just want to underscore, in Ms. 
Podelco's case, her income was her Social Security payment. And 
these companies were clearly making loans to her that could not 
be repaid from her income. Obviously, they were targeting this 
home that had been paid free and clear and which had equity. So 
the whole process was geared to taking the equity out of that 
home.
    Senator Stabenow.
    Senator Stabenow. Well, thank you, Mr. Chairman. And thank 
you again to each of you for coming.
    As we are wrestling with what to do, I would like very much 
to know from each of you, from the information standpoint, 
consumer information, what you would suggest to us as we look 
at not only defining what predatory lending is, so that we can 
clearly state that it is illegal and existing laws need to be 
enforced aggressively, and we need to make sure the resources 
are there to do that. But we all understand that more consumer 
awareness and education is very important. And that is why your 
being here today is so important and the Chairman's focus on 
this issue is so important.
    I would also say on the side that I am pleased and 
appreciate that Freddie Mac is coming to Detroit to help us 
focus in September on the whole question of community awareness 
and education through an effort that they do which is called 
Don't Borrow Trouble. We are appreciative in their leadership 
in this, as well as the support and involvement of Fannie Mae 
in efforts as well.
    But I am wondering if any of you would like to comment on 
what kind of information would be helpful to you to have on the 
front end? Did any of you receive information in writing about 
the terms, the costs, anything comparing what you were paying? 
For instance, Ms. Mackey, your current--the loan before all of 
this happened versus the new loan and the points and fees and 
costs and so on? Did you receive any information in writing? 
And if not, what would you suggest as being something that we 
should focus on in terms of public information?
    Ms. Mackey. I received a good-faith estimate, which I think 
is something that is required from American Equity Mortgage, 
before the final paperwork. I did not see any paperwork other 
than that until the final paperwork that I went in to sign. And 
everything had been increased significantly at that time.
    Senator Stabenow. I am not sure I understood correctly. Did 
you have paperwork that said something different for the exact 
same----
    Ms. Mackey. I am sorry. I had this bug in my ear.
    Senator Stabenow. That is okay. You received information on 
the front end. What exactly did they give you information 
about? What were the numbers? What were the terms that they 
shared with you?
    Ms. Mackey. They went over the rates that I already had and 
they gave me the suggested interest rate or estimated interest 
rate, which was 11-something. The monthly payment would be 
probably around $900 and something.
    At that time, my income was about, take-home was about 
$1,800 a month. So $900 sounded like a whole lot. But sounded 
do-able if I was not going to have all of these other debts to 
take care of.
    All the information on that good-faith estimate, and I am 
sorry I do not have it right before me, the figures were all 
significantly lower. The costs, the points, whatever, all were 
lower than the final paperwork.
    I would like to see something that could be put in the 
hands of the borrower by the lender in advance that was the 
final paperwork, final numbers. An estimate is wonderful, but 
when they up everything by several hundred dollars or more, it 
does not really do much good. And you get there and you think, 
oh my gosh, what have I done? And you are embarrassed and you 
do not know.
    I sat there thinking, I really should just walk out of 
here. But I cannot do that. It is silly to even think that way. 
But I think if I had something to look over at home before I 
went in to sign those papers, it would have given me a better 
opportunity.
    I could have taken it to someone, although I do not know 
that I would, because I did not want to--now I am talking about 
it all. But at that point--what I am doing now is not for me. 
But at that point, I did not want anybody to know what I had 
done.
    Senator Stabenow. Thank you. And so, you were given a piece 
of paper that said the payment would be around $900.
    Ms. Mackey. Yes.
    Senator Stabenow. Instead, it was $1,103.
    Ms. Mackey. Yes.
    Senator Stabenow. And a different interest rate.
    Ms. Mackey. Correct.
    Senator Stabenow. And so, you walked in assuming one thing 
and found out something else.
    Ms. Mackey. And you know, Senator Stabenow, it was several 
days after I went home with this paperwork and looked it over 
thoroughly on my own, that I discovered that my main reason for 
getting this, one of my credit card debts had not been paid. 
And when I called the young man who did the work, he said we 
could not pay everything and give you what you wanted for the 
improvements on your condo. But they could charge me over 
$8,000 in fees.
    You are talking about equity stripping. I had the 
difference between $150,000 and $74,000, what is that? $75,000? 
And now I may have $50,000 equity in my home, if I am lucky.
    I just think that there has to be more education. And it is 
not just the responsibility of the Committee or the industry, 
but it is also our responsibility to avail ourselves of that 
information.
    And that again was my own fault for not doing that because 
I know that there is information out there. But it is that 
embarrassment situation again, which is--I am not embarrassed 
any more. I have learned.
    Senator Stabenow. Well, thank you so much.
    Chairman Sarbanes. Senator Dodd.
    Senator Dodd. Thank you, Mr. Chairman. Again, I think that 
this has been tremendously helpful to have all four of you 
share your testimony.
    I realize, something you just said, Ms. Mackey, was very 
worthwhile because in all of this, obviously, there are some 
other sources of responsibility here. But you properly point 
out, if nothing else, we hope people watching this or listening 
to this will take note of what you just said.
    The important thing is to always check and ask other 
people. There are people you can go to in most communities that 
will help you find out whether what you are being offered is--
my mother used to say, if it sounds too good to be true--
remember that?
    Ms. Mackey. It usually is.
    Senator Dodd. It usually is, yes. And when you hear these 
radio ads and so forth and they are offering to make your life 
easy, offering you more money at less cost, that is usually a 
good signal.
    Ms. Mackey. I understand that. And I was at a point where I 
was very, almost desperate to get this taken care of.
    Senator Dodd. Yes, I understand that.
    Ms. Mackey. So, I lost all good sense.
    Senator Stabenow. Would my friend yield for just one 
moment?
    I would just want to add that in this particular situation, 
Ms. Mackey got information ahead of time, saying, it would be a 
$900 payment and it changed at closing. So, I would just add 
that even when we ask ahead of time, if it is changed, there is 
a problem.
    Senator Dodd. No, I agree. But my point is, again, for 
people listening out there, or who are watching this, who have 
not yet done this, but who are being approached by people, your 
testimony here is a good warning. It does not offer you any 
immediate relief, obviously, but maybe just by being here, you 
may be saving some people from the same kind of tragedy.
    You have been through basically a financial mugging. That 
is what this is. You were mugged. It is almost like walking 
down the street and being mugged. Now it took longer and it was 
more subtle and it was cute. But it is as much as if someone 
had held you up, in my view.
    Senator Reed made a very good point. There are some of us 
who have strongly objected to this so-called bankruptcy reform 
bill. One of the reasons that the bill has not become law today 
is because there are a couple of States in this country where 
affluent homeowners do not want their homes subject to 
bankruptcy laws--the Homestead Exemption. And Ms. Podelco, if 
you just moved to Palm Beach and bought yourself a nice big 
condo, you might not be in this trouble today.
    [Laughter.]
    I do not know if that was possible for you in West 
Virginia. But it is somewhat ironic in a way that we are 
talking about so-called reforms here, where people want to 
prohibit the discharge of credit card responsibility and make 
it more difficult for people who get caught in difficult 
situations to be able to get themselves out of it. But that is 
an aside that I raise to you here today.
    Let me just ask you, because one thing was common in all of 
your stories here. They all have a poignancy to them. But it 
just seemed to me in every case, with some variations on it--
Mr. Satriano, you have something next to you there. What is 
that?
    Mr. Satriano. It is just a picture of my house.
    Senator Dodd. Why not get it the right side up?
    [Laughter.]
    There we go. That is your home?
    Mr. Satriano. Yes.
    Senator Dodd. How long had you been in that house?
    Mr. Satriano. My wife grew up in there.
    Senator Dodd. Your father-in-law built that house?
    Mr. Satriano. Right. 1947.
    Senator Dodd. Well, the one thing I saw as I was listening 
to you talk about it here is that the solicitors in every case 
withheld information, it seems to me, in every case. And 
correct me if I am wrong, but you had very important 
information withheld from you as the solicitations were being 
made. And important information about the terms of the loan, 
you were directly misled in every single case. Is that true?
    Mr. Satriano. [Nods in the affirmative.]
    Ms. Mackey. [Nods in the affirmative.]
    Mr. Williams. [Nods in the affirmative.]
    Ms. Podelco. [Nods in the affirmative.]
    Senator Dodd. You are nodding your head yes.
    Ms. Mackey. Yes.
    Senator Dodd. Now the marketing of this just seems to me it 
is fraud in your cases here. I do not know how else to describe 
it. The marketing techniques that were used against you were 
all in the case promising you a much better deal, obviously, 
than you had in every single case.
    Again, I thank you, Mr. Chairman. I know we have other 
witnesses to hear from. I hope maybe some of our colleagues 
when we look at it--there was a piece in The Wall Street 
Journal, I think it is today's home economics--refinancing boom 
helps explain strength of consumer spending.
    An unprecedented cashflow may prevent recession. Economists 
figure that all of the refinancing activity contributed nearly 
half of 1.2 percent annualized growth in the first quarter 
gross domestic product.
    I mean, this is going on. There is a lot of refinancing 
going on all over the country. Now I am not suggesting, 
obviously, that the refinancing, all of it is predatory 
lending. But I get nervous when I see this, a lot of these 
solicitations going out. And as long as home prices stay up--I 
remember in Hartford, Connecticut a few years ago, we had the 
mid-1980's. And there was this tremendous inflation in values 
of homes. And then we had the real estate market crash. And 
people had mortgages on their homes that vastly exceeded the 
value of these homes.
    I have an uneasy feeling that we may be entering a period 
like that. And we are going to find that not just people like 
yourselves sitting here that have been through and dealt with 
unscrupulous lenders out there that have taken advantage of you 
by withholding information and lying to you, basically, 
deceiving you, that we may find a more compounded problem here 
as a result of this effort to convince people that they can 
refinance their homes and ought to do so, and find that these 
homes are not going to be worth as much as they thought they 
were.
    Again, I thank all four of you. You are courageous people. 
We are grateful to you for being here.
    Chairman Sarbanes. Senator Corzine.
    Senator Corzine. I will be brief, Mr. Chairman.
    I certainly concur that you are courageous to sit and tell 
us these stories, which I think accentuate a major flaw, a 
reprehensible flaw in our economic system. I hope we can get at 
some of the fundamental problems here with precise but 
important legislation as we come through this.
    One thing that yells out at us is the need for financial 
literacy exposure. This morning I was with a group of people 
from the Urban League and Historic Black Colleges and Freddie 
Mac on a Credit Smart program that is designed to deal with 
getting financial literacy out in the community so that we can 
deal with this when you are faced with people that are smooth 
talking and fast talking and trying to give you something for 
nothing.
    But I have one question. How many of you had an 
independent, outside participant with you as you went through 
this, for example, a lawyer?
    For the life of me, I have never gone to a closing on a 
mortgage without a lawyer. And I am wondering whether any of 
you in the situations you had had some independent party that 
would challenge the efficacy of this process.
    Ms. Podelco. [Nods in the negative.]
    Ms. Mackey. [Nods in the negative.]
    Mr. Williams. [Nods in the negative.]
    Mr. Satriano. [Nods in the negative.]
    Chairman Sarbanes. I think the record should show that all 
four panelists, they did not have someone with them.
    Senator Corzine. I am not sure on all of the steps that we 
need to take in this process, but the idea that people who deal 
in the subprime market and this secondary lending have the 
ability to have a one-on-one relationship without someone who 
has the financial skills to evaluate some of these programs 
makes a lot of sense.
    You are courageous. I appreciate very much your statements 
and participation and help in this process, and I look forward 
to us pushing aggressively forward. And I also have to identify 
with the bankruptcy remarks that the Senators from Connecticut 
and Rhode Island made. This is not a one-sided affair, as I 
think we heard it mostly debated on the floor of the Senate.
    Chairman Sarbanes. Thank you very much, Senator Corzine.
    I want to tell the panel members how much we appreciate 
their testimony. As I said at the outset, I know it is 
difficult to appear in this public atmosphere to tell your 
personal story, but it constitutes a valuable contribution to 
this effort we have undertaken.
    Some of my colleagues made note of it, and I think I ought 
to, for the completeness of the record, observe that there are 
a number of financial institutions that have announced 
recently, subsequently to when we scheduled these hearings, a 
number of steps that would address some of the concerns that 
are here today.
    In particular, a number of companies have announced that 
they will no longer finance single premium insurance in their 
loans, roll it into the mortgage and then you end up paying 
interest over a sustained period of time. Other practices have 
also been changed.
    Those are important steps and we welcome them. But there is 
more to be done, obviously, and we intend to continue to press 
forward with really laying out exactly what the problem is, so 
it is fully understood.
    We want the regulators to exercise more effective control. 
We want tougher enforcement of existing laws, which may well 
need the commitment of more resources.
    But there are practices going on that are not illegal under 
existing laws. The repeated refinancing of a loan and the 
stripping out of equity is technically not illegal.
    And so, we need to address those problems. We need to 
address the education dimension which Senator Corzine talked 
about. And I encourage the industry itself to continue to try 
to establish best practices and raise the level of activity 
within the industry.
    It is very helpful in all of this that people will come in 
and speak out about their own experience. I know it is, in some 
respects, as Ms. Mackey said, embarrassing for you, although 
you have passed that threshold, I gather, now.
    But you have made a very substantial contribution here 
today and we thank you very much. We will excuse this panel and 
move on to our next panel.
    Thank you all very much.
    The Committee will take just a brief pause while we move 
this panel out and bring the other panel on.
    [Pause.]
    Chairman Sarbanes. I want to welcome the second panel. I 
know you have been waiting quite a while.
    On this panel we have: Tom Miller, the long-time Attorney 
General of Iowa, and the Chairman of the Predatory Lending 
Working Group of the National Association of State Attorneys 
General; Steve Prough, the Chairman of Ameriquest Mortgage 
Company, one of the larger subprime lenders in the country. And 
Ameriquest has developed a program, with a number of civil 
rights and community organizations, which we are looking 
forward to hearing about this morning; Charles Calomiris, 
professor of finance at the Columbia Business School and the 
Codirector of the Project on Financial Deregulation at the 
American Enterprise Institute; and Martin Eakes, who is the 
President and CEO of the Self-Help Credit Union in North 
Carolina. Mr. Eakes has, as I think we all know, been a leader 
in the effort to fight predatory practices, both in his home 
State of North Carolina and nationally. And of course, North 
Carolina has taken a number of very important initiatives that 
I think are worthy of attention. We welcome all of you.
    Gentlemen, we are running late this morning. I think what 
we will do is we will include your full statements in the 
record. I very much appreciate the obvious effort and time and 
thought that was devoted to preparing these statements. They 
are quite comprehensive and they will be of enormous help.
    If you could summarize your statements in 8 to 10 minutes, 
we would appreciate that. And then we will go to a question 
period. Attorney General Miller, why don't we start with you? 
We are pleased to welcome you before the Committee, and I might 
note that many years ago, in his younger life, Attorney General 
Miller worked as a Vista volunteer in Baltimore, Maryland. We 
were pleased to have him there and we are pleased to have him 
here today before the Committee.
    Mr. Miller.

                 STATEMENT OF THOMAS J. MILLER

              ATTORNEY GENERAL, THE STATE OF IOWA

    Mr. Miller. Thank you, Mr. Chairman.
    You might add that I was also a very enthusiastic volunteer 
in your campaign.
    Chairman Sarbanes. I did not want to make it political.
    [Laughter.]
    Mr. Miller. I will try and summarize as you suggested. In a 
way, a summary is made easy because of what happened before. 
The testimony that we heard before was compelling. It was 
strong. It was complete. And it tells the story. It tells the 
story because it did not happen to just those four individuals. 
It happens to many people throughout the country.
    Even in a place like Iowa. I met 2 days ago with three very 
similar people to the four you heard this morning, very similar 
stories and very sad stories. Indeed, the conduct is bad enough 
and it is being done often enough throughout the country, that 
I believe it is truly a national scandal.
    I think you summarized the elements that are used by 
various people against low income people to do this in America 
and I will just mention them briefly. And keep in mind that it 
is the combination of these tricks and these gimmicks and these 
charges that accomplishes the draining of their equity and the 
loss of their house.
    First of all, as was mentioned, it is the points and 
related charges that can add up to thousands of dollars, often 
5 to 10 percent and more. Then it is the credit insurance. And 
there is absolutely no reason for this insurance. Let us look 
at this.
    A low income person that is trying, struggling to buy a 
house, going to an equity loan, a second mortgage, in terms of 
what they need and what they would choose, would they choose 
insurance payments at a large level? It just does not make 
sense. It is pure exploitation. And I am pleased, as you 
mentioned, that three companies have decided not to use that.
    One of the people we talked to earlier this week had paid 
$10,000 for a single premium credit insurance. And then they 
were going to pay $66,000 in interest. So $76,000 for a product 
that they do not need, would not choose, given their other 
needs.
    The interest rate is higher, sometimes even getting into 
the high-teens and into the 20 percent. And one thing that was 
alluded to by the earlier speakers that I want to point out is 
a whole group of people that are involved in this. And they are 
called bird dogs. They are independent brokers or they are home 
improvement people that often do very fraudulent home 
improvement. And they are out looking for these people.
    They are out looking for the four people that you saw this 
morning, the three people that I saw on Tuesday. And they have 
various ways of finding them. And they do find them. And all of 
this is below the radar screen. They will lie about everything. 
It reminds me a little bit about telemarketing fraud that we 
fought a few years ago. When people got on the phone, those 
telemarketing fraud operators, they would lie about everything 
to close that deal. These bird dogs do exactly the same thing.
    Another abusive practice is the balloon payment. Because of 

everything that these people are being charged and the interest 
rate that is high in addition, people cannot pay off the loans. 
So what they do is they give them a 15 year balloon payment at 
about the same price of the loan itself. So there is no chance 
that they will ever pay it off.
    Then there is flipping that the lady from West Virginia so 
eloquently laid out, the flipping from company to company to 
company, adding on those charges, those 10-, 20-, 30-percent 
charges each time--that is part of it.
    And then just to make sure, once they have people hooked, 
that they do not get off the hook somehow by maybe a family 
member helping or a friend helping, there is the prepayment 
penalty, to hold them on onerous terms. And if they decide that 
they might want to go to court, it is the arbitration clause.
    It is all of these things that are brought together. They 
are a national scandal because of what they do to people. And 
you can tell they are the part of business plans of some of 
these companies.
    The bird doggers that I mentioned are part of just a 
fraudulent operation. This is just a whole set of people and 
circumstances that are exactly out to abuse people in the way 
that is described. And of course they do it primarily with poor 
people, primarily with minorities, primarily with elderly, the 
ones that are most vulnerable in our society. As I say, I 
believe it is a national scandal. The question is what do we do 
about it?
    Well, first of all, society has to recognize that this is 
totally unacceptable. We as a society need to push back. And 
that is why I think it is so important that you have called 
this hearing. Putting the light of day on these practices is 
extremely important. But of course much more has to be done.
    Some things have to be done by the companies. Some very 
reputable companies are involved by owning some of the 
subsidiaries, by buying some of the loans, in some instances 
dealing with the bird dogs.
    They have to change their companies. And I think some of 
them are about doing that. You mentioned on credit insurance. I 
talked to one other company. It is amazing, when my name showed 
up on the witness list, I started to get calls, Senator from 
one of the large companies that indicated perhaps some real 
constructive change.
    The industry has to clean this up because what we have seen 
happen is totally intolerable. And any self-respecting 
individual or company cannot be involved with what I just 
described. They need to recognize that and I think they are 
starting to get the message.
    We need enforcement. We attorney generals recognize this as 
a problem, a big problem. We have just recently put together a 
working group, as you mentioned, of attorney generals to work 
on this, that I lead as well as Attorney General Roy Cooper of 
North Carolina and Attorney General Betty Montgomery of Ohio.
    It is something we are concerned about. The FTC is 
involved. Other law enforcement people are involved, and 
understanding the grievous nature of this problem and what 
needs to be done.
    The Federal Reserve needs to act on the regulations that 
are proposed before them. Thirty-one States and 31 State 
Attorney Generals have endorsed and pushed for those 
regulations. I think it is very important that those reforms go 
forward.
    Congress needs to act. They need to look at some of the 
features perhaps that are preemptive on States. There may be a 
role for States to play, a somewhat larger role, realizing that 
we are dealing with a national problem.
    And you need to take a look at HOEPA. HOEPA has changed 
some things in a constructive way. But there are more things 
that you can do on credit insurance, on balloon payments, on 
the size of fees and charges, and on the ability to pay. We 
need to look at this from a whole range of people.
    Like many problems in the public policy arena, there is no 
silver bullet. There is no one thing that we can do. But we can 
focus on it from a number of different aspects in combination. 
Much like they put those various combinations of bad things 
together to achieve the result, we can push back and make a 
difference.
    And I appreciate what the Senator said about this being a 
problem that needs to be dealt with in a way that does not harm 
legitimate subprime credit. It is very important that low 
income people have the opportunity to get loans and buy houses 
through sub-
prime credit that is reasonable and fair.
    And companies can tell the difference. Companies can tell 
the difference of these elements and the kind of lending that 
Senator Gramm and others talked about.
    It is very important that people like Senator Gramm's mom 
be able to buy a house like she did. But I will tell you what. 
If these people got a hold of her, she would not have been able 
to buy that house. She would either be paying yet today, 52 
years later, or be out of the house.
    That is what is at stake here--to preserve what is good in 
the credit industry, constructive credit, and to deal strongly 
and effectively with destructive credit, which drains the 
equity and the hopes and the dreams from the people of America 
that are affected.
    Mr. Chairman, thank you for inviting me to testify and 
thank you for bringing this issue to the fore. It is a very 
important issue.
    Chairman Sarbanes. Thank you very much, Attorney General 
Miller.
    Mr. Prough.

                 STATEMENT OF STEPHEN W. PROUGH

             CHAIRMAN, AMERIQUEST MORTGAGE COMPANY

                       ORANGE, CALIFORNIA

    Mr. Prough. Good morning, Mr. Chairman. My name is Steve 
Prough and I am Chairman of Ameriquest Mortgage Company. 
Ameriquest Mortgage Company is a specialty lender. We provide 
affordable loans to average American homeowners who have 
imperfect credit profiles. We are headquartered in Orange, 
California. We have 220 offices nationally in 33 States and we 
have 3,200 professionals assisting our customers to utilize 
their most important asset--their home--in order to obtain 
affordable credit to help meet their own personal needs. 
Virtually all of our loans are to allow homeowners to refinance 
and access capital. Our loan production grew to approximately 
$4.1 billion in originations in 2000, and we anticipate that 
growth will continue in 2001, resulting in approximately $5.5 
billion of loan originations. Our servicing portfolio 
totals $8.5 billion in loans.
    From the company's senior management down through our 
newest hires, we at Ameriquest Mortgage Company believe that 
borrowers are best protected against abusive lending practices 
when lenders adopt firm lending practices and when borrowers 
are given the information they need to make informed decisions 
in their own best interests. That is why we instill in all our 
employees a commitment to promoting the importance of fair 
lending practices and consumer awareness.
    As we developed our business, we found that the financial 
needs of many average Americans with impaired credit were not 
being met at all, or at affordable prices by the home financing 
industry. Ameriquest sought to meet those needs by providing 
financing on more favorable terms and at lower cost than had 
historically been offered to credit impaired individuals by 
other lenders.
    Leveraging secondary market sources and capital from Wall 
Street, we originate, package, and then sell our loans. As a 
result of the efficiency of these markets, we are able to offer 
lower costs to our customers. Thus, through our Wall Street 
financing model, we have substantially lowered the cost of 
financing for Ameriquest borrowers.
    We help working families and individuals whose credit may 
be impaired for a variety of reasons. Our average customer is: 
47 years old, from a suburban community, a 10 year homeowner, 
stable income with an average of 12 years' employment and, 
finally, an average income of $70,000. This is a portrait of 
the Ameriquest customer who has special credit needs that we 
have helped achieve their goals.
    We at Ameriquest are very proud of our history of making 
loans available to borrowers who have been denied credit, but 
have credit needs. It should be recognized that the specialty 
lending industry has contributed to the highest homeownership 
in the Nation's history and has helped open access to capital 
for traditionally underserved communities. We feel very 
strongly that all lenders must be subject to rules that 
effectively prevent them from engaging in misleading or 
deceptive practices and from imposing unfair terms or 
practices. These actions are wrong. They have no place in the 
real estate lending industry or, for that matter, in any credit 
transaction whatsoever.
    While we believe that it is important that lenders refrain 
from acting in a manner that seeks to take advantage of 
borrowers, we also believe that it is equally important that 
responsible lenders take action to adopt and implement 
practices specifically designed to promote fair lending and to 
enable borrowers to make intelligent, informed decisions about 
their credit needs. It is for this reason that our business 
philosophy is ``Do The Right Thing.''
    Ameriquest Mortgage Company has fostered long-standing 
relationships with the Leadership Conference on Civil Rights, 
the Nation's oldest and largest civil rights coalition, the 
National Fair Housing Alliance, the National Association of 
Neighborhoods, and more recently, with the Association of 
Community Organizations for Reform Now--ACORN. These groups 
have been our allies in the cause to promote fair lending and 
consumer awareness. Ameriquest Mortgage Company has partnered 
with these committed advocates to develop and implement a set 
of best practices to ensure that our borrowers receive top 
quality service and fair treatment and are able to obtain loans 
that meet their financial needs on reasonable terms and at fair 
prices.
    In developing our set of best practices, we asked our key 
community group allies to help us identify their principal 
concerns regarding subprime lending activities. While 
Ameriquest had long ago 
addressed many of those concerns, we implemented practices and 
policies to address others as part of our constant effort to 
improve our programs to meet our customers' needs.
    Ameriquest Mortgage Company provides to every customer: 
reasonable rates, points, and fees; full and timely disclosure 
of loan terms and conditions in plain English; recommended 
credit counseling; a full week to allow customers to evaluate 
whether our loan best suits their needs; a highly qualified 
loan servicing officer who has been trained in fair lending 
practices.
    In addition, we: report all borrower repayment history to 
credit bureaus; maintain arm's-length relationship with third 
parties such as title companies, loan appraisers, and escrow 
companies.
    The following practices, although legal and conducted by 
some, are not offered by Ameriquest: no single premium credit 
life insurance to borrowers; no refinancing of a loan within 24 
months of its origination; no loans with mandatory arbitration 
clauses; no loans with balloon payments; no negative 
amortization loans.
    Our best practices include providing each customer a one-
page document, written in plain English, that clearly 
identifies all of the important terms of the loan using very 
simple phrases.
    We are very concerned about the fact that you receive a 
big, huge bundle of information and there is no one page that 
this is all put on. So that is why we clearly state on one 
page: your interest rate is--; you have a prepayment charge 
of--; your total fees are--
    Very simple, very straightforward. We prepare a side-by-
side comparison for prospective borrowers of our initial loan 
quote and the final loan offering so that people can see 
exactly what they are getting from what we originally had 
offered them in order to ensure dialogue that would take place 
during the process.
    We recommend credit counseling to all our customers by 
providing the 800-number for HUD-certified loan counseling. 
Instead of the standard three-day rescission period called for 
under existing law, we provide all of our customers in our 
retail lending network with a full week to allow them to shop 
for better loans. That added time allows them to determine 
without pressure and with the help of trained credit counselors 
if ours is the best loan for them. Our loan servicing 
associates go through a stringent training program, with a 
minimum of 80 hours of training. We want to ensure that in the 
case of every borrower, we are being sensitive to that 
borrower's needs.
    All of our best practices empower consumers to make the 
right choice for them. Why do we do this? We do it because it 
is the right thing to do. But we also do it because we honestly 
believe our business benefits from our best practices. We 
benefit when we have fully informed borrowers who recognize 
that they have been treated fairly, rather than dissatisfied 
customers who feel that they have been taken advantage of.
    There are many of us in the specialty lending sector that 
have been fairly and responsibly assisting traditionally 
underserved communities, and have helped countless, hard 
working families gain access to capital. I know you want us to 
continue to lend to this segment of America, since 
homeownership is one of the key elements of our society that 
most embodies the American Dream.
    No responsible lender wishes to engage in abusive lending 
practices. And I am sure everyone in this room would agree that 
a single deceitful loan is one too many. Regulatory authorities 
need to use the full range of their existing enforcement powers 
and to devote more resources to enforcement of existing laws 
designed to guarantee that customers receive loans appropriate 
for their needs and fair terms. We at Ameriquest Mortgage 
Company believe that our set of best practices is designed to 
achieve that very result in three ways: one, our best practices 
prohibit certain specific kinds of abusive practices; two, our 
best practices provide clear and full disclosure of the 
critical loan terms in plain English; and three, we make credit 
counseling available to our borrowers and encourage them to 
make use of it and provide a one-week, post-approval 
period during which the borrower can shop our loan and 
evaluate, with the help of a credit counselor, whether the loan 
we have offered is truly a loan the borrower wants.
    In short, strong enforcement of existing laws coupled with 
a strong set of best practices is the best tools to ensure that 
consumers are best served. Although we do not believe that 
additional laws or regulations are needed, it would be best, if 
there is to be action, for it to come at the Federal level, 
rather than adding to the existing patchwork of State and local 
ordinances.
    Ameriquest Mortgage Company creates loans the old-fashioned 
way--we take the time to develop a loan for each borrower based 
on their individual needs. This is how I started my lending 
career 30 years ago, when banks were more personal and took the 
time to get to know their customers. It is important to 
recognize that this form of lending is more subjective at the 
individual level and requires increased personal attention from 
the loan officer.
    We hope as this Committee considers any proposed new 
legislation, you are careful as you proceed to ensure that 
there are no unintended consequences that would have the effect 
of limiting access to credit for those who need it most. In 
that way, we ask for your support in helping us to continue to 
serve Middle America and reach traditionally underserved 
communities.
    Ameriquest commends you for focusing attention on these 
issues. As one of the Nation's largest retail special lenders, 
we share your commitment to making the dream of homeownership 
affordable and fairly accessible for all Americans. We at 
Ameriquest look forward to continuing to work with you.
    Thank you very much.
    Chairman Sarbanes. Well, thank you very much, Mr. Prough, 
and we appreciate, as Chairman of Ameriquest Mortgage Company, 
you coming across the country from California, in order to be 
here with us at this hearing and to give us this testimony.
    I am also very appreciative of the attachment that you have 
to your statement setting out in considerable detail Ameriquest 
Mortgage Company's retail best practices. It is very helpful to 
the Committee to have that information.
    Professor Calomiris.

               STATEMENT OF CHARLES W. CALOMIRIS

                   PAUL M. MONTRONE PROFESSOR

                    OF FINANCE AND ECONOMICS

        GRADUATE SCHOOL OF BUSINESS, COLUMBIA UNIVERSITY

                       NEW YORK, NEW YORK

    Mr. Calomiris. Thank you, Mr. Chairman. It is a pleasure 
and an honor to address you today on the important topic of 
predatory lending.
    Predatory lending is a real problem. It is, however, a 
problem that needs to be addressed thoughtfully and 
deliberately, with a hard head as well as a soft heart.
    Chairman Sarbanes. That is what we are trying to do, yes.
    Mr. Calomiris. There is no doubt that people have been hurt 
by the predatory practices of some creditors and we have heard 
about that today quite a bit. But we must make sure that the 
cure is not worse than the disease. Unfortunately, many of the 
proposed or enacted municipal, State and Federal statutory 
responses to predatory lending would have adverse consequences 
and in fact already have had adverse consequences that are 
worse perhaps than the problems they seek to redress. Many of 
these initiatives would reduce the supply or have reduced the 
supply of credit to low income homeowners, raise their cost of 
credit, and restrict the menu of beneficial choices available 
to borrowers.
    Fortunately, there is a growing consensus in favor of a 
balanced approach to this problem. That consensus is reflected 
in the viewpoints expressed by a wide variety of individuals 
and organizations, including Robert Litan of the Brookings 
Institution, Fed Governor Edward Gramlich, most of the 
recommendations of last year's HUD Treasury report, the 
voluntary standards set by the American 
Financial Services Association, the recent predatory lending 
statute passed by the State of Pennsylvania, and the 
recommendations and practices of many subprime lenders.
    An appropriate response to predatory practices should 
occur, I think, in two stages. First, there should be an 
immediate regulatory response to strengthen enforcement of 
existing laws, enhance disclosure rules, provide counseling 
services, amend existing regulation in some ways, and limit or 
ban some practices. I believe that these initiatives, which I 
will describe in detail in a minute, will address all of the 
serious problems associated with predatory lending.
    Second, in other areas, especially the regulation of 
prepayment penalties and balloons, any regulatory change, I 
think, should await a better understanding of the extent of 
remaining predatory problems that result from these features. 
And the best way to address those is through appropriate 
regulation. The Fed is currently pursuing the first systematic 
scientific evaluation of these areas as part of its clear 
intent to expand its role as the primary regulator of subprime 
lending. Given its authority under HOEPA, the Fed has the 
regulatory authority and the expertise necessary to find the 
right balance between preventing abuse and permitting 
beneficial contractual flexibility.
    I think the main role Congress should be playing at this 
time is to rein in actions by States and municipalities that 
seek to avoid established Federal preemption by effectively 
setting mortgage usury ceilings under the guise of consumer 
protection rules. Immediate Congressional action to dismantle 
these new undesirable barriers to individuals' access to 
mortgage credit would ensure that consumers throughout the 
country retain their basic contractual rights to borrow in the 
subprime market.
    The problems that fall under the rubric of predatory 
lending are only possible today because of the beneficial 
democratization of consumer finance and mortgage markets in 
particular that has 
occurred over the past decade. Predatory practices are part and 
parcel of the increasing complexity of mortgage contracting in 
the high-risk, subprime mortgage area. That greater contractual 
complexity has two parts: One, the increased reliance on risk 
pricing using Fair Issac scores rather than the rationing of 
credit via a yes or no lending decision. And second, the use of 
points, credit insurance, and prepayment penalties to limit the 
risks lenders and borrowers bear and the costs borrowers pay.
    These practices make economic sense and can bring great 
benefits to consumers. Most importantly, these market 
innovations allow mortgage lenders to gauge, price, and control 
risk better than before and thus allow them to tolerate greater 
gradations of risk among borrowers.
    According to last year's HUD-Treasury report, subprime 
mortgage originations skyrocketed since the early 1990's, 
increasing by ten-fold since 1993. The dollar volume of 
subprime mortgages was less than 5 percent of mortgage 
originations in 1994, and in 1998, it was 12.5 percent. As 
Governor Gramlich has noted, between 1993 and 1998, mortgages 
extended to Hispanic-Americans and 
African-Americans increased the most, by 78 and 95 percent, 
respectively, largely due to the growth in subprime mortgage 
lending.
    Subprime lending is risky. The reason that so many low-
income and minority borrowers tend to rely on the subprime 
market is that, on average, these classes of borrowers tend to 
be riskier. It is worth bearing in mind that default risk 
varies tremendously in the mortgage market. The probability of 
default--based on Standard & Poor's credit ratings--for the 
highest risk class of subprime mortgage borrowers is roughly 23 
percent, which is more than 1,000 times the default risk of the 
lowest risk class of prime mortgage borrowers.
    When default risk is that great, in order for lenders to 
participate in the market, they must be compensated with 
unusually high interest rates. But, default risk is not the 
only risk that lenders bear. Indeed, prepayment risk is of a 
similar order of magnitude in the mortgage market.
    In the subprime market where borrowers' creditworthiness is 
also highly subject to change, prepayment risk results from 
improvements in borrower riskiness, as well as changes in U.S. 
Treasury interest rates.
    Borrowers in the subprime market are subject to significant 
risk that they could lose their homes as a result of death, 
disability, or job loss of the household's breadwinners. 
Because single premium insurance commits the borrower to the 
full length of the mortgage, the monthly cost of single premium 
credit insurance is much lower than the cost of monthly 
insurance.
    Single premium insurance has been much maligned here today. 
Mr. Miller said there is no reason to have single premium 
insurance. But I checked on some facts. I called up Assurant 
Group, which is a major provider ultimately of credit insurance 
in the mortgage market, and asked for a cost comparison. The 
monthly cost, that is, taken on a monthly basis over the life 
of the mortgage, the monthly present-value cost for monthly 
credit insurance that is paid each month, not all at once, on a 
5 year mortgage, on average, is about 50 percent more expensive 
than the monthly cost of single premium credit insurance.
    A lot of these intermediaries have left the market because 
the bad public relations about single premium insurance has 
been bad for their business. That is unfortunate, I think, and 
I will come back to how I think we can regulate single premium 
insurance without doing harm to borrowers.
    The Congress recognized that substantial points, prepayment 
penalties, short mortgage maturities, and credit insurance, 
have arisen in the primary market in large part because these 
contractual features offer preferred means of reducing overall 
costs and risks to consumers. Default and prepayment risks are 
higher in the subprime market and therefore, mortgages are more 
expensive and mortgage contracts are more complex.
    The goal of policymakers should be to define and address 
predatory practices without undermining real important 
opportunities in the subprime market. So what are those 
practices? They have already been mentioned.
    According to the HUD-Treasury report, they are loan 
flipping, packing or excessive fee charges, lending without 
regard to the borrower's ability to repay, and outright fraud.
    Many alleged predatory problems revolve around questions of 
fair disclosure and fraud prevention. But the critics of 
predatory lending are correct when they say inadequate 
disclosure and outright fraud are not the only ways borrowers 
may be fooled. Let me now turn to an analysis of specific 
proposed remedies.
    First, I would recommend enhanced disclosure and new 
counseling opportunities for mortgage applicants. In my 
statement, I go through a very long list of ways to improve 
disclosure and counseling, but I will omit that here in the 
interest of time.
    Credit history reporting. It is alleged that some lenders 
withhold favorable information about customers in order to keep 
and use that information privately. I think it is appropriate 
to require lenders not to selectively report information to 
credit bureaus.
    Now single premium insurance. Keep in mind, roughly one in 
four households do not have any life insurance. And so, single 
premium credit insurance or monthly credit insurance can be 
very beneficial. To prevent abuse, though, of single premium, 
there should be a mandatory requirement that lenders that offer 
single premium insurance have to do three things. One, they 
must give borrowers a choice between single premium and monthly 
premium credit insurance. Second, they must clearly disclose 
that credit insurance, whether single premium or monthly, is 
optional and that the other terms of the mortgage are not 
related to whether the borrower chooses credit insurance. And 
third, they must allow borrowers to cancel their single premium 
credit insurance and receive a full refund of the payment 
within a reasonable time after closing.
    What about limits on flipping? Well, I think there have 
been several new proposals. I agree that there needs to be some 
action. The Fed rule that has been proposed would prohibit 
refinancing of 
a HOEPA loan by the lender or its affiliate within the first 12 
months, unless that refinancing is, ``in the borrower's 
interest.'' This is a reasonable idea so long as there is a 
clear and reasonable safe harbor in the rule for lenders that 
establishes criteria under which it will be presumed that the 
refinancing was in the borrower's interest. For example, if a 
refinancing either, A, provides substantial new money or debt 
consolidation, B, reduces monthly payments by a certain amount 
or, C, reduces the duration of the loan, then any one of those 
features should protect the lender from any claim that the 
refinancing was not in the borrower's interest.
    What about limits on refinancing of subsidized government 
or not-for-profit loans? It has been alleged that some lenders 
have tricked borrowers into refinancing heavily subsidized 
government or not-for-profit loans. Lenders that refinance 
these loans, I believe should face very strict tests for 
demonstrating that the refinancing was in the interest of the 
borrower.
    Should we have any outright prohibitions? Well, I believe 
that some mortgage structures really do add little real value 
to the menu of consumer options and are especially prone to 
abuse. In my judgment, the Federal Reserve Board has properly 
identified payable-on-demand clauses or call provisions as 
examples of such contractual features that should be 
prohibited.
    How should we deal with prepayment penalties? We should 
require lenders to offer loans with and without prepayment 
penalties. Rather than regulate prepayment penalties at this 
time, I would recommend requiring that HOEPA lenders offer that 
choice.
    What about balloons? I think that, again, limits on 
balloons and also proposed limits on new brokers' practices may 
be a good idea, but I think that we should await more data 
before we know exactly how to shape those rules.
    My final point and I know I am running out of time is 
dealing with usury laws. These are very bad ideas. I want to 
focus on the recent legislation that has been enacted and the 
problems that have come from it. Because of legal limits on 
local authorities to impose usury ceilings because of Federal 
preemption, explicitly, that is, they cannot explicitly impose 
usury ceilings, they have adopted what I would call an 
alternative stealth approach to usury laws. The technique is to 
impose unworkable risks on subprime lenders that charge rates 
or fees in excess of government-specified levels and thereby, 
drive high-interest rate lenders from the market. Several 
cities and States have passed or are currently debating these 
stealth usury laws for subprime lending.
    For example, the City of Dayton, Ohio, this month passed a 
Draconian antipredatory lending law. This law places lenders at 
risk if they make high-interest loans that are, ``less 
favorable to the borrower than could otherwise have been 
obtained in similar transactions by like consumers within the 
City of Dayton.'' And lenders may not charge fees and/or costs 
that, ``exceed the fees and/or costs available in similar 
transactions by like consumers in the City of Dayton by more 
than 20 percent.''
    In my opinion, it would be imprudent for a lender to make a 
loan in Dayton governed by this statute. Indeed, I believe that 
the statute's intent must be to eliminate high-interest loans, 
which is why I describe it as a stealth usury law. Immediately 
upon the passage of the Dayton law, Banc One announced that it 
was withdrawing from origination of loans that were subject to 
the statute. No doubt, others will exit, too. The recent 131 
page antipredatory lending law passed in the District of 
Columbia is similarly unworkable.
    What about North Carolina, which pioneered this area in 
1999? As Donald Lampe points out, massive withdrawal from the 
subprime lending market has occurred in response to the overly 
zealous initiative against predatory lending by North Carolina.
    Michael Staten of the Credit Research Center of Georgetown 
University has compiled a new database on subprime lending that 
permits one to track the damage, the chilling effect, of the 
North Carolina law on subprime lending in the State.
    Staten's statistical research, which I reproduced with his 
permission in the appendix to my testimony, compares changes in 
mortgage originations in North Carolina with those of South 
Carolina and Virginia before and after the passage of the 1999 
North Carolina law.
    Staten finds that originations of subprime mortgage loans, 
especially first lien subprime loans, in North Carolina, 
plummeted after passage of the 1999 law, both absolutely and 
relatively to its neighbors, and that the decline was almost 
exclusively in the supply of loans available to low- and 
moderate-income borrowers, those most dependent on high-cost 
credit. For borrowers in the low income group, with annual 
incomes less than $25,000, originations were cut in half. For 
those in the next income class, with annual incomes between 
$25,000 and $49,000, originations were cut by roughly a third. 
The response to the North Carolina law provides clear evidence 
of the chilling effect of antipredatory laws on the supply of 
subprime mortgage loans to low-income borrowers. And in fact, 
was anticipated in the critical remarks that Bob Litan made 
about these laws.
    The history of the last two decades shows that usury laws 
are highly counter-productive. Limits on the ability of States 
to regulate consumer lenders headquartered outside their State 
were undermined happily by the 1978 Marquette National Bank 
case and furthered by the 1982 passage of the Alternative 
Mortgage Transaction Parity Act.
    I will not go into all my details in this discussion, but I 
want to emphasize that it would be very useful for Congress to 
reassert Federal preemption to prevent any more damage from 
taking place.
    Let me conclude, for the most part, predatory lending 
practices can be addressed by focusing effort on better 
enforcing laws, improving disclosure rules, offering government 
finance counseling, and placing a few well thought-out limits 
on credit industry practices. The Fed already has the authority 
and the expertise to formulate those rules and is in the 
process of doing so based on a new data collection effort that 
will permit an informed and balanced approach to regulating 
subprime lending.
    And again, I emphasize, the main role of Congress should be 
to reestablish Federal preemption. And I hope also Members of 
Congress, and especially Members of this Committee, will speak 
out in defense of honest subprime lenders, of which there are 
many. The possible passage of State and city usury laws is not 
the only threat to the supply of subprime loans. There is also 
the possibility that bad publicity, orchestrated perhaps by 
well-meaning community groups, itself could force some lenders 
to exit the market.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Well, thank you. This is a very useful 
statement and appendix for the Committee to have because it 
puts together a lot of the assertions that have been made, 
which I think will require very careful analysis on our part.
    We are approaching this issue with a hard head and we would 
be interested to see how this analysis withstands a hard head 
analysis, how this statement withstands a hard head analysis. 
So, it is helpful to have it all put together the way you have 
done it and I want to thank you because, obviously, a good deal 
of effort has gone into it.
    Mr. Calomiris. Thank you, Mr. Chairman.
    Chairman Sarbanes. Mr. Eakes.

                   STATEMENT OF MARTIN EAKES

           PRESIDENT AND CEO, SELF-HELP ORGANIZATION

                     DURHAM, NORTH CAROLINA

    Mr. Eakes. Thank you, Mr. Chairman.
    I too in the last couple of weeks since my name has been on 
this list have been called by numerous lenders telling me that 
they are giving up single premium credit insurance, hoping that 
I would not mention their names in this hearing, including one 
as late as yesterday. I come to you today in two roles.
    The first is in my role as CEO of Self-Help, which is an 
$800 million community development financial institution. That 
makes us the largest nonprofit community-development lending 
organization in the Nation, which is also about the size of one 
large bank branch, to put it into perspective. Self-Help has 
been making subprime mortgage loans for 17 years. We are 
probably one of the oldest, still-remaining, subprime mortgage 
lenders. We have provided $1.6 billion of financing to 23,000 
families across the country. We charge about one-half of 1 
percent higher rate than a conventional-rate mortgage. We have 
had virtually no defaults whatsoever in 17 years. If you have a 
23 percent default, I can almost assure you, it is the result 
of lending with fraud in that process. Subprime lending can be 
done right. We agree that there are good subprime lenders. We 
hope that we are one.
    I come to you, second, as a spokesperson for an 
organization that started in North Carolina, called the 
Coalition for Responsible Lending. The coalition that formed in 
North Carolina was a really remarkable event for anyone who 
watches politics among financial institutions. This coalition 
started in early 1999 and started with 120 CEO's of financial 
institutions who came together to ask for a law to be passed in 
order that they could squeeze the bad apples out of the lending 
industry in North Carolina.
    Let me ask you on this Committee, how many times have you 
had credit unions and every bank in the country come together 
and ask you to pass a bill that would regulate them as well as 
everyone else? Ever?
    Chairman Sarbanes. We are working at that right now.
    Mr. Eakes. We are working at that.
    [Laughter.]
    We ended up with a coalition that had 88 organizations that 
represented over 3 million people in the membership of those 
organizations in North Carolina. North Carolina only has 5 
million adult voters in the State. This group included all the 
credit unions, every thrift, every bank, the Mortgage Bankers 
Association, the Mortgage Brokers Association, the realtors, 
the NAACP, civil rights groups, housing groups, AARP and 
seniors groups--every single organization that had something to 
say about mortgage lending in the State of North Carolina came 
together to pass what was not a perfect bill, it was a 
compromise bill among all those parties. And we passed a bill. 
The bill in North Carolina in 1999 passed both the Senate and 
the House virtually unanimously. We had one vote against in the 
Senate and two in the House out of 120 members.
    Let me tell you what the philosophy of the North Carolina 
bill was, which shows you why there was such an encompassing 
consensus. We started with two key principles. The first 
principle was that this bill would add no additional 
disclosures whatsoever. The industry representatives and the 
consumer representatives agreed that real estate closings now 
have 30 plus documents to sign and go through.
    I am a real estate attorney. I have closed hundreds, if not 
thousands, of real estate loans. And I am not sure that I can 
understand every little piece of fine print in those 30 forms. 
I assure you that no ordinary real person can read those 
documents and understand them. It is also unfair to say that 
education or disclosure will solve the problem. I will give you 
an example.
    My father, who was this ornery--some people think I am 
ornery and hard to get along with. I used to be nicer. My 
father was at least twice as mean as I am. He ran a business, 
contracting business. No one could take advantage of him until 
the last 6 months of his life when he was bedridden with 
cancer. And then, all of a sudden, he had people calling him, 
saying, can you refinance your house? And even my father, mean, 
technically competent, a business person, could fall prey to a 
lender who approached him in his own house.
    The second principle that we had was that we would place no 
cap on the interest rate on mortgages. Now this was somewhat 
controversial. We did that for an explicit reason. We said, by 
putting no cap on the interest rate, there can be no rationing 
of legitimate subprime credit in the State of North Carolina.
    Instead, we focused on all the hidden elements of pricing 
in a mortgage loan. And we said, we are going to try to 
prohibit those and force the price into the interest rate, the 
one factor that most borrowers understand best. It has been 
said that it is hard to define predatory lending. Well, in 
North Carolina, whether you like what we did or did not do, 
that is precisely what we did. We identified six practices that 
we thought were the essence of predatory lending.
    In the North Carolina bill, we dealt with only four of 
them. That is all we could do in the first bill. But what we 
did in legislation was precisely define these four predatory 
lending practices in legal, legislative language, and enact 
them into law. The following four practices are what we focused 
on in the North Carolina bill.
    First, we put a threshold limit on upfront fees. It is 
simply a problem, as we heard from the woman from West 
Virginia, when you have upfront fees, you can never get them 
back. The moment you sign the document, you may have lost your 
entire life savings in less than one second of signing your 
name. Instead, what the North Carolina bill said was, no 
financing of fees if the amount of fees is greater than 5 
percent. Now, in all honesty, 5 percent fee to originate a 
mortgage is a very large number. The standard amount paid for a 
conventional, middle-class mortgage that most of us would go 
and obtain is 1.1 percent. That is the standard across the 
country.
    So 5 percent is a pretty extreme compromise. It is not 
something I went home and was proud of after the bill was 
passed. And we said 5 percent of fees, not counting lawyer 
fees, not counting 
appraisals, any of the third-party fees that you normally pay 
at a mortgage closing, that is a limit beyond which there are 
some protections in the North Carolina law. And I guess I would 
call that a stealth usury provision if you want to say that 
charging more than 5 percent fees is a good thing.
    Second, we focused on the practice of flipping. The reason 
that this was so poignant for us in North Carolina is that we 
had done research--you may know this--but President Carter came 
to Charlotte. We have one of the most active Habitat For 
Humanity networks in North Carolina of any State. We found 
researching loan by loan at courthouses that more than 10 to 15 
percent of all Habitat for Humanity borrowers who had $40,000, 
zero-percent first mortgages from Habitat, had been refinanced 
into 14 percent finance company mortgages. Now what does that 
tell you?
    That 10 to 15 percent could not have been acting rationally 
in the way that in academia we assume is a fully functioning 
perfect market. Moreover, it shows that if lenders will take 
advantage of 10 to 15 percent of people who have zero percent 
mortgages and refinance them into 14 percent mortgages, what do 
you think that says about the people who have those measly 7\1/
2\ and 8 percent mortgages. They are certainly fair game for 
flipping. We passed a prohibition for all home loans in North 
Carolina that says you may not flip, refinance a home loan, 
unless there is a net tangible benefit to the borrower.
    Third, we prohibited prepayment penalties on all mortgage 
loans. Well, that is nothing new. In North Carolina, we had 
that prohibition already since 1973. In fact, 31 States across 
the country have limitations prohibiting or restricting 
prepayment penalties on mortgages currently. This one really 
drives me crazy.
    We tell poor people that it is your goal and your message 
is to get out of debt. That is what we charge people with. And 
yet, for the average African-American family with a $150,000 
loan on a home, the average prepayment penalty is about 5 
percent. To pay off that debt, get out of debt, or refinance to 
another borrower, is 5 percent of $150,000, $7,500. That is 
more than the median net wealth of African-American families in 
this country. So in one second, when you sign up for this 
mortgage, you can put at risk an entire lifetime savings of 
wealth for the average median African-American family in this 
country.
    And four, we prohibited in North Carolina the financing of 
credit insurance on all home loans in North Carolina. Before 
predatory lending, I was a nicer human being. But as I listened 
to Professor Calomiris, I hope in the question and answer 
session you will let me come back and maybe engage him in a 
little academic questioning on those terms.
    To say that monthly pay insurance costs 50 percent more 
than single premium insurance is the worst kind of analytic 
mistake or intellectual dishonesty that I can imagine. Every 
analyst who has looked at single premium insurance finds it 
more expensive, which it is. I will give you an example.
    If I came to you and said, you pay for your electric bill 
on a monthly basis every month for the next 5 years and you pay 
it with no interest. Instead, I give you the option to finance 
all 60 months of your electric payment into a loan at the front 
end and pay the interest on it over the next 5 years. And a 
typical case would come to, say, $7,000 or $8,000 of interest. 
At the end of the 5 years, you still owe all of the electric 
payments because you have not paid anything off. Everyone who 
has analyzed single premium credit insurance will tell you that 
it costs twice as much as monthly pay, no matter how you run 
the assumptions, no matter what you do.
    The predatory lenders use this tactic with a borrower the 
same way it is used in public--to say that your monthly cost 
will be lower because all you are paying is the interest. But 
the cost for the single premium credit insurance, like 
financing your electric payments, is still 100 percent, 99 
percent due at the end of 5 years.
    I used to not lose my temper, but this is really driving me 
nuts. Let me tell you how I came to this work.
    For 17 years, I worked and was a preacher preaching that we 
needed to get access to credit, particularly for African-
American homeowners. Access to credit was my watchword.
    In the last 2 years, it has turned totally on its head and 
I no longer worry about whether there is access to credit. It 
is now the terms of credit. And where there were sometimes 
lenders who were starving communities from getting credit they 
needed, the problem now is that many lenders are actually 
eating those communities. They are eating the equity of these 
families.
    I had a borrower who came into my office and he told me 
this story which I really did not believe. I said, bring me 
your paperwork for your loan, which he did. We sat down. He 
showed me his loan. He had gotten a refinance loan from the 
Associates in 1989. It refinanced a Wachovia Veterans 
Administration loan and it was a $29,000 loan. On his 
paperwork, it showed that he had $15,000 of charges added into 
the loan for what was a $29,000 refinance. So, he had $44,000 
of total debt. He paid on that loan for 10 years until he came 
to see me in early 1999. He told me that he had three different 
times tried to pay the loan and that the Associates, recently 
purchased by Citigroup, would not allow him to pay off the loan 
and refinance it.
    I said, I am a lawyer. I know that cannot be true. That is 
illegal. I do not believe it. As I got ready to call the 
company on his behalf, he sat down and tears welled up in his 
eyes and he said, let me tell you one more thing. The reason 
that this house means so much to me is not just the shelter, 
that it is the house I have lived in, but I lost my wife 3 
years ago and I have a 9-year-old daughter. And this house is 
the only connection that my 9-year-old daughter will ever have 
with her mother. And I am sitting here, oh, God.
    And I call the company and the woman on the phone says, ``I 
am not going to give you the pay-off quote.'' Well, there are 
people who have worked with me for 18 years who have never 
really seen me get mad. But at that point, I really lost it and 
I told her--she said,``You are just a competing lender. Why 
should I give you the pay-off quote?'' You are just going to 
refinance them.
    And I told her, if it takes me the rest of my life, I will 
sue you to hell and back and we will get this person out from 
under your thumb. And we will refinance this loan if I lose 
every penny of it. I do not care any more.
    And we did. We refinanced it. We litigated. We reduced the 
loan in half. And that was the beginning, my first knowledge of 
the 
Associates, which many people knew was the rogue company in 
predatory lending. There are a lot. But that one is just a 
horrible company. That was the beginning for me of this 
coalition that started in North Carolina.
    I have since traveled around the country and I have said 
that I will spend every penny that Self-Help owns, I will spend 
every penny that I own until we stop this practice of basically 
stealing people's homes in the guise of lending. A couple more 
stories and I will end and then we can have some questions.
    I got called as an expert witness by the banking 
commissioner in North Carolina who was trying to remove the 
license of a lender. The story was this. The lender has made 
5,000 loans in North Carolina. This can only happen in the 
South. He had advertised on the radio that this is a good 
Christian company. Please come here and we will take care of 
you. He did take care of them. The average fees--he would not 
close a loan for less than 11 points on the front end for any 
of those loans. The person who was the principal of this 
business had met his other senior management in prison for 
trafficking cocaine.
    What came out in the hearing, and I am on the witness stand 
and his lawyer is cross-examining me, saying, why are you 
picking on this company? We are not nearly as bad as three 
others he named. The problem in North Carolina we found was 
unbelievable.
    We found that between 10,000 and 20,000 families in North 
Carolina were losing the equity in their homes or losing their 
homes outright every year. For me, personally, this was really 
an affront. I had spent 18 years at that point helping families 
own homes. And what I found was one or two lenders--I do not 
have to look at the average for the industry--but one or two 
lenders who are undoing in a month's time every possible step 
of good that Self-Help had done with its 23,000 loans over 18 
years. It stopped being an academic issue for me at that point, 
although I think I would be pleased to argue it on academic 
terms.
    There are things that Congress needs to do. We need to 
repeal the Parity Act in its entirety. We need to strengthen 
HOEPA.
    But I will stop there. Thank you.
    Chairman Sarbanes. Thank you very much, Mr. Eakes.
    I am going to ask a few questions. I hope that no one on 
the panel is under an immediate time pressure.
    I want to go to this single premium credit life insurance 
and the assertion that it is cheaper than paying it by the 
month. I just have great difficulty with that analysis. First 
of all, the mortgage is usually for 30 years. The single 
premium is for 5 years. Correct, in most instances?
    Mr. Calomiris. That is not what I am talking about, 
Senator.
    Chairman Sarbanes. Are you talking about a 30 year single 
premium?
    Mr. Calomiris. No.
    Chairman Sarbanes. No one does a 30 year single premium 
because the cost of that premium would be so huge, that it just 
would not fly.
    Mr. Calomiris. I am talking about a 5 year single premium.
    Chairman Sarbanes. That is right. And then they get to the 
end of the 5 years and then they refinance, and then they throw 
in another 5 year single premium. Is that right? Is that what 
happens in almost every instance?
    Mr. Calomiris. I do not think anyone knows what happens in 
almost every instance, Mr. Chairman. But I think we can agree 
on some basic arithmetic principles. I hope we can.
    First of all, we are talking about a stream of cashflows, 
whether you talk about the monthly premium or the single 
premium. And then the question is, if it is monthly premium, 
you have to decide what discount rate do you discount those 
cashflows to arrive at a present value because the right 
comparison, I think you will agree, is that you want to ask 
whether the present value of monthly premium insurance or the 
present value of single premium insurance is larger. If you 
discount, which is the correct way to do it, at the interest 
rate that is charged in the loan, because that is the 
borrower's discount rate, you arrive at a calculation that 
single premium is half as costly.
    Whether you are financing that single premium up front or 
paying it up front, it is equivalent. It does not matter. The 
fact that you are only paying the interest and then 5 years 
from now, you still have to continue paying the interest 
because you have not repaid the balance on the money you 
borrowed to pay the single premium insurance, is irrelevant to 
the computation. I think what we are really having a problem 
with here is what I would call basic finance arithmetic. And I 
think that is unfortunate.
    Chairman Sarbanes. Well, Martin, do you want to address 
that?
    Mr. Eakes. I would love to get into basic finance 
arithmetic with someone because now you are really on my turf. 
I have been a lender for almost 20 years. There is no way that 
you can have a cashflow that includes interest and discount it 
back at any interest rate and have that come out to be lower 
than something that has no interest whatsoever.
    It does not matter. You still have the terminal amount that 
is the full amount of the premium. It does not matter. I am 
absolutely certain that this is an analytic bad mistake in 
every way it can be.
    Chairman Sarbanes. My perception of it is that it is like 
trying to walk up the down escalator. You just keep losing 
ground.
    Let me give you an example from one company. They had a 
$50,000, 15 year mortgage loan with a single premium life 
insurance policy costing $1,900 that was in force for 5 years. 
At the end of the 5 years, the homeowner still owed about 
$1,600 on the original insurance premium. So then he 
refinances. He takes out another policy. So there is another 
$1,900 that is thrown into the loan. Now it is $3,500 that has 
been pulled out of him. We do not really go after the 
protections of the insurance if they pay it on a monthly basis. 
But that is outside of being folded into the loan and then 
paying interest on that large charge. Then the person ends up 
losing their home because you have packed all these fees into 
it.
    Mr. Miller. Senator, if I could just make a couple of 
practical points, too. Think about the income level of the 
people we are talking about.
    Chairman Sarbanes. I want to get to that, too, in a minute 
on the balloon payment, yes.
    Mr. Miller. In this context. All the demands on their 
financial resources. Life insurance would not naturally be high 
on their list. It would not fit in, except for what the lenders 
are doing.
    And think, too, to finance insurance, would that be 
something they would want to put their home in jeopardy for and 
put that in the mortgage? No. It just does not make sense from 
the consumer's point of view. It is only in there for the 
lenders. And indeed, in my view, it is a litmus test of whether 
a lender is in good or bad faith.
    They are out to drain the consumer, if they are selling 
single premium credit life insurance. It is just very clear to 
me where they are headed.
    Mr. Calomiris. Mr. Chairman, if I could just interject.
    Chairman Sarbanes. Certainly.
    Mr. Calomiris. What I am proposing, of course, is not to 
leave things as they are. I am proposing some pretty big 
changes. I am proposing that the lender has to offer both 
products--single premium and monthly premium--that the lender 
has to fully disclose what is the cash that I am going to get 
back? What is the monthly payment I am going to have to make in 
totality? All the charges. And then let the borrower choose.
    And make it also clear that this is entirely optional 
because a lot of the complaints have been that people did not 
understand it was optional, that all of the other terms in the 
loan do not change.
    Somebody has to explain to me why, when somebody is being 
given a choice that is clearly spelled out, and we are going to 
make sure that the disclosure is right, and they decide that 
they would prefer what I would regard, in some cases, at least, 
and from what I understand, on average, cheaper insurance over 
the life of that 5 years, somebody has to explain to me why, 
because a Senator or an activist or an attorney general 
believes that is not the right choice, why they, with 
counseling, on their own, with all information, cannot do it?
    Mr. Miller. Charles, were you here this morning? Did you 
hear what was going on?
    Mr. Calomiris. I was here this morning.
    Mr. Miller. And do you have any sense of the power and 
influence of the industry making these loans and running them 
through? Yours is an academic approach. What we really need to 
do is deal with the real people that we saw this morning, and 
in that setting, to set up these complicated disclosures just 
does not make any sense in the real world.
    Mr. Eakes. This is a product that never benefits the 
consumer. Never. Not a single case. That is why it is so easy. 
And if we have a trained economist who cannot get it right, how 
do we expect a borrower to get it right? When you offer a 
choice between something that in every case costs you the extra 
interest, every single case, it makes it a false choice.
    And so the borrower, yes, they can be deceived into 
choosing it because the predatory lender focuses on the monthly 
payment. And they say, this example of a $100,000 loan with 
$10,000 of up front credit insurance, if you pay for that 
interest only, it would be $133 a month, which is what 
financing it as single premium is. If you pay for it on a 
monthly basis, your monthly payment will be $167.
    So, he is right. It does, on the monthly basis, cost a 
little bit less. But at the end, you still owe $9,900 of the 
single premium credit insurance. To offer a choice of something 
that, in every single case, is worse for the borrower, is 
merely a deception. How can we possibly have the consumer 
understand that. Put it in the interest rate if the lender 
needs that compensation. This is ridiculous.
    Chairman Sarbanes. Let me ask this question.
    How is a borrower in the subprime market who almost by 
definition is right at the limit of their ability to handle the 
matter, going to handle a balloon payment at the end of the 
mortgage period?
    Is that not, to a large extent, building up a huge risk of 
default, or perhaps more likely which keeps happening, a 
refinancing when they get to that point, again in which a lot 
of fees are packed into the loan and we get the sort of process 
that was laid out here this morning where the equity is being 
stripped out of this loan? Does anyone want to address that?
    Mr. Calomiris. When I was younger, I borrowed balloon loans 
because the interest rates are lower because, by keeping 
maturity lower, typically, in a loan, risk is lower--and then I 
rolled it over with the same bank.
    Chairman Sarbanes. And what were your earning prospects 
when you did that?
    Mr. Calomiris. I do not know. I was in my early 20's. I was 
a graduate student at the time. I suppose that if you were 
optimistic about my career ability, you would say they were 
pretty good.
    Chairman Sarbanes. They were pretty good. Now suppose you 
were 70 years old and you were living on Social Security.
    What is the rationale for the balloon payment in that case? 
That is your income. You are at the end of your working life. 
That is your income. And you take out a subprime loan. They 
slap on this balloon payment. Now what is the rationale there?
    Mr. Calomiris. Again, balloon payments tend to reduce 
interest cost, so they can be beneficial. In my statement, of 
course, I recognize that you may want to limit balloons in some 
cases. And, in fact, I argue that was one of the things that I 
hope the Fed will look at. But I do not believe we want to 
rashly decide whether a 1 year balloon or a 3 year balloon or a 
5 year or 7 year, is the right route.
    Chairman Sarbanes. We are not going to decide anything 
rashly.
    Mr. Calomiris. Right.
    Chairman Sarbanes. Let me make that very clear. Nothing 
will be decided rashly.
    Mr. Calomiris. Balloon payments reduce interest costs and 
that is the main benefit anyone derives from them. If there is 
rollover risk, as I think you are suggesting there can be in 
some cases, or if people are tricked and do not understand that 
they are facing a balloon, then I think there is a real issue. 
But let us again not throw the baby out with the bathwater.
    But if I can just make one other comment about flipping. 
Again, I have specific ideas about how you can prevent 
flipping. The problem with the North Carolina law, and the 
reason that it is had such a chilling effect on subprime 
lending already in North Carolina is that it does not give 
anybody safe harbor.
    If you are going to say people cannot flip, that is fine. I 
am all for it. But let us define what flipping is in a very 
clear way, because if we do not define what it is, the legal 
risk that comes from being potentially sued for having flipped 
puts a chilling effect on lending. Let us go after flipping. 
But let us not go after it in a vague way, which is what the 
North Carolina law does. And that is why I think it is had such 
a negative effect.
    Chairman Sarbanes. Well, Mr. Eakes, Professor Calomiris to 
some extent, took out after North Carolina.
    Mr. Eakes. Yes, I think he called me out to a duel, right?
    Chairman Sarbanes. So, you are entitled to some response to 
it, if you choose to make it.
    Mr. Eakes. Let me respond and maybe I will ask a question.
    The data that is cited is from a study paid for by industry 
that looked at nine lenders. Nine lenders. That is the study. 
What it shows is that there has been a drop in lending, which I 
have not seen before today, that says that North Carolina 
dropped in the third quarter of 1999 and the fourth quarter and 
the first two quarters of 2000. That was the data that I saw in 
that study.
    I wish that data were correct. I really do, because it 
would show that the goal that we had in North Carolina--Mr. 
Calomiris may or may not know this--but of the four practices 
that I mentioned, only one of them had gone into effect as of 
the third quarter of 1999 and that is the flipping. So that had 
to be what would show a reduction in originations, by 25 and 50 
percent.
    I wish that number were right because when we passed the 
bill, the goal of the North Carolina legislation was to reduce 
flipping. And the way you reduce flipping is have less loans 
originate. That data would show that gap.
    Here is what I would like to ask, is whether Mr. Calomiris 
knows of any other events that were active in North Carolina 
during the third quarter of 1999? Are you aware of any other 
environmental changes?
    Mr. Miller. Was there a hurricane?
    Mr. Eakes. We had in North Carolina, on September 15, 1999, 
the largest flood in the history of North Carolina ever 
recorded. It took 15,000 units directly down the river. As many 
as 100,000 families were dislocated. September 15, 1999. They 
could not have borrowed money if the predatory lenders had come 
to them in a boat.
    [Laughter.]
    So, his assessment--I wish it were right. I wish that 
really had seen a, ``chilling effect because the only provision 
that we had in effect was the antiflipping.''
    That is what we wanted to do, was to reduce the number of 
flips. But, unfortunately, I am afraid--I actually have heard 
this. It is remarkable. I travel around the country and I hear 
the North Carolina bill--first, I heard that every lobbyist who 
supported it lost their job. Totally false.
    Chairman Sarbanes. Mr. Prough, I want to put a couple of 
questions to you. You have been very patient.
    Mr. Prough. Yes, sir. Well, I would have liked to have 
participated in the conversation on credit life and balloons, 
but since we do not offer those products, there was no need.
    Chairman Sarbanes. Yes. Ameriquest does not engage in those 
practices. Correct?
    Mr. Prough. Never. We never have.
    Chairman Sarbanes. I have the impression by establishing 
this high level of performance, you have been able to make it 
succeed. But I am concerned about--I want to ask this question, 
which may not be fully applicable to you because you have 
really made it work. But if lenders try to follow that course, 
would they be at a competitive disadvantage with respect to 
others in the industry?
    Let me put it this way. I guess they would be missing out 
on the opportunity to make some fast money. Now they choose to 
do that. But they are passing up such an opportunity, are they 
not?
    Mr. Prough. Everybody runs their own business model, 
Senator.
    Our approach is that by using the secondary market, using 
Wall Street, and bundling our loans, we are able to create 
efficiencies and create our profits through moving loans that 
way. And that way, we can pass that cost savings on to the 
consumer.
    Some of these other products just do not fit for that model 
because you are adding costs to the loan which eventually then 
have to be financed through Wall Street. That causes 
complications. We prefer to keep it very simple, very 
straightforward, and do exactly what the customer expects us to 
do, provide home financing.
    Chairman Sarbanes. Well, it is a very interesting model and 
we appreciate your coming here today to tell us about it. No 
question.
    I am going to draw this to a close.
    Mr. Calomiris. May I just make one comment, Mr. Chairman?
    Chairman Sarbanes. Certainly.
    Mr. Calomiris. Because I did not get a chance to respond.
    Chairman Sarbanes. I do not want you to go away feeling 
that. We try to be eminently fair here. Yes.
    Mr. Calomiris. I mean respond on one fact.
    Chairman Sarbanes. Yes.
    Mr. Calomiris. The evidence that I presented in the 
appendix showed that the decline in subprime lending occurred 
only in some income classes. So it seems a little strange to 
say it was the result of a flood, because then you would have 
to believe that the flood only affected people with incomes 
below $50,000.
    Chairman Sarbanes. But the subprime lending occurs 
primarily in certain income classes, does it not?
    Mr. Calomiris. The point, Mr. Chairman, is that I have it 
for the different income classes, only subprime lending. I am 
not looking at all lending. Just subprime. The point is that it 
only affected people who are really subject to these particular 
rules. And I did note that was phased in over 2000 and the data 
are about 2000, not about the end of 1999. I just want to 
emphasize that we do not have all the facts here before us. I 
do not claim that we do.
    Chairman Sarbanes. You want to get out from under the 
flood, I take it. Is that it?
    Mr. Calomiris. Exactly.
    [Laughter.]
    As I say, that dog is not going to hunt.
    Mr. Eakes. If I could just--and I promise I will be quick.
    Chairman Sarbanes. Yes, I have to draw this to a close.
    Mr. Eakes. The poor people, where they own homes, happens 
to often be in low-lying land that ends up being flood plain.
    Rich people do not live in flood areas. And so it is 
extremely reasonable that you would have families in the lower 
income brackets who are homeowners who are subject to these 
loans.
    I really wish I could bring--you are at Columbia? I would 
love to bring him just for a few days to actually see how the 
marketplace works, both in floods and out of floods, because he 
does not get it right now.
    [Laughter.]
    Chairman Sarbanes. Mr. Prough, you sat quietly through all 
of this. Is there any comment you want to add before I draw 
this to a close?
    Mr. Prough. No, sir.
    [Laughter.]
    Chairman Sarbanes. No wonder you all have been so 
successful.
    [Laughter.]
    Well, I want to thank this panel very much. I am sure we 
will be back to you about one thing or another as we proceed to 
explore this matter. Again, I want to thank you for your 
helpful testimony and for the obvious careful thought that went 
into the statements.
    The hearing now stands adjourned.
    [Whereupon, at 1:10 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional materials supplied for the record follow:]
             PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
    Today is the first of two hearings on ``Predatory Mortgage Lending: 
the Problem, Impact, and Responses.'' This morning we will hear first, 
from a number of families that have been victimized by predatory 
lenders. Then, later this morning and tomorrow, an array of public 
interest and community advocates, industry representatives, and legal 
and academic experts will have the opportunity to discuss the broader 
problem and the impact predatory mortgage lending can have on both 
families and communities.
    Homeownership is the American Dream. It is the opportunity for all 
Americans to put down roots and start creating equity for themselves 
and their families. Homeownership has been the path to building wealth 
for generations of Americans; it has been the key to ensuring stable 
communities, good schools, and safe streets.
    Predatory lender play on these hopes and dreams to cynically cheat 
people of their wealth. These lenders target lower income, minority, 
elderly, and, often, unsophisticated homeowners for their abusive 
practices. It is a contemptible practice.
    Let me briefly describe how predatory lenders and brokers operate. 
They target people with a lot of equity in their homes, many of whom 
may already be feeling the pinch of growing consumer and credit card 
debts; they underwrite the property often without regard to the ability 
of the borrower to pay the loan back. They make their money by charging 
extremely high origination fees, and by ``packing'' other products into 
the loan, including upfront premiums for credit life, disability, and 
unemployment insurance, and others, for which they get significant 
commissions but for which homeowners continue to pay for years beyond 
the terms of the policies.
    The premiums for these products get financed into the loan, greatly 
increasing the loan's total balance amount. As a result, and because of 
the high interest rates being charged, the borrower is likely to find 
himself in extreme financial difficulty.
    As the trouble mounts, the predatory lender will offer to refinance 
the loan. Unfortunately, another characteristic of these loans is that 
they have high prepayment penalties. So, by the time the refinancing 
occurs, with all the fees repeated and the prepayment penalty included, 
the lender or broker makes a lot of money from the transaction, and the 
owner has been stripped of his or her equity and, oftentimes, his home.
    Nearly every banking regulator has recognized this as an increasing 
problem. Taken as a whole, predatory lending practices represent a 
frontal assault on homeowners all over America.
    I want to make clear that these hearings are aimed at predatory 
practices. There are people who may have had some credit problems who 
still need access to affordable mortgage credit. They may only be able 
to get mortgage loans in the subprime market, which charges higher 
interest rates. Clearly, to get the credit they will have to pay 
somewhat higher rates because of the greater risk they represent.
    But these families should not be charged more than the increased 
risk justifies. These families should not be stripped of their home 
equity through financing of extremely high fees, credit insurance, or 
prepayment penalties. They should not be forced into constant 
refinancings, losing more and more of the wealth they have taken a 
lifetime to build to a new set of fees, with each transaction. They 
should not be stripped of their legal rights by mandatory arbitration 
clauses that block their ability to go to court to vindicate their 
protections under the law.
    Some people argue that there is no such thing as predatory lending 
because it is a practice that is hard to define. I think the best 
response to this was given by Federal Reserve Board Governor Edward 
Gramlich, who said earlier this year:

          ``Predatory lending takes its place alongside other concepts, 
        none of which are terribly precise safety and soundness, unfair 
        and deceptive practices, patterns, and practices of certain 
        types of lending. The fact that we cannot get a precise 
        definition should not stop us. It does not mean this is not a 
        problem.''

    Others, recognizing that abuses do exist, contend that they are 
already illegal. According to this reasoning, the proper response is 
improved enforcement.
    Of course, I support increased enforcement. The FTC, to its credit, 
has been active in bringing cases against predatory lenders for 
deceptive and misleading practices. However, because it is so difficult 
to bring such cases, the FTC further suggested last year a number of 
increased enforcement tools that would help to crack down on predators. 
I hope we will get an opportunity to discuss these proposals as the 
hearings progress.
    I also support actions by regulators to utilize authority under 
existing law to expand protections against predatory lending. That is 
why I sent a letter, signed by a number of my colleagues on the 
Committee, strongly supporting the Federal Reserve Board's proposed 
regulation to strengthen the consumer protections under current law. I 
also note that the Federal Trade Commission voted 5 to 0 last year in 
support of many of the provisions of the proposed regulation.
    Campaigns to increase financial literacy and industry best 
practices must also be a part of any effort to combat this problem. 
Many industry groups have contributed time and resources to educational 
campaigns of this type, or developed practices and guidelines, and I 
applaud and welcome this as an integral part of a comprehensive 
response to the problem of predatory lending.
    But neither stronger enforcement, nor literacy campaigns are 
enough. Too many of the practices we will hear outlined this morning 
and in tomorrow's hearing, while extremely harmful and abusive, are 
legal. And while we must aggressively pursue financial education, we 
must also recognize that education takes time to be effective, and 
thousands of people are being hurt every day. At his recent 
confirmation hearing, Fed Governor Roger Ferguson summed it up well 
when he said that ``legislation, careful regulation, and education are 
all components of the response to these emerging consumer concerns.''
    Again, I want to reiterate, subprime lending is an important and 
legitimate part of the credit markets. But such lending must be 
consistent with and supportive of the efforts to increase 
homeownership, build wealth, and strengthen communities. In the face of 
so much evidence and so much pain, we must work together to address 
this crisis. Before taking your testimony, let me express my 
appreciation to all of you for your willingness to leave your homes and 
come to Washington to speak publically about your misfortunes. I know 
it must be very difficult. In my view, you ought to be proud that you 
are contributing to a process that I hope will lead to some action to 
put an end to the kinds of practices that have caused each of you such 
heartache and trouble.
                               ----------
               PREPARED STATEMENT OF SENATOR WAYNE ALLARD
    I would like to thank Chairman Sarbanes for holding this hearing. 
This is an 
important topic, and I am glad that this Committee will have an 
opportunity to examine it more closely. I know that predatory lending 
is an issue that Chairman Sarbanes has followed very closely, as the 
so-called ``flipping'' form of predatory lending has been a particular 
problem in Baltimore.
    In the various Housing and Transportation Subcommittee hearings 
over the last 3 years, predatory lending came up on several occasions. 
It is an abhorrent practice, and as Ranking Member of the Subcommittee 
I am particularly concerned about predatory lending that involves FHA 
loans. The fraud perpetrated in those cases not only victimizes the 
individual family, but also robs the taxpayers, who are responsible for 
backing the loan through FHA.
    During my years as Chairman, and now as Ranking Member of the 
Housing Subcommittee, I have seen firsthand how important homeownership 
is to Americans, after all, it is the American Dream. It is 
reprehensible that a small number of individuals prey upon those hopes 
and dreams, turning the dream into a nightmare.
    I am pleased that this Committee will have an opportunity to 
examine some of the issues surrounding predatory lending. While we hear 
a great deal about predatory lending, much of what we know seems to 
come from anecdotes. I believe it is important that we examine the 
problem in a careful, reasoned way. In this manner we can first get a 
clear idea of exactly what constitutes predatory lending, and how great 
the scope of the problem is. Next, we can consider whether current laws 
are adequate or whether we need additional laws.
    I particularly wish to focus on the matter of enforcement. While 
predatory lending is obviously occurring under the current laws, it may 
very well be that the current laws are adequate, but simply not well 
enforced. Similarly, any additional laws that this Committee may pass 
would be of little value if they are not enforced.
    As important as it is to curb predatory lending, any actions 
considered by Congress, the States, or regulatory bodies must be made 
with caution. While predatory lending is by its nature deceptive and 
fraudulent and should be stopped, there is certainly room for a 
legitimate subprime lending market. Subprime lending expands 
homeownership opportunities for those families that may have 
experienced credit problems or who have not had an opportunity to 
establish credit. The subprime market gives them access to financing 
that allows them to experience the dream of homeownership.
    Without access to this market, far fewer people would own a home. 
It is no coincidence that subprime lending has greatly expanded as the 
country is experiencing record homeownership rates. If we are not 
careful with any legislation, we could end up hurting the very people 
that we are trying to help.
    We also cannot lose sight of the fact that laws cannot solve all 
problems. Because there will always be those who disregard the laws, we 
must also find ways to promote personal protection and responsibility. 
I believe that we need to find a better way to educate and empower 
consumers. I believe that knowledge can be a very powerful weapon, and 
this is particularly true for financial matters. Survey after survey 
has found that Americans lack basic financial knowledge. This lack of 
information can lead to financial disaster. Better consumer and 
financial knowledge will leave consumers better protected--regardless 
of what the laws may be.
    Again, I would like to thank the Chairman for holding this hearing. 
While today's cases are genuine tragedies, I hope that we will be able 
to learn from their situations to help stem predatory lending in 
America. I thank the witnesses for being willing to come forward to 
share their stories. I look forward to your testimony.
                               ----------
               PREPARED STATEMENT OF SENATOR JIM BUNNING
    Mr. Chairman, I would like to thank you for holding this hearing, 
and I would like to thank our witnesses for testifying today and 
tomorrow.
    Nobody is in favor of ``Predatory'' lending. We have all heard the 
horror stories of unscrupulous people preying on the elderly, going 
through an entire neighborhood and negotiating home improvement loans. 
These same individuals then strip the 
equity from these homes, usually without even doing the repairs. There 
is a word for these practices, and it is fraud. These practices should 
not and cannot be tolerated. The perpetrators of these practices should 
be prosecuted to the fullest extent of the law.
    But we must not throw the baby out with the bath water. Sixty-eight 
percent of Americans own their own homes. While I do not know the exact 
statistics, I am willing to bet not all of that 68 percent were 
candidates for the prime rate. I am pretty sure many of them did not 
qualify for prime.
    So then, how are these people, who are not rich, or may have missed 
a payment or two in their lifetime able to afford homes? The answer, of 
course, is the subprime market.
    The subprime market has been the tool for many Americans to achieve 
the American Dream of owning their own home. Many of our largest and 
most reputable financial institutions are a part of the subprime 
industry. I believe this is a good thing, and a viable subprime market 
is good for our country.
    We need to punish the bad actors. When fraud is committed, the 
perpetrators should be punished and punished severely. But we also 
should encourage the good actors. Citibank and Chase, to name two, have 
put into practice new guidelines to help eliminate abuses or even the 
possibility of abuses. Companies taking these steps should be 
commended.
    When we try to eliminate abuse, we must make sure we do not kill 
the subprime market. We must not drive out the reputable institutions 
that make home ownership possible to so many who otherwise would not be 
able to achieve that dream.
    Thank you Mr. Chairman.
                               ----------
                 PREPARED STATEMENT OF THOMAS J. MILLER
                  Attorney General, the State of Iowa
                             July 26, 2001
Introduction
    I would like to thank you, Mr. Chairman, and the Committee for 
giving me the chance to speak on this critically important issue. This 
is one of the most important challenges among the issues within this 
Committee's jurisdiction, and I welcome the opportunity to participate 
in the public discussion.
    Homeownership is ``the American Dream,'' and America is rightfully 
proud of its record in the number of Americans who have achieved 
that.\1\ The mortgage market we normally think of, and are proud of, is 
``productive credit''--a wealth-building credit that millions of 
Americans have used to make an investment in their lives and their 
childrens' futures: the market that has helped those 66 percent of 
Americans buy their homes; keep those homes in good repair; help 
finance the kids' education, and for some, helped them start a small 
business. But make no mistake: what we are talking about today is a 
threat to that dream and a very different mortgage market. Today, we 
are talking about asset-depletion. This is ``destructive debt,'' with 
devastating consequences to both the individual homeowners and to their 
communities. We are talking about people who are being convinced to 
``spend'' the homes they already own or are buying, often for little or 
nothing in return.\2\ Tens of thousands of Americans, elderly Americans 
and African-Americans disproportionately among them, are seeing what 
for many is their only source of accumulated wealth--the equity in 
their homes--siphoned off. Too often, the home itself is lost.\3\ Then 
what? How do they--particularly the elderly--start over?
---------------------------------------------------------------------------
    \1\ Homeownership reached a record level of 66 percent in 1998. 
Arthur B. Kennickell, et al., Recent Changes in U.S. Family Finances: 
Results from the 1998 Survey of Consumer Finances, 86 Fed. Res. Bull. 
1, 15-18 (2000).
    \2\ Part of the problem with the subprime market generally is it is 
not offering what many people need. Overwhelmingly, it offers refinance 
and consolidation loans--irrespective of whether that is wanted, 
warranted, or wise. See section I-C, below.
    \3\ See Alan White and Cathy Lesser Mansfield, Subprime Mortgage 
Foreclosures: Mounting Defaults Draining Home Ownership, (testimony at 
HUD predatory lending hearings, May 12, 2000), indicating 72,000 
families were in or near foreclosure.
    While the foreclosures are devastating for the families, the impact 
on the lenders is less clear. First, there is a distinction to be made 
between delinquencies/defaults and actual credit loss. Second, as we 
note below, some of this risk to the lender is self-made. See Section 
II-A , below. See also Appendix B, page 1, in which insurance padding 
added $76,000 to the cost of the loan, raised the monthly payment 
nearly $100, and all by itself, created a $54,000 balloon payable after 
the borrower would have paid over $204,000.
---------------------------------------------------------------------------
    Please keep this in mind when you hear the caution that legislative 
action will ``dry up credit.'' Drying up productive credit would be of 
grave concern; drying up destructive debt is sound economic and public 
policy.\4\
---------------------------------------------------------------------------
    \4\ We should also keep in mind that this prediction has been made 
of most consumer protection and fair lending legislation in my memory--
from the original Truth in Lending up through HOEPA. And it has never 
happened.
---------------------------------------------------------------------------
    In the previous panel, some of those affected by this conduct 
shared their experiences with you. Earlier this week, some Iowans 
shared their experiences with me. Their stories were typical, but the 
suffering caused by these practices is keenly felt by each of these 
individuals. One consumer who has paid nearly $18,000 for 4 years would 
have had her original $9,000 mortgage paid off by now, had she not been 
delivered into one of these loans by an unscrupulous contractor. The 
lender who worked with the contractor to make the home improvement loan 
refinanced that mortgage with the $27,000 home improvement cost. But 
the contractor's payment was little more than a very large broker's 
fee, for he did incomplete and shoddy work, and then disappeared. The 
lender's promises to make it right were all words for 4 years, while 
they took her money. In the other cases, the homeowners I visited with 
were not looking for loans, but they have credit cards from an issuer 
who also has a home equity lending business. They were barraged by 
cross-marketing telemarketers, and convinced that it would be a sound 
move to refinance. Indeed a sound move--for the lender who charged 
$6,900 in fees on $57,000 of proceeds. (The fees, of course, were 
financed.) These families are the faces behind these lenders' sales 
training motto: ``These loans are sold, not bought.'' \5\ These 
families are the faces behind the sordid fact that predatory lending 
happens because people trusted; and because these lenders and the 
middlemen who deliver the borrowers to them do not deserve their trust. 
These lives have been turned upside down by a business philosophy run 
amuck: a philosophy of total extraction when there is equity at hand.
---------------------------------------------------------------------------
    \5\ See Gene A. Marsh, ``The Hard Sell in Consumer Credit: How the 
Folks in Marketing Can Put You in Court,'' 52 Cons. Fin. Law Qtrly Rep. 
295, 298 (Summer, 1998) (quoting from a sales training manual: another 
instruction--``sell eligible applicants to his maximum worth or high 
credit.'')
---------------------------------------------------------------------------
    I know that my counterparts in North Carolina heard similar 
stories, which is why Former Attorney General, now Governor Easley and 
Attorney General Cooper as well, have been so instrumental in North 
Carolina's pioneering reform legislation. This problem is about these 
people--in Iowa, West Virginia, Pennsylvania, North Carolina--and all 
over this country; this is not about abstract market theories. And it 
is a problem that Congress has a pivotal role in curbing.
    In some of our States, we are finding other types of predatory 
practices that are preying on the vulnerable by appealing to--and 
subverting--their dreams of buying a home. Some cities are seeing a 
resurgence of property flipping. In some areas of my State, we are 
seeing abusive practices in the sale of homes on contracts. In fact, it 
appears that such contracts may be taking their place along with 
brokers and home improvement contractors as another ``feeder'' system 
into the high-cost mortgage market.\6\
---------------------------------------------------------------------------
    \6\ As is discussed below, many homeowners do not select the 
lenders they use, but are delivered to those lenders by middlemen. In 
the case of some of the abusive land contracts, a contract seller will 
sell a home to an unsophisticated borrower at a greatly inflated price 
on a 2-5 year balloon, telling the buyer that their contract payments 
will help establish a credit record. The hitch is that it is likely to 
be difficult, if not impossible, to get conventional mortgage financing 
when the balloon comes due because the inflated sales price would make 
the loan-to-value ratio too high for a conventional market. The result? 
Another way of steering the less sophisticated home buyer into the 
high-cost refinancing market.
---------------------------------------------------------------------------
    My office has made predatory lending a priority--both in the home 
equity mortgage lending context and in the contract sales abuses. In 
addition to investigations, we are considering adopting administrative 
regulations to address some of the areas within the scope of our 
jurisdiction, and are working with a broad-based coalition on education 
and financial literacy programs. But today I am here to talk to this 
Committee solely about the home equity mortgage lending problem, 
because that is where Congressional action is key. HOEPA has been a 
benefit, but improvements are needed. Federal preemption is hindering 
States' ability to address these problems on their own. The measures 
which have been introduced or passed at the State and municipal levels 
dramatically demonstrate the growing awareness of the serious impact on 
both individuals and communities of predatory lending, and the desire 
for meaningful reform.\7\
---------------------------------------------------------------------------
    \7\ See section III-B, below on how preemption has hampered the 
ability of States to deal with the kind of predatory lending practices 
we are talking about in these hearings.
---------------------------------------------------------------------------
What Is Predatory Lending and How Does It Happen?
The Context: The Larger Subprime Marketplace
    Predatory lending is, at its core, a mindset that differs 
significantly from that operating in the marketplace in which most of 
us in this room participate. It is a marketplace in which the operative 
principle is: ``take as much as you think you can get away with, 
however you can, from whomever you think is a likely mark.'' This is 
not Adam Smith's marketplace.
    Today's prime market is highly competitive. Interest rates are low, 
and points and fees are relatively so. Competition is facilitated by 
widespread advertisement of rates and points. Newspapers weekly carry a 
list of terms available in the region and nationwide, and lenders 
advertise their rates. The effectiveness of this price competition is 
demonstrated by the fact that the range of prime rates is very narrow, 
and has been for years. But in the subprime mortgage market, there is 
little price competition: there are virtually no advertisements or 
other publicity about the prices of loans, and it is difficult for 
anyone seeking price information to get it. Marketing in the subprime 
market, when terms are mentioned at all, tends to focus on ``low-
monthly payments.'' This marketing is, at best, misleading, given the 
products being sold, and is often simply an outright lie.
    I do not mean to imply that all subprime lending is predatory 
lending, nor does my use of statistics about the subprime generally so 
imply. However, most of the abuses do occur within the subprime market. 
We must understand the operations and characteristics of that 
marketplace in order to recognize how and why the abuses within it 
occur, and to try to address those problems.

 Interest rates in the subprime market are high and rising. 
    During a 5 year period when the median conventional rates ranged 
    from 7-8 percent, the median subprime rate was 10-12 percent. But 
    that 5 year period saw two disturbing trends. First, the 
    distribution around that median has changed--with the number of 
    loans on the high side of that median rising. Second, rates have 
    increased, with the top rates creeping up from a thinly populated 
    17-plus percent to nearly 20 percent.\8\
---------------------------------------------------------------------------
    \8\ A graph of the distribution of loans around the median rate 
shifted from a bell-curve distribution in 1995 to a ``twin peaks'' 
distribution around the median in 1999, indicating greater segmentation 
within the subprime market, and shows the ``rate creep'' on the high 
side of the distribution. See Cathy Lesser Mansfield, The Road to 
Subprime ``HEL'' Was Paved With Good Congressional Intentions, 51 So. 
Car. L. Rev. 473, p. 578, Graph 2; p. 586, Graph 6 (2000).

    Percent of loans in securitized subprime pools sold on Wall Street:

      above 12 percent in 1995 was 30 percent; and 1999 was 44 percent;
      above 15 percent in 1995 was 3 percent; and 1999 was 8 percent;
      above 17 percent in 1995 was .02 percent; and 1999 was 1.5 
percent.

    See id., p. 577 Table 1.

    Collecting price data on subprime lending is extraordinarily 
difficult, as the author of this article, one of my constituents, 
Professor Mansfield of Drake University law school, reported to the 
House Committee on Banking and Financial Services a year ago. (May 24, 
2000). As noted above, unlike the prime market, there is no advertising 
information about rates and points in the subprime market available to 
most consumers. Furthermore, that information is not reported for any 
regulatory purposes. It is not information required by the Home 
Mortgage Disclosure Act (HMDA). These statistics relate solely to pools 
of loans packaged as securities, where interest rate information is 
required by SEC rules for prospective investors.
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 Points and fees in the subprime market, while down from the 
    10-15 percent frequently seen prior to the enactment of HOEPA (with 
    its 8 percent points-and-fees trigger), are still high, in the 5-
    7.9 percent range, while the typical cost in the prime market is 1-
    3 percent.
 Subprime loans are disproportionately likely to have 
    prepayment penalties, making it expensive to get out of these 
    loans, and sometimes trapping the borrower in an overly expensive 
    loan. (Seventy-seventy-six percent, compared to less than 2 percent 
    in the prime market.) \9\
---------------------------------------------------------------------------
    \9\ Figures cited in U.S. Department of Treasury Comment on 
Regulation Z (HOEPA) Proposed Rulemaking, Docket No. R-1090 (January 
19, 2001), at page 7.
---------------------------------------------------------------------------
 Single-premium credit insurance, virtually nonexistent in the 
    prime mortgage market, has been estimated to be as much as 50 
    percent of subprime loans, though accurate statistics are not 
    available. (The penetration rate varies considerably, depending 
    upon the provider. Some subprime lenders market it heavily, 
    others very little.) \10\
---------------------------------------------------------------------------
    \10\ Estimate courtesy of the Coalition for Responsible Lending. 
Recently, three major lenders, Citigroup, Household, and American 
General, announced they will stop selling single-premium credit 
insurance.

    The demographics of the subprime marketplace are significant. 
Thirty-five percent of borrowers taking out subprime loans are over 55 
years old, while only 21 percent of prime borrowers are in that age 
group.\11\ (This despite the fact that many of the elderly are likely 
to have owned their homes outright before getting into this market.) 
The share of African-Americans in the subprime market is double their 
share in the prime market.\12\
---------------------------------------------------------------------------
    \11\ Howard Lax, Michael Manti, Paul Raca, Peter Zorn, Subprime 
Lending: An Investigation of Economic Efficiency, p. 9 (unpublished 
paper, February 25, 2000).
    \12\ Twelve percent of subprime loans are taken out by African-
Americans. Subprime loans are 51 percent of home loans in predominately 
African-American neighborhoods, compared with 
9 percent in white neighborhoods. Blacks in upper-income neighborhoods 
were twice as likely to be in the subprime market as borrowers in low-
income white neighborhoods. HUD, Unequal Burden: Income and Racial 
Disparities in Subprime Lending in America.
    The Zorn, et. al study also notes that lower income borrowers are 
also twice as likely to be in the subprime market ``despite the fact 
that FICO scores are not strongly correlated with income.'' p. 9. The 
Woodstock Institute study also found that the market segmentation ``is 
considerably stronger by race than by income. Daniel Immergluck and 
Marti Wiles, Two Steps Back: The Dual Mortgage Market, Predatory 
Lending, and the Undoing of Community Development, p. iii (Woodstock 
Institute, November 1, 1999.)
    With the aid of a Community Lending Partnership Initiative grant, 
the Rural Housing Institute is gathering information on lending in 
Iowa. Preliminary data indicates a similar picture of racial 
disparities in Iowa, though the researchers are awaiting the results of 
the 2000 Census income data to see whether the correlation in Iowa is 
similarly more correlated to race than income.
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    My co-panelist, Martin Eakes and his colleagues have estimated that 
the cost of abuses in these four areas cause homeowners to lose $9.1 
billion of their equity annually, an average of $4,600 per family per 
year.\13\ When I look at that figure in the context of who is most 
likely to be hurt by those abuses, my concern mounts.\14\ Others will 
be talking to this Committee about the fact that predatory lending is 
at the intersection of civil rights and consumer protection, so I will 
only say that, for what may be the first time, our civil rights and 
consumer protection divisions in Attorneys General offices around the 
country are beginning to work together on this common problem.
---------------------------------------------------------------------------
    \13\ The per family figure was found in Coalition for Responsible 
Lending Issue Paper, ``Quantifying the Economic Cost of Predatory 
Lending.'' (March 9, 2001). Mr. Eakes' testimony today may reflect 
revised figures.
    \14\ According to 1990 census, the median net worth for an African-
American family was $4,400. Comparing that to Mr. Eakes estimate of 
$4,600 per family loss is, to put it mildly, sobering.
---------------------------------------------------------------------------
    The most common explanation offered by lenders for the high prices 
in the subprime market is that these are risky borrowers, and that the 
higher rates are priced for the higher risk. But that is far too 
simplistic. Neutral researchers have found that risk does not fully 
explain the pricing, and that there is good reason to question the 
efficiency of subprime lending.\15\ That core mindset I mentioned 
earlier leads to opportunistic pricing, not pricing that is calibrated 
to provide a reasonable return, given the actual risk involved.
---------------------------------------------------------------------------
    \15\ Howard Lax, Michael Manti, Paul Raca, Peter Zorn, Subprime 
Lending: An Investigation of Economic Efficiency, p. 3-4 (unpublished, 
February 25, 2000). While risk does play a key role, ``borrowers' 
demographic characteristics, knowledge, and financial sophistication 
also play a statistically and practically significant role in 
determining whether they end up with subprime mortgages.'' Id. p. 3.
---------------------------------------------------------------------------
    Moreover, the essence of predatory lending is to push the loan to 
the very edge of the borrower's capacity to handle it, meaning these 
loans create their own risk. We cannot accept statistics about 
delinquencies and foreclosure rates in the subprime market without also 
considering how the predatory practices--reckless underwriting, push 
marketing, and a philosophy of profit maximization--create a self-
fulfilling prophecy.\16\ And even with comparatively high rates of 
foreclosures, many lenders continue to be profitable.
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    \16\ It is beyond the scope of my comments to discuss the 
relationship between risk and pricing. But it is important that 
policymakers look not just at delinquency and foreclosure rates without 
also looking at actual losses and revenues.
---------------------------------------------------------------------------
How and Why It Happens?
    If neither risk nor legitimate market forces explain the high 
prices and disadvantageous terms found so frequently in the subprime 
market, then what does explain it?
    ``Push marketing:'' The notion of consumers shopping for a 
refinance loan or a home improvement loan, comparing prices and terms, 
is out of place in a sizeable portion of this market. Frequently, these 
are loans in search of a borrower, not the other way around, as was the 
case with the Iowa borrowers I spoke with this week. Consumers who buy 
household goods with a relatively small installment sales contract are 
moved up the ``food chain'' to a mortgage loan by the lender to whom 
the retailer assigned the contract; door-to-door contractors come by 
unsolicited with 
offers to arrange manageable financing for home improvements; 
telemarketers offer to ``lower monthly payments'' and direct mail 
solicitations make false representations about savings on consolidation 
loans. Another aspect of push marketing is ``upselling.'' 
(``Upselling'' a loan is to loan more money than the borrower needs, 
wants, or asked for.)
    ``Unfair and deceptive, even downright fraudulent sales 
practices:'' In addition to deceptive advertisements, the sales pitches 
and explanations given to the borrowers mislead consumers about high 
prices and disadvantageous terms (or obscure them) and misrepresent 
benefits. Some of these tactics could confuse almost anyone, but when 
the consumer is unsophisticated in financial matters, as is frequently 
the case, the tactics can be quite fruitful.
    While Federal and State laws require disclosures, for a variety of 
reasons, these laws have not proven adequate against these tactics.
    Reverse competition: Price competition is distorted when lenders 
compete for referrals from the middlemen, primarily brokers and 
contractors. When the middleman gets to take the spread from an 
``upcharge'' \17\ on the interest rate or points, it should come as no 
surprise to anyone that some will steer their customers to the lenders 
offering them the best compensation. (Reverse competition is also a 
factor with credit insurance because of commission incentives and other 
profit-sharing programs.) It should also come as no surprise that the 
people who lack relevant education, are inexperienced or have a real or 
perceived lack of alternatives, are the ones to whom this is most 
likely to happen.
---------------------------------------------------------------------------
    \17\ An ``upcharge'' is when the loan is written at a rate higher 
than the underwriting rate. For example, an evaluation of the 
collateral, the borrower's income and debt-to-income ratio, and credit 
history indicates the borrower qualifies for a 11.5 percent interest 
rate. But the broker has discretion to write the note at 14 percent, 
and the broker gets extra compensation from that rate spread. He may 
get it all, or there may be a sharing arrangement with the lender, for 
example, the broker gets first 1 percent, and they split the other 1.5 
percent. The Eleventh Circuit has recently found that a referral fee 
would violate RESPA. Culpepper v. Irwin Mtg. Corp., 253 F. 3d 1324 
(2001).
    A recent review of yield-spread premiums in the prime market found 
that they added an average cost of over $1,100 on each transaction in 
which they were charged. The author found that the most likely 
explanation for the added cost was not added value, nor added services. 
Rather, it is a system which lends itself to price discrimination: 
extra broker-compensation can be extracted from less sophisticated 
consumers, while it can be waived for the few who are savvy about the 
complex pricing practices in today's mortgage market. See Report of 
Howell E. Jackson, Household International Professor of Law, Harvard 
Law School, pp. 72 , 81 (July 9, 2001), submitted as expert witness' 
report in Glover v. Standard Federal Bank, Civ. No. 97-2068 (D. Minn.)
---------------------------------------------------------------------------
    Even without rate upcharges, the brokers, who may have an agreement 
with the borrower, often take a fee on a percentage-basis, so they have 
an incentive to steer the borrower to a lender likely to inflate the 
principal, by upselling, fee-padding, or both. These are self-feeding 
fees. A 5 percent fee from a borrower who needs--and wants--just $5,000 
for a roof repair is only $250. But if the broker turns that into a 
refinance loan, of $40,000, further padded with another $10,000 of 
financed points, fees, and insurance premiums, his 5 percent, now 
$2,500, looks a lot better.
    This divided loyalty of the people in direct contact with the 
homeowner is particularly problematic given the complexity of any 
financing transaction, considerably greater in the mortgage context 
than in other consumer credit. As with most other transactions in our 
increasingly complex society, these borrowers rely on the good faith 
and honesty of the ``specialist'' to help provide full, accurate, and 
complete information and explanations. Unfortunately, much predatory 
lending is a function of misplaced trust.
    These characteristics help explain why the market forces of 
standard economic theory do not sufficiently work in this market. There 
are too many distorting forces. Factor in the demographics of the 
larger subprime marketplace in which these players operate, and we can 
better understand how and why it happens.
Definition
    Having looked at the context in which predatory lending occurs, we 
come to the question of definition. I know that some have expressed 
concern over the absence of a bright line definition. I do not see this 
as a hurdle, and I believe that Attorneys General are in a position to 
offer reassurance on this point. There is a real question as to whether 
a bright line definition is necessary, or even appropriate. All 50 
States and the United States have laws which employ a broad standard of 
conduct: a prohibition against ``deceptive practices,'' or ``unfair and 
deceptive practices.'' \18\ Attorneys General have enforcement 
authority for these laws, and so are in a position to assure this 
Committee that American business can and has prospered with broad, 
fairness-based laws to protect the integrity of the marketplace. 
Indeed, a good case can be made that they have helped American business 
thrive, because these laws protect the honest, responsible, and 
efficient businesses as much as they protect consumers, for unfair and 
deceptive practices are anticompetitive.
---------------------------------------------------------------------------
    \18\ See Section III, below, for a discussion of the adequacy of 
these laws to address predatory mortgage lending.
---------------------------------------------------------------------------
    While statutes or regulations often elaborate on that broad 
language with specific lists of illustrative acts and practices, it has 
never been seriously advanced that illustrations can or should be an 
exhaustive enumeration, and that anything outside that bright line was 
therefore acceptable irrespective of the context. There is a simple 
reason for this, and it has been recognized for centuries: the human 
imagination is a wondrous thing, and its capacity to invent new scams, 
new permutations on old scams, and new ways to sell those scams is 
infinite. For that reason, it is not possible, nor is it probably wise, 
to require a bright line definition.
    Several models for defining the problem have been used. One model 
relates to general principles of unfairness and deception. The 
Washington State Department of Financial Institution defines it simply 
as ``the use of deceptive or fraudulent sales practices in the 
origination of a loan secured by real estate.'' \19\ The Massachusetts 
Attorney General's office has promulgated regulations pursuant to its 
authority to regulate unfair and deceptive acts and practices to 
address some of these practices.\20\ Improving on the HOEPA model has 
been the basis for other responses within the States, most notably 
North Carolina's legislation.\21\ (In enacting HOEPA, Congress 
recognized that it was a floor, and States could enact more protective 
legislation.\22\)
---------------------------------------------------------------------------
    \19\ See, Comments from John Bley, Director of Financial 
Institutions, State of Washington, on Responsible Alternative Mortgage 
Lending to OTS (July 3, 2000). (I note that some abuses also occur in 
the servicing and collection of these loans, so limiting a statutory 
definition to the origination stage only would leave gaps.) Mr. Bley's 
letter notes that the HUD/Treasury definition, quoted in his letter, is 
similar: ``Predatory lending--whether undertaken by creditors, brokers, 
or even home improvement contractors--involves engaging in deception or 
fraud, manipulat-
ing the borrower through aggressive sales tactics, or taking unfair 
advantage of a borrower's lack of understanding about loan terms. These 
practices are often combined with loan terms that, alone or in 
combination, are abusive or make the borrower more vulnerable to 
abusive practices.''
    \20\ 940 C.M.R. Sec. 8.00, et seq. See also United Companies 
Lending Corp. v. Sargeant, 20 F. Supp. 2d 192 (D. Mass. 1998).
    \21\ N.C. Gen. Stat. Sec. 24-1-.1E. See also 209 C.M.R. 32.32 
(Massachusetts Banking Commission); Ill. Admin. Code 38, 1050.110 et 
seq.; N.Y. Comp Codes & Regs. Tit. 3 Sec. 91.1 et seq. Some cities have 
also crafted ordinances along these lines, Philadelphia and Dayton 
being two examples. While legal concerns about preemption and practical 
concerns about ``balkanization'' have been raised in response to this 
increasingly local response much care and thought has gone into the 
substantive provisions, building on the actual experience under HOEPA, 
and may be a good source of suggestions for improvements on HOEPA 
itself.
    \22\ ``[P]rovisions of this subtitle preempt State law only where 
Federal and State law are inconsistent, and then only to the extent of 
the inconsistency. The Conferees intend to allow States to enact more 
protective provisions than those in this legislation.'' H.R. Conf. Rep. 
No. 652, 103d Cong. Sess. 147, 162 (1994), 1994 U.S. C.C.A.N. 1992. 
That has not prevented preemption challenges, however. The Illinois DFI 
regulations have been challenged by the Illinois Association of 
Mortgage Brokers, alleging that they are preempted by the Alternative 
Mortgage Transaction Parity Act.
---------------------------------------------------------------------------
    There is considerable consensus about a constellation of practices 
and terms most often misused, with common threads.
    The terms and practices are designed to maximize the revenue to the 
lenders and middlemen, which maximizes the amount of equity depleted 
from the borrowers' homes. As mentioned earlier, when done by means 
which do not show in the credit price tags, or may be concealed through 
confusion or obfuscation, all the better. That makes deceptive sales 
techniques easier, and reduces the chances for any real competition to 
work.
    Among those practices:

 Upselling the basic loan (includes inappropriate refinancing 
    and debt consolidation). The homeowner may need (and want) only a 
    relatively small loan, for example, $3,000 for a new furnace. But 
    those loans tend not to be made. Instead these loans are turned 
    into the ``cash-out'' refinancing loan, that refinances the first 
    mortgage or consolidation loans (usually consolidating unsecured 
    debts along with a refinance of the existing first mortgage). In 
    the most egregious cases, 0 percent Habitat for Humanity loans, or 
    low-interest, deferred payment rehabilitation loans have been 
    refinanced into high rate loans which stretch the limits of the 
    homeowner's income. But even refinancing a 9-10 percent mortgage 
    into a 14 percent mortgage just to, get the $3,000 for that furnace 
    is rarely justifiable. Like other practices, this has a self-
    feeding effect. A 5 percent brokers fee; or 5 points will be much 
    more remunerative on a $50,000 loan than on a $3,000 loan. Since 
    these fees are financed in this market, they, in turn, make the 
    principal larger, making a 14 percent rate worth more dollars. For 
    the homeowner, of course, that is all more equity lost.\23\
---------------------------------------------------------------------------
    \23\ While most of these loans are more than amply secured by the 
home, well within usual loan-to-value ranges, some lenders are 
upselling loans into the high LTV range, which bumps the loan into a 
higher rate. Some lenders do this by ``loan-splitting,'' dividing a 
loan into a large loan for the first 80-90 percent if the home's 
equity, at, for example, 13-14 percent, and a smaller loan for the rest 
of the equity (or exceeding the equity) at 16-21 percent. These loans 
are often made by ``upselling,'' not because the borrower sought a high 
LTV loan. The practice seems to involve getting inflated ``made-to-
order'' appraisals, then upselling the loan based on the phony 
``appreciation.'' As with some of the other tactics, like stiff 
prepayment penalties, these loans marry the homeowner to this lender. 
The homeowner cannot refinance with a market-rate lender.
---------------------------------------------------------------------------
 Upcharging on rates and points (includes yield spread premiums 
    and steering). The corrosive impact of yield spread premiums 
    generally was described above in connection with the discussion of 
    reverse competition. (See note 17.) The problem is exacerbated in 
    the subprime market, where the much greater range of interest rates 
    \24\ makes greater upcharges possible, and the demographics of the 
    subprime market as a whole lends itself to the type of 
    opportunistic pricing that Professor Jackson posed as the likely 
    explanation.
---------------------------------------------------------------------------
    \24\ See text accompanying note 8.
---------------------------------------------------------------------------
 Excessive fees and points/padded costs. Since the fees and 
    charges are financed as part of the loan principal, and since some 
    of them are percentage-based fees, this kind of loan padding 
    creates a self-feeding cost loop (an example is described earlier 
    in the discussion of upselling), which makes this a very efficient 
    practice for extracting more equity out of the homes.
 Financing single-premium credit insurance. Appendix B is a 
    good example of how effective single-premium credit insurance is as 
    a tool for a predatory lender to strip equity from a borrower's 
    home. It is also a good example of how well it lends itself to 
    manipulation and deceptive sales tactics. Appendix B shows that 
    adding a $10,000 insurance premium (of which the lender keeps 
    approximately 35-40 percent as commission) over the life of the 
    loan, will cost the borrower an extra $76,000 in lost equity over 
    the life of the loan. Even if the borrower prepays (or more likely 
    refinances) at 5 years, the credit insurance adds $9,400 to the 
    payoff. And the lender's estimated commission from the premium was 
    double the amount of revenue the lender got from the three points 
    charged on that loan.\25\
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    \25\ See Appendix B, p. 2 line 5. Compare columns 5 and 6. This is 
not a hypothetical example. It is a loan made to an Iowa couple.
---------------------------------------------------------------------------
 Prepayment penalties. Prepayment penalties trap borrowers in 
    the high cost loans. They are especially troublesome, since 
    borrowers are often told that they need not worry about the high 
    payments, because these loans are a bridge, that can be refinanced 
    after a couple of years of good payment history.\26\
---------------------------------------------------------------------------
    \26\ This is another instance which demonstrates the limits of 
disclosures. A recent loan we saw has an ``Alternative Mortgage 
Transactions Parity Act Prepayment Charge Disclosure,'' which explains 
that State law is preempted, and provides an example of how their 
formula would apply to a $100,000 loan. It is doubtful the example 
would score on any literacy scale below upper college-level.
---------------------------------------------------------------------------
 Flipping. Flipping is the repeated refinancing of the 
    consumer's loan. It is especially useful for equity-stripping when 
    used by lenders who frontload high fees (points, truncated credit 
    insurance,\27\ and so forth). The old fees are pyramided into the 
    new principal, and new fees get added. My staff has seen loans in 
    which nearly 50 percent of the loan principal simply reflected 
    pyramided fees from serial refinancing.
---------------------------------------------------------------------------
    \27\ Truncated credit insurance is insurance sold for a term less 
than the loan term in the example in Attachment B, page 1, the loan 
premium financed in the 20 year balloon note purchased a 7 year policy. 
That frontloads the premium, so if the loan was refinanced at 5 years, 
over 90 percent of the premium would have been ``earned,'' and rolled 
over into the new loan principal--but without any insurance coverage 
from that extra $9,400 in the new loan.
---------------------------------------------------------------------------
 Balloons. While HOEPA did succeed in reducing the incidence of 
    1 and 2 year balloons, what we are seeing now is long-term balloon 
    loans which seem to be offered solely to enable the lender, broker, 
    or contractor to sell the loan based on the low monthly payment. We 
    are seeing 15, and even 20 year balloon loans. The Iowa couple 
    whose loan is discussed in Appendix B borrowed $68,000 (including a 
    $10,000 insurance premium). Over the next 20 years of scheduled 
    payments, they would pay $204,584, and then they would still owe a 
    $54,300 balloon.

    Unfair and deceptive sales practices in sales of the credit: In 
addition to misleading advertisements, the sales pitches and 
explanations given to the borrowers mislead consumers about high prices 
and disadvantageous terms (or obscure them) and misrepresent benefits. 
Again, just a few examples:

 While Federal and State laws require disclosures, for a 
    variety of reasons, these laws have not proven adequate against 
    these tactics. Techniques such as ``mixing and matching'' the 
    numbers from the note and the TIL disclosure low-ball both the loan 
    amount (disguising high fees and points), and the interest rate, 
    thus completely pervert the basic concept of truth in lending.\28\
---------------------------------------------------------------------------
    \28\ This was the technique at issue in the FAMCO cases, see 
Section III, below.
---------------------------------------------------------------------------
 When door-to-door contractors arrange financing with these 
    high-cost lenders (often with lenders who use the opportunity to 
    upsell the credit into a refinancing or consolidation loan), it 
    appears to be common to manipulate the cancellation rights so that 
    the consumer believes he must proceed with a loan which costs too 
    much.\29\
---------------------------------------------------------------------------
    \29\ The practice is a variation of ``spiking.'' (``Spiking'' means 
to start work or otherwise proceed during the cooling off period, which 
leads the consumer to believe they cannot cancel, ``because work has 
begun.'') By trying to separate the sale of the home improvement from 
the financing for it, the borrowers' right to cancel under either the 
State door-to-door sales act or the TIL are subverted. This practice, 
which appears to be common, is described more fully in National 
Consumer Law Center, Truth in Lending Sec. 6.8.4.2, esp. 6.8.4.2.2 (4th 
Ed. 1999.)

    Some of the front-line personnel selling these loans even use the 
lack of transparency about credit scores to convince people that they 
could not get a lower-cost loan, either from this lender or anywhere 
else. As one lawyer who has worked for a decade with elderly victims 
put it, when the broker gets through, the homeowners feel lucky if 
anyone would give them a dime.\30\
---------------------------------------------------------------------------
    \30\ Oral presentation of an AARP lawyer at a conference on 
predatory mortgage lending in Des Moines, Iowa, June 1999.
    It is a fertile area for misrepresentations. When looking at 
mortgage lending in the prime market, the Boston Federal Reserve Bank 
found that approximately 80 percent of applicants had some ding on 
their credit record which would have, looked at in isolation, justified 
a denial.
    The recent move by Fair Isaac to bring transparency to credit 
scores may help, but it will more likely be a help in the prime market 
than in the subprime market. Again, a knowledgeable broker or 
contractor-cum-broker would assure that the consumer knew that, but the 
reverse competition effect may impede that.
---------------------------------------------------------------------------
    Ability to pay: These lenders pay less attention to the ability of 
the homeowner to sustain the loan over the long haul. The old standard 
underwriting motto of ``the 3-C's: capacity, collateral, and 
creditworthiness'' is shortened to ``1-C''--collateral. Capacity is, at 
best, a secondary consideration. Creditworthiness, as mentioned above, 
becomes an instrument for deceptive sales practices in individual 
cases.
    A recent example from Iowa: A 72 and 64 year old couple were 
approached by a door-to-door contractor, who sold them on the need for 
repairs to their home, and offered to make arrangements for the loan. 
The work was to cost approximately $6,500. The contractor brought in a 
broker, who arranged for a refinance plus the cash out for the 
contractor. (The broker took a 5 percent fee on the upsold loan 
($1,800) plus what appears to be a yield-spread premium amounting to 
another $1,440. Now the payments on their mortgage, (including taxes 
and insurance) are $546. That is nearly 60 percent of their income: It 
leaves them $389 a month for food, car and health insurance, medical 
expenses, gasoline and other car expenses, utilities, and everything 
else. This terrific deal the broker arranged was a 30 year mortgage. 
The loan amount was $36,000, and the settlement charges almost $3,900 
(though not all in HOEPA trigger fees). The APR is 14.7 percent.\31\
---------------------------------------------------------------------------
    \31\ The homeowners tried to exercise their right to cancel. But 
the lender claims they never got the notice, and the contractor told 
them not to worry about those payments, they would lower them . . . .
---------------------------------------------------------------------------
    The consequence of all this? ``Risk'' becomes a self-fulfilling 
prophecy. Home ownership is threatened, not encouraged.
    It is not an insurmountable challenge to bring this experience to 
bear in crafting legislation and regulation, as our experience with 
illustrative provisions in UDAP statutes and regulations, and in HOEPA 
itself, show.\32\
---------------------------------------------------------------------------
    \32\ A good example is the FTC Credit Practices Rule, 16 C.F.R. 
444, which prohibited certain practices common in the consumer finance 
industry as unfair or deceptive. At the time it was under 
consideration, opponents predicted it would ``dry up credit to those 
who need it the most.'' It did not. (Indeed, it was predicted that 
HOEPA would ``dry up credit to those who need it the most.'' It has 
not.)
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What Can Be Done Now?
    State Attorneys General have used our State Unfair and Deceptive 
Acts and Practices (UDAP) laws against predatory mortgage lenders, 
including most notably, First Alliance Mortgage Company (FAMCO).\33\ 
FAMCO demonstrates that lenders can be in technical compliance with 
disclosure laws like Truth in Lending and RESPA, yet nonetheless engage 
in widespread deception. When regulators did routine examinations, they 
would see very expensive loans, but no violations of any ``bright 
line'' disclosure laws. The problem was that FAMCO employees were 
rigorously trained as to how to disguise their 20 point charges through 
a sales script full of tricky and misleading information designed to 
mislead consumers into thinking that the charges were much lower than 
they were. This sales script was dubbed ``The Monster Track.'' 
Attorneys General in Minnesota, Massachusetts, Illinois, Florida, 
California, New York, and Arizona have taken action against the 
company, along with the Department of Financial Institutions in 
Washington State. (In the wake of all the litigation and enforcement 
actions, the company filed bankruptcy.)
---------------------------------------------------------------------------
    \33\ FAMCO's practices were the subject of a New York Times 
article, Diana B. Henriques, ``Mortgaged Lives,'' NYT, A1 (March 15, 
2000).
---------------------------------------------------------------------------
    (States which either opted-out of Federal preemption of State 
limitations on points or reenacted them may have effectively prevented 
companies like FAMCO from doing business in their State. Iowa opted-out 
of the Federal preemption on first lien points and rates, and kept a 
two-point limit in place. While there is no concrete proof that this 
point-cap is why FAMCO did not do business in Iowa, it seems a 
reasonable assumption.)
    But our UDAP laws, and our offices are by no means as much as is 
needed for this growing problem.
Impediments to Enforcement of Existing Laws
    Some of the predatory lending practices certainly do fall afoul of 
existing laws. But there are important loopholes in those laws, and 
there are also serious impediments to enforcement of those laws against 
predatory lenders.

 Public enforcement

    Resource limitations: One of the most significant impediments to 
public enforcement of existing applicable laws is insufficient 
resources. While State and Federal agencies have many dedicated public 
servants working to protect consumers and the integrity of the 
marketplace, in the past 15 or so years we have seen an ever-growing 
shortfall in the personnel when compared to the workload. The number of 
credit providers, the volume of lending, and the amount of problem 
lending have all exploded at the same time that the resources available 
to examine, monitor, investigate them, and enforce the laws have 
declined in absolute numbers. The resulting relative disparity is even 
greater. The experience in my State is probably not atypical. The 
number of licensed nondepository providers of household credit has 
roughly tripled in, the past 15 years, and the volume of lending has 
risen accordingly. (And not all out-of-State lenders operating through 
mail, telephone, or the Internet are licensed.) Three entire new 
categories of licensees have been created during those years. Yet, the 
staff necessary to examine these licensees and undertake any 
investigations and enforcement actions have decreased. This is 
undoubtedly true at the Federal level, as well as the State level.
    This disparity between need and supply in the Attorneys General 
offices is exacerbated by the fact that credit is only one of many 
areas for which we have some responsibility. For example, 
telecommunications deregulation and the explosion in 
e-commerce have resulted both in expanded areas of concern for us, and 
an expanded volume of complaints from our citizens.
    Holes in coverage: Some State UDAP statutes do not include credit 
as a ``good or service'' to which the Act applies, or lenders may be 
exempted from the list of covered entities.\34\ Some State statutes 
prohibit ``deceptive'' practices, but not unfair practices. In my 
State, we have no private right of action for our UDAP statute, 
magnifying the impact of the problem of inadequate resources for public 
enforcement. Other claims which might apply to a creditors' practices 
may be beyond the jurisdictional authority given to public agencies.
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    \34\ The theory for exempting lenders is generally that other 
regulators are monitoring the conduct of the entity. Yet, the regulator 
may not have the jurisdictional authority to address unfair and 
deceptive acts and practices generally.
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    The silent victim: There is also a threshold problem of detection. 
Most of the people whose homes are being drained of their equity do not 
complain. Like most Americans, they are unfamiliar with applicable laws 
and so are unaware that the lender may have crossed the bounds; many 
people are embarrassed, or simply feel that it is yet one more of 
life's unfortunate turns. Coupled with the ``clean paper'' on many of 
these loans, this silence means activity goes undetected--at least 
until it is too late for many. As mentioned above, regulatory 
examinations of the records in the lenders' offices (even if there was 
sufficient person-power), often do not reveal the problems.

 Private enforcement

    Mandatory arbitration: We have always recognized that the public 
resources for enforcement would never be adequate to assure full 
compliance. Thus, the concept that consumers can vindicate these rights 
themselves is built into many of the statutes which apply to these 
transactions. Under these statutes, as well as common law, these 
actions may be brought in our courts, where impartial judges and juries 
representing the community at large can assess the evidence and apply 
the law. Some of these statutes help assure that the right is not a 
phantom one, by providing for attorney's fees and costs as part of the 
remedy against the wrong-doer. Critically, the legal system offers an 
open and efficient system for addressing systemic abuses--abuses that 
Governmental enforcement alone could not address.
    But private enforcement faces a serious threat today. Mandatory 
arbitration clauses which deny consumers that right to access to 
impartial judges and juries of their peers are increasingly prevalent. 
This denies all of us the open system necessary to assure that systemic 
problems are exposed and addressed. This is not the forum to discuss in 
detail the way the concept of arbitration has been subverted from its 
premise and promise into a mechanism used by one party to a contract--
the one that is holding all the cards--to avoid any meaningful 
accountability for their own misconduct. These are not, as arbitration 
was envisioned, simple consensual agreements to choose a different 
forum in which to resolve differences cheaply and quickly; these are 
intended to insulate the ones who insist upon them from the 
consequences of their improper actions. While not unique to predatory 
mortgage lending, this rapidly growing practice in consumer 
transactions is a serious threat to effective use of existing laws to 
address predatory lending, as well as to enforcement of any further 
legislative or regulatory efforts to curb it. It is within Congress' 
power to remove this barrier.\35\
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    \35\ The European Union recognizes the problems inherent in 
mandatory arbitration in consumer transactions, and includes it among 
contract terms that are presumptively unfair. See European Union 
Commission Recommendation No. 98/257/EC on the Principles Applicable to 
the Bodies Responsible for the Out-of-Court Settlement of Consumer 
Disputes, and Council Directive 93/13/EC of April 5, 1993 on Unfair 
Terms in Consumer Contracts.
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Preemption
    Federal laws which, by statute or by regulatory action, preempt 
State laws, have played a role in the growth of predatory mortgage 
lending.\36\ Unlike some examples of Federal preemption, preemption in 
the credit arena did not replace multiple State standards with a single 
Federal standard. In important areas, it replaced State standards with 
no real standards at all.
---------------------------------------------------------------------------
    \36\ See, for example Mansfield, The Road to Subprime ``HEL,'' note 
8, above.
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    With commerce increasingly crossing borders, the industry asks that 
it not be subjected to ``balkanized'' State laws, and now, even 
municipal ordinances. But the industry and Congress should recognize 
that these efforts are born of concern for what is happening now to 
people and to their communities, and of frustration at inaction in 
Congress.
    Congress did, on a bipartisan basis, enact HOEPA, which has helped, 
but needs to be improved. However, Congress has not done anything about 
the vacuum (and the uncertainty) left by preemption. Some Federal 
regulatory agencies have made the problem even worse since then, 
through broad (arguably overbroad) interpretations of Federal law. For 
example, the 1996 expansive reading of the Alternative Mortgage 
Transactions Parity Act (AMTPA) to preempt State laws on prepayment 
penalties has contributed to the problems we are talking about today. 
Over a year ago, the OTS asked whether that Act and interpretations 
under it had contributed to the problem, and 45 States submitted 
comments saying ``yes.'' But nothing has come of that.\37\ In the 
meantime, regulators in Virginia and Illinois have been sued by 
industry trade associations on grounds that AMTPA preempts their 
rules.\38\
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    \37\ It is also possible that AMTPA has contributed to the 
prevalence of the ``exploding ARM'' by predatory lenders, as the 
existence of a variable rate is one of the triggers for AMTPA coverage. 
12 U.S.C. Sec. 3802. Although we are focused today on mortgage lending, 
we are also concerned about overbroad preemption interpretations by the 
OCC affecting our ability to address problems in other areas, such as 
payday lending, and, now, perhaps even car loans.
    \38\ Illinois Assoc. of Mortgage Brokers v. Office of Banks and 
Real Estate, (N.D. Ill, filed July 3, 2001); National Home Equity 
Mortgage Association v. Face, 239 F. 3d 633 (4th Cir. 2001), cert. 
Filed June 7, 2001.
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What More Needs To Be Done?
    It is simply not the case that existing laws are adequate. In an 
imperfect market, there must be ground rules. These are some 
suggestions.
Federal Reserve Board: HOEPA Regulation
    Thirty-one States submitted comments to the Federal Reserve Board 
urging it to adopt the HOEPA rules as proposed, without being weakened 
in any respect. Our comments emphasized the importance of including 
single-premium credit insurance among the trigger fees. (A copy of the 
comments is submitted as Appendix A.)
Other Legislative Recommendations
    In addition to closing the enforcement and substantive loopholes 
created by mandatory arbitration and preemption, HOEPA could be 
improved in light of the lessons we have learned from almost 6 years of 
experience with it. Some of the suggested reforms include:

 Improve the ``asset-based lending'' prohibition. Since this is 
    the key issue in predatory lending, it is vital that it be 
    effectual and enforceable. As it stands, it is neither. The 
    ``pattern and practice'' requirement should be eliminated from the 
    provision prohibiting making unaffordable loans.\39\ The concept of 
    ``suitability,'' borrowed from the securities field, might be 
    incorporated.
---------------------------------------------------------------------------
    \39\ It is not a violation to make unaffordable loans, it is only a 
violation to engage in a ``pattern and practice of doing so,'' a 
difficult enforcement challenge. See Newton v. United Companies, 24 F. 
Supp. 2d 444 (E.D. Pa 1998).
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 Prohibiting the financing of single-premium credit insurance 
    in HOEPA loans, as HUD and the FRB have recommended.
 Remove the Federal preemption hurdle to State enforcement of 
    laws prohibiting prepayment penalties, or, at a minimum, prohibit 
    prepayment penalties in HOEPA loans. The current HOEPA provision on 
    prepayment penalties, as a practical matter, is so convoluted as to 
    be virtually unenforceable.
 Improve the balloon payment provisions. While we no longer see 
    1 and 2 year balloons, we now see 15 and 20 year balloons, whose 
    sole purpose is to enable the lender or broker to low-ball the cost 
    by selling on ``low monthly payments.'' And without prepayment 
    penalties, there is no real reason for balloon loans: if a consumer 
    is planning on selling in 5 years, they can prepay the loan in any 
    event.
 Limit the amount of upfront fees and points which can be 
    financed.

    My colleagues and other State and local officials are seeing more 
and more of the hardship and havoc that results from these practices. 
We are committed to trying to address them as best we can within the 
limits of our jurisdiction and our resources. Federal preemption is 
part of what is limiting our ability to respond. Congress has a signal 
role here, for this is a national problem.
    I would like to offer my continuing assistance to this Committee, 
and I know that my colleagues will, as well.
    Thank you for giving me this opportunity to share my views with 
you.


































          ORIGINAL PREPARED STATEMENT OF CHARLES W. CALOMIRIS
          Paul M. Montrone Professor of Finance and Economics
  Graduate School of Business, Columbia University, New York, New York
                             July 26, 2001
    Mr. Chairman, it is a pleasure and an honor to address you today on 
the important topic of predatory lending.
    Predatory lending is a real problem. It is, however, a problem that 
needs to be addressed thoughtfully and deliberately, with a hard head 
as well as a soft heart. There is no doubt that people have been hurt 
by the predatory practices of some creditors, but we must make sure 
that the cure is not worse than the disease. Unfortunately, many of the 
proposed or enacted municipal, State, and Federal statutory responses 
to predatory lending would have adverse consequences that are worse 
than the problems they seek to redress. Many of these initiatives would 
reduce the supply of credit to low-income homeowners, raise their cost 
of credit, and restrict the menu of beneficial choices available to 
borrowers.
    Fortunately, there is a growing consensus in favor of a balanced 
approach to the problem. That consensus is reflected in the viewpoints 
expressed by a wide variety of individuals and organizations, including 
Robert Litan of the Brookings Institution, Fed Governor Edward 
Gramlich, most of the recommendations of last year's HUD-Treasury 
Report, the voluntary standards set by the American Financial Services 
Association (AFSA), the recent predatory lending statute passed by the 
State of Pennsylvania, and the recommendations and practices of many 
subprime mortgage lenders (including, most notably, Household). In my 
comments, I will describe and defend that balanced approach, and offer 
some specific recommendations for Congress and for financial 
regulators.
    To summarize my recommendations at the outset, I believe that an 
appropriate response to predatory practices should occur in two stages: 
First, there should be an immediate regulatory response to strengthen 
enforcement of existing laws, enhance disclosure rules and provide 
counseling services, amend existing regulation, and limit or ban some 
practices. I believe that these initiatives, described in detail below, 
will address all of the serious problems associated with predatory 
lending.
    In other areas--especially the regulation of prepayment penalties 
and balloon payments--any regulatory change should await a better 
understanding of the extent of remaining predatory problems that result 
from these features, and the best ways to address them through 
appropriate regulations. The Fed is currently pursuing the first 
systematic scientific evaluation of these areas, as part of its clear 
intent to expand its role as the primary regulator of subprime lending, 
given its authority under HOEPA. The Fed has the regulatory authority 
and the expertise necessary to find the right balance between 
preventing abuse and permitting beneficial contractual flexibility.
    Congress, and other legislative bodies, should not rush to judgment 
ahead of the facts and before the Fed has had a chance to address these 
more complex problems, and in so doing, end up throwing away the 
proverbial baby of subprime lending along with the bathwater of 
predatory practices.
    I think the main role Congress should play at this time is to rein 
in actions by States and municipalities that seek to avoid established 
Federal preemption by effectively setting mortgage usury ceilings under 
the guise of consumer protection rules. Immediate Congressional action 
to dismantle these new undesirable barriers to individuals' access to 
mortgage credit would ensure that consumers throughout the country 
retain their basic contractual rights to borrow in the subprime market.
    My detailed comments divide into four parts: (1) a background 
discussion of subprime lending, (2) an attempt to define predatory 
practices, (3) a point-by-point evaluation of proposed or enacted 
remedies for predatory practices, and (4) a concluding section.
Subprime Lending, the Democratization of Finance, and
Financial Innovation
    The problems that fall under the rubric of predatory lending are 
only possible today because of the beneficial ``democratization'' of 
consumer credit markets, and mortgage markets in particular, that has 
occurred over the past decade. Predatory practices are part and parcel 
of the increasing complexity of mortgage contracts in the high-risk 
(subprime) mortgage area. That greater contractual complexity has two 
parts: (1) the increased reliance on risk pricing using Fair, Isaac & 
Co. (FICO) scores rather than the rationing of credit via yes or no 
lending decisions, and (2) the use of points, insurance, and prepayment 
penalties to limit the risks lenders and borrowers bear and the costs 
borrowers pay.
    These practices make economic sense and can bring great benefits to 
consumers. Most importantly, these market innovations allow mortgage 
lenders to gauge, price, and control risk better than before, and thus 
allow them to tolerate greater gradations of risk among borrowers.
    According to last year's HUD-Treasury report, subprime mortgage 
originations have skyrocketed since the early 1990's, increasing by 
tenfold since 1993. The dollar volume of subprime mortgages was less 
than 5 percent of all mortgage originations in 1994, but by 1998 had 
risen to 12.5 percent. As Fed Governor Edward Gramlich (2000) has 
noted, between 1993 and 1998, mortgages extended to Hispanic-Americans 
and African-Americans increased the most, by 78 and 95 percent, 
respectively, largely due to the growth in subprime mortgage lending.
    Subprime loans are extended primarily by nondepository 
institutions. The new market in consumer credit, and subprime credit in 
particular, is highly competitive and involves a wide range of 
intermediaries. Research by economists at the Federal Reserve Board 
indicates that the reliance on nondepository intermediaries reflects a 
greater tolerance for lending risk by intermediaries that do not have 
to subject their loan portfolios to examination by Government 
supervisors (Carey et al. 1998).
    Subprime lending is risky. The reason that so many low-income and 
minority borrowers rely on the subprime market is that, on average, 
these are riskier groups of borrowers. It is worth bearing in mind that 
default risk varies tremendously in the mortgage market. The 
probability of default for the highest risk class of subprime mortgage 
borrowers is roughly 23 percent, which is more than one thousand times 
the default risk of the lowest risk class of prime mortgage borrowers.
    When default risk is this great, in order for lenders to 
participate in the market, they must be compensated with unusually high 
interest rates. For example, even if a lender were risk-neutral 
(indifferent to the variance of payoffs from a bundle of loans) a 
lender bearing a 20 percent risk of default, and expecting to lose 50 
percent on a foreclosed loan (net of foreclosure costs) should charge 
at least the relevant Treasury rate (given the maturity of the loan) 
plus 10 percent. On second trust mortgages, loan losses may be as high 
as 100 percent. In that case, the risk-neutral default premium would be 
20 percent. Added to these risk-neutral premia would be a risk premium 
to compensate for the high variance of returns on risky loans (to the 
extent that default risk is nondiversifiable), as well as premia to pay 
for the costs of gathering information about borrowers, and the costs 
of maintaining lending facilities and staff. These premia would be 
charged either in the form of higher interest rates or the present 
value equivalent of points paid in advance.
    Default risk, however, is not the only risk that lenders bear. 
Indeed, prepayment risk is of a similar order of magnitude in the 
mortgage market. To understand prepayment risk, consider a 15 year 
amortized subprime mortgage loan of $50,000 with a 10 percent interest 
rate over the Treasury rate, zero points and no prepayment penalty. If 
the Treasury rate falls, say by 1 percent, assume that the borrower 
will choose to refinance the mortgage without penalty, and assume that 
this decline in the Treasury rate actually happens 1 year after the 
mortgage is originated.
    If the interest rate on the mortgage was set with the expectation 
that the loan would last for 15 years, and if the cost of originating 
and servicing the loan was spread over that length of time, then the 
prepayment of the loan will result in a loss to the lender. An 
additional loss to the lender results from the reduction in the value 
of its net worth as the result of losing the revenue from the mortgage 
when it is prepaid (if the lender's cost of funds does not decline by 
the same degree as its return on assets after the prepayment).
    In the competitive mortgage market, lenders will have to protect 
against this loss in one of several ways: First, lenders could charge a 
prepayment fee to discourage prepayment, and thus limit the losses that 
prepayment would entail. Second, the lender could ``frontload'' the 
cost of the mortgage by charging points and reducing the interest rate 
on the loan. This is a commitment device that reduces the incentive of 
the borrower to refinance when interest rates fall, since the cost of a 
new mortgage (points and interest) would have to compete against a 
lower annual interest cost from the original loan. A third possibility 
would be avoiding prepayment penalties and points and simply charging a 
higher interest rate on the mortgage to compensate for prepayment risk.
    In a competitive mortgage market, the present value of the cost to 
the borrower of these three alternatives is equivalent. If all three 
alternatives were available, each borrower would decide which of these 
three alternatives was most desirable, based on the borrower's risk 
preferences.
    The first two alternatives amount to the decision to lock in a 
lower cost of funds rather than begin with a higher cost of funds and 
hope that the cost will decline as the result of prepayment. In 
essence, the first two choices amount to buying an insurance policy 
compared to the third, where the borrower instead prefers to retain the 
option to prepay (effectively ``betting'' that interest rates will 
fall).
    If regulation were to limit prepayment penalties, by this logic, 
those wishing to lock in low mortgage costs would choose a mortgage 
that frontloads costs through points as an alternative to choosing a 
mortgage with a prepayment penalty.
    Loan maturity is another important choice for the borrower. The 
borrower who wishes to bet on declining interest rates can avoid much 
of the cost of the third alternative mentioned above (that is, paying 
the prepayment risk premium) by keeping the mortgage maturity short-
term (for example, by agreeing to a balloon payment of principal in, 
say, 3 years). Doing so can substantially reduce the annual cost of the 
mortgage.
    In the subprime market, where borrowers' creditworthiness is also 
highly subject to change, prepayment risk results from improvements in 
borrower riskiness as well as changes in U.S. Treasury interest rates. 
The choice of either points, prepayment penalties, or neither amounts 
to choosing, as before, whether to lock in a lower overall cost of 
mortgage finance rather than betting on the possibility of an 
improvement. Similarly, retaining a prepayment option, or choosing a 
balloon mortgage, allows the individual to ``bet'' on an improvement in 
his creditworthiness.
    Borrowers in the subprime market are subject to significant risk 
that they could lose their homes as the result of death, disability, or 
job loss of the household's breadwinner(s). Some households will want 
to insure against this eventuality with credit insurance. Credit 
insurance comes in two main forms: monthly insurance (which is paid as 
a premium each month), or ``single-premium'' insurance, which is paid 
for the life of the mortgage in a single lump sum at the time of 
origination, and typically is financed as part of the mortgage. Because 
single-premium insurance commits the borrower to the full length of 
time of the mortgage (and because there is the possibility that the 
borrowers' risk of unemployment, death, or disability will decline 
after origination), the monthly cost of single-premium insurance is 
much lower than the cost of monthly insurance. Borrowers who want the 
option to be able to cancel their insurance policy (for example, to 
take advantage of a decline in their risk of unemployment) pay for that 
valuable option in the form of a higher premium per month on monthly 
insurance. According to Assurant Group (a major provider of credit 
insurance to the mortgage market), the monthly cost for monthly credit 
insurance on 5 year mortgages, on average, is about 50 percent more 
expensive than the monthly cost of single-premium credit insurance.
    Economists recognize that substantial points, prepayment penalties, 
short mortgage maturities, and credit insurance have arisen in the 
subprime market, in large part, because these contractual features 
offer preferred means of reducing overall costs and risks to consumers. 
Default and prepayment risks are higher in the subprime market, and 
therefore, mortgages are more expensive and mortgage contracts are more 
complex. Clearly, there would be substantial costs borne by many 
borrowers from limiting the interest rates or overall charges on 
subprime mortgages, or from prohibiting borrowers from choosing their 
preferred combination of rates, points, penalties, and insurance. As 
Fed Governor Edward Gramlich writes:

          ``. . . some [predatory lending practices] are more subtle, 
        involving misuse of practices that can improve credit market 
        efficiency most of the time. For example, the freedom for loan 
        rates to rise above former usury ceilings is mostly desirable, 
        in matching relatively risky borrowers with appropriate 
        lenders. . . . Most of the time balloon payments make it 
        possible for young homeowners to buy their first house and 
        match payments with their rising income stream. . . . Most of 
        the time the ability to refinance mortgages permits borrowers 
        to take advantage of lower mortgage rates. . . . Often mortgage 
        credit insurance is desirable. . . .'' (Gramlich 2000, p. 2)

    Any attempts to regulate the subprime market should take into 
account the potential costs of regulatory prohibitions. As I will argue 
in more detail in section 3 below, many new laws and statutory 
proposals are imbalanced in that they fail to take into account the 
costs from reducing access to complex, high-cost mortgages.
Predatory Practices
    So much for the ``baby''; now let me turn to the ``bathwater.'' The 
use of high and multiple charges, and the many dimensions of mortgage 
contracts, I have argued, hold great promise for consumers, but with 
that greater complexity also comes greater opportunity for fraud and 
for mistakes by consumers who may not fully understand the contractual 
costs and benefits they are being offered.
    That is the essential dilemma. The goal of policymakers should be 
to define and address predatory practices without undermining the 
opportunities offered by subprime lending.
    According to the HUD-Treasury report, predatory practices in the 
subprime mortgage market fall into four categories: (1) ``loan 
flipping'' (enticing borrowers to refinance excessively, sometimes when 
it is not in their interest to do so, and charging high refinancing 
fees that strip borrower home equity), (2) excessive fees and 
``packing'' (charging excessive amounts of fees to borrowers, allegedly 
because borrowers fail to understand the nature of the charges, or lack 
knowledge of what would constitute a fair price), (3) lending without 
regard to the borrower's ability to repay (that is, lending with the 
intent of forcing a borrower into foreclosure in order to seize the 
borrower's home), and (4) outright fraud.
    It is worth pausing for a moment to note that, with the exception 
of fraud (which is already illegal) these problems are defined by 
(often subjective) judgments about the outcomes for borrowers 
(excessive refinancing, excessive fees, excessive risk of default), not 
by clearly definable actions by lenders that can be easily prohibited 
without causing collateral harm in the mortgage market.
    For example, with regard to loan flipping, it may not be easy to 
define in an exhaustive way the combinations of changes to a mortgage 
contract that make a borrower better off. There are clear cases of 
purely adverse change (for example, across-the-board increases in rates 
and fees with no compensating changes in the contract), and there are 
clear cases of improvement, but there are also gray areas in which a 
mix of changes occurs, and where a judgment as to whether the position 
of the borrower has improved or deteriorated depends on an evaluation 
of the probabilities of future contingencies and a knowledge of 
borrower preferences.
    Similarly, whether fees are excessive can often be very difficult 
to gauge, since the sizes of the fees vary with the creditworthiness of 
the borrower and with the intent of the contract. For example, points 
are often used as a commitment device to limit prepayment risk.
    And what is the maximum ``acceptable'' level of default risk on a 
mortgage, which would constitute evidence that a mortgage had been 
unreasonably offered because of the borrower's inability to repay?
    Many alleged predatory problems revolve around questions of fair 
disclosure and fraud prevention. These can be addressed to a great 
degree by ensuring accurate and complete disclosure of facts (making 
sure that the borrower is aware of the true APR, and making sure that 
legally mandated procedures under RESPA, TILA, and HOEPA are followed 
by the lender). In section 3, I will discuss a variety of proposals for 
strengthening disclosure rules and protections against fraud.
    But the critics of predatory lending argue that inadequate 
disclosure and outright fraud are not the only ways in which borrowers 
may be fooled unfairly by lenders. For some elderly people, or people 
who are mentally incapacitated, predatory lending may simply constitute 
taking advantage of those who are mentally incapable of representing 
themselves when signing loan contracts. And for others, lack of 
familiarity with financial language or concepts may make it hard for 
them to judge what they are agreeing to.
    Of course, this problem arises in markets all the time. When 
consumers purchase automobiles, those who cannot calculate present 
values of cashflows (when comparing various financing alternatives) may 
be duped into paying more for a car. And when renting a car, less savvy 
consumers may pay more than they should for gasoline or collision 
insurance. In a market economy, we rely on the time-honored common law 
principle of caveat emptor because on balance we believe that market 
solutions are better than Government planning, and markets cannot 
function if those who make choices in markets are able to reverse those 
choices after the fact whenever they please.
    But consumer advocates rightly point out that, given the importance 
of the mortgage decision, a misstep by an uninformed or mentally 
incapacitated consumer in the mortgage market can be a life changing 
disaster. That concern explains why well-intentioned would-be reformers 
have turned their attentions to proposals to regulate mortgage 
products. But those proposed remedies often are excessive. Reformers 
advocate what amount to price controls, and prohibitions of contractual 
features that they deem to be onerous or unnecessary.
    Some of these advocates of reform, however, seem to lack a basic 
understanding of the functioning of financial markets and the pricing 
of financial instruments. In their zeal to save borrowers from harming 
themselves they run the risk of causing more harm to borrowers than 
predatory lenders.
    Other reformers seem to understand that their proposals will reduce 
the availability of subprime credit to the general population, but they 
do not care. Indeed, one gets the impression that some paternalistic 
community groups dislike subprime lending and feel entitled to place 
limits on the decisionmaking authority even of mentally competent 
individuals. Other critics of predatory lending may have more sinister 
motives related to the kickbacks they receive for contractually 
agreeing to stop criticizing particular subprime lenders.
    Whatever the motives of these advocates, it is easy to show that 
many of the extreme proposals for changing the regulation of the 
subprime mortgage market are misguided and would harm many consumers by 
limiting their access to credit on the most favorable terms available. 
There are better ways to target the legitimate problems of abuse.
Evaluating Proposed Reforms
    Let me now turn to an analysis of each of the proposed remedies for 
predatory lending, which I divide into three groups: (1) those that are 
sensible and that should be enacted by Fed regulation, (2) those that 
are possibly sensible, but which might do more harm than good, and thus 
require more empirical study before deciding whether and how to 
implement them, and (3) those that are not sensible, and which would 
obviously do more harm than good.
Sensible Reforms That Should Be Implemented Immediately by the Fed
    Under HOEPA, the Fed is entitled to regulate subprime mortgages 
that either have interest rates far in excess of Treasury rates (the 
Fed currently uses a 10 percent spread trigger, but can vary that 
spread between 8 percent and 12 percent) or that have total fees and 
points greater than either 8 percent or $451. HOEPA already specifies 
some contractual limits on these loans (for example, prepayment 
penalties are only permissible for the first 5 years of the loan, and 
only when the borrowers' income is greater than 50 percent of the loan 
payment). It is my understanding that the Fed currently has broad 
authority to establish additional regulatory guidelines for these 
loans, and is currently considering a variety of measures. Following is 
a list of measures that I regard as desirable.
Disclosure and Counseling
    Disclosure requirements always add to consumers' loan costs, but in 
my judgment, some additional disclosure requirements would be 
appropriate for the loans regulated under HOEPA. I would recommend a 
mandatory disclosure statement like the one proposed in section 3(a) of 
Senate bill S. 2415 (April 12, 2000), which alerts borrowers to the 
risks of subprime mortgage borrowing. It is also desirable to make 
counseling available to potential borrowers on HOEPA loans, and to 
require lenders to disclose that such counseling is available (as 
proposed in the HUD-Treasury report). The HUD-Treasury report also 
recommends amendments to RESPA and TILA that would facilitate 
comparison shopping and make timely information about the costs of 
credit and settlement easier for consumers to understand and more 
reliable. I also favor the HUD-Treasury suggestions of imposing an 
accuracy standard on permissible violations from the Good Faith 
Estimate required under RESPA, requiring lenders to disclose credit 
scores to borrowers (I note that these scores have since been made 
available by Fair Isaac Co. to borrowers via the Internet), and 
expanding penalties on lenders for inadequate or inaccurate 
disclosures. The use of ``testers'' to verify disclosure practices 
would likely prove very effective as an enforcement tool to ensure that 
lenders do not target some classes of individuals with inadequate 
disclosure. I also agree with the suggested requirement that lenders 
notify borrowers of their intent to foreclose far enough in advance 
that borrowers have the opportunity to arrange alternative financing (a 
feature of the new Pennsylvania statute) as a means of discouraging 
unnecessary foreclosure. Finally, I would recommend that, for HOEPA 
loans where borrowers' monthly payments exceed 50 percent of their 
monthly income, the lender should be required to make an additional 
disclosure that informs the borrower of the estimated high probability 
(using a recognized model, like that of Fair Isaac Co.) that the 
borrower may lose his or her home because of inadequate ability to pay 
debt service.
Credit History Reporting
    It is alleged that some lenders withhold favorable information 
about customers in order to keep information about improvements in 
customer creditworthiness private, and thus limit competition. It is 
appropriate to require lenders not to selectively report information to 
credit bureaus.
Single-Premium Insurance
    Roughly one in four households do not have any life insurance, 
according to Household (2001). Clearly, credit insurance can be of 
enormous value to subprime borrowers, and single-premium insurance can 
be a desirable means for reducing the risk of losing one's home at low 
cost. To prevent abuse of this product, there should be a mandatory 
requirement that lenders that offer single-premium insurance (1) must 
give borrowers a choice between single-premium and monthly premium 
credit insurance, (2) must clearly disclose that credit insurance is 
optional and that the other terms of the mortgage are not related to 
whether the borrower chooses credit insurance, and (3) must allow 
borrowers to cancel their single-premium insurance and receive a full 
refund of the payment within a reasonable time after closing (say, 
within 30 days, as in the Pennsylvania statute).
Limits on Flipping
    Several new laws and proposals, including a proposed rule by the 
Federal Reserve Board, would limit refinancing to address the problem 
of loan flipping. The Fed rule would prohibit refinancing of a HOEPA 
loan by the lender or its affiliate within the first 12 months unless 
that refinancing is ``in the borrower's interest.'' This is a 
reasonable idea so long as there is a clear and reasonable safe harbor 
in the rule for lenders that establishes criteria under which it will 
be presumed that the refinancing was in the borrower's interest. For 
example, if a refinancing either (a) provides substantial new money or 
debt consolidation, (b) reduces monthly payments by a minimum amount, 
or (c) reduces the duration of the loan, then any one of those features 
should protect the lender from any claim that the refinancing was not 
in the borrower's interest.
Limits on Refinancing of Subsidized Government or Not-for-Profit Loans
    It has been alleged that some lenders have tricked borrowers into 
refinancing heavily subsidized Government or not-for-profit loans at 
market (or above market) rates. Lenders that refinance such loans 
should face very strict tests for demonstrating that the refinancing 
was in the interest of the borrower.
Prohibition of Some Contractual Features
    Some mortgage structures add little real value to the menu of 
consumers' options, and are especially prone to abuse. In my judgment, 
the Federal Reserve Board has properly identified payable-on-demand 
clauses or call provisions as an example of such contractual features 
that should be prohibited.
Require Lenders To Offer Loans With and Without Prepayment Penalties
    Rather than regulate prepayment penalties further as some have 
proposed, I would recommend requiring that HOEPA lenders offer 
mortgages both with and without prepayment penalties, so that the price 
of the prepayment option would be clear to consumers. Then consumers 
could make an informed decision whether to pay for the option to 
prepay.
Proposals That Require Further Study
    In addition to the aforementioned reforms, many other potentially 
beneficial, but also potentially costly, reforms have been proposed and 
should be studied to determine whether they are necessary over and 
above the reforms listed above, and whether on balance they would do 
more good than harm. The list of potentially beneficial reforms that 
are worthy of careful scrutiny includes:

          (1) A limit on balloons (for example, requiring a minimum of 
        a certain period of time between origination and the balloon 
        payment) is worth exploring--although many of the proposed 
        limits on balloons do not seem reasonable; for example both the 
        Pennsylvania statute's 10 year limit and the HUD-Treasury 
        report's proposed 15 year limit, seem to me far too long; but 
        shorter-term limits on balloons (say, a 3 or 5 year minimum 
        duration) may be desirable.
          (2) The establishment of new rules on mortgage brokers' 
        behavior (as proposed in the HUD-Treasury report) may be 
        worthwhile, as a means of ensuring that mortgage brokerage is 
        not employed to circumvent effective compliance; and
          (3) It may be desirable, as the Fed has proposed, to lower 
        the HOEPA interest rate threshold from 10 percent to 8 percent. 
        The main drawback of lowering the trigger point for HOEPA, 
        which has been noted by researchers at the Fed, and by Robert 
        Litan, is the potential chilling effect that reporting 
        requirements may have on the supply of credit in the subprime 
        market. (I note in passing that I do not agree with the 
        proposal to include all fees into the HOEPA fee trigger; fees 
        that are optional, and not conditions for granting the 
        mortgage--like credit insurance--should be excluded from the 
        calculation.)
Proposals That Should Be Rejected
Usury Laws
    Under the rubric of bad ideas, I will focus on one in particular: 
price controls. It is a matter of elementary economics that limits on 
prices restrict supply. Among the ideas that should be rejected out of 
hand are proposals to impose Government price controls--on interest 
rates, points, and fees--for subprime mortgages.
    Because of legal limits on local authorities to impose usury 
ceilings (due to Federal preemption) States and municipalities intent 
on discouraging high-cost mortgage lending have pursued an alternative 
``stealth'' approach to usury laws. The technique is to impose 
unworkable risks on subprime lenders that charge rates or fees in 
excess of Government specified levels and thereby drive high-interest 
rate lenders from the market.
    Additionally, some price control proposals are put forward by 
community groups like ACORN in the form of ``suggested'' voluntary 
agreements between community groups and lenders.
    Several cities and States have passed, or are currently debating, 
stealth usury laws for subprime lending. For example, the city of 
Dayton, Ohio this month passed a draconian antipredatory lending law. 
This law places lenders at risk if they make high-interest loans that 
are ``less favorable to the borrower than could otherwise have been 
obtained in similar transactions by like consumers within the City of 
Dayton,'' and lenders may not charge fees and/or costs that ``exceed 
the fees and/or costs available in similar transactions by like 
consumers in the City of Dayton by more than 20 percent.''
    In my opinion, it would be imprudent for a lender to make a loan in 
Dayton governed by this statute. Indeed, I believe that the statute's 
intent must be to eliminate high-interest loans, which is why I 
describe it as a stealth usury law. Immediately upon the passage of the 
Dayton law, Bank One announced that it was withdrawing from origination 
of loans that were subject to the statute. No doubt others will exit, 
as well.
    The recent 131 page antipredatory lending law passed in the 
District of Columbia is similarly unworkable. Lenders are subject to 
substantial penalties if they are deemed to have lent at an interest 
rate ``substantially greater than the home borrower otherwise would 
have qualified for, at that lender or at another lender, had the lender 
based the annual percentage rate upon the home borrowers' credit scores 
as provided by nationally recognized credit reporting agencies,'' or if 
loan costs are ``unconscionable,'' or if loan discount points are ``not 
reasonably consistent with established industry customs and 
practices.''
    The District law is fundamentally flawed in several respects. 
First, it essentially requires lenders to charge no more than the rate 
indicated by the customer's credit score. That is an improper use of 
credit scores. Credit scores are not perfect indicators of risk; they 
are used as one of many--and sometimes not the primary--means of 
judging whether and on what terms to make a loan. Second, the DC law 
places the ridiculous burden on the lender of making sure, prior to 
lending, that his customer could not find a better deal from his 
competitors. Finally, the vague wording makes the legal risks of 
subprime lending so great that no banker would want to engage in it.
    As Donald Lampe points out, massive withdrawal from the subprime 
lending market occurred in response to the overly zealous initiative 
against predatory lending by the State of North Carolina. To quote from 
Lampe's (2001) summary of the North Carolina experience:

          ``Virtually all residential mortgage lenders doing business 
        in North Carolina have elected not to make ``high-cost home 
        loans'' that are subject to N.C.G.S. 24-1.1E. Instead, lenders 
        seek to avoid the ``thresholds'' established by the law.'' (p. 
        4)

    Michael Staten of the Credit Research Center of Georgetown 
University has compiled a new database on subprime lending that permits 
one to track the chilling 
effect of the North Carolina law on subprime lending in the State. The 
sample coverage of the database nationwide includes 39 percent of all 
subprime mortgage loans made by HMDA-reporting institutions in 1998.
    Staten's statistical research (reproduced with permission in an 
appendix to this testimony) compares changes in mortgage originations 
in North Carolina with those in South Carolina and Virginia, before and 
after the passage of the North Carolina law (which was passed in July 
1999 and phased in through early 2000). South Carolina and Virginia are 
included in these tables as controls to allow for changes over time in 
mortgage originations in the Upper South that were not specific to 
North Carolina.
    As shown in the appendix, Staten finds that originations of 
subprime mortgage loans (especially first-lien loans) in North Carolina 
plummeted after passage of the 1999 law, both absolutely and relatively 
to its neighbors, and that the decline was almost exclusively in the 
supply of loans available to low- and moderate-income borrowers (those 
most dependent on high-cost credit). For borrowers in the low-income 
group (with annual incomes less than $25,000) originations were cut in 
half; for those in the next income class (with annual incomes between 
$25,000 and $49,000) originations were cut by roughly a third. The 
response to the North Carolina law provides clear evidence of the 
chilling effect of antipredatory laws on the supply of subprime 
mortgage loans to low-income borrowers.
    Robert Litan (2001) had anticipated this result. He wrote that:

          ``. . . statutory measures at the State and local level at 
        this point run a significant risk of unintentionally cutting 
        off the flow of funds to creditworthy borrowers. This is a very 
        real threat and one that should be seriously considered by 
        policymakers at all levels of government, especially in light 
        of the multiple, successful efforts that Federal law in 
        particular 
        has made to increase lending in recent years to minorities and 
        low-income borrowers.

          ``The more prudent course is for policymakers at all levels 
        of government to wait for more data to be collected and 
        reported by the Federal Reserve so that enforcement officials 
        can better target practices that may be unlawful under existing 
        statutes. In the meantime, Congress should provide the Federal 
        agencies charged with enforcing existing statutes with 
        sufficient resources to carry out their mandates, as well as to 
        support ongoing counseling efforts to educate vulnerable 
        consumers about the alternatives open to them in the credit 
        market and the dangers of signing mortgages with unduly onerous 
        terms.'' (p. 2)

    The history of the last two decades teaches that usury laws are 
highly counterproductive. Limits on the ability of States to regulate 
consumer lenders head-
quartered outside their State were undermined by the 1978 Marquette 
National Bank case (see DeMuth, 1986). In 1982, the Federal Government 
further expanded consumers' access to credit by preempting State 
restrictions on mortgage lending by mortgage lenders headquartered 
within the State (the Alternative Mortgage Transaction Parity Act of 
1982).
    These measures were crucial contributors to the democratization of 
consumer finance, and particularly, mortgage finance in recent years. 
The Marquette case opened a flood of competition in credit card 
lending, which led the way to establishing a deep market in consumer 
credit receivables and the new techniques for credit scoring--
innovations which have increased the supply and reduced the cost of 
consumer credit.
    The 1982 Parity Act expanded the range of competition in consumer 
mortgage finance preempting State prohibitions on alternative mortgages 
originated by both depository and nondepository institutions. In 
particular, as I understand this law, it effectively preempts State 
usury laws as applied to subprime mortgages. Because mortgage lending 
relies on real estate as security, it can be provided more 
inexpensively than credit card loans or other unsecured consumer credit 
(Calomiris and Mason, 1998). Thus the 1982 Act provided an important 
benefit to consumers over and above the beneficial undermining of State 
usury laws after the Marquette case.
    But the new stealth usury laws of North Carolina, Dayton, and 
Washington DC, and similar proposals elsewhere, pose a new threat. If 
Congress fails to restore the preemption principle in the subprime 
mortgage market established in 1982, then lenders will be driven out of 
the high-risk end of the market, and therefore, many consumers will be 
driven out of the mortgage market and into higher-cost, less desirable 
credit markets (credit cards, pawn shops, and worse).
    That is not progress. Congress should do everything in its power to 
amend the Parity Act to clearly define stealth usury laws as usury 
laws, not consumer protection laws, and thus prevent any further damage 
to individuals' access to credit from these pernicious State and city 
initiatives.
Other Prohibitions
    I have already argued against further regulatory or statutory 
limits on prepayment penalties, or prohibition of single-premium credit 
insurance, in favor of alternative approaches to the abuses that 
sometimes accompany these features.
    I am also opposed to the many proposals that would prevent 
borrowers from agreeing to mandatory binding arbitration to resolve 
loan disputes. Individuals should be able to choose. If an individual 
wishes to commit to binding arbitration, that commitment reduces the 
costs to lenders of originating mortgages, and in the competitive 
mortgage market, that cost is passed on to consumers. Requiring 
consumers not to commit to binding arbitration is only good for 
America's trial lawyers.
Conclusion
    For the most part, predatory lending practices can be addressed by 
focusing efforts on better enforcing laws against fraud, improving 
disclosure rules, offering Government-financed counseling, and placing 
a few well thought out limits on credit industry practices. The Fed 
already has the authority and the expertise to formulate those rules 
and is in the process of doing so, based on a new data collection 
effort that will permit an informed and balanced approach to regulating 
subprime lending.
    The main role of Congress, in my view, should be to monitor the 
Fed's rulemaking as it evolves, make sure that the Fed has the 
statutory authority that it needs to set appropriate regulations, and 
amend the 1982 Parity Act to reestablish Federal preemption and thus 
defend consumers against the ill-conceived usury laws that are now 
spreading throughout the country.
    Members of Congress, and especially Members of this Committee, also 
should speak out in defense of honest subprime lenders, of which there 
are many. The possible passage of State and city usury statutes is not 
the only threat to the supply of subprime loans. There is also the 
possibility that bad publicity, orchestrated by community groups, 
itself could force some lenders to exit the market.
    Some community organizations have been waging a smear campaign 
against subprime lenders. To the extent that zealous community groups, 
whether out of noble or selfish intent, succeed in smearing subprime 
lenders as a group, the public relations consequences will have a 
chilling effect on the supply of subprime credit. The first casualty 
will be the truth. The second casualty will be access to credit for the 
poor.
References
    Calomiris, Charles W., and Joseph R. Mason (1998). High Loan-To-
Value Mortgage Lending. Washington: AEI Press.
    Carey, Mark, Mitch Post, and Steven A. Sharpe (1998). ``Does 
Corporate Lending by Banks and Finance Companies Differ? Evidence on 
Specialization in Private Debt Contracting.'' Journal of Finance 53 
(June), 845-78.
    DeMuth, Christopher C. (1986). ``The Case Against Credit Car 
Interest Rate Regulation.'' Yale Journal on Regulation 3 (Spring), 201-
41.
    Gramlich, Edward M. (2000). ``Remarks by Governor Edward M. 
Gramlich at the Federal Reserve Bank of Philadelphia Community and 
Consumer Affairs Department Conference on Predatory Lending.'' December 
6.
    Household International Inc. (2001). ``News Release: Household 
International to Discontinue Sale of Single Premium Credit Insurance on 
All Real Estate Secured Loans.'' July 11.
    Lampe, Donald C. (2001). ``Update on State and Local Anti-Predatory 
Lending Laws and Regulations: The North Carolina Experience.'' American 
Conference Institute, Predatory Lending Seminar, San Francisco, June 
27-28.
    Litan, Robert E. (2001). ``A Prudent Approach To Preventing 
`Predatory' Lending.'' Working Paper, The Brookings Institution, 2001.
    U.S. Department of Housing and Urban Development and U.S. 
Department of the Treasury (2000). Curbing Predatory Home Mortgage 
Lending: A Joint Report. June.






















           REVISED PREPARED STATEMENT OF CHARLES W. CALOMIRIS
          Paul M. Montrone Professor of Finance and Economics
  Graduate School of Business, Columbia University, New York, New York
                             July 27, 2001
    Mr. Chairman, it is a pleasure and an honor to address you today on 
the important topic of predatory lending.
    Predatory lending is a real problem. It is, however, a problem that 
needs to be addressed thoughtfully and deliberately, with a hard head 
as well as a soft heart. There is no doubt that people have been hurt 
by the predatory practices of some creditors, but we must make sure 
that the cure is not worse than the disease. Unfortunately, many of the 
proposed or enacted municipal, State, and Federal statutory responses 
to predatory lending would have adverse consequences that are worse 
than the problems they seek to redress. Many of these initiatives would 
reduce the supply of credit to low-income homeowners, raise their cost 
of credit, and restrict the menu of beneficial choices available to 
borrowers.
    Fortunately, there is a growing consensus in favor of a balanced 
approach to the problem. That consensus is reflected in the viewpoints 
expressed by a wide variety of individuals and organizations, including 
Robert Litan of the Brookings Institution, Fed Governor Edward 
Gramlich, most of the recommendations of last year's HUD-Treasury 
Report, the voluntary standards set by the American Financial Services 
Association (AFSA), the recent predatory lending statute passed by the 
State of Pennsylvania, and the recommendations and practices of many 
subprime mortgage lenders (including, most notably, Household). In my 
comments, I will describe and defend that balanced approach, and offer 
some specific recommendations for Congress and for financial 
regulators.
    To summarize my recommendations at the outset, I believe that an 
appropriate response to predatory practices should occur in two stages: 
First, there should be an immediate regulatory response to strengthen 
enforcement of existing laws, enhance disclosure rules and provide 
counseling services, amend existing regulation, and limit or ban some 
practices. I believe that these initiatives, described in detail below, 
will address all of the serious problems associated with predatory 
lending.
    In other areas--especially the regulation of prepayment penalties 
and balloon payments--any regulatory change should await a better 
understanding of the extent of remaining predatory problems that result 
from these features, and the best ways to address them through 
appropriate regulations. The Fed is currently pursuing the first 
systematic scientific evaluation of these areas, as part of its clear 
intent to expand its role as the primary regulator of subprime lending, 
given its authority under HOEPA. The Fed has the regulatory authority 
and the expertise necessary to find the right balance between 
preventing abuse and permitting beneficial contractual flexibility.
    Congress, and other legislative bodies, should not rush to judgment 
ahead of the facts and before the Fed has had a chance to address these 
more complex problems, and in so doing, end up throwing away the 
proverbial baby of subprime lending along with the bathwater of 
predatory practices.
    I think the main role Congress should play at this time is to rein 
in actions by States and municipalities that seek to avoid established 
Federal preemption by effectively setting mortgage usury ceilings under 
the guise of consumer protection rules. Immediate Congressional action 
to dismantle these new undesirable barriers to individuals' access to 
mortgage credit would ensure that consumers throughout the country 
retain their basic contractual rights to borrow in the subprime market.
    My detailed comments divide into four parts: (1) a background 
discussion of subprime lending, (2) an attempt to define predatory 
practices, (3) a point-by-point evaluation of proposed or enacted 
remedies for predatory practices, and (4) a concluding section.
Subprime Lending, the Democratization of Finance, and
Financial Innovation
    The problems that fall under the rubric of predatory lending are 
only possible today because of the beneficial ``democratization'' of 
consumer credit markets, and mortgage markets in particular, that has 
occurred over the past decade. Predatory practices are part and parcel 
of the increasing complexity of mortgage contracts in the high-risk 
(subprime) mortgage area. That greater contractual complexity has two 
parts: (1) the increased reliance on risk pricing using Fair Isaac Co. 
(FICO) scores rather than the rationing of credit via yes or no lending 
decisions, and (2) the use of points, insurance, and prepayment 
penalties to limit the risks lenders and borrowers bear and the costs 
borrowers pay.
    These practices make economic sense and can bring great benefits to 
consumers. Most importantly, these market innovations allow mortgage 
lenders to gauge, price, and control risk better than before, and thus 
allow them to tolerate greater gradations of risk among borrowers.
    According to last year's HUD-Treasury report, subprime mortgage 
originations have skyrocketed since the early 1990's, increasing by 
tenfold since 1993. The dollar volume of subprime mortgages was less 
than 5 percent of all mortgage originations in 1994, but by 1998 had 
risen to 12.5 percent. As Fed Governor Edward Gramlich (2000) has 
noted, between 1993 and 1998, mortgages extended to Hispanic-Americans 
and African-Americans increased the most, by 78 and 95 percent, 
respectively, largely due to the growth in subprime mortgage lending.
    Subprime loans are extended primarily by nondepository 
institutions. The new market in consumer credit, and subprime credit in 
particular, is highly competitive and involves a wide range of 
intermediaries. Research by economists at the Federal Reserve Board 
indicates that the reliance on nondepository intermediaries reflects a 
greater tolerance for lending risk by intermediaries that do not have 
to subject their loan portfolios to examination by Government 
supervisors (Carey et al. 1998).
    Subprime lending is risky. The reason that so many low-income and 
minority borrowers rely on the subprime market is that, on average, 
these are riskier groups of borrowers. It is worth bearing in mind that 
default risk varies tremendously in the mortgage market. According to 
Frank Raiter of Standard & Poor's, the probability of default (over the 
lifetime of the mortgage, which is typically 3 to 5 years) for the 
highest risk class of subprime mortgage borrowers is roughly 23 
percent, which is more than one thousand times the default risk of the 
lowest risk class of prime mortgage borrowers. There is variation in 
default risk within the highest risk class, as well, so that some 
subprime mortgages have even higher risk of default.
    When default risk is this great, in order for lenders to 
participate in the market, they must be compensated with unusually high 
interest rates. Consider an extreme case. For example, even if a lender 
were risk-neutral (indifferent to the variance of payoffs from a bundle 
of loans) a lender bearing a 20 percent risk of default (on average, in 
each year of the mortgage), and expecting to lose 50 percent on a 
foreclosed loan (net of foreclosure costs) should charge at least the 
relevant Treasury rate (given the maturity of the loan) plus 10 
percent. On second-trust mortgages, loan losses may be as high as 100 
percent. In that case, the risk-neutral default premium would be 20 
percent. Added to these risk-neutral premia would be a risk premium to 
compensate for the high variance of returns on risky loans (to the 
extent that default risk is nondiversifiable), as well as premia to pay 
for the costs of gathering information about borrowers, and the costs 
of maintaining lending facilities and staff. These premia would be 
charged either in the form of higher interest rates or the present 
value equivalent of points paid in advance.
    Default risk, however, is not the only risk that lenders bear. 
Indeed, prepayment risk is of a similar order of magnitude in the 
mortgage market. To understand prepayment risk, consider a 15 year 
amortized subprime mortgage loan of $50,000 with a 10 percent interest 
rate over the Treasury rate, zero points and no prepayment penalty. If 
the Treasury rate falls, say by 1 percent, assume that the borrower 
will choose to refinance the mortgage without penalty, and assume that 
this decline in the Treasury rate actually happens 1 year after the 
mortgage is originated.
    If the interest rate on the mortgage was set with the expectation 
that the loan would last for 15 years, and if the cost of originating 
and servicing the loan was spread over that length of time, then the 
prepayment of the loan will result in a loss to the lender. An 
additional loss to the lender results from the reduction in the value 
of its net worth as the result of losing the revenue from the mortgage 
when it is prepaid (if the lender's cost of funds does not decline by 
the same degree as its return on assets after the prepayment).
    In the competitive mortgage market, lenders will have to protect 
against this loss in one of several ways: First, lenders could charge a 
prepayment fee to discourage prepayment, and thus limit the losses that 
prepayment would entail. Second, the lender could ``frontload'' the 
cost of the mortgage by charging points and reducing the interest rate 
on the loan. This is a commitment device that reduces the incentive of 
the borrower to refinance when interest rates fall, since the cost of a 
new mortgage (points and interest) would have to compete against a 
lower annual interest cost from the original loan. A third possibility 
would be avoiding prepayment penalties and points and simply charging a 
higher interest rate on the mortgage to compensate for prepayment risk.
    In a competitive mortgage market, the present value of the cost to 
the borrower of these three alternatives is equivalent. If all three 
alternatives were available, each borrower would decide which of these 
three alternatives was most desirable, based on the borrower's risk 
preferences.
    The first two alternatives amount to the decision to lock in a 
lower cost of funds rather than begin with a higher cost of funds and 
hope that the cost will decline as the result of prepayment. In 
essence, the first two choices amount to buying an insurance policy 
compared to the third, where the borrower instead prefers to retain the 
option to prepay (effectively ``betting'' that interest rates will 
fall).
    If regulation were to limit prepayment penalties, by this logic, 
those wishing to lock in low mortgage costs would choose a mortgage 
that frontloads costs through points as an alternative to choosing a 
mortgage with a prepayment penalty.
    Loan maturity is another important choice for the borrower. The 
borrower who wishes to ``bet'' on declining interest rates can avoid 
much of the cost of the third alternative mentioned above (that is, 
paying the prepayment risk premium) by keeping the mortgage maturity 
short-term (for example, by agreeing to a balloon payment of principal 
in, say, 3 years). Doing so can substantially reduce the annual cost of 
the mortgage.
    In the subprime market, where borrowers' creditworthiness is also 
highly subject to change, prepayment risk results from improvements in 
borrower riskiness as well as changes in U.S. Treasury interest rates. 
The choice of either points, prepayment penalties, or neither amounts 
to choosing, as before, whether to lock in a lower overall cost of 
mortgage finance rather than betting on the possibility of an 
improvement. Similarly, retaining a prepayment option, or choosing a 
balloon mortgage, allows the individual to ``bet'' on an improvement in 
his creditworthiness.
    Borrowers in the subprime market are subject to significant risk 
that they could lose their homes as the result of death, disability, or 
job loss of the household's breadwinner(s), which might make them 
unable to make their mortgage payments. Some households will want to 
insure against this eventuality with credit insurance. Credit insurance 
comes in two main forms: monthly insurance (which is paid as a premium 
each month), or ``single-premium'' insurance, which is paid for the 
life of the mortgage in a single lump sum at the time of origination, 
and typically is financed as part of the mortgage.
    Much has been said and written recently about single-premium, 
insurance. Single-premium insurance, it is often alleged, is a means 
unscrupulous lenders employ to trick borrowers into overpaying for 
coverage. The reason for that claim is that, in present value terms, 
single-premium insurance is more expensive for borrowers than monthly 
premium insurance.
    For example, using data provided to me by Assurant Group (a major 
provider of credit insurance to the mortgage market), a typical single-
premium policy for a 12 percent APR mortgage would have a monthly 
payment today of approximately $22 per month for 30 years. That policy 
provides coverage, however, for only the first 5 years. Its costs are 
amortized, however, over the entire 30 year period. A comparable 5 year 
average monthly cost for monthly insurance would be roughly $33, but 
that higher monthly payment would end after 5 years. Clearly, monthly 
insurance is much cheaper on a present value basis.
    Defenders of single-premium insurance argue that it is sold because 
insurers are unwilling to supply monthly insurance in many cases 
because its price (which is regulated at the State level) is set too 
low to be profitable for issuers. Defenders also argue that single-
premium insurance has some benefits that customers appreciate which 
would make them prefer it, even at current prices, even if both single-
premium and monthly insurance were available. The former argument seems 
to have some merit, although I have not been able to assemble evidence 
to prove or disprove it. The latter argument I find hard to believe, 
although I do not have evidence to refute it.
    In any case, while I am in favor of regulating single-premium 
insurance to prevent abuse (as discussed below in section 3), I am not 
in favor of prohibiting it, for two reasons. First, it may be that, as 
defenders argue, under current State price controls, it is the only 
economically feasible alternative. In that case, prohibiting it, 
without also changing State price limits, would reduce the supply of 
credit insurance available to consumers.
    Second, if it were possible to deregulate the pricing of credit 
insurance, to allow the market to set prices for both kinds of 
insurance, and if reasonable objections to current practices of selling 
credit insurance could be addressed, then some consumers would prefer 
single-premium coverage over monthly coverage. The reason is that the 
market price (in present value) of single-premium coverage would 
probably be lower than that of monthly coverage. Because single-premium 
insurance commits the borrower to the full length of time of the 
mortgage (and because there is the possibility that the borrowers' risk 
of unemployment, death, or disability will decline after origination), 
if prices were set by a competitive market, single-premium insurance 
would be less expensive (in present value terms) because buyers of 
monthly insurance are also purchasing an implicit option. Borrowers who 
want the option to be able to cancel their insurance policy (for 
example, to take advantage of a decline in their risk of unemployment, 
or upon repaying their mortgage) would prefer monthly insurance and 
would pay for that valuable option in the form of a higher premium per 
month on monthly insurance.
    So, while I recognize that under current rules, single-premium 
insurance is priced above monthly insurance, that does not imply that 
buyers of single-premium insurance have been cheated, or that it should 
be prohibited. If we can find a way for lenders to offer both kinds of 
insurance in a way that enhances consumer choice, and avoids defrauding 
borrowers, theory suggests that this would be desirable.
    In short, economists recognize that substantial points, prepayment 
penalties, short mortgage maturities, and credit insurance have arisen 
in the subprime market, in large part, because these contractual 
features offer preferred means of reducing overall costs and risks to 
consumers. Default and prepayment risks are higher in the subprime 
market, and therefore, mortgages are more expensive and mortgage 
contracts are more complex. Clearly, there would be substantial costs 
borne by many borrowers from limiting the interest rates or overall 
charges on subprime mortgages, or from prohibiting borrowers from 
choosing their preferred combination of rates, points, penalties, and 
insurance. As Fed Governor Edward Gramlich writes:

          ``. . . some [predatory lending practices] are more subtle, 
        involving misuse of practices that can improve credit market 
        efficiency most of the time. For example, the freedom for loan 
        rates to rise above former usury ceilings is mostly desirable, 
        in matching relatively risky borrowers with appropriate 
        lenders. . . . Most of the time balloon payments make it 
        possible for young homeowners to buy their first house and 
        match payments with their rising income stream. . . . Most of 
        the time the ability to refinance mortgages permits borrowers 
        to take advantage of lower mortgage rates. . . . Often mortgage 
        credit insurance is desirable. . . .'' (Gramlich 2000, p. 2)

    Any attempts to regulate the subprime market should take into 
account the potential costs of regulatory prohibitions. As I will argue 
in more detail in section 3 below, many new laws and statutory 
proposals are imbalanced in that they fail to take into account the 
costs from reducing access to complex, high-cost mortgages.
Predatory Practices
    So much for the ``baby''; now let me turn to the ``bathwater.'' The 
use of high and multiple charges, and the many dimensions of mortgage 
contracts, I have argued, hold great promise for consumers, but with 
that greater complexity also comes greater opportunity for fraud and 
for mistakes by consumers who may not fully understand the contractual 
costs and benefits they are being offered.
    That is the essential dilemma. The goal of policy makers should be 
to define and address predatory practices without undermining the 
opportunities offered by subprime lending.
    According to the HUD-Treasury report, predatory practices in the 
subprime mortgage market fall into four categories: (1) ``loan 
flipping'' (enticing borrowers to refinance excessively, sometimes when 
it is not in their interest to do so, and charging high refinancing 
fees that strip borrower home equity), (2) excessive fees and 
``packing'' (charging excessive amounts of fees to borrowers, allegedly 
because borrowers fail to understand the nature of the charges, or lack 
knowledge of what would constitute a fair price), (3) lending without 
regard to the borrower's ability to repay (that is, lending with the 
intent of forcing a borrower into foreclosure in order to seize the 
borrower's home), and (4) outright fraud.
    It is worth pausing for a moment to note that, with the exception 
of fraud (which is already illegal) these problems are defined by 
(often subjective) judgments about the outcomes for borrowers 
(excessive refinancing, excessive fees, excessive risk of default), not 
by clearly definable actions by lenders that can be easily prohibited 
without causing collateral harm in the mortgage market.
    For example, with regard to loan flipping, it may not be easy to 
define in an exhaustive way the combinations of changes to a mortgage 
contract that make a borrower better off. There are clear cases of 
purely adverse change (for example, across-the-board increases in rates 
and fees with no compensating changes in the contract), and there are 
clear cases of improvement, but there are also gray areas in which a 
mix of changes occurs, and where a judgment as to whether the position 
of the borrower has improved or deteriorated depends on an evaluation 
of the probabilities of future contingencies and a knowledge of 
borrower preferences.
    Similarly, whether fees are excessive can often be very difficult 
to gauge, since the sizes of the fees vary with the creditworthiness of 
the borrower and with the intent of the contract. For example, points 
are often used as a commitment device to limit prepayment risk.
    And what is the maximum ``acceptable'' level of default risk on a 
mortgage, which would constitute evidence that a mortgage had been 
unreasonably offered because of the borrower's inability to repay?
    Many alleged predatory problems revolve around questions of fair 
disclosure and fraud prevention. These can be addressed to a great 
degree by ensuring accurate and complete disclosure of facts (making 
sure that the borrower is aware of the true APR, and making sure that 
legally mandated procedures under RESPA, TILA, and HOEPA are followed 
by the lender). In section 3, I will discuss a variety of proposals for 
strengthening disclosure rules and protections against fraud.
    But the critics of predatory lending argue that inadequate 
disclosure and outright fraud are not the only ways in which borrowers 
may be fooled unfairly by lenders. For some elderly people, or people 
who are mentally incapacitated, predatory lending may simply constitute 
taking advantage of those who are mentally incapable of representing 
themselves when signing loan contracts. And for others, lack of 
familiarity with financial language or concepts may make it hard for 
them to judge what they are agreeing to.
    Of course, this problem arises in markets all the time. When 
consumers purchase automobiles, those who cannot calculate present 
values of cashflows (when comparing various financing alternatives) may 
be duped into paying more for a car. And when renting a car, less savvy 
consumers may pay more than they should for gasoline or collision 
insurance. In a market economy, we rely on the time-honored common law 
principle of caveat emptor because on balance we believe that market 
solutions are better than Government planning, and markets cannot 
function if those who make choices in markets are able to reverse those 
choices after the fact whenever they please.
    But consumer advocates rightly point out that, given the importance 
of the mortgage decision, a misstep by an uninformed or mentally 
incapacitated consumer in the mortgage market can be a life changing 
disaster. That concern explains why well-intentioned would-be reformers 
have turned their attentions to proposals to regulate mortgage 
products. But those proposed remedies often are excessive. Reformers 
advocate what amount to price controls, and prohibitions of contractual 
features that they deem to be onerous or unnecessary.
    Some of these advocates of reform, however, seem to lack a basic 
understanding of the functioning of financial markets and the pricing 
of financial instruments. In their zeal to save borrowers from harming 
themselves they run the risk of causing more harm to borrowers than 
predatory lenders.
    Other reformers seem to understand that their proposals will reduce 
the availability of subprime credit to the general population, but they 
do not care. Indeed, one gets the impression that some paternalistic 
community groups dislike subprime lending and feel entitled to place 
limits on the decisionmaking authority even of mentally competent 
individuals. Other critics of predatory lending may have more sinister 
motives related to the kickbacks they receive for contractually 
agreeing to stop criticizing particular subprime lenders.
    Whatever the motives of these advocates, it is easy to show that 
many of the extreme proposals for changing the regulation of the 
subprime mortgage market are misguided and would harm many consumers by 
limiting their access to credit on the most favorable terms available. 
There are better ways to target the legitimate problems of abuse.
Evaluating Proposed Reforms
    Let me now turn to an analysis of each of the proposed remedies for 
predatory lending, which I divide into three groups: (1) those that are 
sensible and that should be enacted by Fed regulation, (2) those that 
are possibly sensible, but which might do more harm than good, and thus 
require more empirical study before deciding whether and how to 
implement them, and (3) those that are not sensible, and which would 
obviously do more harm than good.
Sensible Reforms That Should Be Implemented Immediately by the Fed
    Under HOEPA, the Fed is entitled to regulate subprime mortgages 
that either have interest rates far in excess of Treasury rates (the 
Fed currently uses a 10 percent spread trigger, but can vary that 
spread between 8 percent and 12 percent) or that have total fees and 
points greater than either 8 percent or $451. HOEPA already specifies 
some contractual limits on these loans (for example, prepayment 
penalties are only permissible for the first 5 years of the loan, and 
only when the borrowers' income is greater than 50 percent of the loan 
payment). It is my understanding that the Fed currently has broad 
authority to establish additional regulatory guidelines for these 
loans, and is currently considering a variety of measures. Following is 
a list of measures that I regard as desirable.
Disclosure and Counseling
    Disclosure requirements always add to consumers' loan costs, but in 
my judgment, some additional disclosure requirements would be 
appropriate for the loans regulated under HOEPA. I would recommend a 
mandatory disclosure statement like the one proposed in section 3(a) of 
Senate bill 2415 (April 12, 2000), which alerts borrowers to the risks 
of subprime mortgage borrowing. It is also desirable to make counseling 
available to potential borrowers on HOEPA loans, and to require lenders 
to disclose that such counseling is available (as proposed in the HUD-
Treasury report). The HUD-Treasury report also recommends reasonable 
amendments to RESPA and TILA that would facilitate comparison shopping 
and make timely information about the costs of credit and settlement 
easier for consumers to understand and more reliable. I also favor the 
HUD-Treasury suggestions of imposing an accuracy standard on 
permissible deviations from the Good Faith Estimate required under 
RESPA, requiring lenders to disclose credit scores to borrowers (I note 
that these scores have since been made available by Fair Isaac Co. to 
borrowers via the Internet), and expanding penalties on lenders for 
inadequate or inaccurate disclosures. The use of ``testers'' to verify 
disclosure practices would likely prove very effective as an 
enforcement tool to ensure that lenders do not target some classes of 
individuals with inadequate disclosure. I also agree with the suggested 
requirement that lenders notify borrowers of their intent to foreclose 
far enough in advance that borrowers have the opportunity to arrange 
alternative financing (a feature of the new Pennsylvania statute) as a 
means of discouraging unnecessary foreclosure. Finally, I would 
recommend that, for HOEPA loans where borrowers' monthly payments 
exceed 50 percent of their monthly income, the lender should be 
required to make an additional disclosure that informs the borrower of 
the estimated high probability (using a recognized model, like that of 
Fair Isaac Co.) that the borrower may lose his or her home because of 
inadequate ability to pay debt service.
Credit History Reporting
    It is alleged that some lenders withhold favorable information 
about customers in order to keep information about improvements in 
customer creditworthiness private, and thus limit competition. It is 
appropriate to require lenders not to selectively report information to 
credit bureaus.
Single-Premium Insurance
    Roughly one in four households do not have any life insurance, 
according to the Life and Health Insurance Foundation (1998). Clearly, 
credit insurance can be of enormous value to subprime borrowers, and 
single-premium insurance may be, as its defenders claim, a desirable 
means for reducing the risk of losing one's home at low cost. To 
prevent abuse of this product, however, there should be a mandatory 
requirement that lenders that offer single-premium insurance must do 
three things. (1) Lenders, when computing the equivalent monthly 
payment on single-premium insurance in their disclosure statement, 
should be required to fully amortize the cost of the insurance over the 
period of coverage (typically 5 years) rather than over a 30 year 
period. That will avoid confusion on the part of borrowers about the 
effective cost of the insurance product. (2) Lenders should clearly 
disclose that credit insurance is optional and that the other terms of 
the mortgage are not related to whether the borrower chooses credit 
insurance. (3) Lenders should allow borrowers to cancel their single-
premium insurance and receive a full refund of the payment within a 
reasonable time after closing (say, within 30 days, as in the 
Pennsylvania statute).
Limits on Flipping
    Several new laws and proposals, including a proposed rule by the 
Federal Reserve Board, would limit refinancing to address the problem 
of loan flipping. The Fed rule would prohibit refinancing of a HOEPA 
loan by the lender or its affiliate within the first 12 months unless 
that refinancing is ``in the borrower's interest.'' This is a 
reasonable idea so long as there is a clear and reasonable safe harbor 
in the rule for lenders that establishes criteria under which it will 
be presumed that the refinancing was in the borrower's interest. For 
example, if a refinancing either (a) provides substantial new money or 
debt consolidation, (b) reduces monthly payments by a minimum amount, 
or (c) reduces the duration of the loan, then any one of those features 
should protect the lender from any claim that the refinancing was not 
in the borrower's interest.
Limits on Refinancing of Subsidized Government or Not-for-Profit Loans
    It has been alleged that some lenders have tricked borrowers into 
refinancing heavily subsidized Government or not-for-profit loans at 
market (or above market) rates. Lenders that refinance such loans 
should face very strict tests for demonstrating that the refinancing 
was in the interest of the borrower.
Prohibition of Some Contractual Features
    Some mortgage structures add little real value to the menu of 
consumers' options, and are especially prone to abuse. In my judgment, 
the Federal Reserve Board has properly identified payable-on-demand 
clauses or call provisions as an example of such contractual features 
that should be prohibited.
Require Lenders To Offer Loans With and Without Prepayment Penalties
    Rather than regulate prepayment penalties further as some have 
proposed, I would recommend requiring that HOEPA lenders offer 
mortgages both with and without prepayment penalties, so that the price 
of the prepayment option would be clear to consumers. Then consumers 
could make an informed decision whether to pay for the option to 
prepay.
Proposals That Require Further Study
    In addition to the aforementioned reforms, many other potentially 
beneficial, but also potentially costly, reforms have been proposed and 
should be studied to determine whether they are necessary over and 
above the reforms listed above, and whether on balance they would do 
more good than harm. The list of potentially beneficial reforms that 
are worthy of careful scrutiny includes:

          (1) A limit on balloons (for example, requiring a minimum of 
        a certain period of time between origination and the balloon 
        payment) is worth exploring--although many of the proposed 
        limits on balloons do not seem reasonable; for example both the 
        Pennsylvania statute's 10 year limit and the HUD-Treasury 
        report's proposed 15 year limit, seem to me far too long; but 
        shorter-term limits on balloons (say, a 3 or 5 year minimum 
        duration) may be desirable.
          (2) The establishment of new rules on mortgage brokers' 
        behavior (as proposed in the HUD-Treasury report) may be 
        worthwhile, as a means of ensuring that mortgage brokerage is 
        not employed to circumvent effective compliance; and
          (3) It may be desirable, as the Fed has proposed, to lower 
        the HOEPA interest rate threshold from 10 percent to 8 percent. 
        The main drawback of lowering the trigger point for HOEPA, 
        which has been noted by researchers at the Fed, and by Robert 
        Litan, is the potential chilling effect that reporting 
        requirements may have on the supply of credit in the subprime 
        market. (I note in passing that I do not agree with the 
        proposal to include all fees into the HOEPA fee trigger; fees 
        that are optional, and not conditions for granting the 
        mortgage--like credit insurance--should be excluded from the 
        calculation.)
Proposals That Should Be Rejected
Usury Laws
    Under the rubric of bad ideas, I will focus on one in particular: 
price controls. It is a matter of elementary economics that limits on 
prices restrict supply. Among the ideas that should be rejected out of 
hand are proposals to impose Government price controls--on interest 
rates, points, and fees--for subprime mortgages.
    Because of legal limits on local authorities to impose usury 
ceilings (due to Federal preemption) States and municipalities intent 
on discouraging high-cost mortgage lending have pursued an alternative 
``stealth'' approach to usury laws. The technique is to impose 
unworkable risks on subprime lenders that charge rates or fees in 
excess of Government specified levels and thereby drive high-interest 
rate lenders from the market.
    Additionally, some price control proposals are put forward by 
community groups like ACORN in the form of ``suggested'' voluntary 
agreements between community groups and lenders.
    Several cities and States have passed, or are currently debating, 
stealth usury laws for subprime lending. For example, the city of 
Dayton, Ohio this month passed a draconian antipredatory lending law. 
This law places lenders at risk if they make high-interest loans that 
are ``less favorable to the borrower than could otherwise have been 
obtained in similar transactions by like consumers within the City of 
Dayton,'' and lenders may not charge fees and/or costs that ``exceed 
the fees and/or costs available in similar transactions by like 
consumers in the City of Dayton by more than 20 percent.''
    In my opinion, it would be imprudent for a lender to make a loan in 
Dayton governed by this statute. Indeed, I believe that the statute's 
intent must be to eliminate high-interest loans, which is why I 
describe it as a stealth usury law. Immediately upon the passage of the 
Dayton law, Bank One announced that it was withdrawing from origination 
of loans that were subject to the statute. No doubt others will exit, 
as well.
    The recent 131 page antipredatory lending law passed in the 
District of Columbia is similarly unworkable. Lenders are subject to 
substantial penalties if they are deemed to have lent at an interest 
rate ``substantially greater than the home borrower otherwise would 
have qualified for, at that lender or at another lender, had the lender 
based the annual percentage rate upon the home borrowers' credit scores 
as provided by nationally recognized credit reporting agencies,'' or if 
loan costs are ``unconscionable,'' or if loan discount points are ``not 
reasonably consistent with established industry customs and 
practices.''
    The District law is fundamentally flawed in several respects. 
First, it essentially requires lenders to charge no more than the rate 
indicated by the customer's credit score. That is an improper use of 
credit scores. Credit scores are not perfect indicators of risk; they 
are used as one of many--and sometimes not the primary--means of 
judging whether and on what terms to make a loan. Second, the DC law 
places the ridiculous burden on the lender of making sure, prior to 
lending, that his customer could not find a better deal from his 
competitors. Finally, the vague wording makes the legal risks of 
subprime lending so great that no banker would want to engage in it.
    As Donald Lampe points out, massive withdrawal from the subprime 
lending market occurred in response to the overly zealous initiative 
against predatory lending by the State of North Carolina. To quote from 
Lampe's (2001) summary of the North Carolina experience:

          ``Virtually all residential mortgage lenders doing business 
        in North Carolina have elected not to make ``high-cost home 
        loans'' that are subject to N.C.G.S. 24-1.1E. Instead, lenders 
        seek to avoid the ``thresholds'' established by the law.'' (p. 
        4)

    Michael Staten of the Credit Research Center of Georgetown 
University has compiled a new database on subprime lending that permits 
one to track the chilling 
effect of the North Carolina law on subprime lending in the State. The 
sample coverage of the database nationwide includes 39 percent of all 
subprime mortgage loans made by HMDA-reporting institutions in 1998.
    Staten's statistical research (reproduced with permission in an 
appendix to this testimony) compares changes in mortgage originations 
in North Carolina with those in South Carolina and Virginia, before and 
after the passage of the North Carolina law (which was passed in July 
1999 and phased in through early 2000). South Carolina and Virginia are 
included in these tables as controls to allow for changes over time in 
mortgage originations in the Upper South that were not specific to 
North Carolina.
    As shown in the appendix, Staten finds that originations of 
subprime mortgage loans (especially first-lien loans) in North Carolina 
plummeted after passage of the 1999 law, both absolutely and relatively 
to its neighbors, and that the decline was almost exclusively in the 
supply of loans available to low- and moderate-income borrowers (those 
most dependent on high-cost credit). For borrowers in the low-income 
group (with annual incomes less than $25,000) originations were cut in 
half; for those in the next income class (with annual incomes between 
$25,000 and $49,000) originations were cut by roughly a third. The 
response to the North Carolina law provides clear evidence of the 
chilling effect of antipredatory laws on the supply of subprime 
mortgage loans to low-income borrowers.
    Robert Litan (2001) had anticipated this result. He wrote that:

          ``. . . statutory measures at the State and local level at 
        this point run a significant risk of unintentionally cutting 
        off the flow of funds to creditworthy borrowers. This is a very 
        real threat and one that should be seriously considered by 
        policymakers at all levels of government, especially in light 
        of the multiple, successful efforts that Federal law in 
        particular 
        has made to increase lending in recent years to minorities and 
        low-income borrowers.
          ``The more prudent course is for policymakers at all levels 
        of government to wait for more data to be collected and 
        reported by the Federal Reserve so that enforcement officials 
        can better target practices that may be unlawful under existing 
        statutes. In the meantime, Congress should provide the Federal 
        agencies charged with enforcing existing statutes with 
        sufficient resources to carry out their mandates, as well as to 
        support ongoing counseling efforts to educate vulnerable 
        consumers about the alternatives open to them in the credit 
        market and the dangers of signing mortgages with unduly onerous 
        terms.'' (p. 2)

    The history of the last two decades teaches that usury laws are 
highly counterproductive. Limits on the ability of States to regulate 
consumer lenders head-
quartered outside their State were undermined by the 1978 Marquette 
National Bank case (see DeMuth, 1986). In 1982, the Federal Government 
further expanded consumers' access to credit by preempting State 
restrictions on mortgage lending by mortgage lenders headquartered 
within the State (the Alternative Mortgage Transaction Parity Act of 
1982).
    These measures were crucial contributors to the democratization of 
consumer finance, and particularly, mortgage finance in recent years. 
The Marquette case opened a flood of competition in credit card 
lending, which led the way to establishing a deep market in consumer 
credit receivables and the new techniques for credit scoring--
innovations which have increased the supply and reduced the cost of 
consumer credit.
    The 1982 Parity Act expanded the range of competition in consumer 
mortgage finance preempting State prohibitions on alternative mortgages 
originated by both depository and nondepository institutions. In 
particular, as I understand this law, it effectively preempts State 
usury laws as applied to subprime mortgages. Because mortgage lending 
relies on real estate as security, it can be provided more 
inexpensively than credit card loans or other unsecured consumer credit 
(Calomiris and Mason, 1998). Thus the 1982 Act provided an important 
benefit to consumers over and above the beneficial undermining of State 
usury laws after the Marquette case.
    But the new stealth usury laws of North Carolina, Dayton, and 
Washington DC, and similar proposals elsewhere, pose a new threat. If 
Congress fails to restore the preemption principle in the subprime 
mortgage market established in 1982, then lenders will be driven out of 
the high-risk end of the market, and therefore, many consumers will be 
driven out of the mortgage market and into higher-cost, less desirable 
credit markets (credit cards, pawn shops, and worse).
    That is not progress. Congress should do everything in its power to 
amend the Parity Act to clearly define stealth usury laws as usury 
laws, not consumer protection laws, and thus prevent any further damage 
to individuals' access to credit from these pernicious State and city 
initiatives.
Other Prohibitions
    I have already argued against further regulatory or statutory 
limits on prepayment penalties, or prohibition of single-premium credit 
insurance, in favor of alternative approaches to the abuses that 
sometimes accompany these features.
    I am also opposed to the many proposals that would prevent 
borrowers from agreeing to mandatory binding arbitration to resolve 
loan disputes. Individuals should be able to choose. If an individual 
wishes to commit to binding arbitration, that commitment reduces the 
costs to lenders of originating mortgages, and in the competitive 
mortgage market, that cost saving is passed on to consumers. Requir-
ing consumers not to commit to binding arbitration is only good for 
America's trial lawyers.
Conclusion
    For the most part, predatory lending practices can be addressed by 
focusing efforts on better enforcing laws against fraud, improving 
disclosure rules, offering Government-financed counseling, and placing 
a few well thought out limits on credit industry practices. The Fed 
already has the authority and the expertise to formulate those rules 
and is in the process of doing so, based on a new data collection 
effort that will permit an informed and balanced approach to regulating 
subprime lending.
    The main role of Congress, in my view, should be to monitor the 
Fed's rulemaking as it evolves, make sure that the Fed has the 
statutory authority that it needs to set appropriate regulations, and 
amend the 1982 Parity Act to reestablish Federal preemption and thus 
defend consumers against the ill-conceived usury laws that are now 
spreading throughout the country.
    Members of Congress, and especially Members of this Committee, also 
should speak out in defense of honest subprime lenders, of which there 
are many. The possible passage of State and city usury statutes is not 
the only threat to the supply of subprime loans. There is also the 
possibility that bad publicity, orchestrated by community groups, 
itself could force some lenders to exit the market.
    Some community organizations have been waging a smear campaign 
against subprime lenders. To the extent that zealous community groups, 
whether out of noble or selfish intent, succeed in smearing subprime 
lenders as a group, the public relations consequences will have a 
chilling effect on the supply of subprime credit. The first casualty 
will be the truth. The second casualty will be access to credit for the 
poor.
References
    Calomiris, Charles W., and Joseph R. Mason (1998). High Loan-To-
Value Mortgage Lending. Washington: AEI Press.
    Carey, Mark, Mitch Post, and Steven A. Sharpe (1998). ``Does 
Corporate Lending by Banks and Finance Companies Differ? Evidence on 
Specialization in Private Debt Contracting.'' Journal of Finance 53 
(June), 845-78.
    DeMuth, Christopher C. (1986). ``The Case Against Credit Car 
Interest Rate Regulation.'' Yale Journal on Regulation 3 (Spring), 201-
41.
    Gramlich, Edward M. (2000). ``Remarks by Governor Edward M. 
Gramlich at the Federal Reserve Bank of Philadelphia Community and 
Consumer Affairs Department Conference on Predatory Lending.'' December 
6.
    Lampe, Donald C. (2001). ``Update on State and Local Anti-Predatory 
Lending Laws and Regulations: The North Carolina Experience.'' American 
Conference Institute, Predatory Lending Seminar, San Francisco, June 
27-28.
    Life and Health Insurance Foundation (1998). America's Financial 
Security 
Survey.
    Litan, Robert E. (2001). ``A Prudent Approach To Preventing 
`Predatory' Lending.'' Working Paper, The Brookings Institution, 2001.
    U.S. Department of Housing and Urban Development and U.S. 
Department of the Treasury (2000). Curbing Predatory Home Mortgage 
Lending: A Joint Report. June.


















                   PREPARED STATEMENT OF MARTIN EAKES
   President and CEO, Self-Help Organization, Durham, North Carolina
                             July 26, 2001
    Mr. Chairman and Members of the Committee, thank you for holding 
this important hearing to examine the problem of predatory mortgage 
lending and thank you for providing Self-Help and the Coalition for 
Responsible Lending the opportunity to testify before you today.
Introduction
    Fundamentally, I am a lender. Self-Help (www.self-help.org), the 
organization for which I serve as President, consists of a credit union 
and a nonprofit loan fund. Self-Help is a 20 year old community 
development financial institution that creates ownership opportunities 
for low-wealth families through home and small business lending. We 
have provided $1.6 billion dollars of financing to help 23,000 low-
wealth borrowers buy homes, build businesses, and strengthen community 
resources. Self-Help believes that homeownership represents the best 
possible opportunity for families to build wealth and economic security 
and take their first steps into the middle class. Accumulating equity 
in their homes is the primary way most families earn the wealth to send 
children to college, pay for emergencies, and pass wealth on to future 
generations, as well as develop a real stake in society. Some would 
call us a subprime lender. We have had significant experience making 
home loans available to families who fall outside of conventional 
guidelines because of credit blemishes or other problems, and our loan 
loss rate is well under 0.5 percent each year. Self-Help's assets are 
$800 million.
    I am also spokesperson for the Coalition for Responsible Lending 
(CRL). CRL (www.responsiblelending.org) is an organization representing 
over three million people through 80 organizations, as well as the 
CEO's of 120 financial institutions. CRL was formed in response to the 
large number of abusive home loans that a number of lenders and housing 
groups witnessed North Carolina. We found that the combination of the 
explosive growth in subprime lending, the paucity of regulation of the 
industry and the lack of financial sophistication for large numbers of 
subprime borrowers have created an environment ripe for abuse.
    We discovered that too many families in our State--over 50,000--
have been victimized by abusive lenders, losing their homes or a large 
portion of the wealth they spent a lifetime building. Some lenders, we 
found, target elderly and other vulnerable consumers (often poor or 
uneducated) and use an array of practices to strip the equity from 
their homes.\1\ We even found that abusive lenders ``flipped'' over 10 
percent of Habitat for Humanity borrowers from their zero percent first 
mortgages 
to high interest and high cost subprime loans.\2\ The problem is not 
anecdotal; it is closer to an epidemic.\3\
---------------------------------------------------------------------------
    \1\ See an example loan document at www.responsiblelending.org/
hud1.pdf. Note that the borrower in this case needed $53,755.22 to pay 
off other debts. But total loan amount was $76,230.12, a difference of 
over $20,000. Five thousand dollars was dispersed to borrower. The bulk 
of the rest of the fees are a $4,063 origination fee and an $11,630 
upfront credit insurance premium. The loan also includes a $63,777.71 
balloon payment due at the end of the 15 year term. This is not an 
atypical case. Abusive lenders often obtain a list of homeowners in 
lower-middle class neighborhoods and target those with high equity, 
low-income and credit blemishes. The sales pitch focuses on lowering 
monthly payments by consolidating debts, getting cash for a vacation, 
or other needs. The unwitting borrower signs the loan, not realizing it 
is packed with credit insurance premiums, high origination fees, hidden 
balloons (that allow the lender to charge high fees AND show a lower 
monthly payment), and/or prepayment penalties that lock the borrower 
into the loan. And then, if there is more equity left, the same lender 
or broker or another lender will come and offer to refinance the loan 
again (or ``flip it'') and charge high fees once more.
    \2\ See http://www.responsiblelending.org/PL%20Issue%20-
%20Habitat%20FAQ.htm
    \3\ See Joint HUD/Treasury Report, pp. 12-49; Panels I to III at 
May 24, 2000 House Banking Committee Hearings: http://www.house.gov/
banking/52400toc.htm; Unequal Burden: Income and Racial Disparities in 
Subprime Lending in America, Department of Housing and Urban 
Development, April 12, 2000; National Training and Information Center, 
Preying on Neighborhoods: Subprime Mortgage Lenders and Chicagoland 
Foreclosure (September 21, 1999); Daniel Immergluck & Marti Wiles, Two 
Steps Back: The Dual Mortgage Market, Predatory Lending, and the 
Undoing of Community Development (The Woodstock Institute, 1999). See 
also New York Times Special Report by Diana Henriques with Lowell 
Bergman: MORTGAGED LIVES: A SPECIAL REPORT: Profiting From Fine Print 
With Wall Street's Help, March 15, 2000, Section 1, page 1 (companion 
piece ran on ABC's 20/20 the same night).
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The North Carolina Law
    The standard industry response at the national level has been to 
fight against stronger rules and for tighter enforcement of existing 
laws. We found that those calls rang hollow: people's hard-earned 
equity was being stolen and their homes being lost through practices 
that complied with the law. These practices were entirely legal. Since 
Federal law was insufficient, as a second-best solution we decided to 
try to amend North Carolina's mortgage lending law to prohibit 
predatory lending practices.
    Thus, in 1999, CRL spearheaded an effort that helped enact the 
North Carolina predatory lending law. The bill was the result of a 
collaborative effort supported by associations representing the State's 
large banks, community banks, mortgage bankers, credit unions, mortgage 
brokers, realtors, the NAACP, and consumer, community development, and 
housing groups. There were two principles we all agreed upon from the 
beginning. First, we would not rely on disclosures. In the blizzard of 
paper that constitutes a home loan closing, even lawyers can lose track 
of what they are signing. In addition, 22 percent of the adult American 
population is functionally illiterate, unable to fill out an 
application.\4\ In our experience, disclosures often do more harm than 
good, because unscrupulous lenders use them as a shield for abuse. 
Second, we would not ration credit by attempting to cap interest rates. 
We believe in risk-based pricing; in fact, Self-Help has engaged in it 
for 17 years. Loans with higher risk should bear an appropriately 
higher interest rate in order to compensate lenders for this risk. We 
believe, however, that the risk should primarily be paid for through 
higher interest rates rather than fees, because a subsequent lender can 
always refinance a borrower out of a loan with an excessive rate 
(barring a prepayment penalty). Fees, on the other hand, must be paid 
in full once agreed to; there is nothing a responsible lender can do to 
help a borrower whose prior loan financed exorbitant fees.
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    \4\ ``National Adult Literacy Survey,'' National Center for 
Education Statistics, 1992. These Level 1 individuals cannot read 
``well enough to fill out an application, read a food label, or read a 
simple story to a child.'' See http://www.nifl.gov/nifl/
faqs.html#literacy.
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    The bill we supported utilized market principles and common sense 
rather than credit rationing or other extreme measures, it enjoyed 
widespread support within the North Carolina banking industry and the 
State's credit unions. Some would say that if the State's credit unions 
and banks could come to agreement over the bill, it had to be a good 
idea. Consumer groups did just that. They saw the bill as a credible 
response to the predatory lending that was harming our communities. As 
a result of the support of all major groups, the bill passed both 
chambers almost unanimously in July 1999.
    Some say that it is impossible to define predatory lending. I 
disagree. The North Carolina bill did just that, in the same way that 
statutes attack any problem: by setting parameters for what is 
acceptable, that encourage certain actions while discouraging others. 
The practices that the North Carolina law discourages are exactly the 
abusive lending practices that we find most harmful to borrowers. 
Please see the Coalition for Responsible Lending Issue Paper entitled 
Quantifying the Economic Cost of Predatory Lending that is included in 
the appendix for a discussion of the cost that predatory lending 
practices imposes on hundreds of thousands of borrowers across the 
country.
Abusive Lending Practices
 Financing single-premium credit insurance on home loans.
 Charging fees, direct and indirect, over 3-5 percent of the 
    loan amount.
 Levying back end prepayment penalties on subprime loans, which 
    serve as anticompetitive tools to keep responsible lenders from 
    remedying abusive situations.
 ``Flipping'' borrowers through repeated fee-loaded 
    refinancings.
 ``Steering'' borrowers into loans with higher-rates than those 
    for which they 
    qualified.
 Permitting mortgage broker abuses, including broker kickbacks.
 Requiring mandatory arbitration clauses in any home loans.

    I would like to briefly discuss these abusive practices and how the 
North Carolina law has defined and attempted to correct them.
Financing Single-Premium Credit Insurance On Home Loans
    One type of credit insurance, credit life, is paid by the borrower 
to repay the 
lender should the borrower die. The product can be useful when paid for 
on a monthly basis. When it is paid for upfront, however, it does 
nothing more than strip equity from homeowners. This is why the 
mortgage industry is disavowing single-premium credit insurance (SPCI) 
in the face of heavy criticism.
    Fannie Mae and Freddie Mac, U.S. Departments of Treasury and 
Housing and Urban Development, bills introduced in the Senate and House 
Banking Committees, and the Federal Home Loan Bank of Atlanta have all 
condemned the practice for all home loans.\5\ In addition, Bank of 
America, Chase, First Union, Wachovia, Ameriquest, Option One, 
Citigroup, Household, and just this week, American General, have all 
decided not to offer SPCI on their subprime loans.\6\ The Federal 
Reserve has proposed to count SPCI in determining what loans are ``high 
cost,'' which will further disfavor the practice. Conseco Finance, 
formerly Greentree, seems to be the last large lender continuing to 
defend it. Conventional loans almost never include, much less finance, 
credit insurance. The North Carolina law prohibited the practice for 
all home loans.
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    \5\ See http://www.freddiemac.com/news/archives2000/predatory.htm 
and http://www.fanniemae.com/
news/speeches/speech--116.html; Joint HUD/Treasury Report, page 91; 
H.R. 4250 (Rep. LaFalce/S. 2415 (Senator Sarbanes), Sec. 2(b)(3); 
Federal Home Loan Bank of Atlanta BankTalk, Nov. 27, 2000.
    \6\ See ``Equicredit to Stop Selling Single-Premium Credit Life,'' 
Inside B&C Lending, April 2, 2001, p. 3 (Bank of America); Erick 
Bergquist, ``Gloom Turns to Optimism in the Subprime Business,'' 
American Banker, May 15, 2001, p. 10 (Chase); ``First Union and 
Wachovia Announce Community Commitment for the New Wachovia,'' May 24, 
2001; statements by officers of Ameriquest and Option One; Jathon 
Sapsford, ``Citigroup Will Halt Home-Loan Product Criticized by Some as 
Predatory Lending,'' Wall Street Journal (6/29/01); Anitha Reddy, 
``Household Alters Loan Policy,'' The Washington Post (7/12/2001).
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Charging Fees Greater Than 3-5 Percent of the Loan Amount
    Points and fees (as defined by HOEPA) that exceed this amount (not 
including third party fees like appraisals or attorney fees) take more 
equity from borrowers than the cost or risk of subprime lending can 
justify. By contrast, conventional borrowers generally pay at most a 1 
percent origination fee. Again, subprime lenders can always increase 
the interest rate. The North Carolina law sets a fee threshold for 
``high cost'' loans at 5 percent. If a loan reaches this threshold, a 
number of protections come into place: the lender cannot finance any 
upfront fees or make a loan without considering the consumer's ability 
to repay; the loan may not be structured as a balloon where the 
borrower owes a large lump sum at some point during the term or permit 
negative amortization; and the borrower must receive housing counseling 
to make sure the loan makes sense for his or her situation.
Charging Prepayment Penalties On Subprime Loans
(defined by interest rates above conventional)
 Prepayment penalties trap borrowers in high-rate loans, which 
    too often leads to foreclosure and bankruptcy. The subprime sector 
    serves an important role for borrowers who encounter temporary 
    credit problems that keep them from receiving lower-rate 
    conventional loans. This sector should provide borrowers a bridge 
    to conventional financing as soon as the borrower is ready to make 
    the transition. Prepayment penalties prevent this from happening. 
    Why should any borrower be penalized for doing just what they are 
    supposed to do--namely, pay off a debt?
 Prepayment penalties are hidden, deferred fees that strip 
    significant equity from over half of subprime borrowers. Prepayment 
    penalties of 5 percent are common. For a $150,000 loan, this fee is 
    $7,500, more than the total net wealth built up over a lifetime for 
    the median African-American family.\7\ According to Lehman 
    Brothers' prepayment assumptions, over half of subprime borrowers 
    will be forced to prepay their loans--and pay the 4 percent to 5 
    percent in penalties--during the typical 5 year lock-out period. 
    And borrowers in predominantly African-American neighborhoods are 
    five times more likely to be subject to wealth-stripping prepayment 
    penalties than borrowers in white neighborhoods. Prepayment 
    penalties are therefore merely deferred fees that investors fully 
    expect to receive and borrowers never expect to pay.
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    \7\ According to the 1990 census, median net worth for African-
American families was $4,400 compared to $44,000 for white families. 
Home equity is the primary factor in this disparity.
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 Borrower choice cannot explain the 80 percent penetration rate 
    of prepayment penalties in subprime loans. Only 2 percent of 
    conventional borrowers accept prepayment penalties in the 
    competitive conventional market, while, according to Standard & 
    Poor's, 80 percent of subprime loans had prepayment penalties. The 
    North Carolina law prohibited prepayment penalties on all loans of 
    less than $150,000.
``Flipping'' Borrowers Through Repeated Fee-Loaded Refinancings
    One of the worst practices is for lenders to refinance subprime 
loans over and over, taking out home equity wealth in the form of high 
fees each time, without providing significant borrower benefit. Some 
lenders originate balloon or adjustable rate mortgages only to inform 
the borrowers of this fact soon after closing to convince them to get a 
new loan that will pay off the entire balance at a fixed rate. Others 
require borrowers to refinance in order to catch up if the loan goes 
delinquent. The North Carolina law prohibits refinancings that do not 
provide the borrower with a net tangible benefit, considering all of 
the circumstances; this standard is similar to the ``suitability'' 
standard applicable to the securities industry.
Mortgage Broker Abuses, Including Broker Kickbacks
    Brokers originate over half of all mortgage loans and a relatively 
small number of brokers are responsible for a large percentage of 
predatory loans. Lenders should identify--and avoid--these brokers 
through comprehensive due diligence. In addition, lenders should refuse 
to pay kickbacks (yield-spread premiums) to brokers. These are fees 
lenders rebate to brokers in exchange for placing a borrower in a 
higher interest rate than that for which the borrower qualifies. These 
lender kickbacks violate fair lending principles since they provide 
brokers with a direct economic incentive to steer borrowers into costly 
loans. While we decided to focus on lenders and not brokers in the 
bill, we are working in collaboration with the brokers' association in 
North Carolina on a mortgage broker licensing bill this session to 
crack down on abusive brokers.
``Steering'' Borrowers Into Higher Cost Loans
Than That for Which They Qualify
    As Fannie Mae and Freddie Mac have shown, subprime lenders charge 
borrowers with prime credit who meet conventional underwriting 
standards higher rates than justified by the risk incurred. This is 
particularly troubling for lenders with prime affiliates--the very same 
``A'' borrower who would receive the lender's lowest-rate loan from its 
prime affiliate pays substantially more from the subprime affiliate. 
HUD has shown that steering has a racial impact since borrowers in 
African-American neighborhoods are about five times more likely to get 
a loan from a subprime lender--and therefore pay extra--than borrowers 
in white neighborhoods. A minority borrower with the same credit 
profile as a white borrower simply should not pay more for the same 
loan. Therefore, lenders should either offer ``A'' borrowers loans with 
``A'' rates, or refer such borrowers to an affiliated or outside lender 
that offers these rates. This is not a problem we were able to address 
in the North Carolina bill.
Imposing Mandatory Arbitration Clauses in Home Loans
    Increasingly, lenders are placing predispute, mandatory binding 
arbitration clauses in their loan contracts. While many lenders' mantra 
has been the need to enforce current laws, many of these same lenders 
are making this goal impossible by denying borrowers the right to have 
their grievances heard. These clauses burden consumers because they 
increase the costs of disputing unfair and deceptive trade practices, 
limit available remedies, and prevent consumers from having their day 
in court. Mandatory arbitration imposes high costs on consumers in 
terms of filing fees and the costs of arbitration proceedings.\8\ 
Arbitration also limits the availability of counsel, cuts off 
traditional procedural protections such as rules of discovery and 
evidence, slows dispute resolution, and restricts judicial review.\9\ 
Lenders benefit unfairly from arbitration as repeat players, and in 
some cases, have used the mandatory arbitration clause to designate an 
arbiter within the industry, producing biased decisions. Further, 
lenders are able to use arbitration to handle disputes in secret, 
avoiding open and public trials which would expose unfair lending 
practices to the public at large.\10\
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    \8\ See Victoria Nugent, Arbitration Clauses that Require 
Individuals to Pay Excessive Fees are Unconscionable, The Consumer 
Advocate 8, 9-10 (September/October 1999).
    \9\ Paul D. Carrington and Paul H. Haagen, Contract and 
Jurisdiction, 1996 Sup. Ct. Rev. 331, 346-9 (1996).
    \10\ See John Vail, Defeating Mandatory Arbitration Clauses, Trial 
70 (January 2000).
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    Lenders have used mandatory arbitration to close the courtroom door 
for millions of consumers and have forced borrowers to waive their 
constitutional right to a civil jury trial. This situation has only 
been made worse as many mandatory arbitration clauses have been 
expanded to also contain provisions that waive the consumers' right to 
participate in class action suits against the lender, making it more 
difficult for smaller claims to prevail. For these reasons, mandatory 
arbitration clauses are unfair to consumers who do not know what they 
are giving up or do not have a choice but to sign adhesion contracts. 
If an informed consumer thinks that arbi-
tration is a helpful step in resolving a dispute with a lender, the 
consumer and lender should be permitted to agree to arbitration at that 
time. Because the Federal 
Arbitration Act preempts State regulation of mandatory arbitration 
clauses, we were unable to get any language prohibiting mandatory 
arbitration in the North Carolina bill.
    And what are the results of North Carolina's law? The only 
significant data to date about the law's effects are comforting. The 
Residential Funding Corp., the Nation's largest issuer of subprime 
mortgage securities, reported that North Carolina's share of subprime 
mortgages issued nationwide actually increased in 2000. And we have 
publicly and repeatedly challenged lenders to show us a single 
responsible loan made impossible under the law. No one has accepted our 
challenge to date.
Congress Should Address the Weaknesses in Federal Law
That the North Carolina Law Identified
    The fact that so many people went to so much trouble to help enact 
North Carolina's law is an indictment of current Federal law. While 
mortgage lending in our State conforms to reasonable rules, balancing 
consumer protections and lenders' need to make a profit, families in 
the rest of the country have no such protection. Ideally, therefore, 
Congress should pass a Federal statute that would address the seven 
predatory lending practices identified above in ways similar to what we 
accomplished in North Carolina.
    The major Federal law designed to protect consumers against 
predatory home mortgage lending is the Home Ownership and Equity 
Protection Act of 1994. HOEPA has manifestly failed to stem the 
explosion of harmful lending abuses that has accompanied the recent 
subprime lending boom. Strengthening the law is important to protect 
homeowners from abuse. I recommend for the Committee's consideration 
two excellent HOEPA bills: legislation introduced last session by 
Chairman Sarbanes and Senator Schumer.
    Looking at our definition of abusive lending practices, while I 
would go a bit further, the bill Chairman Sarbanes introduced is very 
strong. Specifically, it prohibits the financing of single-premium 
credit insurance, reduces the HOEPA points and fees trigger to 5 
percent from the current 8 percent, imposes significant limits on 
prepayment penalties for high cost loans, disfavors broker kickbacks by 
including them in the definition of points and fees, and prohibits 
mandatory arbitration for HOEPA loans.
The Federal Reserve Board Should Promptly Issue
Strong Predatory Lending Regulations
    It is important that regulators take advantage of the authority 
that current laws have provided them to address predatory lending. The 
Federal Reserve Board (the ``Board'') is the regulatory agency with by 
far the most existing authority to address predatory lending practices. 
In December of last year, the Board proposed substantial regulations on 
HOEPA and the Home Mortgage Disclosure Act (HMDA). While modest, the 
Board's proposed HOEPA and HMDA changes are a very constructive step 
forward.
HOEPA Regulation Proposal
    The proposed HOEPA regulations would broaden the scope of loans 
subject to its protections by, most significantly, including single-
premium credit insurance and similar products in its fee-based trigger, 
as well as by reducing its rate-based trigger by 2 percentage points. 
In addition, the Board suggested a modest flipping prohibition that 
would restrict creditors from engaging in repeated refinancing of their 
own HOEPA loans over a short time period when the transactions are not 
in the borrower's interest and similarly restrict refinancing 
subsidized-rate nonprofit and Governmental loans.
    The Board's HOEPA proposal to include SPCI would be an 
extraordinarily important move against predatory lending. In 1994, the 
Board stated that ``The legislative history [of HOEPA] includes credit 
insurance premiums as an example of fees that could be included, if 
evidence showed that the premiums were being used to circumvent the 
statute.'' \11\ It has become clear in the seven succeeding years that 
unscrupulous lenders have indeed used the exclusion of credit insurance 
from ``points and fees'' to circumvent the application of HOEPA to 
loans that really are ``high cost''. Financed credit insurance alone 
exceeds the HOEPA limits in many cases--up to 20 percent of the loan 
amount--yet the borrowers do not qualify for HOEPA protections.
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    \11\ 59 Fed Reg. 61,832, 61,834 (December 2, 1994).
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    The Board should address this evasion, as proposed, by including 
these fees in the definition of ``points and fees''. Since including 
SPCI in a loan in most cases will make it a HOEPA loan, and HOEPA 
imposes certain duties on lenders and has a stigma attached, lenders 
will have the incentive to provide credit insurance on a monthly basis, 
a form that does not strip borrower equity. This is exactly what has 
happened in North Carolina: lenders have uniformly switched from SPCI 
to monthly outstanding basis (except for CUNA Mutual, which has always 
done almost exclusively monthly outstanding balance credit insurance), 
and borrowers have benefited enormously.
    The Board's proposal to reduce the APR trigger is welcome also, 
since at present only 2 percent of subprime loans are estimated to meet 
the very high HOEPA triggers. Finally, the restriction on refinancing 
subsidized loans would benefit thousands of borrowers and avoid what we 
experienced in North Carolina, where Habitat for Humanity borrowers 
were flipped from zero percent loans to 12 percent and 14 percent 
loans.
HMDA Regulation Proposal
    The Board's proposed changes to HMDA would enhance the public's 
understanding of the home mortgage market generally, and the subprime 
market in particular, as well as to further fair lending analysis. At 
the same time, the Board has attempted to minimize the increase in data 
collection and reporting burden. Most significantly, the Board would 
require lenders to report the annual percentage rate of the loan. The 
lender also would have to report whether the loan is subject to HOEPA 
and whether the loan involves a manufactured home. In addition, it 
would require reporting by additional nondepository lenders by adding a 
dollar-volume threshold of $50 million to the current loan-percentage 
test.
    The Board's proposal to require lenders to report the APR on loans 
is crucial. It is currently impossible to obtain any pricing data on 
loans and therefore to determine which loans are subprime and which are 
not, or to draw any conclusions about the cost of credit that borrowers 
undertake. The most important fair lending issues today are no longer 
the denial of credit, but the terms of credit. Providing the APR is a 
good start in providing information on terms. Requiring additional 
nondepository lenders to report is also important; Household Finance, 
the Nation's second largest subprime lender, does not currently report 
HMDA information because of a quirk in the rule that the Board rightly 
proposes to fix.
    Because these proposed changes would significantly help in the 
battle to combat predatory lending, I would urge the Board not to 
backtrack on any of these suggestions and to finalize these regulations 
as soon as possible.
    Notwithstanding our support for these proposals, I believe that 
each should be strengthened. For HOEPA, first, the Board should count 
authorized prepayment penalties in the new loan in the points and fees 
threshold. When a borrower pays a 
5 percent prepayment penalty on the back end, that 5 percent is 
stripped directly out of the family's accumulated home equity wealth 
exactly the same as if it were a fee that was financed on the front 
end. This fee should therefore also be counted in determining which 
loans are high cost. Some mortgage industry representatives will argue 
that a prepayment penalty should not be counted because it is a 
contingent fee. When 50 percent of borrowers actually pay the fee, it 
is hardly a speculative contingency. If the contingent nature of an 
authorized prepayment penalty is persuasive to the Board, however, then 
the Board at minimum should include the authorized prepayment penalty 
discounted by the frequency with which it is paid.
    Second, the Board should hold the initial purchaser of a brokered 
loan responsible for the broker's actions, so the marketplace will 
self-police equity-stripping practices by mortgage brokers. When these 
activities occur, borrowers are often left with no remedy because many 
brokers are thinly capitalized and transitory, leaving no assets for 
the borrower to recover against. The borrower generally cannot recover 
against the lender who benefited from the broker's actions because the 
broker is considered an independent contractor under the law. In 
addition, many times the holder-in-due-course doctrine prevents the 
borrower from raising these defenses against the note holder, even in a 
foreclosure action.
    The Board should address the problem of brokers by making the 
original lender funding the loan responsible for the broker's acts and 
omissions, for all loans. To accomplish this goal, the Board should 
prohibit a lender from funding a loan where the broker violates State 
or Federal law in arranging the loan unless the lender exercised 
reasonable supervision over the broker transaction. In addition, the 
Board should prohibit lenders from funding a loan arranged by a broker 
who is not certified or licensed under State law.
    For HMDA, the Board should replace the HOEPA yes-no field with 
``points and fees.'' Loan pricing is the most important issue in 
understanding the fairness of mortgage markets. Although in the popular 
mind, abusive lending is primarily associated with high interest rates, 
the primary issue is actually the high fee total charged to borrowers. 
Lenders should use the HOEPA definition of ``points and fees,'' since 
lenders already count these fees to determine whether the loan is 
subject to HOEPA. HOEPA also provides the most comprehensive, and 
therefore descriptive, catalogue of charges available. It is a very 
simple calculation. Reporting APR does not lessen the need for 
reporting points and fees, because the APR understates the true cost of 
fees since the APR amortizes fees over the original term of the loan, 
and almost all loans are paid off well before the term expires.
At A Minimum, Weak Federal Law Should Not Preempt
State Consumer Protections
    Little is as frustrating or disheartening than to observe specific 
predatory lending abuses happening to real people; work successfully to 
get a State law or regulation passed to address the problem; and then 
find that Federal law has been interpreted to preempt this State 
consumer protection. Congress has not acted in a substantial manner 
against predatory lending practices since it enacted HOEPA in 1994. 
Since then, however, subprime lending has increased 1,000 percent, and 
abusive lending is up commensurately. Rather than acting as a sword in 
the fight against abusive practices, Federal law has functioned instead 
as a shield, enabling the continuation of abusive lending at the 
expense of entire neighborhoods.
    I already discussed the problem of mandatory arbitration 
restrictions being preempted by the Federal Arbitration Act. The FAA 
was originally enacted in 1925 to overturn a common law rule that 
prevented enforcement of agreements to arbitrate between commercial 
entities. Ironically, it was intended to lower the costs of dispute 
resolution within the business community, but today is used to raise 
the costs of vindicating consumer rights. The States are unable to 
respond to this problem, because the Supreme Court has held that State 
laws that impose any restrictions specific to arbitration clauses are 
incompatible with the FAA. Preemption even applies to basic disclosure 
requirements such as a Montana law that required notice of an 
arbitration requirement to be ``typed in underlined capital letters on 
the first page of the contract'' in order to make the agreement 
enforceable.
    The States are unable to protect their consumers from mandatory 
arbitration as long as the FAA preempts even requiring disclosure of 
arbitration clauses. We propose the prohibition of mandatory 
arbitration clauses in consumer loan contracts and amending the FAA to 
allow State regulation of consumer arbitration agreements. Of course, 
these changes would not affect the ability of consumers to voluntarily 
agree to submit a dispute with a lender to arbitration after the 
dispute had occurred. These changes would only protect consumers from 
signing away their rights before they knew the consequences.
    A second important example is the Alternative Mortgage Transaction 
Parity Act (the Parity Act). Passed during the high interest rate 
crisis of the early 1980's, the Parity Act enabled State depository 
institutions and ``other housing creditors'' (unregulated finance 
companies) to make adjustable rate mortgages without complying with 
State laws prohibiting such mortgages. For 13 years, this Federal 
preemption did not pose a significant problem to consumers. However, in 
1996, the OTS ``reexamined'' the purposes of the Parity Act and 
``reevaluated'' its regulations. This ``reinterpretation'' occurred 10 
years after States lost the ability to opt-out of the law. At that 
time, the OTS concluded the Parity Act required it to extend Federal 
preemption to restrictions on prepayment penalties and late fees.
    Since this novel interpretation, predatory lending by unregulated 
finance companies has exploded, based in part on these companies' 
ability to avoid compliance with State laws, especially those State 
laws limiting prepayment penalties. In fact, the Illinois Association 
of Mortgage Brokers has filed suit asserting that the Parity Act 
preempts the State of Illinois' predatory lending regulations in their 
entirety for all alternative mortgages, including even the common sense 
requirement that lenders verify borrower ability to repay the loan. The 
OTS's definition of ``alternative mortgage'' is so loose, that nearly 
any loan could be made to fall under this category. CRL estimates that 
up to 460,000 families across the country have $1.2 billion stripped 
from their home equity each year directly as a result of the Parity 
Act.
    Forty-six State Attorneys General, both Republican and Democrat, 
have urged the Office of Thrift Supervision (OTS) to reduce the scope 
of Parity Act preemption,\12\ but without Congressional action, OTS 
feels constrained to act. The best solution to the legacy of problems 
caused by the Parity Act is simply to repeal the legislation. It serves 
no good purpose anymore, and many unregulated nondepository 
institutions are taking advantage of Federal preemption in ways that 
are abusive to borrowers without any corresponding regulatory 
obligations. If the Parity Act were 
repealed, finance companies would not be able to use the Federal law to 
avoid meaningful regulation by States. A less preferable, although 
still extremely helpful, solution would be to simply delete reference 
to finance companies in the Act. This would still allow State-chartered 
depository institutions to piggyback on the preemption authority that 
Federally chartered institutions have. At a minimum, given that the 
Act's broad effect goes far beyond what was understood when it was 
enacted, Congress should reopen the opt-out period for States that did 
not initially opt-out (only six States did).
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    \12\ See OTS comments of the National Association of Attorneys 
General at http://www.ots.treas.gov/
docs/48197.pdf.
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    Finally, although it does not involve mortgage lending, we have 
been active in North Carolina attempting to reform payday lending. This 
relatively new industry has grown, rapidly to 10,000 outlets and 
provides desperate borrowers with a two-week loan, often at 500 percent 
annualized interest rates, secured by a deferred check. However, with 
such a short term, borrowers invariably lack the time to solve the 
problems that led them to take such a high fee loan in the first place. 
They therefore get stuck paying a $45 fee every 2 weeks just to keep 
same $255 loan outstanding; in fact, 90 percent of total payday loans 
come from customers caught on flipping treadmill (five or more payday 
loans per year). Reforming this industry is made much more difficult by 
the payday lenders engaging in a ``rent a charter'' partnership 
arrangement to enable them to take advantage of the Federal preemption 
of usury limits available to regulated depository institutions. For 
example, Eagle National Bank (1 percent of payday fee) claims 
preemption on behalf of its ``agent'' Dollar Financial (99 percent of 
payday fee).
Conclusion
    Fundamentally, I am a lender. Attempting to make loans to borrowers 
stuck in predatory loans taught me what lender practices were abusive. 
Finding out that these practices were legal under Federal law made me 
angry. And so, on behalf of thousands of borrowers who face losing 
their homes and all the wealth they accumulated through a lifetime of 
hard work, I would ask the following: pass the bill that Chairman 
Sarbanes introduced last session, urge the Federal Reserve Board 
expeditiously to adopt the predatory lending rules it has proposed, and 
remove the obstacles placed on States in protecting their citizens by 
revising the Federal Arbitration Act, the Parity Act, and laws 
potentially allowing payday lending ``rent a charters.'' If Congress 
could take these steps, then we will have come a long way to making 
sure that family home equity wealth is protected.
    Thank you for the opportunity to testify before this Committee 
today. I am happy to answer any questions and to work with the 
Committee in the future.






































               STATEMENT OF ELIZABETH C. GOODELL, COUNSEL
     Community Legal Services of Philadelphia, Inc., Philadelphia, 
                              Pennsylvania
                      On Behalf of Leroy Williams
                             July 26, 2001
    The interest (note) rates on Mr. Williams' loans were as follows: 
EquiCredit, 9.65 percent. New Jersey Mortgage, 14.5 percent. Option 
One, 11.25 percent. We do not know the APR's for the loans from 
EquiCredit and New Jersey Mortgage, but the APR for the Option One loan 
is 13.136 percent.
    We do not know, if the loans from EquiCredit or New Jersey Mortgage 
were HOEPA loans. Based on the TILA disclosures for the Option One 
loan, the fees, and other prepaid finance charges totaled 7.469 percent 
of the amount financed, just barely under the HOEPA fee trigger of 8.0 
percent.
    The transaction costs in the third loan (including prepaid finance 
charges and fees that are not included in the finance charge) total 
approximately $2,700, or 8.3 percent of the principal balance of the 
loan. Although we do not have all the loan documents from the first two 
loans, if the transaction costs of the first and second loans were 
similar to the costs of the third loan, Mr. Williams paid approximately 
$8,700 to lenders, brokers and title companies (including the 
prepayment penalty and interest paid on the second loan when the third 
tender refinanced it barely 3 months after origination) in connection 
with the three loans, representing nearly 27 percent of the $32,435 
principal balance of the most recent loan.
    Mr. Williams' story is typical of low income homeowners with 
subprime loans in several respects. First, once Mr. Williams had 
executed one high-cost loan, he became the victim of targeted marketing 
by other brokers and lenders of high-cost subprime loans. We find that 
brokers and lenders research public records to identify homeowners with 
mortgages originated by other subprime lenders and target such 
homeowners, attempting to sell new loans within a relatively short 
period of time. Like many low income homeowners with a succession of 
subprime, high-cost loans, Mr. Williams was sought out by the lenders 
rather than seeking them.
    Second, Mr. Williams was caught up in loans with complex terms he 
did not understand. Based on the loan documents, the second (New Jersey 
Mortgage) loan included a prepayment penalty and a balloon. Mr. 
Williams did not know about and did not understand either of these 
terms. The third (Option One) loan includes a prepayment penalty, a 
variable rate, and an arbitration provision. Again, Mr. Williams did 
not know about and did not understand these terms, although there is 
some indication that the broker tried to explain the prepayment 
penalty.
    It is a fiction that the market--or present statutes and 
regulations--adequately protect homeowners when they are 
unsophisticated about consumer lending. Additional protections are 
needed to prevent what happened to Mr. Williams. A lower HOEPA fee 
trigger which included the prepayment penalty might have discouraged 
the third senseless and in fact harmful refinancing. Substantive 
prohibitions against such blatantly inappropriate/no benefit 
refinancings would accomplish the same goal directly, as would imposing 
a duty on mortgage brokers and lenders to avoid making loans that are 
unsuitable, a duty already required of stockbrokers.
                               ----------
                 STATEMENT OF DANIEL F. HEDGES, COUNSEL
        Mountain State Justice, Inc., Charelston, West Virginia
                       On Behalf of Mary Podelco
                             July 26, 2001
    In thirty years of representing low income consumers, I have always 
observed some level of home improvement fraud (particularly in the 
decade of the 1970's, to a lesser extent in the 1980's). In the last 5 
to 7 years, however, there has been an explosion of predatory home 
equity lending and flipping. Predatory practices on low income 
consumers, and in particular, vulnerable consumers such as the elderly, 
illiterate working families and minorities, have become routine.
    Current law provides no meaningful restriction on the kind of 
flipping that occurred in Ms. Podelco's case and occurs in hundreds of 
other cases per year in my State, which results in the skimming of 
equity from borrowers in their homes. Meaningful prohibition of 
flipping calls for a simplified remedy (for example, the prohibition of 
charging new fees and points). West Virginia had such a time limitation 
on refinancing by the same lender and charging new points and fees. The 
2000 enactment was repealed in 2001, after the new Banking Commissioner 
pushed for the elimination of that restriction at the industry's 
behest.
    The opportunity for recurring closing points and fees financed in 
the loan and the lender to be rewarded immediately for refinancing 
leads to disregard of whether or not a borrower can repay. Ms. Podelco 
is typical of a frequent pattern of consistent loan flipping with the 
last loan pushed off onto another lender who takes the loss. Ms. 
Podelco provides one example of hundreds of West Virginians. On these 
loans no laws are being broken but the flipping is so exploitive that 
it results in loss of the individual's equity in their home, and 
ultimately in many cases the loss of the home, forcing the elderly or 
otherwise vulnerable citizens out of their residence.
    A meaningful cap on fees and on financing points and fees would 
have a substantial impact upon these exploitive loans. I would urge the 
Committee to consider an easy definition that limits high points and 
fees up front and provides other protections against exploitive equity 
based lending, a system that rewards the lender immediately on closing, 
no matter what the fees, regardless of whether the borrower pays, and 
provides economic incentive for this type of conduct to continue 
unchecked.
    A single definition of high points and fees is easily enforceable. 
Lowering the HOEPA points and fee trigger to the greater of 4 percent 
of the loan amount or $1,000 is a first step but it is still not low 
enough to prevent the abuses. The proposed legislation will be helpful 
in (1) prohibiting balloon mortgages, (2) creating additional 
protections in home improvement loans, (3) expanding the TILA 
rescission as a remedy for violations of all HOEPA prohibitions, (4) 
prohibiting the sale of lump sum credit insurance and other life and 
health insurance in conjunction with these loans, and (5) limiting 
mandatory arbitration.
    Virtually all of the subprime balloon mortgages observed in my 
State are very exploitive to the consumer. The fact of such balloon 
payment predestines foreclosure for the consumer in many cases.
    Mandatory arbitration clauses are now used by the majority of home 
equity lenders and they are increasing daily as the technique to deny 
consumers any meaningful opportunity to contest the loss of their home. 
Arbitrators selected by the creditors now decide whether a consumer 
gets to keep his home. Notwithstanding the fact that there are many 
exploitive abuses, the arbitrator designated by the lender in the loan 
agreement now decides the merits of all claims. Practically speaking, 
this means that the consumer loses, and arbitration rules provide that 
the practices of the lender are kept confidential.
    In the subprime mortgage context, that is, outside of conventional 
loans, there is an urgency to address the following exploitive lending 
practices:

          (1) Prohibition of mandatory arbitration clauses in all 
        subprime loans.
          (2) Prohibition of subprime balloon payment loans. Low income 
        borrowers generally cannot meet these loans and the lender 
        cannot expect them to make a balloon payment. Such loans assure 
        (a) the loss of a home or (b) require refinancing on usually 
        very exploitive terms if the borrower can even get the loan.
          (3) Excessive interest rates, not justified by any additional 
        risk, are frequent for the vulnerable consumer groups. The risk 
        is covered by the real property security.
          (4) Broker kickbacks should be prohibited. They are a very 
        anticompetitive practice and in the subprime market result 
        primarily in increasing the cost.
          (5) Home solicitation scams have been with us for many years 
        but as a means for skimming the equity from unsophisticated 
        consumers, home equity lenders are now more frequently using 
        them as a solicitation tool.
          (6) Altered and falsified loan applications are now becoming 
        commonplace in the subprime market. These are altered after 
        signature by fudging the income of the prospective borrower or 
        by alteration of the proposed loan amount. The impact is a 
        level of payments that the consumer cannot make.
          (7) Credit insurance packing (by consumer finance companies) 
        into regular, nonhome secured consumer loans and flipping them 
        into home equity secured loans is commonplace. Consumer finance 
        loans with five insurance policies are common to a greater 
        extent than home equity loans with credit life insurance.
          (8) Excessive loan points and broker fees are primary 
        incentives to abuses. Conventional mortgages with 1-1\1/2\ 
        percent broker fees are standard, while the lack of 
        sophistication of vulnerable groups leads to broker 
        compensation of 3 to 7 percent. These are very discriminatory 
        to unsophisticated consumers given the similarity in the work 
        performed.
          (9) Excessive loan to value loans. One hundred twenty five 
        percent to 200 percent of actual market value loans are not 
        uncommon for brokered loans given the financial incentives to 
        flip, and the lack of any concern for ability of the borrower 
        to pay. The broker's only concern is closing the loan for the 
        fee.
        
        
        
        
        
        
        
        
        
        
                STATEMENT OF AMERICA'S COMMUNITY BANKERS
                             July 26, 2001
    America's Community Bankers (ACB) is pleased to take this 
opportunity to submit a statement on predatory lending practices. ACB 
represents the Nation's community banks of all charter types and sizes. 
ACB members pursue progressive, 
entrepreneurial and service-oriented strategies in providing financial 
services to benefit their customers and communities.
General
    ACB members participate in many important programs and partnerships 
that help average Americans become and remain homeowners. This 
commitment of ACB's members to homeownership is good for communities 
and is good for business. In contrast, predatory lending practices 
undermine homeownership and damage communities. ACB pledges to work 
with this Committee and other policymakers to eliminate predatory 
lending practices in the most effective way and to enhance all 
creditworthy borrowers' access to sound loans. ACB also would 
appreciate the opportunity to provide the Committee with the views of 
our recently formed task force on predatory lending when they are 
available.
    Legislative and regulatory attempts to deal with predatory lending 
face serious challenges. New laws and regulations could discourage 
certain types of lending by inaccurately labeling loans as 
``predatory'' or stigmatizing legitimate loan terms and at the same 
time failing to stop predators from engaging in egregious practices. It 
is essential to recognize the important difference between legitimate 
loan product terms and predatory lending practices. Any loan term is 
subject to abuse if it is not properly disclosed or if the loan officer 
falsifies documents.
    An overly broad law or regulation could impose restrictions that 
would limit the availability of credit while allowing predators to 
continue their deceptive practices. Rather than imposing more 
regulations on heavily supervised institutions, ACB continues to 
recommend stronger supervision of unsupervised lenders. A combination 
of vigorous enforcement of existing laws and regulations and enhanced 
opportunities for homeownership education and counseling would be the 
best approach to the problem.
    The Board of Governors of Federal Reserve System (Federal Reserve) 
is considering amendments to its regulations implementing the Home 
Ownership and Equity Protection Act of 1994 (HOEPA).\1\ The Office of 
Thrift Supervision and the FDIC continue their review of regulations 
and policies. In addition, the new Administration--particularly the 
Department of the Treasury and the Department of Housing and Urban 
Development (HUD)--have indicated that they will become engaged on the 
topic. While this Committee's hearings are timely and appropriate, 
Congress will likely wish to review the Federal Reserve's and the 
agencies' final regulations and receive the Administration's views 
before moving on legislation.
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    \1\ Pub. L. 103-325, Title 1, Subtitle B (September 23, 1994). Our 
comments on the Federal Reserve's proposed amendments are an appendix 
to this testimony.
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    One troubling development is the actions by various State and local 
governments regarding predatory lending. They have considered--and in 
some cases passed--overly broad legislation. The effect has already 
been to discourage lenders from making subprime loans in some of these 
jurisdictions, cutting off credit to those who need it most.
    While regulation and improved supervision have important roles to 
play, the consumer is the first line of defense against abusive 
practices. Homeownership education and counseling cannot be 
overemphasized as a way to help borrowers avoid becoming victims of 
predatory lenders. This is particularly true for borrowers with little 
or no experience in homeownership and finance. ACB members currently 
provide counseling on their own or in combination with other 
institutions or community groups. ACB will continue to work with the 
American Homeowner Education and Counseling Institute as a founding 
member to provide more education and counseling. Lenders, community 
groups, and public agencies should work to expand these programs.
Equal Enforcement Is Essential
    Most proposed legislation and regulations would, in theory, apply 
to almost all mortgage lenders. Indeed, many nondepository institution 
lenders assert they must adhere to the same regulations that insured 
depository institutions must follow. However, many of the firms most 
commonly associated with predatory practices are not Federally insured 
and are not subject to regular examination and rigorous supervision. 
Such firms are examined on a complaint-only basis. The joint report by 
the Federal Reserve and the HUD issued in 1998 acknowledged these 
facts, stating:

          Abusive mortgage loans are not generally a problem among 
        financial institutions that are subject to regular examination 
        by Federal and State banking agencies. Abuses occur mainly with 
        mortgage creditors and brokers that are not subject to direct 
        supervision.\2\
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    \2\ Joint Report to the Congress Concerning Reform to the Truth in 
Lending Act and the Real Estate Settlement Procedures Act, July 1998, 
p. 66.

    Abusive practices--for example, falsifying documents; hiding or 
obscuring disclosures; orally contradicting disclosures--are the 
essence of predatory lending. The proper remedy for these abuses is to 
ensure that loan originators do not violate laws against fraud and 
deceptive practices and properly disclose loan terms. If existing and 
new regulations are effectively applied only to Federally supervised 
depository institutions, they will fail to deal with the problem. ACB 
is concerned that the current focus on abusive lending practices could 
lead to overly broad regulations. By unduly tightening restrictions on 
subprime lending, there is a risk of discouraging insured depository 
institutions from making responsible subprime loans, which would 
effectively open the door even wider to unregulated predators.
    To avoid this, the focus of regulatory efforts should be on 
enhancing systems to detect and deter deception and fraud without 
restricting the availability of credit. Borrowers should enjoy the same 
consumer protections, regardless of the institutions they patronize, 
and the institutions that offer similar products should operate under 
the same rules. Therefore, ACB strongly encourages increased 
supervision of non-Federally insured lenders.
    ACB recommends that Congress provide the Federal Trade Commission 
(FTC) with adequate resources to enforce the laws under its 
jurisdiction, particularly with respect to unsupervised lenders. The 
Federal banking agencies should work with the States and the FTC to 
ensure that Federal regulations apply in practice, as well as in 
theory, to all lenders, including State-licensed, nondepository 
lenders.\3\ The application of the standards and enforcement of these 
regulations is particularly important because State-licensed lenders 
can choose to follow regulations issued by the Office of Thrift 
Supervision under the Alternative Mortgage Transactions Parity Act.\4\ 
Without adequate enforcement, there may be situations where State law 
is preempted but Federal regulations are not enforced.
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    \3\ Letter of July 5, 2000 in response to OTS advanced notice of 
proposed rulemaking on responsible alternative mortgage lending.
    \4\ 12 U.S.C. 3801-3806.
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Subprime Lending vs. Predatory Practices
    It is important that policymakers distinguish between subprime 
lending and predatory lending practices. These terms are often 
mistakenly used interchangeably. Subprime lending provides financing to 
individuals with impaired credit or other risk factors, though at 
somewhat higher rates or under stricter terms than are available to 
more creditworthy borrowers. The rise of subprime lending has given 
many previously underserved borrowers access to credit; before the 
expansion of subprime lending, a consumer either qualified for a prime 
loan or was denied credit. Subprime loans now offer a middle ground and 
have helped consumers achieve and maintain home ownership at record 
levels.
    A properly underwritten subprime mortgage benefits both the 
borrower and the lender. To be considered properly underwritten, a 
subprime loan--indeed any loan--must be priced appropriately. The best 
credit risk enjoys the lowest rate; those with weaker credit histories 
are risk priced at higher rates for access to credit. By expanding the 
pool of eligible borrowers, lenders are able to add earning assets to 
their books. However, subprime borrowers also add risk to the balance 
sheet. By taking borrowers' circumstances into account in pricing, 
lenders are properly compensated for the risks they take. Done right, 
subprime lending is good for an institution's customers, community, 
stakeholders, and deposit insurance fund.
    In contrast, true predatory lending benefits only the lender. All 
lending should balance the interests of lenders and borrowers. In the 
case of loans made on an 
abusive or predatory basis, the mortgage broker, home improvement 
contractor, or lender receive excessive fees, while borrowers who 
cannot meet the terms of their loans may diminish their equity, damage 
their credit ratings, and even risk the loss of their home. To avoid 
foreclosure, borrowers must often carry ultra-high debt service until 
they can secure new financing. These predatory lenders charge far more 
than what is required to fairly compensate for risk or lend to 
borrowers that are unqualified. They do so to extract as much profit 
from the transaction as possible.
Adjusting the HOEPA Triggers
    The Federal Reserve has authority under HOEPA to adjust the annual 
percentage rate (APR) trigger from 10 to 8 percentage points over the 
comparable treasury rates. The Federal Reserve may also include 
additional fees in to the points and fees trigger.
Adjusting the APR Trigger
    There are many descriptions of predatory lending practices, but 
they cannot easily be translated into a clear statutory or regulatory 
definition of predatory lending. Rather than attempting to define the 
term, HOEPA draws a line between high-cost loans--which require special 
disclosures and restrictions--and all other loans. This bright line has 
the advantage of clarity, but HOEPA does not encompass all loans that 
might be predatory. That is probably an impossible goal, but ACB 
members believe that the current APR threshold of 10 percent over 
comparable Treasuries could be lowered to 8 percent without restricting 
the subprime market.
    According to last year's report on predatory lending practices by 
HUD and the Treasury, only 0.7 percent of subprime loans originated 
from July through September of 1999 met the current HOEPA APR 
threshold.\5\ By lowering the threshold from 10 to 8 percent, HUD and 
Treasury estimated that 5 percent of subprime loans would be 
covered.\6\ ACB recommended that the Federal Reserve take this step 
under its current HOEPA authority.
---------------------------------------------------------------------------
    \5\ ``Curbing Predatory Home Mortgage Lending: A Joint Report'' 
(June 20, 2000) p. 85.
    \6\ Id at p. 87.
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    Lowering the threshold to 8 percent would cover a larger universe 
of transactions and provide additional protection to consumers. Doing 
so will not, however, solve the problem. Some lenders may try to avoid 
the HOEPA trigger by shifting the coupon rate and the upfront fees by 
small amounts. In any event, predatory lenders may not bring the HOEPA 
disclosures to the borrowers' attention or may tell the borrower the 
disclosures are irrelevant. As pointed out above, rules without 
enforcement are no solution.
    In addition, we caution against lowering the thresholds too far, as 
proposed in some legislation. That could unfairly label legitimate 
subprime loans as predatory and impose additional burdens on legitimate 
subprime lenders.\7\ Imposing additional disclosures; restrictions on 
terms; and reduced access to the secondary market would be harmful, but 
still not effectively deal with the predatory lending problem.
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    \7\ Federal Reserve Governor Edward Gramlich described the problem 
this way in his May 1, 2000 letter to Senate Banking Committee Chairman 
Phil Gramm. The Governor wrote: ``HOEPA's triggers may bring subprime 
loans not associated with unfair or abusive lending within the acts's 
coverage. Similarly, abusive practices may occur in transactions that 
fall below the HOEPA triggers.'' In a similar letter sent on May 5 to 
Chairman Gramm, Comptroller of the Currency John D. Hawke, Jr. summed 
up the problem this way: ``I am concerned that attempting to define 
this term [predatory lending] risks either over- or under-
inclusiveness.''
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    Regulators have suggested that they will not consider HOEPA loans 
for purposes of Community Reinvestment Act compliance, a step ACB 
supports. The secondary mortgage market, at least as far as the 
Government-sponsored enterprises are concerned, will not now accept 
HOEPA loans. These are helpful steps under the current HOEPA limits, 
but could be perversely damaging if the current trigger values are 
decreased too far. Such a chain of events could force more borrowers 
away from regulated lenders to the unregulated.
Points and Fees Trigger
    In general, ACB opposes adding additional items to the points and 
fees trigger. We recommend applying the HOEPA definition to a 
substantial number of additional loans by reducing the APR trigger. 
That change, when coupled by the increased reluctance of lenders to 
make any HOEPA loans and investors to buy such loans, would have a 
substantial effect. Policymakers risk overreaching if they also bring 
more loans under HOEPA through the points and fees mechanism. If 
Congress or the Federal Reserve believe it is necessary to add items to 
the points and fees trigger, ACB believes it should apply only to cases 
where the refinancing takes place within a relatively short period, 
such as 12 months or less.
Prepayment Penalties
    ACB opposes including prepayment fees in the points and fees 
trigger for HOEPA loans as proposed by the Federal Reserve. Prepayment 
penalties are a common option the borrower can accept in exchange for 
other consideration, such as a lower interest rate. This earlier 
transaction has no direct relationship to the new loan. ACB understands 
the concern with the abusive practice known as ``loan flipping'' that 
is used to increase opportunities for predatory loan arrangers to 
impose inappropriate costs and fees at closing. However, the suggestion 
that a new rule be imposed runs the risk of bringing legitimate loans 
and lenders into the HOEPA ambit. ACB recommends that policymakers 
attack these abuses directly, through better enforcement and consumer 
education and counseling. This is a better approach than unfairly 
stigmatizing legitimate transactions.
Points
    As with prepayment penalties on the original loan, ACB believes 
that points paid on that loan have no relationship to the points and 
fees--and hence the HOEPA trigger--on a new loan. The proposed addition 
to the points and fees trigger is another way to discourage loan 
flipping by predatory lenders. Again, ACB urges policymakers to attack 
this problem directly.
Scope of Restriction on Certain Acts or Practices
    In its request for comment last year, the Federal Reserve sought 
comment on several approaches to deal with predatory lending practices 
and asks whether they should apply to:

 All mortgage transactions;
 To refinancings only; or
 To HOEPA loans only.

    The current anecdotal information does not implicate the vast 
majority of mortgage transactions or refinancings. Therefore, ACB 
recommended that any new restrictions apply only to HOEPA-covered 
refinancings to avoid limiting the availability of legitimate subprime 
loans.
Specific Terms and Conditions
    During the debate on this issue, a number of specific proposals 
have been advanced to attempt to prevent predatory lending practices. 
ACB is concerned that certain rates and terms might be defined as 
``predatory,'' even though in most circumstances they would be 
appropriate. Whether a particular term is predatory generally depends 
on the facts and circumstances of the particular transaction. Blanket 
restrictions on loan terms that have a legitimate role in the 
marketplace is not the right solution.\8\
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    \8\ Governor Gramlich described the problem with new rules this way 
before the House Banking Committee on May 24, 2000: ``Frankly, the 
value of rules prohibiting such practices is uncertain, given the 
nature of predatory practices. Some occur even though they are already 
illegal, and others are harmful only in certain circumstances. The best 
solution in many cases may simply be stricter enforcement of current 
laws.''
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    These are ACB's comments on some of these specific issues:
Unaffordable Loans
    One practice used by predatory lenders is to make a loan to an 
individual that he or she is clearly in no position to repay, based on 
the stated amortization schedule. ACB opposes such a practice where the 
borrower does not understand the terms of the loan and has no other 
means to repay. However, there may be some situations where both the 
lender and the borrower understand at the outset that the borrower 
lacks the capacity to amortize the loan from ordinary sources but 
structures the loan to accommodate repayment from an extraordinary 
source. One common example is a ``bridge loan'' where repayment will 
come from the sale of the borrower's current residence. ACB urges that 
policymakers avoid imposing legislation or regulation that might 
interfere with these kinds of accommodating transactions.
    Federally insured banks and savings associations must already 
demonstrate that their loans are made according to sound underwriting 
guidelines. They have a good record of making loans that borrowers can 
repay. If other lenders adhered to similar good business practice, this 
aspect of the predatory lending issue would be substantially mitigated.
    There are some indications that the capital markets are already 
pulling away from predatory lenders because of losses due to 
foreclosures and increased public and regulatory scrutiny. While many 
predatory loans may remain on the books and reports suggest that 
borrowers are continuing to suffer from predatory practices, capital 
market discipline is likely to become increasingly effective. 
Therefore, it is important that policymakers not overreact and impose 
rules that discourage mainstream lenders from providing credit to 
underserved areas and populations.
Limits on Refinancing
    Another predatory technique involves frequent refinancings, 
sometimes within a brief period. One of the most egregious examples 
involves refinancing low-cost loans on community development housing 
and simply replacing them with much higher-rate loans. Such practices 
are completely inappropriate.
    Yet additional regulation to protect consumers is not the answer. 
First, refinancing a loan at a higher rate is not, by itself, a 
predatory practice. For example, a borrower may wish to convert a 
substantial amount of equity into cash, resulting in a higher loan-to-
value ratio and risk profile for the new transaction. Alternatively, 
that borrower may find that market rates may have simply risen since 
the original loan was made. While repeated refinancings at higher rates 
may well be a common predatory practice, a borrower and a lender may 
find it mutually agreeable to restructure their business relationship. 
A well-informed consumer who chooses and can afford the obligation 
should not have that option foreclosed.
    Second, repeated refinancing is generally just one aspect of a 
broader preda-
tory lending scheme that involves deceiving the borrower, falsifying 
loan papers, and ``packing'' the loan with hidden fees. Without these 
illegal practices, there would be little point in repeated refinancing. 
Thus, a special rule on refinancing is not 
necessary.
    Some have suggested language that would permit refinancing at 
higher rates if there is a tangible net benefit to the borrower. This 
is an intensely fact-based standard that--if imposed by law--could 
create an unprecedented burden on institutions, for example to analyze 
and document the ``tangible net benefit'' for every loan. ACB opposes 
this standard as both unnecessary and overly burdensome.
Balloon Payments
    Balloon payment provisions can be used by predatory lenders to 
force a refinancing or even foreclosure. However, it is important to 
recognize that balloon payments can serve legitimate purposes. A 
balloon provision would make sense for a borrower who wishes to pay the 
loan on a long-term schedule, but fully expects to refinance or repay 
the loan before the date the balloon payment is due. For example, a 
borrower may have a fixed-rate, fully amortizing loan (no balloon) 
coupled with a line of credit with interest-only payments until a date 
certain when the loan must be paid in full. Properly used balloon 
transactions give borrowers the benefits of short-term interest rates 
and long-term amortization of the loan debt. A borrower who is fully 
informed by the lender and who understands his or her obligations can 
avoid foreclosure by a planned sale of the property, refinancing the 
balloon transaction, seeking an extension before the final due date, or 
taking some other action.
    These positive features depend on an informed borrower who 
understands the implications of a balloon payment. Based on the 
anecdotal information provided during last year's HUD-Treasury forums, 
it appears that some victims of predatory lending practices have not 
understood this particular loan term. As indicated below in the 
discussion of improved disclosures, ACB believes that it should be 
determined why this is the case and steps taken to correct the problem, 
rather than imposing unnecessary and disruptive restrictions.
Prepayment Penalties
    Unreasonable prepayment penalties can make it extremely difficult 
for a borrower to replace a loan made on an abusive or predatory basis. 
In other instances, prepayment penalties which are typically in effect 
only a few years--are appropriate and beneficial to borrower and lender 
alike. They decrease the likelihood that a borrower will pay off a loan 
quickly (decreasing anticipated income to investors) or compensate the 
investor for lost income if the borrower does decide to prepay the 
loan.
    What is the benefit to the borrower? Investors are willing to 
accept a loan with a lower interest rate, with the protection of a 
prepayment penalty. This is an especially good option for borrowers who 
expect to remain in their homes for a longer period. It is also 
important to emphasize that these clauses may discourage the refinance 
option for only a limited time and may not be binding at all if the 
borrower seeks to sell the home. In some cases, borrowers prefer loans 
without prepayment penalties and lenders do not include them. This is 
an appropriate market response.
    Some have proposed limiting prepayment penalties to cases where the 
borrower receives a benefit, such as lower upfront costs or lower 
interest rates. This is similar to the ``tangible net benefit'' test 
discussed above in connection with limits on refinancing. However 
expressed, ACB believes that it would be extremely difficult for an 
institution to reliably measure and demonstrate compliance with such a 
requirement across an entire loan portfolio, especially in periods of 
high mortgage interest rates. Each case would depend on particular 
facts and circumstances, requiring an economic analysis of each 
situation.
    Regulatory evaluation could even turn on the subjective intent of 
the borrower. For example, a borrower who had no intention, at the time 
of closing, of selling the home soon might later decide for any number 
of reasons to sell his or her house and prepay the mortgage. He or she 
would have received a lower interest rate or fewer points in exchange 
for a prepayment penalty that he or she never expected to incur. 
However, what might have looked like a good bargain at closing could 
turn out to be relatively costly just a short time later simply because 
the borrower chose a different course.
    ACB believes that this is another case where informed consumer 
consent, rather than a difficult to enforce standard makes the most 
sense.
Negative Amortization
    Some loans have payment schedules that are so low that interest is 
added to the principal, rather than being paid as it accrues. This can 
be harmful if too much interest is added to the loan's principal and 
the loan terms do not provide a way to reverse the process. However, 
like a prepayment penalty, the possibility of negative amortization can 
help borrowers. For example, some lenders offer fixed-payment, 
adjustable rate loans that--depending on prevailing interest rates--
could result in some negative amortization. These loans are sometimes 
made to ease the debt service requirement for a defined and often 
limited period. The interest rate on these loans is capped, the 
possibility of negative amortization is fully disclosed, and the 
negative amortization potential is itself capped. Sometimes the 
negative amortization is provided to assist the borrower in a time of 
financial stress or in times of unusually high short-term interest 
rates.
Misrepresentations Regarding Borrower's Qualifications
    Some have suggested a rule that would prohibit lenders from 
misleading consumers into thinking that they do not qualify for a lower 
cost loan. In a request for comment last year, the Federal Reserve 
indicates that, ``Such a practice generally would be illegal under 
State laws. . . .'' \9\ ACB believes that State authorities should 
enforce these laws with respect to lenders they regulate. It is 
unlikely that Federally insured depository institutions are engaged in 
these practices and, if they are, the existing examination process 
would correct them.
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    \9\ 65 Fed. Reg. 42892 (July 12, 2000).
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Reporting Borrowers' Payment History
    One important potential benefit of responsible subprime lending is 
that it can give those borrowers with credit blemishes a chance to 
qualify for prime loans. ACB strongly supports the reporting of all 
loan performance data and is opposed to the reported practice by some 
lenders of choosing not to report positive performance for fear their 
customers will be targeted by competitors for refinancing. If a lender 
does not report positive credit experience, the credit report is no 
longer accurate and the benefit of an improved credit report is lost. 
Lenders that report data must report all data and not subjectively 
choose what to report. This is an instance where consumers benefit from 
appropriate disclosure of their financial information.
Referral to Credit Counseling Services
    ACB strongly supports homeownership education and counseling and 
our members have no objection to telling borrowers that counseling is 
available. In fact, many of our members offer counseling or participate 
in joint programs. And, as indicated above, ACB is a founding member of 
the American Homeowner Education 
and Counseling Institute. However, we are reluctant to endorse 
mandatory counseling for all high-cost loans, as some have suggested--
particularly if a substantially higher number of loans are covered by a 
new definition. Mandatory counseling could create perverse incentives 
and give rise to meaningless counseling programs. Consumer 
representatives told the HUD-Treasury joint task force that they were 
concerned that counseling certifications could become yet another 
document that predatory lenders would routinely falsify. And, they 
indicated that if the mandatory counseling actually took place, it 
could be used as a shield against later claims that the loan was 
predatory or otherwise improper.
    Nevertheless, ACB believes that counseling can be a real benefit to 
borrowers, 
especially those with little or no experience in homeownership and 
finance. Counseling gives potential victims of predatory lenders tools 
to avoid an inappropriate transaction.
Mandatory Arbitration
    Arbitration agreements have been criticized when included in some 
HOEPA loans or loans deemed ``predatory.'' However, arbitration can be 
a simple, fast, more affordable alternative to foreclosure litigation. 
Attorneys who represent homeowners victimized by predatory lenders 
often complain that they lack the time and resources to pursue claims 
in court. Fair and properly structured arbitration arrangements could 
help them. Of course, they must be fully and properly disclosed. In 
legitimate agreements, consumers retain all of their substantive legal 
rights. And, the record shows that there is no inherent bias against 
consumers in arbitration proceedings.
HOEPA Disclosures
    In addition to increasing the number of loans considered high-cost, 
some have suggested increasing the disclosures that must be made for 
these loans. ACB believes that requiring substantial additional 
disclosures would provide little benefit. The HUD-Treasury forums 
presented convincing evidence that the existing 
disclosures are sometimes ineffective, and more elaborate disclosures 
might even give predators more opportunities to confuse consumers. 
Rather, ACB recommends that the Federal Reserve and other policymakers 
thoroughly study why the existing disclosure regime is ineffective and 
what alternatives might work. Those efforts should concentrate on 
simpler, ``plain English'' disclosures that focus consumer 
attention on relevant information. Regulators also should work to 
ensure that disclosures are provided in a timely way, particularly by 
institutions that are not regularly supervised.
    One approach might be adapted from the Truth in Lending Act (TILA) 
tables required for mortgage loans and the requirement that credit card 
solicitations include a special table (sometimes known as the ``Schumer 
box'') that highlights key terms.\10\ For a loan (as opposed to credit 
sale) the highlighted terms are:
---------------------------------------------------------------------------
    \10\ Regulation Z, Appendix G-10(A) & (B) & H-2.

 Annual percentage rate
 Finance charge
 Amount financed
 Total of payments
 Payment number, amount, due dates

    The form also includes information on credit insurance, security 
interest, filing fees late charges, and prepayment penalties.
    For credit cards, these terms are:

 Annual percentage rate
 Variable rate (if any)
 Method of computing the balance for purchases
 Annual fees
 Minimum finance charge
 Transaction fee for purchases
 Transaction fee for cash advances and fees for paying late or 
    exceeding the credit limit

    These special disclosure boxes provide consumers with conspicuous 
disclosures of the key terms, though do not substitute for the full 
TILA disclosures.
    In contrast, the special HOEPA disclosures--provided 3 days before 
closing--are limited to APR, monthly payment, and statutorily 
prescribed language that states, ``You are not required to complete 
this agreement . . .'' and ``. . . you could lose your home . . 
.''.\11\ These disclosures do not address the predatory practices used 
to strip equity from borrowers' homes.
---------------------------------------------------------------------------
    \11\ 15 U.S.C. 1639(a).
---------------------------------------------------------------------------
    ACB suggests that policymakers carefully study why the current 
HOEPA disclosure system may be inadequate and determine how it could be 
improved. As things now stand, in some situations borrowers do not 
understand the disclosures or lenders do not provide the disclosures or 
discourage their use.
    If the problem is lack of borrower understanding, the disclosures 
should be improved and lenders should make greater efforts to educate 
and counsel consumers. If the problem is with the lenders, ACB urges 
greater enforcement.
    Certainly, disclosures should be written using plain language. But 
in addition, ACB recommends that Congress direct the agencies to work 
with lenders to field test the entire disclosure system. Such a review 
may reveal that even disclosures drafted in plain language are not 
fully understood by consumers. ACB cautions against overloading 
consumers with too much detail. ACB members' ``field tests''--conducted 
at loan closings every day--demonstrate that many consumers do not 
understand the current disclosures.
Open End Home Equity Lines
    Some have raised concern that lenders could use open-end credit 
lines to evade HOEPA and, if so, whether such structuring should be 
prohibited. ACB does not have any evidence that HOEPA is being evaded 
in this fashion. In addition, ACB members generally do not offer open-
end mortgage loans; secured lines of credit are generally offered for a 
specified term, for example, 5 or 10 years, to give the lender an 
opportunity to review and restructure the agreement. In any case, ACB 
believes it would be very difficult to distinguish between legitimate 
lines of credit and ``evasions,'' because whether a particular loan was 
an evasion would depend on the lenders state of mind.
Community Outreach and Consumer Education
    The Committee should be aware of a wide variety of community 
outreach activities and consumer education efforts already underway. As 
indicated above, ACB is a founding member of the American Homeowner 
Education and Counseling Institute (AHECI), a nonprofit organization, 
which supports national standards for organizations and individuals 
that provide education and counseling services. This organization is 
the creation of a diverse group of mortgage industry stakeholders who 
realized that existing educational programs or counseling services had 
neither uniform content or value. The effort also recognized the need 
to determine and measure the qualifications and standards of conduct of 
those who deliver these services. AHECI has established minimum 
standards for educational program content and duration; these standards 
have been widely circulated and well received by the industry. AHECI 
certification of instructors and program approval will provide 
borrowers and lenders of a degree of assurance as to the quality and 
utility of locally offered programs never before available, once the 
certification/approval process is in place.
    ACB also participated with other associations in the creation of a 
brochure designed to help consumers understand the terms of their loans 
before they commit in writing. This brochure defines key loan terms and 
includes a worksheet to help consumers compare their monthly spending 
plans before and after taking out a new mortgage loan. It also helps 
consumers compare all the terms of various mortgages. Finally, the 
brochure lists key rights available to protect against predatory 
lenders, such as the right to cancel a refinancing within three 
business days of a closing. A copy of this brochure is included with 
this statement. (Brochure held in Senate Banking Committee files.)
    Whether through formal counseling programs or in the normal loan 
underwriting process, ACB member institutions work to ensure that 
borrowers understand their responsibilities and will be able to fulfill 
them.
    Despite these efforts, supervised mortgage lenders have a difficult 
time competing with the aggressive marketing tactics of some lenders 
and brokers. The economics faced by the different types of lenders may 
go a long way toward explaining the problem. Simply put, a predatory 
lender that charges rates and fees substantially above prime can afford 
to devote substantial resources to marketing. This may include print, 
broadcast, and even ``house calls'' by loan sales people. Prime or 
near-prime lenders may have a better product, but their profit on a 
given loan is too small to support a similarly aggressive sales 
campaign.
    Because of this imbalance in the market and because of the 
important public policy goal of blunting predatory lending practices, 
ACB believes that the Government agencies have a role in consumer 
information and education. The FDIC recently launched a financial 
literacy program with the Department of Labor. The OTS and the 
Comptroller of the Currency also have financial literacy programs. 
Federal Reserve Banks provide training sites for education and 
counseling services. Government agencies could--through public service 
announcements and the like--urge consumers to seek out education and 
counseling and encourage lenders to offer or recommend those services. 
In addition, ACB strongly supports funding for HUD's home ownership 
education and counseling programs.
Mortgage Lending Reform
    Some assert that simplifying the application and settlement rules 
could go a long way toward solving the predatory lending problem. ACB 
supports simplification efforts, but we also recognize they are not a 
panacea for predatory lending. Industry and policymakers have tried 
repeatedly to streamline this process, but no matter how successful 
they are, making the biggest purchase and taking on the biggest 
financial obligation in your life is inherently complicated. But as 
indicated above, solid education and counseling can help borrowers 
learn enough about the process to understand whether or not they are 
being fairly treated.
Conclusion
    In conclusion, we would like to emphasize the following points:

 Policy makers should avoid imposing over-inclusive legislation 
    or regulations that unfairly label legitimate loans as predatory or 
    stigmatize legitimate loan terms;
 Many firms associated with predatory practices are not subject 
    to regular examination and rigorous supervision, and the Federal 
    financial supervisory agencies should work with the FTC and the 
    States to help ensure that new and existing rules are effectively 
    and equally applied to all mortgage lenders;
 Unless all lenders are subject to the same rigorous 
    enforcement, new rules only will increase the burden on 
    institutions that are now heavily supervised while failing to solve 
    the predatory lending problem;
 Existing disclosures should be made clearer--and validate 
    these improvements through field testing--rather than adding 
    lengthy new disclosures.
 Education and counseling can be an effective way to prevent 
    predatory lending. ACB and its members pledge to increase access to 
    high-quality homeownership education and counseling.
    
    
    
    
    
    
                       STATEMENT OF GALE CINCOTTA
       Executive Director, National Training & Information Center
             National Chairperson, National People's Action
                             July 25, 2001
    I want to thank Chairman Sarbanes and other Members of the Senate 
Banking Committee for holding hearings on predatory lending. My name is 
Gale Cincotta and I serve as Executive Director of the National 
Training & Information Center (NTIC) as well as the Chairperson of 
National People's Action (NPA). In these positions, I remain committed 
to stomping out this scourge. We hope that these hearings will lead to 
Federal legislation which would protect homeowners from the 
deceptive and equity-stripping practices used by predatory lenders.
    NTIC is a 30 year old training and resource center for grassroots 
community organizations across the country. NPA is a coalition of 302 
community groups from 38 States who organize locally and coalesce 
nationally around issues of mutual concern that require national 
action.
    We are proud that Chicago was the first city to pass an 
antipredatory lending ordinance that required financial institutions 
with city deposits or contracts to swear-off predatory lending 
practices. We are also proud that Illinois passed strong antipredatory 
lending regulations in April (see http://www.obre.state.il.us/
predatory/predrules.htm for details and attached articles).
Documenting the Problem
    Both of these victories came after NTIC spent 2 years organizing at 
the local and State levels to address predatory lending. We argued for 
reform by getting homeowners and advocates directly involved in the 
fight.
    We also documented that subprime lenders are the source of an 
explosion of foreclosures in the Chicago area--subprime lenders went 
from initiating 163 foreclosures in 1993 to filing 4,796 in 1999 (see 
attached maps). Similarly, the share of foreclosures by subprime 
lenders grew from 2.6 percent in 1993 to 36.5 percent in 1999 for the 
same seven county metropolitan area.
    The countless stories associated with the foreclosure dots on the 
maps reveal a dozen or so predatory practices that pushed the borrower 
into bankruptcy and foreclosure. While this foreclosure data does not 
exist in most cities, the stories do. A dozen local organizations 
across the midwest, southwest, and northeast have been organizing 
homeowners ripped-off by predatory lenders. The stories are similar and 
the effects are devastating: elderly and other borrowers are left 
homeless, the equity wealth and credit records of entire families is 
ruined, and communities are left with abandoned buildings. (See 
attached articles).
    The roots of these problems--predatory lending--must be pulled up. 
We have begun the process in one State, Illinois, and are willing to 
work in 30 more. 
However, we are pleased that you are using your leadership powers to 
move Federal legislation.
    The organizations affiliated with NTIC and NPA who are working on 
this issue have all achieved intermediate success. (See attached 
``NPA's National and Local Accomplishments on Predatory Lending''). All 
agree, however, that ultimately the solution is strong Federal 
legislation that is strictly enforced. The money to be made through 
predatory lending will last as long as Americans have equity in their 
homes.
Predatory Lending Policy Recommendations
    NTIC and affiliated organizations have found that effective 
legislation should contain the following elements:

          1. Sets the annual percentage rate (APR) triggers at T-bill 
        plus 4 percent points and fee triggers at 3 percent of the 
        total loan amount to capture the full range of loans likely to 
        contain predatory loan terms. Predatory lending is most often 
        found in refinance and equity loans that carry higher-than-
        normal interest rates and fees. Currently, the Home Ownership 
        Equity Protection Act (HOEPA) captures only a tiny percentage 
        of the subprime loans. Predatory lenders have learned to 
        originate loans that fly under the radar of HOEPA's annual 
        percentage rate and fee triggers; in fact, only loans with 
        close to a 16 percent interest rate are subject to restrictions 
        on predatory terms under HOEPA. However, borrowers with 
        interest rates of even 10 percent are being successfully 
        targeted with predatory loans that steal equity out from under 
        the homeowner. Similarly, HOEPA applies too high of a fee 
        trigger to loans. While Freddie Mac has determined that banks 
        charge a prime rate customer 1-2 percent points of the loan 
        amount in fees, predatory lenders often charge borrowers 5-20 
        percent in financed fees. These come in the form of inflated 
        origination & broker fees, as well any number of ``junk fees.''
          2. Prohibits Steering: Charging high, subprime interest rates 
        (9-25 percent) on borrower's who have good enough credit to 
        qualify for prime-rate loans (7-9 percent).
          3. Prohibits lending without ability to repay: Making a loan 
        based on the equity that the borrower has in the home, without 
        regard to the borrower's ability to repay the loan.
          4. Prohibits single-premium credit insurance packing: 
        Including overpriced insurance such as credit life, disability, 
        and unemployment insurance. The lender finances the insurance 
        as part of the loan, instead of charging periodic premiums 
        outside of the loan.
          5. Prohibits Loan Flipping: Frequent, unnecessary 
        refinancings of a loan with no benefit to the borrower.
          6. Prohibits fees in excess of 3 percent of the total loan 
        amount: While Freddie Mac has determined that banks charge a 
        prime-rate customer 1-2 percent points of the loan amount in 
        fees, predatory lenders often charge borrowers 5-20 percent in 
        financed fees. These come in the form of inflated origination 
        and broker fees, as well any number of ``junk fees.''
          7. Prohibit Prepayment Penalties: Huge fees charged when a 
        borrower pays off the loan early or refinances into another 
        loan. Prepayment penalties are designed to lock borrowers into 
        high-interest loans, thereby undermining our free market 
        economy by taking away a borrower's right to choose the best 
        product available to them at a given time.
          8. Prohibit Balloon Loan: A loan that includes an 
        unreasonably high payment due at the end of or during the 
        loan's term. The balloon payment is often hidden and almost the 
        size of the original loan. These loans are structured to force 
        foreclosure or refinancing.
          9. Prohibit Adjustable Rate Mortgages (ARM's): ARM's by 
        predatory lenders are usually indexed so that they only adjust 
        up, increasing a borrower's interest rate a full point every 6 
        months. As a result, a borrower's monthly payment increases 
        twice a year even though they likely were told that the 
        adjustable rate mortgage would fluctuate with the economy.
          10. Requires lenders to escrow for property insurance and tax 
        premiums: Many predatory lenders artificially reduce a 
        borrower's monthly payments by not charging them the full 
        amount necessary to pay for property taxes and insurance 
        premiums out of an escrow account. As a result, homeowners who 
        have never had to worry about saving for separate property tax 
        and insurance payments are hit with bills potentially as big as 
        their mortgage payments twice a year.
          11. Prohibits Home Improvement Scams: A home improvement 
        contractor arranges the mortgage loan for repairs, often 
        charging the borrower for incomplete or shoddy work.
          12. Prohibits Bait & Switch: A lender offers one set of loan 
        terms when 
        the borrower applies, but pressures the borrower to accept 
        worse terms at the closing.
Other Efforts To Combat Predatory Lending
    While the Congress begins to debate the legislative remedy to this 
issue, we will continue to pursue four distinct strategies to combat 
predatory lending:

Compelling and Supporting Increased Enforcement Through
the Federal Trade Commission (FTC), State Banking Departments,
and Attorneys General
    In March 2001, Assistant to the Director of Consumer Protection, 
Ron Isaac, represented the FTC at the NPA Conference. At the 
conference, Mr. Isaac committed the FTC to participating in predatory 
lending hearings in seven cities over within 12 months. Mr. Isaac 
committed to attending himself (or sending a representative of equal 
authority from the national FTC office), asking a regional 
representative to also attend, and to attending the NPA Conference in 
2002. At the hearings, local organizations will expose predatory 
lenders through personal testimony and statistical supporting evidence. 
NTIC and NPA also recognize that the FTC has sweeping powers under 
Section 5 of the FTC Act to write regulations that would guard against 
``unfair practices.'' We will be asking the FTC to use these powers to 
regulate against predatory lending practices.
Targeting Citigroup's CitiFinancial/Associates, Nationally, and
Other Problem Lenders, Locally, for Lending Reform
    Pressure from NPA and other groups has forced Citigroup to 
discontinue one of its most profitable and abusive lending practices--
the sale of single-premium credit insurance. But while celebrating the 
conglomerate's decision, NPA demands that Citigroup take additional 
steps toward lending reform.
    NPA leaders in Chicago, Cincinnati, Cleveland, Des Moines, central 
Illinois, Indianapolis, Pittsburgh, Syracuse, Wichita, and other cities 
say that Citigroup must cap fees at 3 percent, eliminate terms that 
lock borrowers into predatory loans, and allow borrowers their American 
right to sue predatory lenders in court.
    Furthermore, Citigroup must review and restructure the predatory 
loans made by The Associates and CitiFinancial which tens of thousands 
of homeowners are currently struggling to repay. Many of these 
homeowners will ultimately end up in bankruptcy and foreclosure unless 
Citigroup repairs the loans so that borrowers are able to repay their 
loans and remain in their homes.
    Finally, NPA calls on Citigroup to offer affordable, prime-rate 
loans throughout the 48 States where they operate. Currently, most 
borrowers can only get high-interest loans through CitiFinancial 
branches, even if they have good credit and qualify for a prime-rate 
loan. This Citigroup policy creates a discriminatory loan system where 
most borrowers pay too much for mortgage credit.
Pursuing Increased Protection in States Where Local Groups Are
Positioned--Through Either State-Level Legislation or Regulation
    Several States are at or nearing the point where they are poised to 
push for legislative or regulatory protection from predatory lending as 
was accomplished in 
Illinois in 2001.
Working With Responsible Lenders To Develop Lending Products
That Provide an Alternative to the Quick-cash Predatory Loans
    Under the Predatory Lending Intervention and Prevention Project, 
NTIC, and affiliated NPA organizations joined Fannie Mae and several 
lenders in Chicago last November to kick-off a pilot product that 
refinances borrowers out of predatory loans and into loans that they 
can afford to repay. Similarly, some groups such as the Northwest 
Neighborhood Federation in Chicago are pursuing banks to develop their 
own loan products to provide borrowers alternatives to the quick-cash 
promises of predatory loans. We are currently expanding this pilot to 
central Illinois, Cincinnati, Cleveland, and Des Moines.
    While these are all important ways to stop predatory lending, 
everyone would agree that thorough, strong Federal regulation is the 
most effective way to protect borrowers.
    Please let me know how I, NTIC, and NPA can help the Banking 
Committee on this issue in the future.
Please See the Attachments That Follow
    1. Maps of ``Foreclosures Started by Subprime Lenders in Chicago, 
1993 and 1999''
    2. Maps of ``Foreclosures Started by Subprime Lenders in 
Chicagoland, 1993 and 1999''
    3. Selected articles
    4. ``NPA's National and Local Accomplishments on Predatory 
Lending''








                     STATEMENT OF ALLEN J. FISHBEIN
      General Counsel, Center for Community Change, Washington, DC
                             July 26, 2001
    My name is Allen J. Fishbein, and I am General Counsel of the 
Center for Community Change and I also Codirect the Center's 
Neighborhood Revitalization Project. Mr. Chairman and Members of the 
Committee, I want to commend you for holding this hearing on the 
problems associated with predatory mortgage lending and thank you for 
the opportunity to provide testimony on behalf of my organization on 
this important topic.
    Prior to rejoining the Center in December of last year, I served 
for almost 2 years as the Senior Advisor to the Assistant Secretary for 
Housing at the U.S. Department of Housing & Urban Development. My 
duties at HUD included helping to direct the activities of National 
Task Force on Predatory Lending, which the Department established in 
conjunction with the Treasury Department.
    The Center for Community Change (www.communitychange.org) is a 
national, nonprofit organization that provides training and technical 
assistance of many kinds to locally based community organizations 
serving low income and predominately minority communities across the 
country. For the last 25 years, the Center's Neighborhood 
Revitalization Project has advised hundreds of local organizations on 
strategies and ways of developing innovative public/private 
partnerships aimed at increasing the flow of mortgage credit and other 
financial services to the residents of these underserved areas.
    The rapid rise in predatory lending has been a disturbing part of 
the growth in the subprime mortgage market. It threatens to quickly 
reverse much of the progress made in recent years to expand 
homeownership to underserved households and communities. At a time when 
a record number of Americans own their own home for too many families 
the proliferation of abusive lending practices has turned the dream of 
homeownership into a nightmare. Abusive practices in the subprime 
segment of the mortgage lending market have been stripping borrowers of 
home equity they spend a lifetime building and threatens thousands of 
families with foreclosure, destabilizing urban and rural neighborhoods 
and communities that are just beginning to reap success from the recent 
economic expansion. Further, predatory lending disproportionately 
victimizes vulnerable populations, such as the elderly, women-headed 
households and minority homeowners. The predators selectively market 
their high-cost loans to unsuspecting borrowers, saddling these 
families with expensive debt, when in many cases, they qualify for less 
costly loans.
    Given the nature and prevalence of this problem, a comprehensive 
approach is required, involving all levels of government, the mortgage 
and real estate industries, together with community and consumer 
organizations. This was the approach recommended last year by the 
Treasury Department and HUD and we think this approach makes the most 
sense.
    To be sure, increased consumer awareness about predatory lending 
practices must be part of the mix and there is much that industry and 
nonprofit organizations are doing and can do to improve the financial 
literacy, especially for at-risk homeowners. Expanded enforcement is 
needed as well.
    However, efforts to increase financial literacy among consumers and 
incremental increases in enforcement, in and of themselves, will not be 
sufficient to curb the growing problem of predatory lending. Existing 
consumer protections must also be strengthened, since existing laws are 
simply inadequate to prevent much of the abuse that is occurring. 
Further, better mortgage loan data collection by the Federal Government 
is necessary to provide regulators and the public with more 
comprehensive and consistent information about those areas most 
susceptible to predatory lending activity. And there is much more to be 
done by those who purchase or securitize high-cost subprime loans to 
ensure that, knowingly or unknowingly, they do not support the 
activities of predatory loan originators.
    Later in my testimony I discuss our recommendations for the 
additional Federal action that is needed to combat the problem.
What Is Predatory Mortgage Lending?
    The term ``predatory lending'' is a short hand term that is 
commonly used to encompass a wide range of lending abuses. The local 
community organizations, housing counseling agencies, and legal aid 
attorneys we work with report a steep rise over the past few years in 
the incidence of these abusive practices. Disturbingly, while home 
mortgage lending is regulated by the States and at the Federal level, 
local groups working on this issue find that many of the most abusive 
practices by predators are technically permissible under current law.
    Predatory lending generally occurs in the subprime market, where 
most borrowers use the collateral in their homes for debt consolidation 
or other consumer credit purposes. Most borrowers in this market have 
limited access to the mainstream financial sector, yet some would 
likely qualify for prime loans. While predatory lending can occur in 
the prime market, it is ordinarily deterred in that market by 
competition among lenders, greater homogeneity in loan terms and 
greater financial in-
formation among borrowers. In addition, most prime lenders are banks, 
thrifts, or credit unions, which are subject to more extensive Federal 
and State oversight and supervision, unlike most subprime lenders.
    The predatory lending market works quite differently than the 
mainstream mortgage market. It usually starts with a telephone call, a 
mailing, or a door-to-door solicitation during which time unscrupulous 
lenders or brokers attempt to persuade a borrower to use home equity 
for a loan. High-pressure sales techniques, deception, and outright 
fraud are often used to help ``close the deal.'' According to a recent 
AARP survey over three quarters of seniors who own homes receive these 
types of solicitations, while many takeout loans relying solely on 
these overtures, without taking the necessary time to shop around to 
find the best possible loan deal for themselves.
    Some would have this Committee believe that the term predatory 
lending is not well defined and therefore, cannot be used as a basis 
for enacting stronger regulation. A broad consensus emerged last year 
among a diverse range of institutions, including Federal and State 
regulators and the Government Sponsored Housing Enterprises (GSE's) 
about the common elements associated with predatory lending. Testimony 
from victims and others at the public forums sponsored by Treasury and 
HUD, and by the Federal Reserve Board, also illustrated the all too-
frequent abuses in the subprime lending market.
    The joint report issued last year by the Treasury Department and 
HUD, Curbing Predatory Home Mortgage Lending (June, 2000), catalogued 
the key features commonly associated with predatory loans. These 
include the following:

 Lending without regard to a borrower's ability to repay. 
    Instead of establish-
    ing the borrower's ability to pay, predators underwrite the 
    property and charge very high origination and other fees that are 
    not related to the risk posed by the borrower.
 Packing. Single-premium credit life insurance policies and 
    other fees are ``packed'' into loans but not disclosed to borrowers 
    in advance. The financing of these products and fees increases the 
    loan balance, stripping equity from the home.
 Loan flipping. The predators pressure borrowers into repeated 
    refinancings over short time periods. With each successive 
    refinancing the borrower is asked to pay more high fees, thus 
    stripping further equity.
 Prepayment penalties. Excessive prepayment penalties ensure 
    that the loan cannot be paid off early without paying significant 
    fees, trapping borrowers into to high-cost mortgages.
 Balloon payments. Predatory loans may have low monthly 
    payments at first, but the loan is structured so that a large lump 
    sum payment is due within a few years.
 Mandatory arbitration. Mandatory arbitration clauses to 
    resolve disputes are usually required as a condition for receiving 
    a loan. Such clauses reduce the legal rights and remedies available 
    to victims of predatory lending.

    The report concluded that practices such as these, alone or in 
combination, are abusive or make the borrower more vulnerable to 
abusive practices in connection with high-cost loans.
What Are the Reasons for the Growth in Predatory Lending?
    The Nation's economic success has caused home values to rise. 
Consequently, Americans have found greater equity in their homes, which 
has fostered an enormous expansion in consumer credit, as many 
homeowners have refinanced their mortgages to consolidate their debts 
or pay-off other loans. The growth in the subprime lending over the 
last several years may have benefited many credit-impaired borrowers. 
Subprime lenders have allowed these borrowers to access credit that 
they perhaps could not otherwise obtain in the prime credit market. 
Nationally, subprime mortgage refinancings rose from 100,000 in 1993 to 
almost one million in 1998, a ten-fold increase in just 6 years.
    However, studies by HUD, the Chicago-based Woodstock Institute, and 
others have demonstrated that subprime lending is disproportionately 
concentrated in low income and minority communities. Mainstream lenders 
active in white and upper-income neighborhoods were much less active in 
low income and minority neighborhoods effectively leaving these 
neighborhoods to unregulated subprime lenders. Certainly, not all 
predatory practices are confined to the subprime market. However, as 
the Treasury-HUD report concluded, subprime lending has proven to be 
fertile ground for predatory practices.
    According to HUD statistics, subprime lenders are three times more 
likely in low income neighborhoods than in upper-income neighborhoods 
and five times more 
likely in predominately African American neighborhoods than in white 
neighborhoods. Moreover, subprime lending is twice as prevalent in 
high-income African American neighborhoods as it is in the low income 
white communities (See, HUD's report Unequal Burden: Income and Racial 
Disparities in Subprime Lending in America, April 2000).
The Effects of Predatory Lending
    The dramatic growth in foreclosure actions in some neighborhoods 
that has accompanied the growth in subprime lending over the last 
several years suggest the damaging effects of lending abuses. In fact, 
foreclosure rates for subprime loans provide the most concrete evidence 
that many subprime borrowers are entering into mortgage loans that they 
simply cannot afford. And the most compelling evidence that subprime 
lending has become a fertile ground for predatory practices is the 
current, disproportionate percentage of subprime loan foreclosures in 
low income and minority neighborhoods.
    HUD and others have documented the wave of foreclosures now coming 
out of the subprime market in recent research studies. Studies of 
subprime foreclosures in Chicago (by the National Training and 
Information Center), Atlanta and Boston (by Abt Associates) and 
Baltimore (by HUD), as well as other research, reinforce raises serious 
concerns about the impact of subprime loans on low income and minority 
neighborhoods in urban areas. These findings provide recent evidence 
that predatory lending can potentially have devastating effects for 
individual families and their neighborhoods.
Additional Federal Action Is Needed To Combat Predatory Lending
    Predatory lending has received considerable attention in the news 
media, largely because of the efforts of national and local community 
and consumer organization, some of who have provided testimony to this 
Committee on this subject. In addition, growing concerns about abuses 
in the subprime market have led States and increasingly, localities to 
mount their own legislative and regulatory efforts to curb predatory 
lending.
    Some industry groups have complained about and lobbied against the 
adoption of State and local antipredatory laws. They say they fear 
being subjected to growing set of local, and possibly, conflicting 
standards. However, in our opinion, these local legislative efforts 
will continue and expand in the absence of decisive action being taken 
at the Federal level.
    We believe that the Federal Government can make a significant dent 
in the problem of predatory lending by taking action in five key areas 
(similar recommendations were endorsed by the Treasury-HUD report):
Strengthening the Home Ownership and Equity Protection Act (HOEPA)
and the Fair Lending Laws
    A key recommendation in the Treasury-HUD report was that HOEPA 
needs to be strengthened (HOEPA is the key Federal protection for 
borrowers of certain high-cost loans by requiring lenders to provide 
additional disclosures and by restricting certain terms and conditions 
that may be offered for such loans). We agree that Congress needs to 
take this action.
    As witnesses before this Committee in connection with these 
hearings have testified, the ``dirty, rotten secret'' of predatory 
lending is that many of the worst abuses are not necessarily illegal 
under existing consumer protections. This means that beefed-up 
enforcement of the existing laws alone will not curb the problem.
    Currently, HOEPA is a useful, but limited tool. For one thing, it 
covers very few high-cost loans (about 1 percent). It does not cover 
home purchase or home equity and home improvement loans that are 
structured as open-end credit lines. Moreover, the statute currently 
does not cover some critical abusive practices associated with high-
cost lending and the civil remedies that are provided need to be 
enhanced.
    We are pleased that the Federal Reserve Board is contemplating 
using the administrative discretion it has under HOEPA to revise and 
expand some limited aspects of the regulations governing the 
implementation of this statute. For example, the Board is proposing to 
adjust the existing interest rate trigger to bring additional loans 
under HOEPA. The proposal also would expand the Act's coverage to 
include most loans in which credit life or similar products are paid by 
the borrower at or before closing.
    But the Board has yet to act on its proposal and even if these 
changes were eventually adopted, the vast majority of high-cost loan 
borrowers (95 percent or more, according to most estimates) still would 
not be covered by HOEPA's protections.
    Consequently, we support the type of legislation that was 
introduced last year in the Senate by Chairman Sarbanes and in the 
House of Representatives by Representative LaFalce (and reintroduced in 
the House again this year, as H.R. 1051, by Mr. LaFalce). We also 
commend Senator Schumer for legislation he offered last year. Passage 
of this type of legislation would help to curb what appear to be the 
key elements of abusive mortgage lending. We are pleased, Mr. Chairman, 
that you have indicated your intention to reintroduce your bill and 
your strong desire to have a bill reported out of Committee.
    The proposed legislation extends HOEPA protections to a greater 
number of high-cost mortgage transactions, restricts additional abusive 
practices in connection with high-cost lending, and strengthens 
consumer rights and legal remedies. Moreover, the proposed legislation 
balances curbs that are need to deter the abusive lending without 
cutting off the legitimate access to credit that helps families of 
modest means to move up the economic ladder.
    Also, since predatory mortgage lending appears, in many respects, 
to be a fair lending problem, legislation is needed to make the Equal 
Credit Opportunity Act (ECOA) a more effective tool in this area. In 
particular, ECOA should be amended to explicitly prohibit ``reverse 
redlining'' (that is, the discriminatory steering of inferior loan 
products to neighborhoods disinvested by prime lenders). Tougher 
penalties for those lenders who persist in engaging in these practices 
are also needed. Representative LaFalce has introduced legislation in 
the House of Representatives that addresses both of these points (H.R. 
1053). Mr. Chairman, we urge you to introduce similar legislation in 
the Senate.
Providing Additional Federal Funding of Home Mortgage Counseling
    Virtually everyone associated with mortgage lending, both industry 
and consumer and community organizations alike, agree that 
understanding the terms of a home loan and taking the time to shop 
around for the best available loans are critical steps that borrowers 
must take to avoid being victimized by predatory lenders. This is 
especially true for borrowers in the subprime mortgage market since a 
substantial number of these may qualify for less expensive, prime 
mortgages.
    The borrowers who have access to qualified premortgage loan 
counseling are less likely to enter into loans they cannot afford. 
Current law requires certain categories of these borrowers, such as 
recipients of HUD's Home Equity Conversion Mortgage program (HECM) to 
receive preloan counseling. However, a substantial gap in qualified 
counseling exists, especially for those homeowners most vulnerable to 
being victimized by predatory lenders.
    Congress should require lenders to recommend certified housing 
counseling to all high-cost loan applicants. Additional Federal funding 
should be provided to increase the availability premortgage loan 
counselors. These funds should be targeted to borrowers and communities 
most susceptible to predatory lending.
Encouraging the Expansion of Prime Lending In Underserved Communities
    The lack of competition from prime lenders in low income and 
minority neighborhoods increases the chances that borrowers in these 
communities are paying more for credit than they should. According to 
HUD research, higher income African-American borrowers rely more 
heavily on the subprime market than low income, white borrowers which 
suggests that a portion of subprime lending occurs with borrowers whose 
credit would qualify them for lower cost prime loans. There is also 
evidence that the higher interest rates charges by subprime lenders 
cannot be fully explained solely as the function of the additional risk 
they bear (for example, Fannie Mae has estimated that one-half and 
Freddie Mac has estimated that 10 to 35 percent of subprime borrowers 
could qualify for lower cost loans). Thus, a greater presence by 
mainstream lenders could possibly reduce the high interest and fees 
currently being paid by the residents of underserved areas.
    One of the problems that may contribute to the misclassification of 
borrowers is that by and large financial institutions do not have 
adequate processes in place to refer-up borrowers who qualify for prime 
credit from their subprime affiliates to mainstream banks and thrifts. 
Expanding the universe of prime borrowers would help to curb predatory 
lending.
    Accordingly, Congress should urge the Federal banking regulators to 
use authority under the Community Reinvestment Act and other laws to 
``promote'' borrowers from the subprime to the prime market, while 
penalizing lenders who make predatory loans. Moreover, the Federal 
Reserve Board should utilize the authority it has under the Gramm-
Leach-Bliley Financial Modernization Act to conduct examinations of 
subprime lenders that are subsidiaries of bank holding companies where 
it believes that such entities are violating HOEPA or otherwise 
engaging in predatory lending.
Improving Loan Data on Subprime Lending
    Despite the explosive growth in subprime mortgage lending over the 
past several years, there is no consistent, comprehensive source of 
data on where those loans are being made geographically, by which 
lenders, and to what types of borrowers. In truth, the data collection 
requirements of the Federal Government have failed to keep up with 
these trends.
    Virtually all of the research to date is based on a list of 
subprime lenders compiled, on his own initiative, by an enterprising 
researcher at HUD. The Federal Reserve Board, HUD, and other 
Governmental agencies, as well as lenders, academics use this list, and 
anyone else interested in the field. Lenders on the list are classified 
as subprime if they identify themselves as such. All loans reported by 
those lenders are counted as subprime, and no loans reported by lenders 
that do not identify themselves as subprime are counted. Further, HUD 
is under no mandate to compile this list, and should it cease to do 
this, there would be virtually no future information available about 
where and to whom they are going. This is the best information 
available on subprime lender, and nobody thinks that it serves the need 
adequately.
    The Federal Reserve Board has proposed to amend the Home Mortgage 
Disclosure Act regulations (with which this information about subprime 
lenders is combined). The Fed's proposal would, among other things, 
collect and disclose information on the annual percentage rates of 
loans reported, and indicate whether a particular loan was classified 
as a HOEPA loan. The proposal would also revise the rules to ensure 
that some large, nondepository subprime lenders, not currently covered 
under HDMA, would be required to submit annual reports on their loan 
activities. Unfortunately, the Fed has yet to finalize these rules.
    Accordingly, Congress should adopt legislation requiring more 
systematic reporting by lenders under HMDA on their subprime lending 
activities. In addition to revising ECOA, the LaFalce bill (H.R. 1053) 
I referenced previously amends HMDA to require reporting on subprime 
lending. It also provides HUD with the necessary authority to impose 
civil money penalties to enforce compliance with HMDA by nondepository 
lenders, similar to the authority banking regulators have for banks and 
thrifts. The lack of reporting by many nonbank financial institutions 
has hindered the ability of regulators to track lenders that may engage 
in abusive lending. Providing HUD with the necessary statutory 
authority in this area also would establish a more level playing field 
between depository and nondepository mortgage lenders.
    We believe that similar legislation should be introduced in the 
Senate as well.
The Federal Government Should Take Steps to Prevent the Secondary 
        Market
From Supporting Predatory Lending
    Ultimately predatory lending could not occur but for the funding 
that is provided by the secondary market to finance these loans. The 
rapid rise in subprime lending that has occurred in recent years was 
possible because many of these loans were purchased in the secondary 
market either whole or through mortgage-backed securities (about 35 
percent of subprime loans by dollar volume in 1999 was securitized).
    While the secondary market to some extent has been part of the 
problem connected with predatory lending, it can become an important 
part of the solution. The refusal by the secondary market to purchase 
or securitize loans with abusive features, or to conduct business with 
lenders that originate such loans could curtail their liquidity and 
thus, reduce their profitability.
    Last year, Fannie Mae and Freddie Mac, the two Government sponsored 
housing enterprises, pledged not to buy loans with predatory features. 
HUD acted further to discourage the GSE's from purchasing predatory 
loans, when it also elected to disallow the GSE's from receiving credit 
toward fulfillment of their affordable housing goals for the purchase 
of loans with predatory features. The GSE's pledges and the provisions 
in the Affordable Housing Goals rule must be monitored to ensure that 
the two enterprises are living up to their commitments.
    However, the GSE's constitute a relatively small share of the 
subprime market and unfortunately, other secondary market players have 
been less willing to adopt similar corporate policies against predatory 
lending. HOEPA provides that purchasers or assignees of mortgages 
covered by that statute are liable for violations unless ordinary due 
diligence would not reveal them as such. Similarly, Section 805 of the 
Fair Housing Act makes the secondary market potentially liable for 
financing discriminatory loans.
    Consequently, the secondary market institutions appear to have 
taken at least some notice of their potential legal liability for the 
purchase of high-cost loans involving HOEPA violations. However, 
because HOEPA loans represents such a small share of the highcost loan 
market and discrimination claims are difficult to prove, these 
developments have not yet resulted in across the board vigilance and 
screening by the secondary market that makes an impact by constricting 
the funding pipeline for predatory lenders.
    Expanding HOEPA coverage to a greater share of the market and 
clarifying that parent companies are liable for the sins of their 
subprime affiliates (a provision contained in the Sarbanes and LaFalce 
bills) could encourage loan purchasers to develop the necessary due 
diligence to filter out abusive loans from their business activities. 
Expanding liability in this area is critical given the recent influx of 
many of the Nation's largest financial institutions into the subprime 
market. Unfortunately, some of the subprime lenders acquired by these 
giant entities are being sued or otherwise have been exposed for their 
connection to predatory lending practices. Establishing that parent 
companies and officers of lenders, or subsequent holders of loans by 
contractors, or liable for the predatory practices of originators would 
encourage these mega-financial institutions to develop the necessary 
internal controls to deter abusive loan practices.
    We urge this Committee and the Congress to move decisively in the 
areas we have identified. It will take such comprehensive action by the 
Federal Government to curb the predatory lending problem.
    Thank you Mr. Chairman for the opportunity to provide our views on 
this subject.










































































































                      STATEMENT OF JEFFREY ZELTZER
     Executive Director, National Home Equity Mortgage Association
                             July 26, 2001
    Chairman Sarbanes and Committee Members, I am Jeffrey Zeltzer, the 
Executive Director of The National Home Equity Mortgage Association 
(``NHEMA'').\1\ I appreciate the opportunity to provide NHEMA's views 
on how to stop inappropriate mortgage lending practices that many now 
call ``predatory lending.'' NHEMA abhors abusive lending and wants it 
stopped. We advocate a multitrack strategy for stopping these abuses: 
(1) tougher enforcement of existing laws; (2) voluntary industry self-
policing by such things as adopting ``Best Lending Practices'' 
Guidelines; (3) greatly enhanced consumer education programs; (4) 
broad-based reform and simplification of RESPA and TILA requirements; 
and (5) targeted legislative reforms where appropriate to address 
specific abusive practices. Subsequently, we will comment further on 
each of these areas.
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    \1\ Founded in 1974, NHEMA serves as the principal trade 
association for home equity lenders. Our current membership of 
approximately 250 companies employs tens of thousands of people 
throughout the Nation and underwrites most of the subprime consumer 
mortgage loans.
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    Subprime consumer mortgage lenders are performing an extremely 
important service by making affordable credit available on reasonable 
terms to millions of Americans who otherwise could not easily meet 
their credit needs. Before the subprime market became well established 
over the past decade, consumers in many underserved markets often found 
it difficult, if not impossible to obtain credit. Today, virtually 
every American has the opportunity to obtain mortgage credit at fair 
and reasonable prices. We are very proud that our industry has played a 
key role in democratizing the mortgage credit markets and in helping so 
many consumers. We also are deeply troubled both by the continued 
existence of abusive lending practices in the subprime marketplace and 
by the unintended adverse consequences that are likely to arise if 
corrective measures are not drafted with extreme care.\2\ NHEMA is 
committed to helping eradicate such lending abuses that are harming too 
many of our borrowers and undermining our industry's reputation. We 
commend Chairman Sarbanes and the Committee for focusing attention on 
this problem, and we pledge to work constructively with you to help 
stop the abuses.
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    \2\ Federal Reserve Board Governor Gramlich recognized many of 
these points in a recent speech at the Board's Community Affairs 
Research Conference: ``Studies of urban metropolitan data submitted 
under the Home Mortgage Disclosure Act (HMDA) have shown that lower-
income and minority consumers, who have traditionally had difficulty in 
getting mortgage credit, have been taking out loans at record levels in 
recent years. Specifically, conventional home-purchase mortgage lending 
to low income borrowers nearly doubled between 1993 and 1999. . . . 
Much of this increased lending can be attributed to the development of 
the subprime mortgage market. Again using HMDA data, we see a thirteen-
fold increase in the number of subprime home equity loans and a 
sixteen-fold increase in the number of subprime loans to purchase 
homes. The rapid growth in subprime lending has expanded homeownership 
opportunities and provided credit to consumers who have difficulty in 
meeting the underwriting criteria of prime lenders because of blemished 
credit histories or other aspects of their profiles. As a result, more 
Americans now own a home, are building wealth, and are realizing 
cherished goals. . . . However, this attractive picture of expanded 
credit access is marred by those very troubling reports of abusive and 
unscrupulous credit practices, predatory lending practices, that can 
strip homeowners of the equity in their homes and ultimately even 
result in foreclosure. . . . Though we have held discussions on the 
different categories of subprime loans, the credit profiles of 
vulnerable borrowers, and the marketing and underwriting tactics that 
predatory lenders employ, 
we find that the absence of hard data inhibits a full understanding of 
the predatory lending problem. Exactly what are the most egregious 
lending practices? How prevalent are they? How can they be stopped? 
Absent the available data and the analysis and relationships they re-
veal, rulemakers and policymakers are challenged to ensure that their 
actions do not have unintended consequences. We are mindful that 
expansive regulatory action intended to deter 
predatory practices may discourage legitimate lenders from providing 
loans and restrict the access to credit that we have worked so hard to 
expand. . . .''
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    Although there is little quantitative data to document the 
prevalence of such problems, we know that some abuses are occurring, 
and NHEMA believes that they must be stopped. None of our borrowers 
should be preyed upon and risk losing their homes by even a few 
unscrupulous mortgage brokers, lenders, and home improvement 
contractors. Having devoted a great deal of time and resources to 
addressing these concerns, we are convinced that there is no single, 
simple ``silver bullet'' solution to prevent abusive or improper 
practices that some parties are perpetrating on unsuspecting and often 
unsophisticated borrowers. Before discussing our five part strategy for 
preventing mortgage lending abuses, we want to first share some general 
information and observations that we believe will be helpful to the 
Committee's understanding of the predatory lending issue and the 
subprime segment of the mortgage market.
Background
    What is ``Predatory Lending?'' While there is no precise definition 
of the term ``predatory lending,'' it is generally recognized as a term 
that encompasses a variety of practices by home improvement contractors 
and mortgage brokers and lenders that are abusive, grossly unfair, 
deceptive, and often fraudulent. These practices include such things as 
unreasonably high charges for interest rates, sales commissions 
(points) and closing costs, imposing loan terms that are unfair in 
particular situations, and outright fraudulent misrepresentations. In 
recent years, the label ``predatory'' has been used in recognition of 
the fact that some of the perpetrators literally prey upon the elderly, 
the less affluent, and more vulnerable homeowners, including in some 
cases, minorities.
    ``Subprime Lending'' vs. ``Predatory Lending'' While abusive 
practices do in fact occur to some extent in all types of consumer 
credit transactions, including the so-called ``prime'' or 
``conventional'' mortgage market, it appears some abuses are 
concentrated more heavily in the subprime market segment. Regrettably, 
this occurrence has undoubtedly caused some people to confuse 
``subprime'' and ``predatory'' lending. It is critically important that 
Congress fully understand that subprime mortgage lending should not be 
equated with ``predatory.'' Subprime loans are a wholly legitimate and 
an absolutely vital segment of the broader mortgage market. Between 10 
percent to 15 percent of all U.S. mortgages fall within the subprime 
category. Roughly 50 percent of subprime loans are originated through 
mortgage brokers, with the remainder coming from retail sales by 
lenders.
    ``Subprime'' is the term that generally is used to refer to loan 
products that are offered to borrowers who do not qualify for what are 
called ``prime'' or conventional products. Prime mortgage borrowers 
have more pristine, ``A'' grade credit, are considered less risky and 
accordingly qualify for the lowest available rates. Borrowers whose 
qualifications are below the ``prime'' requirements are usually 
referred to as ``subprime'' and have to pay somewhat higher rates as 
they are viewed as being higher credit risks. Most subprime mortgage 
loans are made to people who have varying degrees of credit 
impairments. We want to emphasize, however, that many borrowers with 
``A'' grade credit do not automatically qualify for prime mortgage 
rates because credit is not the only factor considered in underwriting 
a loan. Other issues, such as the amount of equity that the borrower 
has to invest in the property (the ``loan-to-value ratio''), 
nonconforming property types, one's employment status or the lack of 
adequate loan documentation often prevent borrowers from qualifying for 
a prime mortgage product.
    Unlike the relatively limited number of prime loan products, there 
are a wide variety of subprime products and rates, which reflect the 
more customized, risk-based pricing underwriting of the subprime market 
segment. Lenders in the subprime market usually offer mortgages in 
categories broadly described as ``A-minus,'' ``B,'' ``C,'' and ``D.'' 
(Many lenders have numerous subcategories with graduated prices within 
each of these general categories.) The majority of subprime loans, 
roughly 60-65 percent, fall into the ``A-minus'' range and have 
interest rates only moderately higher than prime loans. Another 20-25 
percent qualify as ``B,'' which have a few more credit impairments and 
slightly higher rates to reflect more risk. The remaining 10-20 percent 
tend to be mostly ``C'' grade loans, which have substantially more 
credit defects, and a small percentage of ``D'' loans, which present 
the highest credit risks.
    It is important to understand that while subprime borrowers present 
higher risks, and accordingly must be charged higher rates to reflect 
those risks, they still generally are good customers who remain current 
in their mortgage payments. They do, however, require a higher level of 
loan servicing work to help keep them on track, and this also entails 
higher costs to the lenders, which must be reflected in loan pricing.
    Who are the subprime borrowers? Many media stories relating to 
abuses in the subprime market have left people with a misimpression 
that most subprime borrowers are elderly, minorities, very poor, and 
likely to be unable to repay their loans, and therefore are destined to 
lose their homes in foreclosure. In fact, the typical subprime customer 
is totally different from this stereotype. The overwhelming majority of 
subprime borrowers are white, not minorities. They are mostly in their 
40's, with only a small percentage over 65 years old. And, their 
incomes typically range between $50,000 and $60,000 per year. Most 
repay in a timely manner, and the foreclosure rate is only somewhat 
higher than that for prime loans. The subprime borrower's profile is 
basically that of a ``prime'' borrower, and it is one's credit record, 
not age or race, that is the main distinguishing factor. NHEMA 
commissioned a study last year by SMR Research, which is one of the 
Nation's leading independent mortgage market research and analysis 
firms, to review subprime lending. SMR's report, which we are providing 
to the Committee's staff, offers additional details regarding our 
market segment and customer characteristics.
Protecting Borrowers' Access to Credit
    In sharp contrast to legitimate subprime or prime lending, some 
unethical loan originators do engage knowingly in abusive lending 
practices and many of these abuses are now often lumped together in the 
term ``predatory lending.'' These abusive practices include a variety 
of improper marketing practices and inappropriate loan terms. Sometimes 
it is quite easy to identify predatory lending, but it often is much 
more difficult to determine whether abuses are occurring. Moreover, a 
number of the loan terms being attacked are not per se improper, but 
can sometimes be used improperly.\3\
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    \3\ Governor Gramlich, in a speech to the Fair Housing Council of 
New York, aptly pointed out how wholly legitimate terms and practices 
can be misused: ``. . . The harder analytical issue involves abuses of 
practices that do improve credit market efficiency most of the time. . 
. . Mortgage provisions that are generally desirable, but complicated, 
are abused. For these generally desirable provisions to work properly, 
both lenders and borrowers must fully understand them. Presumably 
lenders do, but often borrowers do not. As a consequence, provisions 
that work well most of the time end up being abused and hurting 
vulnerable people enormously some of the time.''
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    To illustrate this point, we want to highlight several loan terms 
typically help consumers and are not per se abusive, yet many consumer 
advocates now often seem to be alleging these terms are inherently 
predatory:

 Prepayment Fees--Many subprime loans contain terms that impose 
    a prepayment fee or penalty if the borrower pays off the loan 
    before the end of the agreed upon loan period. Some critics are 
    strongly attacking prepayment fees as predatory and unfair, and 
    some legislators have proposed prohibiting such fees. Are 
    prepayment fees abusive? Most of the time, absolutely not. 
    Prepayment fee clauses actually provide a major benefit to most 
    consumers because they allow the borrower to get a significantly 
    lower rate on the loan than they would get without the clause. 
    Prepayment provisions are very important in keeping rates lower and 
    helping make more credit available in the subprime market. Loans 
    are priced based on the assumption that they will remain 
    outstanding for some projected time period. If a loan is paid off 
    earlier, the lenders or secondary market investors who may buy the 
    loan cannot recover the upfront costs unless they address this 
    issue in the terms of the loan. Instead of charging a higher 
    interest rate or higher initial fees, lenders know it is usually 
    fairer and better for the borrower to have an early payment fee to 
    protect against losing these upfront costs. On the other hand, it 
    is certainly possible to have an abusive prepayment clause that 
    imposes too much of a penalty and/or that applies for too long a 
    time. The point here is that most of the time the consumer benefits 
    and the provision is not abusive. Sometimes, however, this 
    otherwise wholly legitimate provision can be applied in an abusive 
    manner. Again, the challenge for all of us is to find ways to 
    prevent the abusive application of such provisions without denying 
    the consumer the benefit of the provision, which applies in most 
    cases. With regard to prepayment provisions, this benefit can be 
    easily accomplished (for example, requiring that the borrower be 
    given an option of a product with and without the fee and limiting 
    the fee amount and the time it is applicable).
 Arbitration Clauses--Some parties contend that loan terms that 
    require disputes between the lender and borrower to be arbitrated 
    are inherently oppressive and abusive. We strongly disagree with 
    such a general characterization of arbitration clauses. Yes, it is 
    certainly possible to structure a clause so that it is unfair. For 
    example, if a national lender operating in California required that 
    the arbitration always be conducted at the lender's headquarters in 
    New York, we think this is obviously unfair (and a court would 
    probably not enforce such a loan clause). On the other hand, 
    appropriately structured arbitration generally is recognized by 
    courts as an acceptable, fair alternative dispute resolution 
    procedure that frequently can benefit all parties. Arbitration 
    allows disputes to be resolved much more quickly and with less 
    expense than litigation. Arbitration clauses that meet certain 
    safeguards, such as restricting venue to where the property is 
    located and compliance with the rules set forth by a nationally 
    recognized arbitration organization, should not be deemed 
    inherently abusive.

    In addition to preserving such loan terms that are legitimate, 
NHEMA wishes to emphasize that attacks on certain lending practices are 
unjustified. In particular, some consumer advocates criticize the 
financing of points and fees by subprime lenders. We strongly believe 
that their criticisms are not valid. Most subprime borrowers do not 
have extra cash readily available to pay closing costs, so they 
voluntarily elect to finance them in connection with the loan. Prime 
borrowers often do the same thing. Subprime borrowers should not be 
discriminated against and should be allowed to continue to finance such 
costs. Why should they be forced to borrow money from other sources, 
typically at higher, unsecured rates, to pay such necessary costs? In 
many cases, it could prove very difficult, if not impossible, to obtain 
the funds needed to pay such costs.
    Legislators and regulatory officials have a difficult task in 
balancing the competing and often conflicting considerations that arise 
in this area. While wanting abuses stopped, NHEMA cannot overemphasize 
the importance of moving very carefully and deliberately in addressing 
the abuses because there is a great danger that new restrictions would 
limit terms or practices that are generally helpful and desirable for 
most consumers.
    NHEMA believes that this Committee can make a tremendous 
contribution by demonstrating how thoughtful legislators can sort 
through the complexities involved and develop truly workable provisions 
to the extent that additional legislation is needed as part of the 
overall solution.
How Best Can Abusive Lending Problems Be Addressed?
    Although NHEMA does not believe that abusive or predatory practices 
are pervasive in the subprime mortgage sector, and we know that some 
alleged problems are not necessarily real abuses, we recognize that 
there are legitimate areas of concern. For example, ``loan flipping,'' 
which involves repeated refinancing of a mortgage in a relatively brief 
period of time with little or no real economic benefit to the borrower, 
does occur to some degree, and it should be stopped. Likewise, far too 
many borrowers are victims of home improvement lending scams. Others 
are required to pay excessive loan origination fees to mortgage brokers 
or loan officers. Industry, regulators and legislators must work 
together to find effective ways to stop such abuses. In doing so, 
however, we must be very careful not to overreact and adopt 
inappropriate restrictions that raise the cost of subprime mortgage 
credit, or curtail credit availability to those who need it.
    As mentioned earlier in our testimony, NHEMA believes that a 
multitrack strategy must be taken to deal with these questions:

          (1) Greater Enforcement of Existing Laws and Regulations--A 
        substantial portion of predatory lending abuses involve fraud 
        and deception that are clearly already illegal. In many cases 
        it also appears that some unscrupulous mortgage brokers and 
        lenders are disregarding current laws such as the Real Estate 
        Settlement Procedures Act (RESPA), the Home Ownership Equity 
        Protection Act (HOEPA), the Equal Credit Opportunity Act 
        (ECOA), and the Federal Trade Commission Act, which prohibits 
        unfair and deceptive practices. First, and foremost, we feel 
        that these laws, and related regulations, need to be enforced 
        more vigorously. Many abuses could be handled quite effectively 
        by better enforcement. The FTC has already brought a number of 
        enforcement actions involving most of the recognized predatory 
        lending practices under the existing HOEPA and the FTC Act, and 
        has obtained a handful of settlements. Obviously, the FTC 
        already has broad authority in this area. We hope that the FTC 
        will do much more to enforce these current laws to curtail 
        abuses. In addition, the Federal Reserve Board (FRB) is now in 
        the process of issuing enhanced HOEPA regulations. NHEMA has 
        provided information and comments to these and other regulatory 
        bodies and will continue to work with regulators to help 
        control abuses. NHEMA urges this Committee and the Congress 
        generally to support making whatever additional appropriations 
        are reasonably necessary to help Federal agencies enforce the 
        current laws and regulations more effectively. In addition, we 
        encourage the agencies to request additional funds if they need 
        them. It also is very important to remember that States have 
        various laws and regulations that apply to many of the 
        questionable practices. State regulatory officials and State 
        legislators need to consider how existing State laws and 
        regulations can be better enforced to prevent abusive lending 
        practices.
          (2) Consumer Education--Helping Consumers to 
        ``BorrowSmart''--Obviously, a key element of the problem is 
        that some borrowers, especially lower-income, less-educated 
        people, do not understand their mortgage loan terms. NHEMA's 
        number one priority is supporting the consumer's right of free 
        and fair access to affordably priced credit. That priority is 
        served by NHEMA's support of consumer education initiatives. 
        Educated consumers are good borrowers. They know how to avoid 
        unethical and abusive lending practices. They know how to get 
        the loan terms that work best for them. And they know how to 
        manage their money wisely and avoid running up new debt after 
        taking out a home equity loan. To educate consumers, NHEMA 
        created and supports the BorrowSmart Public Education 
        Foundation,\4\ a separate organization, which is undertaking a 
        number of education initiatives:
---------------------------------------------------------------------------
    \4\ Additional information concerning our BorrowSmart program and 
educational materials is contained in Appendix A. Held in Senate 
Banking Committee files.

          BorrowSmart.org. This website will show consumers how the 
        home equity lending process works, offer tips for avoiding 
        abusive practices, provide borrowers with resources they can 
        turn to if they think they have been a victim of fraud of 
        misrepresentation, educate borrowers about their rights and 
        responsibilities and offer other valuable information.
          Consumer Education Materials and Cooperation with Consumer 
        Groups--NHEMA has produced consumer brochures for distribution 
        by our member institutions to inform and educate borrowers 
        about the loan process, and the importance of smart money 
        management. We have distributed CD-ROM's with consumer 
        education materials to all our members so they can easily 
        reproduce and distribute them to their customers. NHEMA also 
        has worked to build education partnerships with consumer 
        groups. For example, we have published a joint brochure with 
        the Consumer Federation of America about the importance of 
        keeping credit card debt in check after taking out a home 
        equity loan to consolidate debt. The BorrowSmart Foundation is 
        now taking over producing such educational materials and in 
        working cooperatively with consumer groups.

          In addition, NHEMA conferences, seminars, and publications 
        encourage association members to keep borrowers educated and 
        informed. Our goal is to keep home equity loans available as a 
        financial resource for all homeowners, while ensuring that 
        every borrower understands how to use that resource wisely and 
        effectively.
          (3) Voluntary Actions--NHEMA has recognized that there is 
        much that industry can do voluntarily to help raise industry 
        standards and ensure that subprime mortgage lenders follow 
        proper practices. We have taken a proactive posture in this 
        area. In 1998, NHEMA adopted a new, enhanced Code of Ethics to 
        which our members subscribe. We also have adopted new Home 
        Improvement Lending Guidelines (1998) and Credit Reporting 
        Guidelines (2000). Last year, we adopted a particularly 
        significant measure--new comprehensive Fair Lending and Best 
        Practices Guidelines. These guidelines were the product of 
        months of study and analysis, and reflect input from a broad 
        cross-section of our membership. We believe that these 
        guidelines will be very helpful in improving overall industry 
        lending standards and practices. The guidelines provide a 
        useful baseline of what generally should be considered to be 
        appropriate lending practices and procedures.\5\
---------------------------------------------------------------------------
    \5\ Appendix B to this testimony contains a copy of NHEMA's Code of 
Ethics and our various industry Guidelines. Held in Senate Banking 
Committee files.
---------------------------------------------------------------------------
          (4) Comprehensive Legislative & Regulatory Reforms--NHEMA was 
        an active participant in the so-called Mortgage Reform Working 
        Group (MRWG), which began in the spring of 1997 and continued 
        to 1999. This group came together at the urging of key 
        Congressional leaders who wanted industry and consumer groups 
        to try to reach consensus on how the mortgage lending process 
        might be reformed. Participants spent literally thousands of 
        hours considering how mortgage lending might be improved. MRWG 
        participants included basically all relevant national trade 
        organizations and many consumer groups. Representatives from 
        HUD, the FTC, and FRB participated in many of the sessions. 
        Most MRWG participants agreed that there were various problems 
        with the present statutory and regulatory structure as it 
        applies to both prime and subprime mortgage lending. One of the 
        biggest problems identified was that current laws and 
        regulations are overly complex and often very confusing for 
        both borrowers and lenders. This makes it very difficult for 
        many consumers to understand what is occurring and to make 
        proper shopping comparisons. It also poses a host of compliance 
        burdens and uncertainties for lenders and mortgage brokers. A 
        number of the participants, including NHEMA, put forth various 
        reform concepts for discussion by the group, but no consensus 
        was reached, and the process essentially ended without any 
        resolution of the issues. Part of the reason that legislative 
        reforms could not be agreed upon was, and is, that these are 
        complex and difficult issues. For example, as noted earlier in 
        my testimony, many of the loan terms that some parties object 
        to are not necessarily abusive, and it is difficult to craft 
        restrictions that do not do more harm than good. In any case, 
        NHEMA believes that comprehensive reforms of current RESPA and 
        TILA mortgage lending provisions should be seriously considered 
        by Congress, and especially by this Committee. We are certain 
        that changes can be made to encourage more informed comparison-
        shopping for home equity loans. Moreover, we believe that 
        Federal regulators can use their existing authorities to make 
        significant improvements. In addition to the FRB's ongoing work 
        regarding 
        additional HOEPA regulations, we want to point out that HUD has 
        authority to simplify and clarify many relevant policies and 
        regulatory provisions. We urge this Committee to encourage HUD 
        officials to utilize such authority, particularly as it relates 
        to reducing some of RESPA's burdensome and confusing 
        provisions.
          (5) Carefully Crafted Legislation Targeted At Specific 
        Abuses--NHEMA originally proposed new legislative safeguards to 
        protect against particular abuses, such as loan flipping, as a 
        part of its 1997 comprehensive legislative reform proposals.\6\ 
        We subsequently recognized that it might be easier to address 
        many of these concerns in a narrower bill focused on particular 
        practices.\7\ NHEMA has long said that new legislative 
        safeguards appear to be merited in some cases. On the other 
        hand, we have long voiced serious concern that many of the 
        proposals put forward by legislators have been overly broad and 
        would prohibit or unduly restrict perfectly legitimate lending 
        practices while attempting to limit perceived abuses. The old 
        saying that ``the devil is in the details'' is perhaps no place 
        so appropriate as in the context of legislation intended to 
        protect against predatory mortgage lending practices. We 
        implore this Committee to be certain that any legislative 
        proposals you may ultimately put forth have been carefully 
        vetted to ensure that they are clear and do not have the 
        unintended effect of curtailing legitimate lending practices 
        instead of being targeted to stop only the abusive ones.
---------------------------------------------------------------------------
    \6\ NHEMA's 1997 comprehensive outline of proposed legislative 
reforms is attached as Appendix C. Held in Senate Banking Committee 
files.
    \7\ NHEMA's staff developed and widely circulated a working draft 
of a possible model targeted legislative proposal in 1999, a copy of 
which is attached as Appendix D. Held in Senate Banking Committee 
files.
---------------------------------------------------------------------------
Ten Key Issues for the Committee's Consideration
    Given our ongoing efforts to stop abusive lending practices and our 
knowledge of the subprime marketplace, we believe it is helpful to 
highlight 10 key questions and considerations that Congress may wish to 
explore as you grapple with predatory lending concerns:

          (1) What loans should be made subject to special protections? 
        The present regulatory approach contained in the so-called 
        HOEPA provisions of the Truth In Lending Act, essentially 
        targets only the most costly loans made to higher risk 
        borrowers. Under HOEPA, loans that have a rate that is more 
        than 10 percent over a comparable Treasury bill rate, or that 
        have certain loan fees and closing costs that exceed 8 percent 
        of the loan amount or a minimum dollar amount, are subject to 
        special protections. These enhanced safeguards include special 
        disclosures and some specific substantive restrictions (for 
        example, no balloons less than 5 years in duration). Typically, 
        most legislative proposals 
        to address predatory lending, including that put forth earlier 
        by Chairman Sarbanes, have proposed lowering the levels of both 
        the rate and the point/fee triggers. In addition, proposals 
        generally would change the definition of what items must be 
        included in calculating the point/fee trigger amount. The 
        effect of this computational change is to cause a dramatic 
        increase in the number of loans that hit this second trigger 
        level. NHEMA recognizes that Congress might conclude that some 
        modest trigger reductions may be appropriate. However, we see 
        no justification for sweeping in essentially all subprime loans 
        (and many prime ones) as is frequently suggested in legislative 
        proposals. Many lenders will not make HOEPA loans, which 
        unfortunately have developed a very negative stigma, due to the 
        very real reputational and legal risks involved. We fear that 
        any significant expansion HOEPA's coverage will result in many 
        lenders withdrawing from offering covered products and this 
        will have a very negative impact on credit costs and 
        availability. Moreover, we believe that abuses tend to be 
        concentrated primarily in the highest risk grades which is 
        where legislation should be targeted.
          (2) How might ``loan flipping'' be prevented? Without 
        question, ``loan flipping,'' which involves the frequent 
        refinancing of a mortgage loan with the borrower receiving no 
        meaningful benefit and typically having to pay significant 
        refinancing fees, is one area where abuse does exist and where 
        existing laws do not appear adequate to prevent it. Various 
        approaches have been proposed to remedy this problem. Most 
        suggestions have tended to apply special safeguards when a loan 
        is refinanced within 12 months or some other relatively brief 
        time period. The suggested restrictions include, for example: 
        prohibiting or limiting the amount of sales commissions 
        (points) that can be charged; requiring that the borrower 
        receive a benefit from the refinancing; or allowing points to 
        be charged only to the extent they reflect new money actually 
        advanced to the borrower. NHEMA feels that when considering 
        this issue, legislators need to recognize that many borrowers' 
        views of what constitutes a benefit to them differs from what 
        some of the industry's critics believe. Thus, most borrowers 
        who obtain a loan for debt consolidation purposes consider it 
        to be a very real and often critically important benefit to be 
        able to lower their monthly payment even if they will have to 
        pay more money over a longer period of time. Another important 
        point to note is that some of the tests that have been proposed 
        (that is, requiring a ``net tangible benefit'') are hopelessly 
        vague and certain to foster costly litigation. Legislators 
        therefore need to develop simple, clear tests in any new 
        provisions.
          (3) How should a provision be crafted to ensure a borrower's 
        repayment ability is properly considered before a loan is made? 
        Lenders normally carefully review a borrower's credit record 
        and economic situation to ensure that the borrower can repay 
        the loan. In some instances, however, lenders may make the loan 
        more on the basis of the value of the collateral property than 
        on the borrower's ability to repay without reference to the 
        underlying asset. Such asset based lending can lead to loan 
        flipping and may eventually end in the borrower's losing his or 
        her home in foreclosure. HOEPA currently contains a provision 
        that prohibits lenders from engaging in a pattern and practice 
        of lending without proper regard for repayment ability. If the 
        Committee revises present law by removing the pattern and 
        practice requirement, we urge that it do so in a simple and 
        straightforward manner. Traditionally, many lenders have 
        employed a 55 percent debt to income test, but if any such test 
        is embodied in statute, it is important to make it clear that 
        no presumption of a violation arises merely because such a test 
        is not met. We also do not believe that it is necessary to try 
        to employ some complex formula regarding residual income as 
        some have suggested.
          (4) How should single-premium credit insurance be treated? 
        Some lenders have offered customers various credit insurance 
        products that are sold on a single-premium basis where the cost 
        is typically assessed at the time of loan closing and this cost 
        is financed along with other closing costs. While those who 
        sell such credit insurance generally have defended it as a 
        valuable, fairly priced product, many consumer advocates 
        strongly attack such single-premium products. Recently several 
        major lenders have announced that they are ceasing to offer 
        such single pay products. Some have suggested that the 
        continued sale of single-premium insurance should be allowed, 
        provided certain safeguards are met such as: requiring that the 
        borrower be offered a choice of a monthly pay policy instead of 
        a single pay product; requiring additional special disclosure 
        notices relating to the product; and giving the borrower a 
        right to cancel with a full refund for some period of time and 
        thereafter the right to cancel with a refund based on an 
        actuarial accounting method. Many companies believe that if 
        additional restrictions are adopted they should, at a minimum, 
        allow for the sale on credit insurance on a monthly pay basis.
          (5) How might safeguards be crafted to ensure certain 
        legitimate loan terms are not misused? Many predatory lending 
        proposals would prohibit or severely restrict certain loan 
        terms. Some of these terms, such as prepayment penalties, are 
        not necessarily unfair or inappropriate. Quite to the contrary, 
        some such terms are most often beneficial to the borrower. 
        Therefore, it is critically im-
        portant that any new limitations on loan terms be drafted so 
        that legitimate uses of the terms are not prohibited. For 
        example, prepayment penalties can 
        be structured so that the borrower must be given a choice of a 
        loan product with and without a penalty, and the amount of the 
        penalty and the length of 
        time it can apply also can be limited. By applying such 
        balanced and carefully drafted provisions, the consumer can 
        generally gain the significant benefit of lower rates by 
        accepting a penalty provision, while the lender can be 
        protected against loss of expected revenue on which the loan 
        pricing is based. Certain other terms, like balloon payments, 
        could be addressed with similar carefully crafted safeguards. 
        Balloon mortgage payments usually are very helpful for 
        consumers who need lower initial monthly payments for a period 
        of time and who reasonably expect to have higher income to meet 
        higher obligations later. A balloon provision allows many 
        first-time homebuyers to acquire their home. There is nothing 
        inherently wrong with using a balloon payment. On the other 
        hand, an abusive mortgage originator can structure a mortgage 
        with a balloon payment that some consumers can never expect to 
        be able to meet. This could force the borrower to refinance one 
        or more times, having the equity stripped out of his or her 
        home, and ultimately being forced to sell the home, or face 
        foreclosure. By contrast, still others, such as call provisions 
        or accelerating interest upon default, might be appropriately 
        prohibited outright.
          (6) Should restrictions be imposed on subprime borrowers' 
        rights to finance loan closing costs? Mortgage loan closing 
        costs are usually substantial, amounting to several thousand 
        dollars, and many borrowers, especially those in the subprime 
        segment, do not have extra cash readily available to pay such 
        costs. Borrowers therefore generally finance the closing costs 
        and the amount of such costs are rolled into the loan and paid 
        off over an extended period of time. Some parties who have 
        sought to curtail subprime lending have proposed denying 
        consumers' the right to finance their closing costs. NHEMA 
        strongly objects to this unwarranted restriction. Subprime 
        borrowers would be seriously harmed by such discriminatory 
        treatment. Borrowers would have to obtain money to pay closing 
        costs by borrowing from more expensive unsecured sources, or in 
        some cases could not obtain the funds needed to close the loan.
          (7) Are more special disclosures needed? Some have suggested 
        adding to the disclosures that currently apply to HOEPA loans. 
        NHEMA basically has no ob-
        jection to enhancing some present disclosures. However, we do 
        have concerns about continuing to flood the consumer with 
        confusing, lengthy notices that most parties do not read, and 
        would not understand if they did. Again, care must be taken in 
        crafting any further notices (for example, special fore-
        closure warnings) to ensure that they are clear, simple, and 
        actually helpful to borrowers.
          (8) Can home improvement lending scams be prevented? It is 
        well recognized that a great amount of the abuse in the 
        subprime marketplace comes from home improvement lending scams. 
        Vulnerable borrowers are suckered into loan transactions 
        relating to home repairs and other improvements that are never 
        made, or if made are not completed properly. HOEPA requires 
        that home improvement loan disbursements must be made by checks 
        that are payable to both the borrower and the contractor, or at 
        the borrower's option to a third party escrow agent. NHEMA has 
        also issued voluntary guidelines in this area. We urge the 
        Committee to investigate whether there may be other viable 
        restrictions that should be applied to prevent abuses in the 
        home improvement area.
          (9) Should customers be forced to submit to mandatory credit 
        counseling? Some parties argue that all subprime customers 
        should be required to submit to counseling sessions with a 
        professional credit counselor. Although NHEMA strongly supports 
        making counselors available to all customers and encouraging 
        borrowers voluntarily to consider meeting both with a 
        counselor, we do not support mandatory counseling in the case 
        of all subprime loans. Mandatory counseling clearly is not 
        necessary for most customers, and many would find it offensive 
        to have to submit to counseling. Moreover, in many areas there 
        is a serious shortage of qualified counselors, so such a 
        requirement would unduly delay the loan process.
          (10) What must be done to achieve more uniform nationwide 
        rules against abusive practices? \8\ Last, but certainly not 
        least, is the issue of Federal preemption. For most of NHEMA's 
        members, the single biggest concern over predatory lending 
        legislation arises because of the dozens of differing proposals 
        that are constantly being put forth at the State and local 
        levels. This year, we already have differing bills in thirty-
        odd jurisdictions. We believe that it is critical that Congress 
        recognize that in today's nationwide credit markets, a uniform 
        Federal standard is needed for addressing predatory lending 
        concerns. Compliance with scores of differing State and local 
        rules in this area is impractical and unduly burdensome. 
        Federal preemption of differing State and local predatory 
        lending measures is badly needed.
---------------------------------------------------------------------------
    \8\ Although this list is limited as a matter of priority and 
convenience to 10 items, certain other issues merit the Committee's 
consideration. For example, industry today typically already reports 
mortgage payment history data to credit bureaus. NHEMA thus supports 
requiring lenders to provide such data periodically to the major 
national consumer reporting agencies. We also have no problem with 
providing for a modest increase in penalties for violations of an 
amended HOEPA, but believe provisions should be added to allow lenders 
to correct unintentional errors. Another concern that the Committee 
might consider is the question of liability of secondary market 
participants. It is extremely difficult, and usually practically 
impossible, for secondary market participants to know if an abuse has 
occurred unless it happens to be evident on the face of the loan 
documents, which is rarely the case. An additional issue relates to the 
degree to which brokers' roles and compensation should be disclosed, 
and whether better licensing requirements are needed.

    Mr. Chairman, these are difficult and complex issues. NHEMA trusts 
that this Committee and your House counterpart will give them very 
careful consideration, and we want to continue working in good faith 
with you to explore further how to stop abusive lending and related 
concerns. During this process, we encourage everyone to remember that 
the democratization of the credit markets that subprime mortgage 
lenders have helped achieve would be seriously undercut by most of the 
pending legislative proposals which are well-intended, but which have 
serious, unintended adverse consequences for needy borrowers. 
Ultimately, we hope that agreement can be reached on a package of 
reforms that will include workable provisions targeted to prevent 
particular abuses, together with some simplification and streamlining 
of current disclosure requirements and preemption of conflicting State 
and local laws.
    Thank you for this opportunity to present NHEMA's views.


                      PREDATORY MORTGAGE LENDING: 
                   THE PROBLEM, IMPACT, AND RESPONSES

                              ----------                              


                         FRIDAY, JULY 27, 2001

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:08 a.m., in room SD-538 of the 
Dirksen Senate Office Building, Senator Paul S. Sarbanes 
(Chairman of the Committee) presiding.

         OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

    Chairman Sarbanes. The Committee will come to order.
    Today is the Senate Banking, Housing, and Urban Affairs 
Committee's second day of hearings on predatory lending--the 
problem, impact and responses.
    Yesterday, we heard some very eloquent statements of the 
problem from four Americans who worked all their lives to 
attain the dream of homeownership, to build up a little wealth, 
only to have it slowly, piece by piece, loan by loan, taken 
away from them. These people were targeted by unscrupulous 
lenders, often elderly homeowners who have a lot of equity in 
their homes.
    In the case of one lady from West Virginia, Ms. Podelco, 
she actually took the proceeds of the insurance policy on her 
husband's life, $19,000, and paid off the mortgage on her home. 
She had the home free and clear, in a way a prudent thing to 
do, although I guess a lot of smart financial people would have 
said, no, you should have kept the mortgage and invested the 
money.
    But that is, I believe, a standard way of thinking for 
lower income people. They get their home, it is free and clear, 
it is theirs. There is nothing owed on it, and then they 
started approaching her and soliciting her. She had some debts 
and she wanted to do some improvements on the home. She took 
out a loan. Then they came along, they refinanced that loan, 
and then they refinanced that loan. And every time they did it, 
they packed in the fees and the charges and everything. Her 
loan obligation rose and, in the end, in just a few years, she 
lost her home. That is what we are trying to get at. She was 
refinanced six times in about a 2 years period.
    What struck me about these four stories were that many of 
the practices that harmed the witnesses are legal under 
existing law. There have also been abuses that are not legal 
and, of course, I strongly support action by regulators to use 
their authority under existing law to expand protections 
against predatory lending. I support stronger enforcement of 
current protections by the Federal Trade Commission and others. 
I applaud campaigns to increase financial literacy.
    I want to particularly acknowledge Senator Corzine's 
leadership in this effort. Chairman Greenspan actually gave a 
speech just on this issue, and I am hopeful that we will be 
able to help to put together with the industry, and with the 
regulators, and with people sitting at this table and others, a 
good program of financial literacy. I do not think that this 
alone is the solution to this problem.
    I also encourage and welcome industry's effort to establish 
best practices. There have been a number of important 
developments in that regard, and we certainly encourage others 
to follow along.
    I think those who take the position that stronger 
regulatory and/or more aggressive enforcement of existing laws 
will be adequate, have a special burden to carry, particularly 
in light of yesterday's testimony, to make sure that regulatory 
and enforcement tools are adequate to the job.
    At a minimum, at the very beginning, I think they should be 
supporting the Federal Reserve Board's proposed regulation on 
HOEPA, as Ameriquest, who was here yesterday, has done, and now 
as some other financial institutions have undertaken to do. We 
need to support the Fed's effort to gather additional 
information through an expanded HMDA, and the regulatory 
enforcement and enforcement agencies, such as the FTC, the 
Treasury, and HUD, in their recommendations for more effective 
enforcement.
    But, as I said, I do not think stronger enforcement, 
literacy campaigns, best practices alone are enough. Too many 
of the practices that we heard about in yesterday's testimony, 
while extremely harmful and abusive, are legal. And while we 
must pursue aggressively financial education, we need to 
recognize that takes time to be effective, and thousands of 
people are being hurt every day.
    I would like to quote what Fed Governor Roger Ferguson said 
in his confirmation hearing, ``Legislation, careful regulation, 
and education are all components of the response to these 
emerging consumer concerns.'' I subscribe to that view.
    Before turning to my colleagues who have joined us for 
their opening statements, and to the witnesses, I just want to 
take a moment to explain the arrangements here this morning. 
First of all, we had far more requests to testify than we 
really could accommodate. A number of groups and organizations 
and companies asked to come in--the Center for Community 
Change, the Neighborhood Assistance Corporation of America, the 
National People's Action, Neighborhood Housing Services, the 
National Neighborhood Housing Network, the Greenlining 
Institute, America's Community Bankers, Assurant Credit 
Insurance Company, Consumer Bankers Association, Consumer 
Credit Insurance Association, the Realtors, and so forth.
    We obviously could not accommodate everyone. I believe that 
is apparent by the current crowded witness table. We have 
offered to include statements from all of these groups who wish 
to submit them in the record, as well as other organizations. 
As we continue to explore and examine this issue, we may have 
other opportunities for people to come in and actually appear 
and to testify. I want to explain to our witnesses, we had 
considered doing two panels. But it is a Friday. Members have a 
lot of pressure on them at the end of the week, including the 
necessity to get back to their States. We decided that we would 
just put everyone at the table at the same time. We have tried 
to mix you up a bit so you get to know people maybe you have 
not met before.
    [Laughter.]
    We will encourage some dialogue at the table as a 
consequence.
    You have submitted very thoughtful statements. We 
appreciate that. The full statements will be included in the 
record. If each person could take about 5 minutes to summarize 
and make their major points, we will go through the panel and 
then we will have a question period. Often what happens, there 
are a fair number of people around for the first panel. And by 
the time you get to the second panel, a lot of people have 
left.
    If we do it this way, I hope it will work out. I know it is 
somewhat crowded at the witness table and I apologize to you 
for that, but I believe this will work out.
    With that, I am going to yield to Senator Miller for any 
opening statement he may have.

                 COMMENT OF SENATOR ZELL MILLER

    Senator Miller. I do not have an opening statement, Mr. 
Chairman but, again, I thank you for holding these hearings and 
again, welcome to these witnesses.
    We look forward to your testimony.
    Chairman Sarbanes. Thank you. Senator Stabenow.

              COMMENTS OF SENATOR DEBBIE STABENOW

    Senator Stabenow. Well, thank you, Mr. Chairman. And again, 
thank you for holding this important hearing. I think yesterday 
was a very important and moving opportunity to hear from 
witnesses directly about their experiences.
    I will submit a full statement for the record. I just want 
to welcome all of the panelists. I see a lot of familiar faces. 
I want to particularly recognize Tess Canja, who hails from my 
hometown in Lansing, Michigan. Before she was the esteemed head 
of the AARP, we actually started together--I will not say the 
date--in working on issues related to seniors and an effort to 
save a nursing home in Lansing, Michigan, which got me into 
politics.
    We now both find ourselves here in Washington focusing 
again on seniors and important issues. So welcome, Tess. And to 
all of the esteemed panelists, I look forward to hearing from 
all of you about what I think is an incredibly important topic, 
and I hope that we will have the opportunity to move in a way 
that makes sense to really address these issues.
    Chairman Sarbanes. Well, we will consider giving Ms. Canja 
a couple of extra minutes so that she can tell us about Senator 
Stabenow in her earlier years, yes.
    [Laughter.]
    Senator Stabenow. That is all right, Mr. Chairman.
    [Laughter.]
    Senator Corzine. You ought to put her under oath on that.
    [Laughter.]
    Chairman Sarbanes. Senator Corzine.

              STATEMENT OF SENATOR JON S. CORZINE

    Senator Corzine. Senator Sarbanes, Mr. Chairman, you know 
how strongly I feel about this issue. The literacy initiatives 
are one step, and enforcement certainly is. And as you talked 
about, some element of legislative action I think is necessary.
    The stories we heard yesterday, which we must acknowledge 
are anecdotal, I think are indicative of a serious market 
problem that we have. And it is something that I hope we can 
try to cut down to the key elements so that we can be as 
precise as possible.
    It is a difficult issue to define, but it is clearly a 
problem. And I thank all of the witnesses here. We should have 
sold admission and we would have had all of our budget taken 
care of for years.
    [Laughter.]
    Thank you all very much for being here.
    Chairman Sarbanes. I will introduce the panelists one by 
one 
as we turn to you to speak, instead of taking the time to 
introduce everyone right at the outset.
    Our first panelist will be Wade Henderson, who is the 
Executive Director of the Leadership Conference on Civil 
Rights, the Nation's oldest, largest, and most diverse 
coalition of organizations committed to the protection of civil 
rights in the United States.
    The Leadership Conference on Civil Rights has played an 
active role in increasing awareness of predatory lending 
practices and its impact on the civil rights community.
    We have interacted with Mr. Henderson on many issues that 
are on the agenda of this Committee and we always appreciate 
his very positive and constructive contributions.
    Wade, we would be happy to hear from you.

                  STATEMENT OF WADE HENDERSON

           EXECUTIVE DIRECTOR, LEADERSHIP CONFERENCE

                        ON CIVIL RIGHTS

    Mr. Henderson. Well, thank you, Mr. Chairman, and good 
morning to the Members of the Committee. I am pleased to appear 
before you today on behalf of the Leadership Conference to 
discuss this very pressing issue of predatory mortgage lending 
in America.
    Some may wonder why the issue of predatory lending raises 
civil rights issues. But I think the answer is quite clear. 
Shelter, of course, is a basic human need--and homeownership is 
a basic key to financial viability. While more Americans own 
their homes today than at any time in our history, minorities 
and others who historically have been underserved by the 
lending industry still suffer from a significant homeownership 
gap.
    Unequal homeownership rates cause disparities in wealth, 
since renters have significantly less wealth than homeowners at 
the same income level. To address wealth disparities in the 
United States and to make opportunities more widespread, it is 
clear that homeownership rates of minority and low income 
families must rise. Increasing homeownership opportunities for 
these populations is, therefore, central to the civil rights 
agenda of this country.
    Increasingly, however, hard-earned wealth accumulated 
through owning a home is at significant risk for many 
Americans. The past several years have witnessed a dramatic 
rise in harmful home 
equity lending practices that stripped equity from families 
homes and wealth from their communities. These predatory 
lending practices include a broad range of strategies that can 
target and disproportionately affect vulnerable populations, 
particularly minority and low income borrowers, female single-
headed households, and the elderly. These practices too often 
lead minority families to foreclosure and leave minority 
neighborhoods in ruin.
    Today, predatory lending is one of the greatest threats to 
families working to achieve financial security. These tactics 
call for an immediate response to weed out those who engage in 
or facilitate predatory practices, while allowing legitimate, 
responsible lenders to continue to provide necessary credit.
    As the Committee is aware, however, subprime lending is not 
synonymous with predatory lending. And I would ask each of you 
to remain mindful of the need for legitimate subprime lending 
in the market.
    Some have suggested, for example, that subprime lending is 
unnecessary. They contend that if an individual does not have 
good credit, then the individual should not borrow more money. 
But as we all know, life is never that simple. Even hard 
working, good people can have impaired credit, and even 
individuals with impaired credit have financial needs. They 
should not be doomed to a financial caste system, one that both 
stigmatizes and permanently defines their financial status as 
less than ideal.
    Until a decade ago, consumers with blemishes on their 
credit record faced little hope of finding a new mortgage or 
refinancing an existing one at a reasonable rate. And 
therefore, without legitimate subprime loans, those 
experiencing temporary financial difficulties could lose their 
homes and even sink further into red ink or even bankruptcy.
    Moreover, too many communities continue to be left behind 
despite the record economic boom. Many communities were 
redlined when the Nation's leading financial institutions 
either ignored or abandoned inner city and rural neighborhoods. 
And regrettably, as I mentioned earlier, predators began 
filling that void--the payday loan sharks, the check-cashing 
outlets, and the infamous finance companies.
    Clearly, there is a need for better access to credit at 
reasonable rates and legitimate subprime lending serves this 
market. I feel strongly that legitimate subprime lending must 
continue, and therefore, we hope that we will not go back to 
the days when inner city residents had to flee from finance 
companies and others who preyed on them.
    At the outset, I want to recognize that many persons and 
organizations have really helped to advance this debate. 
Yesterday, you heard from Martin Eakes of Self-Help, who is one 
of the leaders in this effort. Maude Hurd, the President of 
ACORN and her colleagues, have done a tremendous job. The 
Nation Community Reinvestment Coalition and others have helped 
to promote the idea of best practices and encourage the 
industry to sit at the table. But in truth, they need help. It 
is simply not enough.
    Recent investigations by Federal and State regulatory 
enforcement agencies, as you stated, Mr. Chairman, document 
that lending abuses are both widespread and increasing in 
number. You mentioned the Federal Trade Commission and the good 
work they have done. We should also acknowledge the States 
attorneys general who have taken out after these practices and 
tried to address them in a significant way, and we encourage 
the regulators to do more than they have done.
    You have talked about the important work of the Fed. You 
talked about the need for additional data under HMDA. All of 
those things are necessary. But even if we got all of that, 
they would still be insufficient.
    Over 30 State and local efforts are currently pending and 
as many as a dozen or more have recently been enacted to 
address these problems. In my testimony, I list nine States and 
local jurisdictions that have addressed these issues and I lay 
out the kinds of steps that they have taken which I think are 
significant, but, again, inadequate.
    Notwithstanding that States have tried to fill the void, we 
believe that more is needed and that the truth is State 
legislation under the current scheme is primarily inadequate.
    First, State legislation may not be sufficiently 
comprehensive to reach the full range of objectionable 
practices. And you mentioned that some of them are still legal 
on the books today.
    For example, while some State and local initiatives impose 
restrictions on single-premium credit life insurance, others do 
not. This, of course, leaves gaps in protection even for 
citizens in some States that have enacted legislation.
    Second, while measures have been enacted in some States, 
the majority of States have not enacted predatory lending 
legislation. And for this reason, the Leadership Conference 
supports the enactment of comprehensive Federal legislation, of 
the sort, Mr. Chairman, that you have introduced here in the 
Senate.
    The Predatory Lending Consumer Protection Act is the 
standard that we think is necessary. We strongly support it and 
we urge its swift enactment. Now one last point.
    We have made efforts to address these issues on a voluntary 
basis. We know that the industry is deeply concerned about the 
problems of predatory lending and they want to disassociate 
themselves from practices that would mark them as predatory.
    So for those good lenders, we have made efforts to work 
with them voluntarily and believing that there may have been an 
opportunity for voluntary responses to these issues, several 
national leaders within the prime and subprime lending 
industry, also with the secondary market, join civil rights and 
housing and community advocates and attempted under the 
auspices of the Leadership Conference to synthesize a common 
set of best practices and self-policies guidelines.
    We achieved a lot of consensus on many issues. However, the 
truth is, in the end, we failed to get consensus on some of the 
most difficult issues which are now being discussed and being 
addressed today, like credit life insurance.
    And one of the reasons that we failed to get that consensus 
is because many in the industry believe they could be insulated 
politically from any mandatory compliance with Federal 
legislation.
    They were not fearful that the Congress would enact a bill 
of a comprehensive nature and therefore, they were unwilling to 
grapple with their own practices, even though they knew they 
were questionable and created hardship on many communities. As 
a result, our view is that only Federal legislation will be 
sufficient.
    I am going to end my testimony where I began--why subprime 
lending? Why is its evil twin, predatory lending, a civil 
rights issue? The answer can be found in America's ongoing 
search for equal opportunity. After many years of difficult and 
sometimes bloody struggle, our Nation and the first generation 
of America's civil rights movement ended segregation. But our 
work is far from over. Today's struggle involves equal 
opportunity for all and making that a reality. Predatory 
lending is a cancer on the financial health of our communities 
and it must be stopped.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you very much. You made reference 
to the State attorneys general and I should just note that we 
had Tom Miller, the Attorney General for the State of Iowa, 
here with us yesterday. He heads up the attorney general's 
special task force on predatory lending and gave some very 
strong testimony.
    Two-thirds of the States' attorneys general have interceded 
with the Federal Reserve in support of the regulation which the 
Federal Reserve now has under consideration with respect to 
this issue.
    Next, we will hear from Ms. Judy Kennedy, the President of 
the National Association of Affordable Housing Lenders.
    I ought to note that over the past 11 years, the NAAHL has 
worked quite successfully to infuse private capital investment 
into low- and moderate-income communities by pioneering a 
number of innovative community investment practices.
    Ms. Kennedy, we are pleased to have you here.

                 STATEMENT OF JUDITH A. KENNEDY

               PRESIDENT, NATIONAL ASSOCIATION OF

                   AFFORDABLE HOUSING LENDERS

    Ms. Kennedy. Thank you, Senator. I am delighted to be here.
    As you pointed out, NAAHL's members are a cross-section of 
the pioneers of community investment--banks, loan consortia, 
financial intermediaries, pension funds, foundations, local and 
national nonprofit providers, public agencies, and allied 
professionals.
    In 1999, we held a conference in Chicago where Gail Cincada 
and others informed us about predators' activities in that 
city. We came to the conclusion then that if NAAHL is not part 
of the solution to predatory lending, we will be part of the 
problem. It is clear that while we are committed to increasing 
the flow of capital into underserved communities, we must be 
equally concerned about access to capital on appropriate terms.
    So in March of this year, we sponsored a symposium that 
brought together experts on this issue--regulators, 
researchers, advocates, for-profit and nonprofit lenders, and 
secondary market participants. We are issuing today that report 
and I hope you have it before you--Juntos Podemos, Together We 
Can.
    Our goal was to accelerate progress in stopping the 
victimization. As the Mayor of Chicago succinctly puts it, ``It 
is all down the drain if we cannot stabilize the communities 
that were stable until these foreclosures started to happen.''
    Our findings are as follows, first, you can profile 
predatory lending. It is clear.
    Second, more needs to be done at the Federal level. More, 
of course, is being done this year, in part, thanks to your 
attention, Senator Sarbanes. But as Elizabeth McCaul, the New 
York State Banking Commissioner, and you have emphasized, it is 
critical to balance the need for credit with the need to end 
abuses. NAAHL members have a history of tailoring credit to the 
unique needs of low income households in underserved 
communities. But as the Federal Reserve has pointed out, a 
significant amount of mortgage lending is not covered by a 
Federal framework. For example, Governor Gramlich reported that 
only about 30 percent of all subprime loans are made by 
depository institutions that have periodic exams. Some estimate 
that as low as 15 percent of originators of subprime loans have 
any reporting and examination. Even if the Fed were to do 
periodic compliance exams of the subsidiaries of financial 
holding companies, that would only increase the number to, at 
best, 40 percent.
    It is not surprising, then, that of the 21 completed 
Federal Trade Commission investigations into fair lending and 
consumer compliance violations, none were Federally examined. 
If the Fed's recent proposal to expand reporting under the Home 
Mortgage Disclosure Act to more lenders is adopted, it will 
still encompass only those whose mortgage lending exceeds $50 
million per year. Many of the other proposed changes to HMDA 
that the Fed proposes which we supported will simply make the 
playing field even less level by putting additional burdens and 
costs on the responsible lenders while the worst lenders go 
unexamined.
    To stop the predators, the symposium confirmed, we need to 
close the bar doors on examination and reporting of mortgages 
in America. A level playing field in enforcement and reporting 
is key. Right now, the institutions that you talk about that 
have best practices in the subprime lending market do extensive 
due diligence of their brokers to ensure fair lending 
practices. They maintain data on those loans. They are 
rigorously examined by the bank regulatory agencies. But the 
majority of lenders in this market are not subject to 
regulatory oversight, do not have the same level of compliance 
management, and often do not even file HMDA reports. In a town 
with no sheriff, the bandits are in charge. Unscrupulous 
brokers who are rejected by legitimate lenders simply go to 
others who have no knowledge of the loan terms or reputation or 
compliance concerns about funding predatory loans.
    Third, our symposium also confirmed that subprime lending 
is an important source of home finance, and I think we agree on 
that.
    Fourth, we heard that vigorous enforcement at all levels of 
Government works. We heard from people actively involved in 
combatting predatory lending on the State and local level and 
we think all of this will help to eradicate predatory lending.
    Fifth, consumer education is key. We know that many 
initiatives in the last year, some as a result of your 
attention and some that preceded that, are making a difference. 
But increased Federal resources for targeted counseling in 
neighborhoods vulnerable to predators could greatly extend the 
efforts of the private sector. As Martin Eakes points out, ``. 
. . the Department of Education says that 24 percent of adult 
Americans are illiterate.'' But targeted counseling could go a 
long way.
    Overall, our symposium confirmed once again that it is a 
complex issue requiring a multifaceted solution. But as our 
closing speaker, HUD Secretary Martinez, pointed out--juntos 
podemos--together, we can.
    As president of an organization whose members have spent 
their careers trying to increase the flow of private capital 
into under-served communities, I say, together we must.
    Chairman Sarbanes. Thank you very much. I simply want to 
note, I thought the symposium that you held out of which this 
report emanated was a very important contribution toward a 
deepening understanding of this issue.
    Ms. Kennedy. Thank you, Mr. Chairman.
    Chairman Sarbanes. I will now turn to Tess Canja, who is 
President of the Board of Directors of the American Association 
of Retired Persons, the AARP, which has for quite sometime now 
taken a very strong campaign against predatory mortgage 
lending, which disproportionately impacts seniors. Seniors are 
clearly, from some of the statements that have been received 
from people who work in the industry, a very heavily targeted 
group.
    I might note that only yesterday, in Roll Call, the AARP, 
as part of its campaign against predatory lending, had this 
ad--``They Didn't Tell Me I Could Lose My Home.'' And then it 
details here being subjected to these pressure tactics and 
high-cost loans that strip equity and then lead to foreclosure.
    Ms. Canja, we would be happy to hear from you.

              STATEMENT OF ESTHER `` TESS'' CANJA

       PRESIDENT, AMERICAN ASSOCIATION OF RETIRED PERSONS

    Ms. Canja. Thank you, Senator, and good morning. Good 
morning to all of the Members of the Committee.
    Thank you for showing that ad from Roll Call because we are 
involved in a very big educational campaign and that is exactly 
what we are calling it--They Didn't Tell Me I Would Lose My 
Home--which is exactly what happens with predatory lending.
    AARP appreciates this opportunity to bring into greater 
focus one of the most troubling forms of financial 
exploitation--namely, making unjustifiable, high-cost home 
equity loans to older Americans. For most Americans, it takes 
time to accumulate home equity. For many, it is a working 
lifetime, so that equity become highly correlated with age. The 
most abusive loans for older Americans are often refinancing 
loans and home modification loans because they target the 
equity value of the home. Equity in a home is frequently the 
owner's largest financial asset. Abusive lending is 
particularly devastating when the older homeowner is living on 
a modest or fixed income.
    In AARP's view, loans become predatory when they take 
advantage of a borrower's inexperience, vulnerabilities, and/or 
lack of information; when they are priced at an interest rate 
and contain fees that cannot be justified by credit risk; when 
they manipulate a borrower to obtain a loan that the borrower 
cannot afford to repay; and when they defraud the borrower.
    Older homeowners are often targeted for mortgage 
refinancing and home equity loans because they are more likely 
to live in older homes in need of repair, are less likely to do 
the repairs themselves, are likely to have substantial equity 
in their homes to draw on, and they are likely to be living on 
a reduced or fixed income.
    AARP's efforts to address these problems are directed at 
improving credit market performance, not at limiting consumer 
access to credit for those with a less-than-perfect credit 
history. We believe that our, and other, consumer financial 
literacy campaigns are very important. These public- and 
private-sector efforts aim to make consumers their own first 
line of defense. However, while consumer education and 
counseling programs are necessary, they certainly are not 
enough.
    AARP believes there is a need to strengthen and expand 
HOEPA's loan coverage. This upgrade will help to ensure that 
the need for credit by subprime borrowers will be fulfilled 
more often by loans that are subject to HOEPA's protections 
against predatory practices. In this context, AARP has urged 
the Federal Reserve Board to issue the final HOEPA amendment as 
soon as possible.
    Chairman Sarbanes, and Members of the Committee, the 
problems associated with abusive home-equity-related lending 
practices are complex and to date, agreement on a comprehensive 
reform of the more mortgage finance system to address these 
problems has proven elusive. We are, therefore, encouraged by 
the Committee's continued efforts to call attention to 
predatory mortgage lending and to establish effective 
deterrence. AARP is committed to working with this Committee, 
Congress, and the Bush Administration to address the problems 
posed to the elderly by these devastating lending practices.
    We thank you, and I will try to answer any questions you 
may have later.
    Chairman Sarbanes. Thank you very much. We appreciate your 
testimony and we always appreciate working with AARP.
    Our next witness will be John Courson, who is the President 
and CEO of Central Pacific Mortgage Company in Folsom, 
California, and the Vice President of the Mortgage Bankers 
Association of America.
    The Mortgage Bankers Association represents companies 
involved in real estate finance, including mortgage companies, 
mortgage brokers, and commercial banks. And this Committee 
deals with a whole range of issues that encompass the concerns 
of the Mortgage Bankers Association.
    Mr. Courson, we are pleased to have you with us here today. 
We look forward to hearing from you.

          STATEMENT OF JOHN A. COURSON, VICE PRESIDENT

            MORTGAGE BANKERS ASSOCIATION OF AMERICA

                       PRESIDENT AND CEO

                CENTRAL PACIFIC MORTGAGE COMPANY

                       FOLSOM, CALIFORNIA

    Mr. Courson. Thank you. Good morning, Mr. Chairman, and 
Members of the Committee. Let me begin by saying that the 
Mortgage Bankers Association and, indeed, all legitimate 
lenders, unequivocally oppose abusive and predatory lending 
practices. There is no hiding from the fact, however, that 
certain rogue lenders continue to prey on our most vulnerable 
populations.
    We all agree that a significant problem exists and we all 
share in the responsibility to address the problem. In 
searching for answers, we should not focus on band-aids that 
merely cover up the harms. Rather, we must work together to 
find lasting solutions that will truly protect even the most 
vulnerable consumers.
    I know from the outset that predatory lending is not a new 
problem. In fact, it has traditionally been referred to as 
mortgage fraud. And I stress that those consumer laws that are 
currently on the books--TILA, RESPA, HOEPA--are all aimed at 
curing problems of fraud and abuses in lending. We must 
recognize that these laws have existed for years and yet, 
predatory lending has managed to survive. The fact that we are 
holding this hearing today should wake us up to that reality.
    MBA believes predatory lending is a problem that has a 
number of sources. We believe there are three keys to effective 
and lasting solutions. These are: enforcement, education and 
simplification.
    First, MBA believes that a general lack of enforcement has 
done much to create an environment for unscrupulous lenders to 
operate. Mortgage lending is among the most regulated of all 
activities. It is subject to pervasive Federal and State 
regulation.
    For these laws to be effective, they need to be enforced. 
We have long held and reaffirm our belief here that predatory 
lenders gouge the public through techniques that constitute 
outright fraud--concealment, forgery, deceptive practices, and 
nondisclosure. We would note that these activities are against 
the law in every single State. It is essential that we enforce 
these laws to the maximum extent possible. Due to a current 
lack of enforcement, there are often no consequences for those 
who engage in predatory lending and we urge the allocation of 
additional resources for enforcement.
    Second, we believe that consumer awareness and education 
are among the most effective tools for combatting predatory 
lending practices. Simply put, consumers who have an 
understanding of the lending process and who are aware of 
counseling and other options are far less likely to fall prey 
to unscrupulous lenders.
    MBA is currently working on new programs designed to 
educate consumers about the mortgage loan process. In 
particular, we are developing interactive tools that will 
empower borrowers confronted with predatory lending practices. 
These tools will include important information advice, provide 
typical warning signs of predatory lending, and have direct 
links to State and Federal regulators that are able to assist 
possible victims of abusive lending.
    And third, the complexity of the current mortgage process 
needs to be addressed. We need to streamline and simplify the 
laws that govern consumer disclosures and protections, RESPA 
and TILA.
    Any consumer that has been through the mortgage process 
knows how bewildering it is. No less than HUD Secretary 
Martinez, who is not only an attorney, but a housing attorney, 
has commented publicly that he was overwhelmed by the 
complexity of the process that he went through when and his 
family bought a house in Washington earlier this year.
    Disclosures provided in the mortgage process are so cryptic 
and so voluminous, that consumers do not understand what they 
read or what they sign. This complexity is the very camouflage 
that allows unscrupulous operators to hide terms and conceal 
crucial information from unsuspecting consumers.
    Partly because of his personal experience, Secretary 
Martinez has made simplification and regulatory reform in this 
area a priority. I hope that Congress will also address this 
very important piece of the predatory lending issue.
    In summary, MBA believes that we must address predatory 
lending on three fronts--a commitment to full enforcement, 
robust education, and simplification of existing laws. Nothing 
short of that will suffice.
    Thank you for the opportunity to appear this morning and I 
look forward to answering your questions.
    Chairman Sarbanes. Thank you very much, Mr. Courson. We 
appreciate your coming.
    We will now hear from Mr. Irv Ackelsberg, who is the 
managing attorney at the Community Legal Services of 
Philadelphia. Mr. Ackelsberg is recognized as one of the 
leading public interest lawyers in the country, and he has been 
involved, of course, in this predatory lending issue.
    He is testifying today not only on behalf of his own 
organization, but also the National Consumer Law Center, 
Consumers Union, Consumer Federation of America, National 
Association of Consumer Advocates, and U.S. Public Interest 
Research Group.
    Mr. Ackelsberg, we would be happy to hear from you.

                  STATEMENT OF IRV ACKELSBERG

       MANAGING ATTORNEY, COMMUNITY LEGAL SERVICES, INC.

                    TESTIFYING ON BEHALF OF

                THE NATIONAL CONSUMER LAW CENTER

               THE CONSUMER FEDERATION OF AMERICA

                       THE CONSUMER UNION

         THE NATIONAL ASSOCIATION OF CONSUMER ADVOCTAES

              U.S. PUBLIC INTEREST RESEARCH GROUP

    Mr. Ackelsberg. Chairman Sarbanes and Members of the 
Committee, thank you so much for this invitation. This is 
actually my first time doing this, so I am really thrilled to 
be here.
    Chairman Sarbanes. We put you right in the middle, as it 
turned out.
    [Laughter.]
    Mr. Ackelsberg. Yes.
    [Laughter.]
    By way of personal introduction, I am a career legal 
services lawyer. I have spent my entire 25 years as a lawyer 
with Community Legal Services of Philadelphia, primarily as a 
consumer law specialist. Because of the extremely high rate of 
homeownership among low income communities in Philadelphia, 
most of the work that I have done during the past 25 years has 
been associated with protecting existing homeowners from loss 
of their homes.
    The predatory lending crisis is so devastating and so 
widespread, that we are currently using six lawyers who are 
working almost exclusively on defending predatory lending 
victims in Philadelphia alone, and we cannot keep up with that 
demand. There is no question that we are expending more 
resources than any other legal service program in the country 
on this problem, and we cannot keep up with it. We have just 
set up, with the cooperation of the Philadelphia Bar 
Association, a special predatory lending panel by which we will 
be training private lawyers and working with them to teach them 
how to do this work.
    I believe that our office has probably reviewed more of 
these transactions than any other law firm in the country and 
it is from the hundreds of stories of victims that I draw most 
of my experience. But I should also add that I have deposed 
countless loan officers, brokers, title clerks, and I was the 
principal trial counsel in the first reported case under HOEPA, 
called Newton v. United Companies Financial.
    I also, by the way, served on the official creditors 
committee in the United Companies Lending Chapter 11 
proceeding. I believe that I am uniquely qualified to speak to 
you about the nature of the problem and the legislation needed 
to remedy the problem.
    First, just to supplement the written testimony on the 
foreclosure explosion that was referred to in the written 
testimony, just a few bits of data from Philadelphia.
    Pennsylvania has a State emergency mortgage assistance 
program that offers financial help to qualified homeowners 
facing foreclosures. These are all foreclosures other than 
FHA's.
    In data obtained from the State agency that administers 
this program, we found that in the year 2000, it received 740 
applications for help from borrowers facing foreclosure in 
Philadelphia. Of those 740 requests for help, 164, or 22 
percent, involved threats of foreclosure from a single lender, 
EquiCredit, the subprime subsidiary of Bank of America, which 
at the moment, according to what we are seeing pouring into the 
office, is the biggest problem.
    Just this week, we looked at the sheriff 's sale listings 
for the month of August. Every month, there is a list of the 
sales. There is a monthly sale in Philadelphia. Forty houses 
are being sold just by EquiCredit in the City of Philadelphia 
in August. The undisputed explosion in foreclosure is indeed a 
reflection of the predatory lending crisis. All across our 
country, we have senior citizens, our mothers, our 
grandmothers, who are anxious about their credit card debt and 
bashful about talking about their finances. They are lonely, 
and they are good, trusting people, all of which combine to 
make them sitting ducks for a veritable parade of low-life 
lenders, brokers, and contractors who are seeking to extract 
what often is the only wealth that they have--their home.
    There is a veritable gold rush going on in our 
neighborhoods and the gold that is being mined is home equity. 
This bleeding of wealth is not simply the result of market 
forces. As we describe in our written testimony, there have 
been critical Federal policies that have fueled the gold rush, 
particularly the first lien usury deregulation of the 1980's 
and the changes in the tax code that limited interest payment 
deductions to only home equity interest.
    There are also Federal policies that have undermined the 
ability of lawyers to defend victims, most notably the Federal 
Arbitration Act, which has been interpreted by the courts to 
basically allow wholesale waiver of borrower's access to the 
courts, and I might add, the restrictions in legal services, 
which have basically made the work that I do virtually 
impossible for Legal Services Corporation-funded programs. And 
for that reason, we had to give up our funding from the Legal 
Services Corporation to do this work.
    The existing HOEPA triggers are too high, particularly the 
points and fees trigger currently at 8 points. This allows the 
predators to make costly loans just under those triggers. 
Indeed, we are seeing 7 point loans, 7.9 points. We even saw 
one last week that had exactly 8.0 of points.
    But there is an upside to that fact. These loans used to 
have 10 to 15 points. That means that the basic structure of 
HOEPA is sound. It is doing good work. It is already functioned 
to nudge down the cost of credit. Remember that the same 
lenders who are warning you today that if you bring down the 
triggers, credit will dry up, said the same thing 7 years ago, 
that if you enacted HOEPA, there will be no credit.
    Subprime credit did not disappear. It just got less costly, 
and it needs to get less costly still. I hope within the 
questioning period I will have the opportunity to discuss some 
of the very specific aspects of S. 2415 which we believe will 
be very helpful to those of us who are trying to save houses. 
And in summation, I would just say, and I apologize if the 
words seem inappropriately too strong, but these words come 
from 25 years of experience.
    I believe that predatory lending is the housing finance 
equivalent of the crack cocaine crisis. It is poison sucking 
the life out of our communities. And it is hard to fight 
because people are making so much money. But we need Government 
to join the fight with zeal and with smarts. S. 2415 has our 
unconditional support.
    Thank you.
    Chairman Sarbanes. Thank you very much, sir.
    We are being joined this morning by Senator Crapo. Mike, do 
you have an opening statement?

                 COMMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman. I do not have an 
opening statement and in fact, I have to leave in just a few 
minutes for a live interview. I hope to get back. I have read 
about half of the testimony already and will read that which I 
am not able to hear. But I appreciate your holding this 
hearing. I look forward to working with you on the legitimate 
problems that are identified and finding solutions that can 
work for everybody.
    Chairman Sarbanes. Thank you very much.
    We will now hear from Neill Fendly, who is the immediate 
Past President of the National Association of Mortgage Brokers, 
NAMB. The NAMB provides education, certification, industry 
representation, and publications for the mortgage broker 
industry.
    Mr. Fendly, we appreciate your being here with us this 
morning.

               STATEMENT OF NEILL A. FENDLY, CMC

                    IMMEDIATE PAST PRESIDENT

            NATIONAL ASSOCIATION OF MORTGAGE BROKERS

    Mr. Fendly. Thank you. Mr. Chairman and Members of the 
Committee, I am the Immediate Past President of the National 
Association of Mortgage Brokers, referred to as NAMB. This is 
the first time that NAMB has testified in the Senate. We are 
truly appreciative of the opportunity to address you today on 
the subject of abusive mortgage lending practices.
    NAMB currently has over 12,000 members and 41 affiliated 
State associations Nationwide. NAMB members subscribe to a 
strict code of ethics and a set of best business practices that 
promote integrity, confidentiality and, above all, highest 
levels of professional service to the consumer.
    I would like to focus this testimony on helping the 
Committee understand the important and unique role of mortgage 
brokers in the mortgage marketplace and offer the unique 
perspective of mortgage brokers in examining the problem of 
predatory lending.
    Today, mortgage brokers originate more than 60 percent of 
all residential mortgages in America. Mortgage brokers are 
critical to ensuring that people in every part of our country 
have access to mortgage credit. Almost anyone can usually find 
a mortgage broker right in their community that gives them 
access to hundreds of loan programs. Mortgage brokers are 
generally small business people who know their neighbors, build 
their businesses through referrals from satisfied customers, 
and succeed by becoming active members of their communities.
    The recent expansion in subprime lending has also relied 
heavily on mortgage brokers. Mortgage brokers originate about 
half of all subprime loans. Many mortgage brokers are 
specialists in finding loans for people who have been turned 
down by other lenders.
    Mortgage brokers often do an amazing amount of work on 
these loans. I recently completed one such loan that took over 
1 year from start to finish. They work with borrowers to help 
them understand their credit problems, work out problems with 
other creditors, clean up their credit reports when possible, 
and review many possible options for either purchasing a home 
or utilizing existing home equity as a tool to improve their 
financial situation.
    We know that mortgage credit is the least expensive source 
of credit for those who may have made some mistakes or had some 
misfortune in the past and now need money to improve their 
home, finance their children's education, or even start a 
business. They need to have the widest possible range of 
choices when they are buying a home or need a second mortgage, 
and today they do. It is important that Congress be very 
careful to avoid measures that will deny people choices they 
deserve and the tools they need to manage and improve their 
financial situation.
    One of the most important choices available to consumers is 
the no- or low-cost loan which enables people to buy a home, 
refinance, or obtain a home-equity loan with little or no cash 
required up front for closing costs. These costs are financed 
through an adjustment to the interest rate. Both mortgage 
brokers and retail lenders offer these popular loans. When a 
mortgage broker arranges a loan like this, the broker is 
compensated from the lender from the proceeds of the loan. This 
kind of payment goes by many names, but is often called a yield 
spread premium. These payments are perfectly legitimate and 
legal under Federal law, RESPA, so long as they are reasonable 
fees and the broker is providing goods and services and 
facilities to the lender. They must be fully disclosed to 
borrowers on the good faith estimate and the HUD-1 settlement 
statement, and are included in the interest rate. Retail 
lenders, however, are not required to disclose their comparable 
profit on a loan that is subsequently sold in the secondary 
market as most mortgages are today.
    Despite the great popularity of this loan with consumers, 
today it is under assault in the courts. Trial lawyers across 
America are pursuing class action lawsuits claiming such 
payments to mortgage brokers are illegal and abusive. This is 
despite Statement of Policy 1991-1, issued at the direction of 
Congress by the Department of Housing and Urban Development in 
1999, which clearly sets forth the Department's view that 
yield-spread premiums are not, per se, illegal and must be 
judged on a case-by-case basis.
    Recently, the 11th Circuit Court allowed a class action to 
be certified in one of these suits. This has resulted in a 
flood of new litigation against mortgage brokers and wholesale 
lenders and has caused a great deal of uncertainty and anxiety 
in the mortgage industry. The cost of defending these class 
actions is staggering. The potential liability could run over 
$1 billion. The prospect of a court deciding that the prevalent 
method of compensation for over half the mortgage loans in 
America is illegal is chilling, to say the least.
    If these lawsuits succeed, the real losers will be 
tomorrow's first-time homebuyers, tomorrow's working families, 
tomorrow's entrepreneurs who will not be able to get a mortgage 
without paying hundreds of dollars up front. Further down the 
road, many small business men and women will not be able to 
stay in business as mortgage brokers without being able to 
offer these no-cost loans. As competition decreases, all 
potential mortgage borrowers will suffer higher costs and fewer 
choices.
    Mr. Chairman, this illustrates the unintended consequences 
that can come from litigation, regulation, or legislation that 
singles out one part of the mortgage industry, places blanket 
restrictions on prohibitions of certain types of loans and 
products, or unreasonably restricts interest rates and fees.
    Virtually no loan terms are always abusive, and almost any 
loan term that is offered in the market today can be beneficial 
to some consumers. Whether a loan is abusive is a question that 
turns on context and circumstances from case to case. This is 
why NAMB and the mortgage industry have opposed legislation or 
regulation that would impose new blanket restrictions or 
prohibition on loan terms. We believe such measures will 
increase the cost of homeownership, restrict consumer choice, 
and reduce the availability of credit, primarily to low- and 
moderate-income borrowers.
    NAMB believes that the problem of predatory lending is a 
three-fold problem: abusive practices by a small number of bad 
actors; lack of consumer awareness about loan terms; and the 
complexity of the mortgage process itself. We believe all three 
of these areas must be addressed together and with equal forces 
if the problem is to be solved without unintended consequences 
that I mentioned earlier. The mortgage industry is working 
vigorously in all three areas and NAMB wants to continue 
working with Congress to address all these areas, in 
particular, reform and simplification of the mortgage loan 
process.
    This part of the solution is one toward which NAMB has put 
a tremendous amount of effort. This is a comprehensive overhaul 
of the statutory framework governing mortgage lending. We 
cannot emphasize enough to this Committee how badly this 
framework needs to be changed and how important this is to 
curtailing abusive lending.
    The two major statutes governing mortgage lending have not 
been substantially changed since they were enacted in 1968 and 
1974. The disclosures required under these laws are confusing 
and overlapping. The laws actually prevent consumers from being 
as well informed as they could be and put consumers at a 
decided disadvantage in the mortgage process. As one of the 
borrowers at yesterday's hearing so eloquently put it, ``the 
problem is the lenders know everything and the borrowers know 
nothing.'' It is impossible for consumers to effectively 
compare different types of mortgage loan products.
    NAMB has been engaged from the beginning in efforts to 
reform the laws regulating mortgage originations and we remain 
committed to the goal of comprehensive mortgage reform and 
simplification. We urge this Committee in the strongest terms 
possible to work with our industry on mortgage reform.
    In conclusion, I want to reiterate that NAMB supports 
measures by the industries and regulators to curb abusive 
practices, punish those who do abuse consumers, and promote 
good lending practices. We support legislation that would 
reform and simplify the mortgage process and believe this is 
the legislation that is most needed to empower consumers. The 
problem of predatory lending can only be solved through a 
three-pronged approach of enforcing existing laws, targeting 
bad actors, educating consumers, and reforming and simplifying 
the mortgage process. In considering any new legislation, we 
urge Congress to apply this fundamental principle: Expand 
consumer awareness and consumer power rather than restrict 
consumer choice and product diversity. That should be the goal 
of any new legislation affecting the mortgage process.
    Thank you for this opportunity to express our views and we 
look forward to working with the Committee in the future.
    Chairman Sarbanes. Thank you very much, sir.
    We will now hear from David Berenbaum, the Senior Vice 
President, Program and Director of Civil Rights for the 
National Community Reinvestment Coalition.
    For more than 10 years, the National Community Reinvestment 
Coalition has been a leading force in promoting economic 
justice and increasing fair access to credit, capital, and 
banking services for traditionally underserved communities.
    Mr. Berenbaum, we are pleased to have you with us.

                  STATEMENT OF DAVID BERENBAUM

                     SENIOR VICE PRESIDENT

              PROGRAM AND DIRECTOR OF CIVIL RIGHTS

           NATIONAL COMMUNITY REINVESTMENT COALITION

    Mr. Berenbaum. Thank you, Chairman Sarbanes, Members of the 
Committee. We are extremely concerned about the prevalence of 
predatory lending in our Nation. During the next 5 minutes, I 
will try to synthesize the remarks included in our over 20 
pages of testimony and exhibits. We are clearly in a dual-
lending marketplace. Let it be said and let it be heard that 
the continuation of redlining is in our Nation.
    Despite popular belief, or the argument that in fact 
subprime lending has ended redlining that is argued by some 
industry associations, in fact, it has put an entirely new face 
on the issue of redlining, a whole new cast on it.
    Before, where overt discrimination occurred, overt consumer 
denial with regard to access to credit was commonplace, today, 
we are dealing with a race tax. In fact, if you look at recent 
HUD-Treasury studies, they report that African-Americans are 
five times more likely to receive subprime loans than their 
white neighbors. Other studies document the fact, studies by 
the GSE's, that 30 to 50 percent of African-Americans who are 
currently receiving subprime loans should have qualified and 
been afforded the opportunity to receive prime paper.
    This is a major failure. Picture yourself living in an 
urban community. You approach a retail lender operation. On the 
front window of that lender is an equal housing opportunity/
equal lender logo. You go in and in fact, they give you papers 
in compliance with the Truth in Lending Act, in compliance with 
all other consumer protections. And then they try to sell you a 
product that has four points, fees, single-premium credit life, 
and that has a balloon note.
    Now picture that individual going into a suburban location. 
In fact, another division of the very same company. And you are 
told, that you can get a prime note with one point, no single-
premium credit. And you have options, you have choices.
    In fact, this is not, as was referenced, a rogue lender. It 
is an example of many corporate lenders in our country right 
now, having subprime divisions that market themselves 
exclusively to urban communities while their prime traditional 
lending banks covered by CRA, in fact, are operating in 
predominantly white areas.
    Included in our testimony, we have maps based on the Home 
Mortgage Disclosure Act that look at, ``minority census 
lending.''
    On the board here, we have a map from the Baltimore area. 
The first map documents subprime lending. You can see the 
concentration of the dots. These are refinanced loans that were 
originated in the subprime marketplace in 1999. You see the 
concentration in the areas that have the darker shading which 
represent predominantly African-American and Latino areas. The 
next map looks at prime lending. Look at the strong difference. 
Prime lending is happening throughout the Baltimore/
Metropolitan Washington area.
    I submit to you that the prime lending that is occurring in 
African-American communities is coming from responsible lenders 
that are living up to their commitments under the Community 
Reinvestment Act and in partnership with community-based 
organizations.
    Financial modernization, the changing nature of the 
mortgage marketplace has prompted an atmosphere where many 
lenders are not falling within compliance reviews, are not 
falling with existing statutory reviews.
    Best practices include the lender marketing their goods in 
both the urban and suburban areas and where they have 
agreements. I respectfully say, and I believe in best 
practices. I believe in financial literacy. NCRC has been a 
leader in doing ``train the trainer'' work with regard to 
financial literacy. We believe in all that.
    But with all due respect, it is not simply rogue lenders 
like Cap Cities Mortgage, right here in Washington, DC, who 
foreclosed on 85 percent of their loans. It is a systemic 
problem with race at the background of the issue that we need 
to address.
    The consumer protection bills that have been introduced, in 
particular, the legislation that you, Chairman Sarbanes, are 
considering, are critical to address HOEPA. I hope during the 
questions and answers, I can go into why these changes are 
necessary.
    Best practices are not enough. These are ethical issues. 
The mortgage practitioner who are stealing homes from seniors, 
from African-Americans, from people who are not sophisticated 
borrowers, should lose their licenses.
    The companies that are buying these products on the 
secondary market need additional regulatory oversight. The 
market is changing. The law needs to be more than a band-aid. 
We need penicillin.
    Chairman Sarbanes. Thank you very much, Mr. Berenbaum.
    Before I turn to our final three witnesses, we have been 
joined by Senators Dodd and Carper.
    I yield to either of them if they wish to make a statement.

             COMMENT OF SENATOR CHRISTOPHER J. DODD

    Senator Dodd. Mr. Chairman, let us continue with the 
witnesses. And when the chance comes around for questioning, I 
will use the time then. But you have been sitting here for a 
long time.
    Chairman Sarbanes. Thank you, Senator Dodd.
    Senator Carper.

              COMMENT OF SENATOR THOMAS R. CARPER

    Senator Carper. I would simply echo the sentiments. And 
again, to the witnesses, thank you for being with us today.
    Chairman Sarbanes. Our next witness is Mr. George Wallace.
    Mr. Wallace is counsel for the American Financial Services 
Association. AFSA is a trade organization that represents a 
wide variety of financial services firms, including market-
funded lenders and credit insurance providers.
    Mr. Wallace, we appreciate your coming today. We would be 
happy to hear from you.

                 STATEMENT OF GEORGE J. WALLACE

        COUNSEL, AMERICAN FINANCIAL SERVICES ASSOCIATION

    Mr. Wallace. Thank you, Mr. Chairman, and Members of the 
Committee.
    Chairman Sarbanes. I think it might help a bit if you pull 
that microphone closer to you.
    Mr. Wallace. Am I close enough now?
    Chairman Sarbanes. That is good, although you are leaning.
    Mr. Wallace. I would like to be heard.
    Chairman Sarbanes. We want you to be heard.
    [Laughter.]
    Mr. Wallace. Some people might not want to hear me, but any 
way----
    Chairman Sarbanes. No, no. We want to hear everybody and 
try to address everyone.
    Mr. Wallace. I am a dissenter today. Today, I want to talk 
about predatory lending, as everybody else is. Allegations of 
predatory lending, particularly in the subprime mortgage 
market, have received significant attention in recent months. 
Advocates of increased regulation have claimed that stepped up 
fraudulent or predatory marketing practices have persuaded 
vulnerable consumers to mortgage their homes in unwise loan 
transactions. Some consumer advocates have strongly urged that 
various loan products and features common to the mortgage 
market are predatory and should be outlawed.
    Extensive new regulation of mortgage credit in the way 
advocates now urge would dramatically reduce loan revenue, 
increase the risk and/or increase costs the lender must bear. 
And I speak for people who have to produce the loans that those 
who wish to make credit available to lower and moderate income 
people, we are the ones who have to produce those loans and we 
are looking at your suggestions and we are seeing that it is 
going to raise costs.
    Initially, the resulting burdens will fall on lenders, in 
the long term, the effects will most always be felt directly by 
working American families, either because of decreased loan 
availability, higher credit prices, or less flexible loan 
administration.
    The resulting reduced credit availability strikes at the 
very heart of the efforts over the last quarter century by 
Congress, many States, and the lending industry to make 
efficiently priced consumer credit available to working 
American families, including 
minorities, single-parent families, and others who for so long 
were unable to obtain credit.
    Consumer advocacy have shared this goal. In testimony 
before this Committee in 1993, Deepak Bhargava, then 
Legislative Director for ACORN, spoke of a credit famine in 
low- and moderate-
income and minority communities in urban and rural areas, and 
also about massive problems of credit access in many 
communities around the country, particularly in minority and 
low-income areas.
    Subprime lenders, spurred on by Congress, have been 
enormously successful in delivering efficiently priced consumer 
credit to working American families, regardless of race, 
ethnicity, or background. Moreover, during the past 5 years, 96 
percent of those who have borrowed from AFSA members have used 
their subprime mortgage loan credit, successfully, 85 percent 
without any significant delinquency.
    Why would Government deny to these deserving Americans 
access to the benefits of credit that middle-class Americans 
enjoy? The 96 percent of Americans who use credit extended by 
AFSA members successfully are not asking for that interference. 
There are some people who have been victims of fraudulent, 
deceptive, illegal, and unfair practices in the marketing of 
mortgage loans. In fact, predatory lending is fundamentally the 
result of misleading and fraudulent sales practices, as others 
have said today.
    Some advocates have mistakenly focused on loan products and 
features as the reason for these victims' misfortune, and have 
reached the faulty conclusion that if regulation just barred 
certain loan features, the harm would be avoided.
    Pursuing this mistaken reasoning, they have tried to label 
as predatory highly regulated loan products and features, such 
as credit insurance, prepayment penalties, balloon payments, 
arbitration, higher rates and fees. However, any legitimate 
consumer good or service can be marketed fraudulently.
    Indeed, the scam artist prefers to use legitimate products 
like loans as a cover because consumers want and need that 
product. The illegality comes in the fraudulent marketing of 
the good or service, not in the good or service itself. We urge 
the Congress not to confuse the loan features that consumers 
want and need with the fraudulent marketing practices that some 
isolated operators have used to prey upon the unfortunate. If 
fraudulent and deceptive practices are the root of the problem, 
how should predatory lending be addressed?
    First, Congress should do no harm to the present system, 
which has been extremely successful in delivering consumer 
credit to America's working families. Such proposals as 
forbidding such features as balloon payments, financed single-
premium insurance, and prepayment fees take away legitimate 
loan features useful to America's working families without 
addressing in the slightest way the fraud underlying the 
predatory practices, and that is an important point to 
remember.
    Second, consumer education should play a major role. AFSA 
has been a leader in developing educational programs to help 
meet the enormous need for greater financial literacy. As a 
founding member of the Jump Start Coalition, a coalition of 
industry, Government and private groups dedicated to increasing 
financial literacy, it has for several years pushed strongly 
for increased efforts to educate Americans about credit.
    We urge Congress to support these and other efforts because 
they hold the greatest promise to help over the long run. We 
particularly want to thank Senator Corzine for his efforts in 
obtaining additional support for financial literacy efforts 
this year.
    Third, industry self-regulation plays an important role. 
AFSA has developed best practices which its member companies 
have voluntarily adopted. They strike a reasonable balance 
between limits on controversial loan terms and providing 
legitimate consumer benefits in appropriate circumstances. A 
copy of AFSA's best practices are attached to my written 
statement.
    And finally, Government's role is appropriately the 
vigorous enforcement of deceptive practices in civil rights 
laws. Any objective analysis of these laws much reach the 
conclusion that they provide some powerful tools to address 
both fraudulent sales practices and discrimination.
    Strong enforcement is appropriate because it addresses the 
real problem--the fraudulent and discriminatory practices--
without affecting the overall ability of lenders to make loans 
available to working American families with less than perfect 
credit.
    That is the appropriate policy balance between dealing with 
the real misfortunes which some borrowers have experienced and 
the continued availability of credit to working American 
families.
    We urge Congress to encourage that an appropriate balance 
be maintained. Thank you, Mr. Chairman, and Members of the 
Committee, for the opportunity to address you today and I look 
forward to any questions you may have later on.
    Chairman Sarbanes. Well, thank you very much, sir. I also 
want to thank you for your statement and for the attachment of 
the best practices AFSA.
    Our next witness is Lee Williams, who is the President of 
the Aviation Associates Credit Union in Wichita, Kansas, and is 
the Chairperson of the Credit Union National Association's 
State issues subcommittee.
    Ms. Williams, we would be happy to hear from you.

                   STATEMENT OF LEE WILLIAMS

             CHAIRPERSON, STATE ISSUES SUBCOMMITTEE

             CREDIT UNION NATIONAL ASSOCIATION, AND

          PRESIDENT, AVIATION ASSOCIATES CREDIT UNION

                        WICHITA, KANSAS

    Ms. Williams. Good morning, Mr. Chairman, Members of the 
Committee. It is indeed a pleasure for me to be here and speak 
to you on behalf of the Credit Union National Association, 
CUNA.
    CUNA represents over 90 percent of the 10,500 State and 
Federal Credit Unions Nationwide. And as Chair of CUNA's State 
issues subcommittee, I have had the privilege of carefully 
considering issues surrounding abusive practices of predatory 
lending and appreciate this opportunity to present to you some 
of our findings.
    America's credit unions strive to help their 80 million 
members create a better economic future for themselves and 
their families. And with that in mind, the credit union system 
abhors the predatory lending practices being used by some 
mortgage brokers and mortgage lenders across the country.
    Predatory lending is a complex and difficult issue to 
resolve. My committee, as well as this Committee, has come to 
that conclusion by hearing testimony of individuals and looking 
at the current situation with predatory lending. Predatory 
lending's primary targets are subprime borrowers. These are 
consumers who do not qualify for prime rate loans because of 
poor credit history or, in some cases, simply a lack of credit 
history. This segment of the population is of particular 
interest to credit unions because, historically, it is this 
population that has turned to us for our flexibility and our 
wide range of credit options.
    CUNA is concerned that the term predatory has become 
synonymous with subprime in the minds of some of our 
policymakers. Consequently, legitimate subprime lending 
programs could suffer if broad prohibitions on certain lending 
practices become law.
    Credit unions urge policymakers to use a scalpel, not an 
elephant gun, when drafting legislation to eliminate predatory 
lending practices. Subprime borrowers need to be served and 
credit unions do not want to lose their ability to create 
flexible, subprime loan programs. A growing number of credit 
unions offer subprime loans to members who do not qualify for a 
prime rate loan. Subprime loans are offered to members with 
poor credit histories at rates above prime to offset the higher 
risk of lending.
    Credit union subprime loans are not predatory. They are a 
vital tool that give borrowers with poor credit history the 
ability to build and/or rebuild their credit history.
    To illustrate some of the alternative subprime lending 
programs offered by credit unions, CUNA created a task force 
last February. The task force has recently completed a handbook 
called, ``Sub-
prime Doesn't Have To Be Predatory--Credit Union 
Alternatives,'' which is included in my attachment, as you have 
seen. The booklet provides a sample of credit union subprime 
loan programs that are designed to help borrowers actually 
improve their credit.
    There are many positive programs being developed in the 
subprime lending market by credit unions to assist consumers of 
all economic circumstances. Credit unions urge policymakers to 
address the abuse of lending practices rather than complete 
prohibition of practices that, when used legitimately, would 
provide flexibility and credit options to meet individual 
borrower's needs.
    America's credit unions support elimination of lending 
practices that are intentionally deceptive and disadvantageous 
to borrowers. CUNA and credit unions across the country have 
been establishing programs to help our members fight back 
against the effects of high cost and predatory loans.
    At Aviation Associations Credit Union, we recently 
initiated a Take Control program. It provides resources for our 
members, allowing them to take control of their financial well-
being and effectively deter the success of payday lenders and 
predatory mortgage lenders in our community.
    Let me give you an example of that. We have members with 
high interest mortgage loans acquired from a mortgage broker 
that have come into our credit union and asked us to refinance 
these loans because they cannot make the payments. My initial 
response, being member-owned, is to offer to refinance these 
loans and to reduce the interest rates. But often, that is no 
solution. Typically, these type of loans have been initially 
packed with so many fees, paid up front and financed, that the 
loan-to-value ratio is often up to 125 percent. Neither my 
credit union, nor many other lenders, can refinance such a 
loan. Even in such a dire situation, our Take Control program 
can improve the member's financial circumstances. Our program 
does this through member education.
    With the help of an on-site consumer credit counselor 
available twice a week at our credit union, members can learn 
how to pay down loans faster, obtain lower fees and rates, and 
even in the grip of predatory mortgage loans, learn how to 
build equity faster so the credit union can at a later point 
refinance these mortgages.
    This is only a band-aid on a serious injury. When the 
credit union refinances for the member, the predatory lender 
wins. At Aviation Associates, we believe our members must never 
fall victim to predatory lending in the first place. That is 
why Take Control also offers a significant component that 
includes education to teach our members how to avoid predatory 
mortgages in the first place. We are convinced education is a 
critical tool, although not the only tool, needed for our 
members to obtain financial independence.
    On a national level, CUNA developed mortgage lending 
standards and ethical guidelines to be adopted by credit unions 
across the country. These guidelines were designed to help 
emphasize credit unions' concerns for consumers and further 
distinguish credit unions as institutions that care more about 
people than money.
    One of the most important programs CUNA is currently 
promoting to combat predatory lending practices is financial 
education of our Nation's youth. Credit unions believe that by 
educating our young people in the area of personal finance, 
they will learn to make sound financial decisions and choose 
not to use high cost or predatory lenders.
    Through our partnership with the National Endowment for 
Financial Education and other efforts, we have reached over 
130,000 students in over 5,000 schools.
    Again, let me say that I am very pleased that you are 
holding these hearings because I see the effects of predatory 
lending daily, and it is not a pretty picture. Credit unions 
are eager to see the abusive practice of predatory lending 
eliminated. Credit unions have taken positive steps in that 
direction through our voluntary efforts to educate our members 
and provide them with fair and sound alternative products. It 
is our hope that we will have allies in our efforts to assure 
all consumers have access to credit products that do not 
unfairly take advantage of their circumstances.
    I thank you for allowing me to be here today and I would 
answer any questions.
    Chairman Sarbanes. Well, Ms. Williams, thank you very much 
for the statement on behalf of CUNA.
    If you had been here yesterday, I think you would have 
appreciated and the Members of the Committee were very careful 
to recognize--and as the witnesses this morning have said right 
from the beginning with Wade Henderson--that there is a role to 
be played in the legitimate subprime market. We are trying to 
get at those people who are abusing that market with these 
predatory practices.
    I was looking at this pamphlet that you told us about and I 
note that you very clearly try to draw that distinction. And 
that is one of the things that we are about here today, is to 
ascertain that line and then knock out what is on the wrong 
side of that line.
    Our last witness this morning is Mike Shea, who is the 
Executive Director of ACORN Housing.
    For over 25 years, ACORN has worked to increase 
homeownership and community development in low-income and 
minority communities. The organization has worked successfully 
with many lenders to develop loan products that provide fair 
and affordable access to credit for individuals traditionally 
shut out of the economic mainstream.
    Mr. Shea, we are pleased to have you with us today. We look 
forward to hearing from you.

                     STATEMENT OF MIKE SHEA

               EXECUTIVE DIRECTOR, ACORN HOUSING

    Mr. Shea. Thank you, Mr. Chairman, Members of the 
Committee. I appreciate the opportunity to appear. I work in 
many of your States and it is a pleasure to be able to share my 
insights on predatory lending. I have been Executive Director 
of the ACORN Housing Corporation since 1986, when the 
organization was formed to create low-income homeownership 
opportunities.
    We learned early on that to create homeownership in 
distressed neighborhoods, you have to do two things. First of 
all, you have to bring private capital back into those 
communities. FHA lending and Government subsidies on their own 
will not do the trick. And second, you have to provide consumer 
education and prepurchase mortgage counseling to potential 
homeowners so that people living in those communities will 
actually apply and qualify for loans.
    To educate community residents about the home-buying 
process and how to qualify for a loan, we operate mortgage 
counseling centers in 27 cities around the country. I am proud 
to say that our lender partnerships along with our mortgage 
counseling and financial literacy efforts have produced home 
loans for 36,000 first-time home-buyers.
    Last month, our largest banking partner, Bank of America, 
announcedthe amount of home mortgages that have been originated 
through our partnership with them has reached the $10 billion 
mark. It is our experience that subprime lenders have not 
played a major role in the creation of homeownership in this 
country. The recent increases in homeownership that we have 
seen in the 1990's was not because of subprime lending.
    Of the 36,000 ACORN clients who have become homeowners, 
only about 1,100 purchased their homes with loans from subprime 
lenders. And our experience is not atypical according to the 
1999 Home Mortgage Disclosure Act data which reported that just 
6.6 percent of all home mortgage loans in the United States 
were originated by subprime lenders, while 82 percent of all 
first-lien subprime loans are refinances.
    In many of the communities that we work, the benefits that 
families have gained from homeownership are under attack. 
Increasingly, we find that as soon as one of our clients moves 
into their new home, they are bombarded with offers from 
subprime lenders to refinance their mortgage or take out 
additional debt, receiving three or four letters a week and 
regular phone calls.
    Now, we know that you have heard these numbers before, but 
it is worth repeating, that half of all refinanced loans in 
communities of color are made by subprime lenders. When you 
consider that number in combination with the observations from 
Fannie Mae and Freddie Mac, that between 30 to 50 percent of 
borrowers in subprime loans could have qualified for ``A'' 
loans, you are clearly talking about a massive drain of equity 
from these communities, the communities that can least afford 
it.
    At a bare minimum, these numbers indicate that huge numbers 
of borrowers are paying interest rates 2 to 3 percent higher 
than they would if they had an ``A'' loan. Consider, for 
example, that for a $100,000 mortgage with a 30 year term, a 
person with a 10\1/2\ percent interest rate will pay $65,000 
more over the life of the loan than a person with an 8 percent 
rate. Fannie Mae Chairman and CEO, Frank Raines, recently put 
it best, and I would like to quote him, ``The central question 
is whether all consumers are enjoying their basic right to the 
lowest-cost mortgage for which they can qualify.'' Answering 
this is critical if we are to close the homeownership gaps 
facing many groups in America.
    Predatory lending is everywhere. Over the July 4th weekend, 
I visited my mother in Benzig County, Michigan. And as Senator 
Stabenow can say, Benzig County is a very conservative, rural 
county in Northern Michigan. When I told her what I was doing, 
she immediately told me of two of her elderly friends, staunch 
Republicans from the day they were born, how they had been 
victimized by predatory lending.
    Paul Satriano yesterday testified, and his testimony 
received extensive coverage in Minnesota. As a result, our 
office in the Twin Cities has received phone calls from 
throughout the States of Minnesota, Wisconsin, South Dakota, 
and even the upper peninsula of Michigan, two people called who 
were victimized by predatory loans and looking for ways to get 
out.
    We have to get rid of all the tricks and hidden practices 
that make it impossible for consumers to know what kind of loan 
they are getting into. What you have now is a situation where 
it is difficult for even my best loan counselors to understand 
all of the damaging bells and whistles embedded in many 
subprime loans.
    That should not be how getting a home loan works. It is not 
what happens in the ``A'' market, but that is what is happening 
every day in the subprime market. We need a strong, clear set 
of rules that will allow homeowners to navigate the subprime 
market with some basic assurances of safety.
    We often hear the argument that predatory lending can be 
eliminated with more education and financial literacy. We 
certainly support financial literacy efforts. In fact, I would 
venture that ACORN Housing, working together with many of our 
bank lending partners, has delivered more information to 
homebuyers about these issues than anyone. Last year alone, 
nearly 100,000 people attended our bank fairs, workshops, and 
other events. We held a bank fair recently in Detroit where 
3,000 people came.
    And Fannie Mae's latest national housing survey found that 
consumer literacy efforts have already lowered the information 
barriers to buying a home, with nearly 60 percent of Americans 
now feeling comfortable with the terminology and process of 
buying a home. In spite of this increased financial literacy, 
we see that predatory lending continues to rise.
    Part of what we have learned from this experience of 
providing financial literacy and education is the limits of the 
approach. First, there is the question of resources. Until we 
are ready to spend the $1,500 to $2,000 per originated loan 
that many predators can spend, we will always be playing catch-
up.
    And second, no advertisement, bus billboard or even 
workbook is going to compete with a one-on-one sales pitch of a 
very good salesman who knows more about the process and about 
the products than the borrower.
    We have also heard the argument that all that is needed is 
better enforcement of existing laws. We see a lot of borrowers 
in heart-breaking situations and we have tried to use current 
law to help protect them. This year, we have helped 40 clients 
in 10 States file grievances with State regulators, and that 
has not worked.
    HOEPA covers only a tiny fraction of loans and it mostly 
requires disclosures. As long as the right piece of paper was 
slipped somewhere into the pile, there is often little the 
borrower can do.
    Fraud and deceit are against the law, but they are 
extremely difficult to prove. It usually turns into a matter of 
he-said/she-said, and when the lender knows more about the 
transaction and has the paperwork, and has the lawyers, the 
borrower loses. And when we hear certain industry groups 
suggest that the solution is better enforcement of current law, 
we wonder how they expect that to happen if they routinely 
include in their loan documents mandatory arbitration clauses 
which severely limit a consumer's right to seek relief in 
court.
    What we need are some basis rules covering a broader group 
of high-cost loans that create a level playing field where a 
borrower in the subprime market, like a consumer in the ``A'' 
market, has a set of understandable options to choose between.
    Buying or refinancing a home is a lot more like buying 
medicine than like buying a tube of toothpaste. We do not 
expect every patient to read the New England Journal of 
Medicine and evaluate for themselves which drugs are safe and 
which are not. Instead, Congress and the FDA establishes rules 
about what is too dangerous to be sold, within those rules, 
patients and their doctors still can choose what is best for 
them. In our view, Congress and the Federal Reserve need to 
make rules about subprime loans in the same way.
    Chairman Sarbanes. Mr. Shea, we are going to have to draw 
to a close.
    Mr. Shea. Thank you. I would like to just make one more 
point. There is a lot of comments by the industry about 
unavailable data. I would just like to say that Jesus did not 
need an economic study to convince him of the need to drive the 
money changers from the temple. He had a moral compass. He knew 
what was right and wrong, and he had the courage to act on 
those beliefs.
    Thank you.
    Chairman Sarbanes. Thank you very much, Mr. Shea.
    We will go to questions. A number of my colleagues have 
been here for a while and I want to at least get them started.
    Senator Dodd wanted to make a very quick comment.
    Senator Dodd. Just while my other colleagues are here. Mr. 
Chairman, thank you for these hearings and thank our witnesses, 
too. It has been tremendously helpful. We are going to be 
constrained in time. Our desire here is to make subprime 
lending more available for people. We do not look to cut that. 
There are many lenders out there who are doing a very good job, 
particularly some who have reacted already. As you have just 
point out, CitiCorp and others have been very helpful.
    I thank them for what they are doing, and we are talking 
about those who engage in predatory practices. Not all subprime 
lending is a predatory practice, and I think it is important 
that we state that here.
    But to be as emphatic as you, Mr. Chairman that we are 
determined as a Committee here, I am convinced the Republicans 
as well as the Democrats, should do everything we can to stop 
that.
    I thank all our witnesses for their your help.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. We have been joined by Senator Santorum.

                COMMENT OF SENATOR RICK SANTORUM

    Senator Santorum. Thank you, Mr. Chairman. I know people 
have been here longer than me. I just want to associate myself 
with the remarks of Senator Dodd that I beileve we do have some 
bad actors out there in the area. But I want to also reiterate 
the importance of subprime lending and having money available 
for those who do not have the kind of credit rating that 
otherwise can succeed. I think we are interested in engaging in 
something that is constructive to deal with this issue and I 
look forward to working with you.
    Chairman Sarbanes. We do not intend to throw the baby out 
with the bathwater. But we do intend to throw the bathwater 
out.
    [Laughter.]
    The dirty bathwater out, I should say.
    [Laughter.]
    Debbie, why don't I recognize you for as long as we can go 
before we have to leave for a vote. I will say to the panel, we 
will have to recess briefly and go for this vote, and then we 
will return and continue the question period.
    Senator Stabenow. Thank you, Mr. Chairman. I appreciate 
that and would note that I will not be able to come back 
because I have to preside at noon. I actually have numerous 
questions. We will not be able to address all of them. And 
possibly, we can follow up in writing with the panelists. I 
appreciate all of your comments.
    We have heard and have to address complex issues. We have 
issues that we heard yesterday of loan flipping and issues on 
mandatory arbitration, disclosures, prepayment penalties, the 
definition of what is a high-cost loan, the whole question of 
regulation, and the effective ways of promoting financial 
education. There is a lot of different issues that we need to 
address. I would simply ask Mr. Courson, Mr. Fendly, and Mr. 
Wallace, whom I will ask first.
    You mentioned consumer education being the primary focus. 
Yesterday, a constituent of mine was here, Carol Mackey, who 
spoke about the fact that she was given a good-faith estimate 
in writing several days before the loan closure, and that in 
fact, when she got there, the interest rate was higher, the 
payments were higher.
    The information she was given on the good-faith estimate 
was not accurate. So, she was attempting to be educated as a 
consumer. She is a bright woman. And found herself, when she 
dug through all the papers, that in fact it was different.
    So, I would ask how you feel----
    Chairman Sarbanes. When she dug through them afterwards, 
when she went back.
    Senator Stabenow. After she settled.
    Chairman Sarbanes. She really was not in the position to do 
so at the closing.
    Senator Stabenow. That is correct, Mr. Chairman.
    She came into the closing with information that she assumed 
was accurate based on the good-faith estimate, found after she 
got home and sorted through--and as someone who closed on a 
home not that long ago and considers myself reasonably 
intelligent and as a Member of the Banking Committee, I found 
myself going through pages and pages and pages and trying to 
make sure that there was not something there that I had not 
seen before and so on, and know how complicated it was.
    I appreciate the issues of simplicity. I think we do have 
to address that and want to work with you on how we might 
simplify this process. I certainly agree that it is extremely 
complicated and difficult to sort through, even when you are 
very conscientious.
    But when we are talking about consumer education and 
someone has been given information, and later, it was found to 
be different in the final analysis, how would you correct that 
through consumer education? Or do you believe, in fact, that it 
is appropriate to require that the good-faith estimate be a 
formal estimate so that it has to be the same 3 days before as 
it is on the day that you close?
    Mr. Wallace.
    Mr. Wallace. Well, I was not here yesterday and I did not 
hear Mrs. Mackey's statement. But as you describe it, the good-
faith estimate is, in fact, an estimate. It has to be given 
within 3 days of application. Then there is a HUD-1 Statement 
which does have to be accurate. So, you are describing what 
appears to be a violation.
    Likewise, the Truth in Lending Statement has to be 
accurate. If it was inaccurate, that would be a violation of 
Truth in Lending. We do have a legal system already in place 
which would appear to address the concerns that you are 
raising.
    Senator Stabenow. If I might just say, though, the 
documents that you are referring to are given on the day of the 
closing.
    Would you support having those documents given to consumers 
several days in advance in straightforward, simple terms, so 
that people know exactly what the costs are, the interest rate, 
the points, the fees, et cetera?
    Mr. Wallace. The difficulty with that is it produces a 
certain degree of inflexibility with regard to borrowers. 
Borrowers often wish to move straight to the closing. I have 
been involved in this for 35 years. People have suggested this 
for many years, and it might be nice to do that. And then you 
start to work out the practicalities of it and it starts to tie 
the borrower's hands.
    I think in the end what we are trying to do is to develop a 
regulatory system which deals both with the problems of 
communicating to people, educating them so that they understand 
when they are communicated to, and working out a system which 
can be consistently applied and appropriately managed by 
creditors without interfering too much with the borrower's 
flexibility. I believe the objection to your mechanism is, and 
other people have raised it, is that it starts to interfere 
with the borrower's flexibility.
    That is a policy trade-off that, in the end, one has to 
deal with.
    Senator Stabenow. I appreciate that. Well, let me just say 
knowing 3 days in advance what you are walking into is not an 
unreasonable request, and if we are focusing on consumer 
education, I think we need to make sure that that education and 
information is accurate.
    Mr. Courson, would you like to respond? I know you have 
spoken in your testimony about early price guarantees.
    Chairman Sarbanes. Well, I think----
    Mr. Courson. I am sorry, Senator?
    Chairman Sarbanes. I think if I do not move my colleagues 
out of here, we are going to miss this vote.
    Could you give a brief----
    Mr. Courson. Thirty second answer.
    Senator Stabenow. Could you give us a 30 second answer?
    Mr. Courson. Yes. Part of the reform that we are 
advocating, simplification, is taking the front-end system, the 
good-faith estimate, which really has no limits in terms of how 
it can change the closing.
    Chairman Sarbanes. There is no liability for a misstatement 
on the estimate.
    Mr. Courson. That is correct.
    Chairman Sarbanes. Contrary to what I think Mr. Wallace 
said, that it was illegal. As I understand it, there is no 
legal penalty for that. Is that correct?
    Mr. Courson. Correct.
    Mr. Wallace. Are you speaking about the HUD-1 or the Truth 
in Lending?
    Chairman Sarbanes. No. I am talking about good-faith 
estimate.
    Mr. Wallace. I was speaking about the Truth in Lending. 
Truth in Lending, there is clearly liability.
    Chairman Sarbanes. All right. But when do you provide that?
    Mr. Wallace. The Truth in Lending is what tells her----
    Chairman Sarbanes. When do you provide that?
    Mr. Wallace. You have to provide that 3 days after 
application on an estimated basis, and then at closing.
    Chairman Sarbanes. And is the estimate--are you liable for 
a misstatement on the estimate?
    Mr. Wallace. On the HUD----
    Chairman Sarbanes. On the estimate.
    Mr. Wallace. On the estimate, the answer is, at this point, 
no.
    Chairman Sarbanes. All right.
    Mr. Courson. Our reform plan envisions, at the time of the 
application, as opposed to the good-faith and the TILA that 
someone gets today, they would get one simple disclosure. That 
disclosure would include really what the customer wants to 
know. How much cash do I have to bring to closing and what are 
my payments? Of course, it would have other disclosures on 
there.
    One of the things that we are advocating is that the 
closing costs that would be included on that disclosure would 
be guaranteed.
    And so, the consumer at three different times through the 
transaction would see the same disclosure with more specificity 
as they go through from application to credit approval to 
closing, with more information completed. But the closing cost 
guarantee itself would not be a violatation. It would stay. If 
it did change, it would be a violation.
    I heard Mrs. Mackey's testimony yesterday. And it is the 
fallacy of the system of not giving the certainty to the 
consumer up front, and then, in fact, when you get to the 
closing, those guaranteed closing costs must remain the same. 
That is part of what we have in our reform proposal and in 
working with Secretary Martinez.
    Chairman Sarbanes. I believe we need to recess, otherwise 
we are going to miss the vote.
    Senator Stabenow. Thank you very much.
    Chairman Sarbanes. I certainly will return. We will recess 
and return after the vote.
    [Recess.]
    Chairman Sarbanes. Let me bring the Committee back into 
session. The hearing will come to order and we will resume.
    Mr. Wallace.
    Mr. Wallace. I wanted to correct my earlier remarks. I 
thought that Senator Stabenow was asking a question about 
conventional mortgage loans. I believe she was asking a 
question about HOEPA loans. Several people have pointed out to 
me, in a HOEPA loan, there is a requirement, 3 days before 
closing, to give an accurate statement. If it is inaccurate, 
there are civil penalties. There are enforcement provisions 
that work quite strongly, and you cannot change the good-faith 
estimate between the closing and the giving of it 3 days in 
advance.
    Indeed, this has been an issue that borrowers have raised 
because they not only have 3 days advanced disclosure that I 
just described, but also the 3 day recision period. So, it 
takes them 6 days to get their money. So, I just wanted to 
correct my remarks, sir.
    Chairman Sarbanes. The correction will be noted. Ms. Mackey 
did not have a HOEPA loan. One of the problems here is that a 
lot of these loans are not HOEPA loans. That is one of the 
reasons that the Fed is now addressing what the HOEPA limits 
are in an effort to include within them more of these loans 
that are now falling outside of it.
    Senator Corzine.
    Senator Corzine. Yes. It was a terrific presentation by all 
of you and I appreciate the discussion.
    I just wanted to make sure that I heard this properly from 
Mr. Courson. The Mortgage Bankers Association believes this is 
a problem and a pervasive problem. And that is something that 
we can count on, your objective view, as we go about debating 
this as we go forward?
    Mr. Courson. You certainly can, Senator. We have been 
involved in this debate as one piece of an effort to really 
reform and simplify the entire mortgage process for over 5 
years, and you have our commitment.
    Senator Corzine. I think sometimes there is a debate about 
whether this is just an anecdotal situation here or there and 
we fine four people here, or 10 people there.
    But my observation, our studies would lead me to believe 
that this is actually a very pervasive issue and needs 
addressing. And I believe it is informative that one of the 
foremost associations underscores that.
    I have this curiosity, and I will let anyone respond. But 
don't most ``A''-lenders have lawyers with them at times of 
closing on mortgages, pretty simple conventional mortgages?
    Does anyone want to address that?
    Mr. Shea. Senator, of the 36,000 families that have gotten 
home loans first to buy a home from our program, we estimate 
about 25 percent use lawyers at closings.
    Senator Corzine. That is in the subprime market, though.
    Mr. Shea. That is in the prime market.
    Senator Corzine. That is in the prime.
    Mr. Shea. In the prime market, there is enough protections 
and it is easy to understand what you are getting into ahead of 
time where you oftentimes do not need a lawyer. We advise 
people to seek legal counsel and we work with them ahead of 
time to review the documents. The subprime market, very few 
people use lawyers.
    Mr. Berenbaum. Could I respond to that on a different 
level?
    The issue of RESPA was addressed. I have to say that the 
National Community Reinvestment Coalition strongly supports the 
consumer actions that have been filed in court. Who is 
empowered in a mortgage settlement or a mortgage closing 
situation? Who has the power?
    The consumer, as has been stated generally, does not 
understand the action, where fees are going. Disclosure is very 
important, and part of the problem of predatory lending are the 
relationships between the players.
    In fact, often a realtor may be working in concert with a 
subprime lender who is a predator. And even the settlement 
agent may be part of that process. We have even seen where 
whole separate corporations are bidding on the foreclosure 
ultimately that are related to this little group of 
conspirators. And that is why in the Capital Cities case, in 
fact, there is a claim trying to stretch and use existing law, 
arguing racketeering.
    Senator Corzine. Sounds like racketeering to me if there is 
a conspiracy of people working together.
    In the ``A'' market, there is a lot of uniformity, 
conformity. I think Freddie Mac and Fannie Mae have asked for 
conformity so that the secondary mortgage market can actually 
work. Is there room for some improvement in standardization in 
subprime lending that would allow for that simplicity that is 
talked about? I understand the need for flexibility, but 
sometimes flexibility is camouflaged for some of the practices 
we have talked about.
    Does anybody want to comment why and whether we ought to 
get to more standardization? It certainly would provide more 
liquidity to the ultimate lender.
    Mr. Ackelsberg. Well, Senator, if I could speak to that.
    I believe the first thing you need to do if you want 
standardization is actually have the rates and the fees 
available to the public to know ahead of time. You have to 
understand that everything we talk about in this market is 
different than your conceptions of what mortgage lending is 
about.
    Number one is, if you start with the assumption that when 
you are in the market, you go to the newspaper on Sunday and in 
the real estate or financial section, they list all the 
mortgages, the prices, the points, and the rates, that does not 
exist in subprime. Just yesterday, I deposed an area manager of 
one of the lenders that has been mentioned as a responsible 
lender within the subprime field. And I said, by the way, can I 
open the paper and see what your rates are this week? And he 
says, oh, no, you cannot do that. I said, why is that? Well, 
subprime lenders do not do that.
    Nothing is really the way that we assume it. Brokers that 
we assume are representing lenders are not representing 
lenders. They are representing themselves. In fact, they are 
being rewarded for upselling their own customers.
    Applications that we assume are being signed at sometime 
early on in the process are routinely signed at the closing. 
You are signing an application at the same time you are signing 
the mortgage.
    And that is done every day. I do not think I have seen a 
transaction where the application was signed prior to the 
closing. Everything about this market is different than the 
notions that we come to the table with, having bought houses 
ourselves, for example.
    Senator Corzine. But are there lessons to be learned from 
the ``A'' market that we ought to be applying to the subprime 
market, since it works efficiently and relatively securely for 
the consumer?
    Mr. Wallace. Senator, one of the things to remember is that 
Fannie Mae and Freddie Mac have withdrawn from the HOEPA market 
entirely. Thus, whatever encouragement they could give to 
standardization does not occur. And if the HOEPA thresholds are 
lower, presumably they will continue to withdraw from the HOEPA 
market. They are concerned about risks. They are concerned 
about the additional liability, I guess, with regard to that 
kind of paper. But there is something which you could address 
perhaps with regard to the secondary market, particularly the 
Government-financed entities not being interested in dealing 
with subprime paper.
    Chairman Sarbanes. I understand, though, that 70 percent of 
the subprime market is what are called ``A''-minus loans. And 
therefore there is a real opportunity, which I gather some 
institutions are now undertaking to upgrade people into ``A'' 
loans. That seems to me a very worthwhile endeavor. And it also 
seems to me that we need to consider carefully what measures or 
how you can encourage just graduating people up.
    And I am told that there are a fair number of people who 
are getting subprime loans who really could get prime loans. 
But it is not happening. Is that correct?
    I am sorry, John. I did not mean to interrupt your 
questioning.
    Senator Corzine. No, no, no. I believe it is going in the 
same direction here.
    Mr. Berenbaum. There is no question. And what we are 
dealing with is a blend of civil rights issues, Fair Housing 
Act issues, as well as consumer issues, whether they be fraud 
or issues relevant to the subprime market.
    There is a new player in town, though. And I would agree 
with any thought that, in fact, the entry of Fannie Mae and 
Freddie Mac into the ``A''-minus market has been corrected. It 
absolutely has been. We wish it would have been sooner. Who is 
the new player in town? It is Wall Street. Who is funding the 
growth? It is private investors? Who is specializing?
    We heard about specialty lenders. Well, these specialty 
lenders better start developing prime paper because right now, 
I believe under existing law, they are facing civil rights 
liability if they do not give an American the loan they are 
qualified for. And that is what is happening here. The greed 
factor, as has been mentioned, is playing a role in our 
financial transactions today.
    And yesterday, there were references made to in the old 
times or in the days when we did things by hand. We are still 
doing things by hand. There are decisions being made by 
executives today with underwriting practices and points and how 
to use credit in a way that is greedy, manipulative, and not 
covered by law.
    And these working-the-law situations are creating the 
scams. There are responsible subprime lenders and then there 
are ones who are making mistakes because they are not thinking 
through their decisions, and then there are predators.
    Senator Corzine. Mr. Fendly, where do you think the 
regulatory world should actually meet the mortgage broker?
    We know the Federal Reserve, the FDIC, and others review 
the balance sheets and practices of the banking industry. Our 
thrift industry has a regulator where the public meets 
creditor. Where would you think, and how would that best be 
applied in the mortgage brokering business?
    Mr. Fendly. Well, obviously, we should have the same 
standards applied to us as any other lender would or any other 
originator would. The only problem is that an awful lot of 
mortgage brokers are extraordinarily small business people. The 
majority of them employ less than five people. And I do not 
think a financial yardstick is what you want to use to analyze 
their credibility in the marketplace.
    When I was talking about mortgage reform and people were 
talking about the good-faith estimate, that is part of the 
whole process and should apply across the board to all lenders, 
all originators, so that people have concise information. The 
system now encourages fraud and it actually is an uneven 
playing field for honest businessmen who cannot compete against 
false good-faith estimates that are changed at closing. That is 
what we are looking for, is clarity, bright lines, and 
accountability.
    Chairman Sarbanes. That is an interesting point because it 
seems to me that if we find ways of eliminating these bad 
practices, it is to the benefit of the responsible people in 
the industry.
    And it seems to me that the responsible people, instead of 
resisting this effort, ought to be supporting it. I know they 
are concerned about how the line is drawn because they are 
concerned whether it will impinge upon the legitimate 
activities.
    But assuming the line can be drawn properly, they ought to 
be supporting it because it will knock out what I guess is 
potentially an unfair competitive advantage which the bad actor 
is able to exploit. I just throw that out there as an 
observation. Go ahead, Jon. I am sorry.
    Senator Corzine. Again, who challenges it? State banking 
regulators? Is that who is looking at most of the mortgage 
brokers?
    Or is there anyone who looks at their practices? Or is it 
just voluntary?
    Mr. Fendly. It depends on what kind of business that they 
do. Most of them have State regulators.
    In my particular State, you are audited every 2 to 3 years 
on all fronts. If you have an entity that is an FHA 
correspondent, they have to provide a HUD-approved audited 
financial statement each year. Those individuals that are very 
small, they are just dealing with their own State regulatory 
agencies.
    Senator Corzine. And do many of them have audits on their 
practices, their business and market practices?
    Mr. Fendly. Yes, they do.
    Mr. Ackelsberg. Senator Corzine, I actually would have to 
disagree with that. Just to use my experience from 
Pennsylvania, it has been said by many people there that in 
Pennsylvania, it is easier to get a broker's license than a 
fishing license. The only difference is that there actually is 
enforcement from the Fish and Game Commission to make sure that 
the laws are being enforced.
    In our experience, in that one State, as a practical 
matter, no enforcement. And we sent lots of complaints. They 
did finally manage, as I understand, to pull the license of 
someone who had plead guilty to stealing from 16 of his 
customers. But to the others, for example, the ones where we 
had a fraud judgment unpaid, that did not seem to rise to the 
level of regulatory interest.
    Senator Corzine. Mr. Courson.
    Mr. Courson. Senator, I believe that is one of the points 
that we made.
    I would agree. Where is the enforcement? Because it is 
besmirching our industry, my company, and other lenders like 
me, if we do not get the enforcement.
    And so, I think what the gentleman just said is exactly 
correct. We have to have the enforcement. If we have the 
licensing out there and do not enforce it, then there is no 
reason to have it.
    It is very disheartening in our business to find the bad 
actors who even have actions taken against them, showing up in 
other companies under other names and other venues, propounding 
the same practices for which they were eliminated from a 
different venue. It makes no sense. We have to have that 
enforcement level.
    Senator Corzine. I do not mean to--please. Go ahead.
    Ms. Williams. I just wanted to add a comment.
    Earlier you had made mention of ``A''-minus borrowers and 
opportunities there.
    Some credit unions have programs in place now where if the 
borrower, an ``A''-minus or ``B''-minus, pays the mortgage as 
agreed for 1 year, then the rate could be adjusted. That may be 
something that could be beneficial. It not only encourages the 
consumer to get on a good plan of making payments on time, but 
it also offers them long-term relief for paying more for that 
mortgage.
    Now I have had instances where my members have actually 
said they were told they could get a 12 percent first mortgage 
now. If they paid as agreed for a year, that mortgage rate 
could be decreased. Only to find out after a year that their 
mortgage had been sold to another company and all bets were 
off.
    So that may be a good option to consider, a way to have an 
option for a consumer to actually pay at a subprime rate 
temporarily, for a limited amount of time, and then have that 
rate decreased without a lot of penalties attached to having 
that done.
    Chairman Sarbanes. Jon, we were so engrossed here, I do not 
think we noticed it, but there is another vote on. I am going 
to have to again recess the hearing in order to vote. I am sure 
the panel appreciates, we have no control over this process. 
Actually, those lights and bells go off, Pavlov should have 
done his experiments here in the Congress.
    [Laughter.]
    We will return very promptly and then we will try to draw 
it to a close because I know that people have conflicting 
engagements.
    We will stand in recess.
    [Recess.]
    Chairman Sarbanes. The hearing will resume. And I am 
hopeful that we will have enough time here to complete. I do 
not want to hold up the panel unduly.
    Mr. Ackelsberg, I want to put a question to you off of 
something that Mr. Shea said, where he said, the recent 
increases in homeownership are not from subprime lenders.
    Now you have some very interesting material in the opening 
part of your statement, which, of course, because of the 
truncated time, you did not present orally. But we should to 
just touch on that a little bit because lots of assertions are 
made about this subprime market and what it permits or what it 
allows that we would regard as desirable. And of course, we 
regard homeownership as desirable in every instance in which it 
really can be warranted. Could you just touch on some of that?
    Mr. Ackelsberg. Yes. As we mentioned in the written 
testimony, you have homeownership increasing by 2 percent 
during a period of time that, for example, foreclosures are----
    Chairman Sarbanes. What is that period of time?
    Mr. Ackelsberg.I believe the table is 1980 to 1999,
    Chairman Sarbanes. What?
    Mr. Ackelsberg. The period of 1980 to 1999.
    Chairman Sarbanes. Okay. And it is during that period, of 
course, more in the 1990's, when the amount of subprime lending 
increased at a very rapid rate. Is that correct?
    Mr. Ackelsberg. Absolutely, Senator. We attribute that to a 
number of factors, one being, as I mentioned in my testimony, 
the Federal policy favoring first-lien mortgage lending, the 
deregulation of usury for first-lien mortgage lending, 
basically encouraging lenders to turn--the typical example that 
we see is someone, for example, wants $5,000 to fix their 
kitchen. And what instead they get is a $30,000 loan that pays 
off all their debt, which they did not need being paid off at 
all. And it is precisely the Federal preemption of usury--the 
Federal deregulation of State usury laws for first-lien lending 
that has made that possible.
    The other thing I would say, as I mentioned, is the change 
in the tax laws to favor home equity lending. And finally, the 
market forces of Wall Street securitizations which have really 
made this a very profitable enterprise.
    Chairman Sarbanes. This Figure 1 you have in your 
statement.
    Mr. Ackelsberg. Yes. It is data from the Mortgage Bankers 
Association.
    Chairman Sarbanes. Where you say the sources are the 
Mortgage Bankers Association.
    You should show Mr. Courson this, too.
    [Laughter.]
    Chairman Sarbanes. Is the figure from the Mortgage Bankers 
or--yes. Is the chart or just the numbers that enabled you to 
make up the chart?
    Mr. Ackelsberg. No, it is the numbers. Actually, I am not 
entirely sure. Senator, my understanding is that it is just the 
numbers that were then put into this chart.
    Chairman Sarbanes. The graphic form. All right. Now, let me 
run through these. You say over this period, there was a 2 
percent growth in the homeownership rate. Is that correct?
    Mr. Ackelsberg. Yes.
    Chairman Sarbanes. Then there was a 29 percent growth in 
mortgages per home. What do you mean by that?
    Mr. Ackelsberg. Well, as it has become more and more 
attractive in the market for people to use their homes when 
they are borrowing money, what you have is more and more people 
doing that.
    For example, many people--and I would say primarily in the 
``A''-borrower kind of universe--we will have a mortgage and 
then we will also have a home equity credit line. So, it has 
become very common for people basically to use their homes to 
access credit.
    Chairman Sarbanes. And then you have foreclosures per 
mortgage. That growth was 120 percent.
    Mr. Ackelsberg. Yes.
    Chairman Sarbanes. What is the significance of that?
    Mr. Ackelsberg. Well, I would also, particularly in the 
1990's, add an additional overlay, which is these have 
basically been good times. You would expect in good times to 
see foreclosures going down. In Philadelphia, we have seen 
foreclosures tripling during a period where jobs were actually 
on the upswing. And we attribute that to the radical change in 
the nature of mortgage lending, that loans are being made in a 
fashion that they were never made 
before.
    Chairman Sarbanes. And then foreclosures per home went up 
184 percent over this period.
    Mr. Ackelsberg. That is correct.
    Chairman Sarbanes. Meaning, what?
    Mr. Ackelsberg. That is just the ratio. Basically, it is 
just another way of saying that the foreclosure rate has really 
exploded during this period of time.
    Chairman Sarbanes. As I understand it, from this footnote, 
this understates the problem because this says the data of 
mortgages and foreclosure at the end of each period studied 
comes from 130 different lenders and is representatives of 
approximately one-half of the mortgages in existence.
    These numbers are actually grossly undercounted because the 
foreclosures of mortgages made by finance companies are not 
included in the statistics compiled by the Mortgage Bankers 
Association of America, which provides the raw data for the 
census statistics. Also, foreclosure statistics do not include 
homeowners who simply turn their home over to the lender to 
avoid foreclosure. Actually, as bad as this sounds as we run 
through these figures, the problem is actually worse than that.
    Mr. Ackelsberg. I would spin that another way. You could do 
the same thing with default and delinquency numbers, Senator. 
For example, I have looked at default and delinquency numbers, 
which are very high for some of these lenders. I did a lot of 
litigation against United Companies Lending that had 15 percent 
default and delinquency rates. But that radically really 
underestimates the problem if you are comparing it to an 
ordinary lender because you are looking at a portfolio that, on 
average, in that particular example was had loans 18 months 
old.
    When you look at a subprime portfolio that is relatively 
unseasoned--that is the term, I believe--an unseasoned 
portfolio, and you see rates that are--even if they are similar 
and they are far higher than you see in the prime market, you 
are understating it because you are not talking about a 
portfolio that has loans as much as 20 years old or 30 years 
old in that portfolio. You are talking about loans that are 1 
year, 2 years, 3 years, often at the most.
    Chairman Sarbanes. Yes. But aren't some of these lenders, 
the bad actors, they are making these loans with the purpose of 
foreclosing and getting the house and taking the equity?
    Mr. Ackelsberg. I think in some cases, that is true. I 
believe it is more accurate to say that they do not really care 
one way or the other. It is probably closer to the truth to 
say, they are making these loans with the intent of selling 
them very quickly. And the more points that they can load into 
those loans, the more revenue they can generate very quickly.
    I think that what it is is basically, the loans are being 
originated by lenders who have no accountability regarding the 
performance of the loans. They do not really care one way or 
the other how the loan performs, as long as there is a market 
out there to buy it from them. And unfortunately, the market is 
booming, largely fueled, I believe, by Wall Street 
securitization.
    I am convinced that the ultimate consumer in this whole 
mess is not Ms. Mackey, with her mortgage. The ultimate 
consumer is my retirement fund, your retirement fund. It is the 
mutual funds insurance companies that decided, for whatever 
reason, and that these were good investments.
    And they have been layered with layer upon layer of credit 
enhancements, so the investors really feel like they are not at 
risk at all, whether it is the insurance on the securitization, 
whether it is the subordinization structure built into the 
instrument.
    It is very complicated. But in the end, you could look at 
it as a very sophisticated laundering of money, where the 
ultimate consumer really has no responsibility for what is 
going on. In fact, there are law review articles built on--one 
that I found very enlightening was called ``The End of 
Liability.'' This is all about structuring things so that no 
one is responsible for what they are doing.
    Chairman Sarbanes. Let me ask--and I really throw this open 
to the panel. This is the joint report of the U.S. Department 
of the Treasury and the U.S. Department of Housing and Urban 
Development, which was issued just about a year ago, entitled: 
``Curbing Predatory Home Mortgage Lending.''
    I obviously found it a very interesting report and we 
intend to make heavy use of it. In this report, they have a 
section discussing mandatory arbitration. And this is what they 
say, and I would like to get the reaction of the panel to this. 
In policy recommendations, after they have a discussion of what 
is the problem, challenges for reform, and so forth.
    Prohibit mandatory arbitration for high-cost loans. The 
most vulnerable borrowers in the subprime market may be the 
least likely to understand adequately the implications of 
agreeing to mandatory arbitration. Since they may also be the 
most likely borrowers to default or be foreclosed upon, it is 
especially important that they retain the rights afforded them 
under Federal fair lending and consumer protection laws.
    In the high-cost loan market, the difference in bargaining 
power between lenders and borrowers is particularly acute, 
making predispute mandatory arbitration an unwise option for 
these consumers. And I would like to get people's reaction to 
that.
    Ms. Canja. I will respond to that. In fact, AARP goes even 
farther. We do not believe that there should be mandatory 
arbitration in any consumer protection laws because you cannot 
have a level playing field. You have the very vulnerable people 
who do not have the experience, they do not have the 
information. They certainly do not have the resources.
    All of those things are all centered on the other side. It 
certainly is even more apparent and they are even more 
vulnerable in this very complex issue of mortgage lending. So, 
we definitely would support that there should not be mandatory 
arbitration.
    Chairman Sarbanes. Yes.
    Mr. Henderson. Mr. Chairman, the Leadership Conference on 
Civil Rights, and I think I speak here for the vast majority of 
organizations in the civil rights community, would strongly 
support the recommendation of the Treasury report in that 
regard.
    Mandatory arbitration of the kind that we are discussing 
this morning is a fundamental violation of the right of 
individuals to protect their own interests by going to court 
when necessary to litigate issues like those that we are 
discussing today, particularly where the unequal relationship 
and power between the consumer and the lending institution is 
as stark as we see it here, and where the regulatory scheme of 
protection that exists both at the Federal level and at the 
State level, is inadequate to protect their interests.
    What we are seeing with these loans is that you are forced 
into an arbitration system. You are in an unequal bargaining 
position. As a general matter, you do not fully understand the 
terms and conditions of the loan, particularly in contrast with 
the lender. You do not have adequate protections at the Federal 
level. You do not have adequate protections at the State level. 
And now we are taking the courts away from you to protect 
fundamental rights. It is an injustice. It needs to be 
corrected.
    Mr. Ackelsberg. I would also add that the one obvious way 
that Congress, when it passes law, can see how the laws are 
functioning is to read the cases that come out of the Federal 
courts.
    You understand, I assume, that these are basically secret 
proceedings. There is no opinion. Nothing is public. And 
therefore, there is really no accountability whatsoever for how 
the laws that this body passes actually are getting enforced.
    Mr. Berenbaum. I would concur with the other consumer 
advocacy groups, and just add a slightly different wrinkle to 
it. We have compliance arrangements and I have also served as a 
consultant to many realtor and real estate companies. What I 
see is a growing trend of realtors to bring matters forward 
where they are so concerned about predatory lending impacting 
on their ability to complete new sales transactions to 
consummate the deals, and they are frustrated for everyone 
involved in the transaction--the buyer, the seller, because 
they see prepayment terms or penalties. It impacts on everyone. 
And they are frustrated because they see these clauses in the 
mortgage papers.
    Mr. Shea. Mr. Chairman, if I could add to that. We have 
found that with our clients who have mandatory arbitration 
clauses, those serve as a tremendous chilling effect for those 
clients seeking redress to right wrongs that they feel are in 
their loans. We found many arbitration clauses, for example, 
that state that if you lose the arbitration, you have to pay 
the cost.
    Well, if you are a low income person, you are not willing 
to do that. You are not willing to take that risk often because 
it could mean the difference between paying the electric bill 
or not.
    Chairman Sarbanes. Mr. Wallace.
    Mr. Wallace. If I could speak, I am going to dissent. We 
found that mandatory arbitration clauses are a substantial 
benefit to the consumer. It provides a cheap, freely available 
remedy. What Mr. Ackelsberg did not point out is that you do 
get a remedy in the arbitration process. What we are talking 
about here is whether we are going to have class actions or we 
are going to have a quick and efficient remedy. The experience 
with class actions has been, unfortunately, one in which the 
trial bar is able to earn a fairly good compensation. But in 
general, the remedies provided to individuals are small.
    Chairman Sarbanes. But do you think----
    Mr. Wallace. Likewise, most of these cases are fraudulent 
cases, cases involving fraud. In individual fraud cases, 
lawyers, individual lawyers, if they are not Legal Aid, find it 
uneconomic to take the case. In arbitration, a remedy is 
available. In a class action, you cannot maintain a class 
action if it is based upon fraud.
    So that arbitration provides an important remedy for the 
consumer. It should be available to consumers and restricting 
the availability of it certainly raises operating costs and 
does not necessarily provide a good remedy.
    Chairman Sarbanes. Well, now, when you say it should be 
available to the consumer, put forward, as it were, on behalf 
of the consumer, what would be your reaction to having 
voluntary arbitration clauses instead of mandatory, so that the 
consumer, if they made the judgment that agreed with the 
rationale you have just laid out, could choose to go to 
arbitration. But if the consumer did not, they would not be 
precluded or denied their opportunity to go to court. What I 
referenced were mandatory arbitration clauses.
    Mr. Wallace. Yes, and I was addressing mandatory 
arbitration as well.
    Chairman Sarbanes. Oh, you were. Now why? On the rationale 
you just gave me, why wouldn't you be accepting of having 
voluntary arbitration clauses?
    Mr. Wallace. Well, the voluntary arbitration clause is no 
different from no arbitration clause at all. I can always in 
litigation agree with the other litigant that I want to go into 
arbitration. That is the effect of a voluntary arbitration 
clause. A mandatory arbitration clause is binding on both 
parties. They should be fair. AFSA's standards require that 
they be fair. There was a question raised about who pays. That 
needs to be fairly handled. But, nonetheless, they are an 
important way of providing the consumer a remedy and they are 
also an important way of managing the very high costs of class-
action strike suits.
    Chairman Sarbanes. If you go to arbitration, as a consumer, 
and lose, you should pay the cost of the arbitration?
    Mr. Wallace. That would be a possible way in which these 
should be structured, yes, sir.
    Chairman Sarbanes. Well, that is the way it is structured 
now.
    Mr. Wallace. I am sorry. Maybe I did not hear you 
correctly.
    Chairman Sarbanes. Do you believe that if a consumer is 
required with mandatory arbitration, goes to arbitration and 
loses, that the cost of the arbitration should then be placed 
upon the consumer?
    Mr. Wallace. AFSA has standards on it. I do not quite 
remember what the standards are. But in any event, it seems to 
me that that ought to be fairly administered. I am not prepared 
to answer that one way or the other. I think it ought to be 
done fairly.
    Mr. Ackelsberg. Senator, Mr. Wallace suggested that these 
are reciprocal obligations taken on both parties.
    In fact, most of the arbitration clauses out there say that 
the lenders can use the courts to foreclose, whereas the 
borrowers have no access to the courts to enforce their rights.
    Chairman Sarbanes. That is a very important point.
    Mr. Henderson. Well, that was my point, Mr. Chairman. I 
think Mr. Wallace, with all due respect, is being very 
disingenuous to focus on the interests of consumers when, in 
fact, the relationship, the unequal bargaining position between 
consumers and the lender is of such a fundamental nature, that 
to structure a system that effectively precludes the option of 
going to court, is to guarantee that the consumer has virtually 
no protection.
    We have established here this morning that the level of 
regulatory inspection and protection out here is deminimus. And 
the truth is that State laws and local laws have proven to be 
woefully inadequate.
    And we now have the courts being cut off from consumers who 
are the most vulnerable and most in need of them. And the idea 
that trial lawyers are being bashed because they choose to 
represent individuals and to advance their interests, I think 
is patently unfair.
    I really just want to take issue with the concept that 
forced, mandatory arbitration is in the consumer's interest. 
This is a situation where let the buyer beware governs the way 
in which the market operates. And it is not in the consumer's 
interest to have that kind of forced arbitration clause.
    Chairman Sarbanes. Is there anyone at the table who would 
object to the Fed, in changing the standards to determine a 
HOEPA loan, so that it would actually reach more loans than are 
now being reached?
    That is under consideration now, as you know. Mr. Wallace 
made reference to the protections that the people get from a 
HOEPA loan. But the fact of the matter is that most of these 
loans that we are talking about are not encompassed within the 
existing HOEPA standards.
    One way to start dealing with this problem, presumably, is 
to change the standards so that more loans are caught by HOEPA 
and therefore, gain the protections of HOEPA. And I would like 
to get the reaction to that. First, is there anyone at the 
table who objects to that, moving in that direction?
    Mr. Courson. Senator, may I respond to that?
    Chairman Sarbanes. Sure.
    Mr. Courson. The Fed proposal has, as you are well aware, 
many different facets to it, several different parts, most of 
which actually the mortgage bankers, in our comments back and 
discussions with the Fed, certainly support.
    In fact, I know there is an antiflipping provision in 
there. There is a low-cost loan provision. We have had 
discussions with them on the pattern and practice provision.
    The one place where our comment back to the Fed did take 
issue was, as I will refer to it, the dropping of the triggers 
or the change of the points and fees test. And our concern was 
one that we voiced in our testimony before, is one that many 
lenders, when HOEPA first was originated, made a decision that 
as part of their products and loans that they would make 
available to consumers, not to make HOEPA loans. That was a 
decision they made.
    The concern is, as we drop the triggers, both rates and 
fees, that there will be more lenders, or those same lenders 
will actually now not serve another tranche of borrowers that 
they perhaps probably today are serving. In addition to that, 
in the secondary market, and we heard about the GSE's being 
unavailable for HOEPA loans, as we continue to drop those 
triggers, to that tranche of loans or additional borrowers, if 
you will, who will be eliminated from the GSE programs.
    We have some concerns about that. And we are concerned in 
that we think that the triggers, per se, will not necessarily 
solve the abusive practices, that is, the enforcement and the 
education we have talked about that solves that issue. And we 
are concerned that just moving the terms and conditions of a 
loan down, which may, in fact, have the effects I have already 
discussed, will also not eradicate the predatory practices we 
are trying to solve.
    Mr. Berenbaum. Senator Sarbanes, if I may, I would like to 
respectfully disagree with the earlier remarks. We think that 
the points issue and other fees issues being addressed by the 
Fed do not go far enough. And we think HUD's recommendation in 
this area should be supported.
    Taking it a step further, we believe that the Home Mortgage 
Disclosure Act should be amended to capture these issues in the 
reporting, so that we will have indicators, a report card, so 
to speak, on these subprime issues, which will actually aid the 
Fed in its current research on the issue.
    The reality is, if you look at larger subprime lenders, 
responsible lenders today, once you are in their pool of 
customers, you are part of the territory that they, ``farm'', 
to use the industry language itself. They will approach you for 
a home equity line of credit. They will possibly suggest 
packing of various products. We need to capture these types of 
real estate guaranteed and unsecured properties in this HOEPA 
threshold.
    Chairman Sarbanes. Mr. Wallace.
    Mr. Wallace. Yes, sir. In general, our view is that if you 
are trying to get at predatory lending, HOEPA is not the tool 
to do it. That was what my testimony said and I want to 
reiterate that.
    You have fraudulent practices out there. HOEPA does not 
address fraudulent practices. We said that in 1994. Experience 
has proved that to be the case. You have fraud. That is the 
cause of the predatory practices. That statute is not going to 
deal with it.
    Now whether the Fed should drop the thresholds I think is a 
question of credit availability. I think that some of the 
advocates who are here today, perhaps, and at least some of the 
advocates out in the background would just as soon not have 
credit so widely available. There is a hostility toward it that 
is perhaps out there.
    If that is the goal, well, then, drop the thresholds 
because that is the effect that is going to have. We think that 
is a policy question. We think that is one that the Fed can 
probably make fairly well because they can see the overall 
effects.
    But we do caution that the basic effect of dropping HOEPA 
thresholds is that the availability of capital for that type of 
loan in the past has become more difficult and we expect that 
to continue in the future.
    Chairman Sarbanes. Well, of course, at the extreme, and you 
have to ascertain what the extreme is, even though you want to 
make credit available and you want people to have the 
opportunity, you may say, these terms for making credit 
available in the real world are so abusive, that it is a mirage 
that is being made available. The person thinks he is getting 
credit made available, but the next thing you know, it is all 
gone, and he is in the pit, so to speak. You have to be careful 
about that because we all want people to have access to credit. 
I was very struck by Mr. Henderson's statement at the outset, 
which I thought was very careful to draw that distinction.
    But on the other hand, at some point, you can look at this 
thing and say, you are packing in so many things and engaged in 
a whole series of practices here, that this is not making 
credit available. This is all a flim-flam to take this person 
to the cleaner's, particularly when you are coming in and 
refinancing the home where someone has built up to these senior 
citizens that Ms. Canja talked about, built up their equities 
in their home, and so forth and so on.
    I understand that a number of lenders, including some large 
subprime lenders, actually are supporting reductions of the 
HOEPA triggers as the Fed now wrestles with this problem. Does 
anyone else want to add anything on that point?
    Ms. Canja. I will just add that we also support lowering 
those triggers because there are so many people that just do 
not--you saw yesterday, I think, that those are the cases that 
came within the triggers, but there are so many that do not. 
And so, we support lowering the trigger.
    Mr. Ackelsberg. Senator, as between the two triggers, the 
rate trigger and the points and fees trigger, I would say the 
points and fees trigger is by far the most important.
    Now under the current legislation, while the Fed has the 
ability to lower the rate trigger from 10 to 8, it does not 
have the ability to lower the points and fees trigger. What it 
does have is the ability to include more items within the 
definition of points and fees as they are doing with credit 
life insurance.
    But, again, I would reiterate what I said in my oral 
testimony, that the proof is really in the pudding, in the 
empirical record since Congress passed HOEPA, which is in fact, 
we are not seeing less loans. We are seeing less costly loans, 
precisely as was said, because many lenders are just choosing 
not to make HOEPA loans because they do not want to have the 
liability attached to it.
    So while, theoretically, you might get to the point where 
you could take the triggers so low, that you would in fact have 
an impact on credit, we are certainly far away from that.
    When you have lenders making loans at seven points, I do 
not think there is any economic argument to say that is 
connected to any aspect of credit access or risk or anything 
else, other than gouging.
    Mr. Berenbaum. Mr. Eakes' testimony yesterday was extremely 
probative of the North Carolina experience.
    Chairman Sarbanes. Yes, I was just going to refer to the 
North Carolina case. Mr. Courson, let me ask you this question. 
You spoke earlier about you are considering an initiative where 
you would guarantee the fees ahead of time.
    You provide people with information about the fees and 
charges and they would be told, guaranteed that is what they 
would be at closing. Is that correct?
    Mr. Courson. Yes, sir.
    Chairman Sarbanes. Now, do you do the same thing for the 
interest rate?
    Mr. Courson. No sir. On the interest rate issue, it is a 
two-part process.
    Chairman Sarbanes. Yes.
    Mr. Courson. At the time of the application, the closing 
costs would, of course, be guaranteed, the lender's cost of 
making that loan.
    The consumer has a couple of choices, as they do today, to 
deal with an interest rate. Obviously, interest rates are a 
very dynamic market. We spent a year arguing and discussing 
this back and forth as to how you would deal with the interest 
rate.
    Today, as we would under our proposal, a consumer can 
choose, in fact, to select and, if you will, lock-in or 
guarantee an interest rate that exists, or they can continue to 
float.
    Our proposal would say, then, once credit is off the 
table--we have an application. We have a guarantee of the 
closing costs. Once the credit decision has been made, the 
lender now has approved the loan, that is the point at which 
the customer, and now the lender, knowing what they have in 
terms of risk, product, and so on, can give to the customer the 
right to accept a guaranteed interest rate, in addition to the 
guaranteed closing costs, which would be the same because, of 
course, those costs are fixed to the type of loan, as opposed 
to the dynamic moving of the money markets.
    There would be the second point in the process where the 
consumer would get the same disclosure they received initially, 
and this time it would be completed in that it would guarantee 
an interest rate and points, if they choose to take it. Some 
may not choose to take it at that point and continue to move 
with the market, and some of us think that we are smarter than 
the markets out there, so we float.
    But there would be that opportunity at the time of the 
credit approval for them to accept that guaranteed rate. And 
then that would be the rate that would be guaranteed when the 
loan moved on to the closing process.
    Chairman Sarbanes. Does anyone have any reaction to that, 
anyone else at the table, about that process?
    Mr. Berenbaum. Again, if the consumer was afforded the 
choice, the way the consumer should be, the way we all expect 
to be, that would be fine. The reality is the consumer is not 
being afforded that choice in our system right now, and there 
is a need for a correction.
    Chairman Sarbanes. Well, all of you have been very generous 
with your time and we appreciate the statements. I think we 
should draw this to a close. We have been here now for quite 
sometime. Let me ask this, though. Is there anyone at the table 
who wanted to give an answer to a question that was not asked?
    [Laughter.]
    Or get in that last response to something that someone else 
said. I am going to give you this opportunity so you do not 
walk away feeling frustrated from this hearing. Does anyone 
want to--yes, Mr. Shea.
    Mr. Shea. Mr. Chairman, I would just like to make one final 
point, and that has to do with the reliability of so-called 
risk-based pricing. I think most people at this table would say 
that if you could come up with a scheme that would adequately 
price a person's real risk, that that would be legitimate.
    The problem is we too often times see that there is various 
schemes that are being used to judge a person's risk and they 
vary tremendously. I have a credit report here from one of our 
clients. It is a triple-merge credit report. It contains three 
credit scores. Remember, currently, 620 to 660 is considered a 
prime ``A'' lender cut-off, from there and above.
    This person has three credit scores on here, one from Fair 
Issacs is a 505. D, very high risk. It is going to be a high 
interest rate loan for this person for most lenders. The second 
one has a credit score of 565 for the same person. The third 
one has a credit score of 658 for the same person.
    This is an inexact science we are dealing with. This is a 
client, by the way, that made their home payments on time every 
month for 2 years, and they still have this wide variety of 
credit scores.
    So the subprime industry is an inexact world right now and 
people get caught up with it and they get trapped in it, which 
is why many of the features that have been discussed here 
today, like arbitration clauses, prepayment payments that are 
lengthy, need to be eliminated.
    Chairman Sarbanes. Thank you. Anyone else? Mr. Wallace.
    Mr. Wallace. Yes, sir. I just wanted to make one point. 
There was a discussion between yourself and Mr. Berenbaum about 
North Carolina. We have studied, and I believe it was mentioned 
yesterday, we have studied North Carolina. Our data ended 6 
months after the North Carolina legislation went in.
    We found a very major decrease in subprime loan volume 
occurring amongst our members, very spectacular. Most lower-
income people, people below $50,000. I want to point that out 
to you. Mr. Eakes, I understand, does not agree with that. I 
was not here yesterday. But I understand that he does not agree 
with that.
    Chairman Sarbanes. No. Mr. Eakes made the point that was 
one of the objectives of the legislation. Namely, that, as I 
understand it, some 80 percent of these loans are for 
refinancing. Is that correct?
    Mr. Wallace. I will take your word for it, sir.
    Chairman Sarbanes. All right. He said that one of the 
things that they were trying to get at in passing the 
legislation was to decrease or reduce the amount of refinancing 
that was taking place by low income people because it was 
perceived that was being used to simply strip them of their 
equity in their home, which, of course, was two of the very 
poignant examples that were presented to the Committee 
yesterday.
    It is a complicated relationship, and we need to analyze 
the figures very carefully. But they are subject to a different 
interpretation and a different conclusion. And he was very 
forceful in making that point.
    Mr. Wallace. I understand the point and we can all make 
value judgments about the basic point.
    But if the goal of legislation is to reduce credit 
availability, that would be an enormous change in the policy of 
this country, which has been to increase credit availability.
    Chairman Sarbanes. No, the goal is to prevent abusive 
practices. That is the goal.
    Mr. Wallace. Yes.
    Chairman Sarbanes. And I do not accept that in order to get 
the maximum credit availability, you are going to accept 
grossly abusive practices. The system ought to be able to do 
better than that. I mean, America ought to have a better 
performance standard than that, it seems to me.
    Mr. Wallace. Well, of course. And we all agree with that.
    Mr. Berenbaum. Senator Sarbanes, yesterday, the Home 
Mortgage Disclosure Act data for 2000 was issued. It is brand 
new raw data that I am sure everyone at the table is analyzing.
    But you should be aware that, unfortunately, last year, 
there was a 16 percent drop across the board in both prime and 
subprime lending, loan origination. I am afraid there are 
issues of our economy, as much as many other issues, impacting 
on this discussion.
    Mr. Wallace. This was actually compared to two adjacent 
States and the effect did not occur in the other States.
    There is one other point. I would like to commend ACORN in 
their statement. They indicated that they are somewhat 
reluctant to see local ordinances dealing with subprime issues 
and predatory issues. We agree with that point of view.
    Mr. Shea. Whoa. That is taken way out of context.
    [Laughter.]
    You just got me on that.
    Mr. Wallace. I thought we all agreed together on that.
    [Laughter.]
    Chairman Sarbanes. Why don't you put it in context, Mr. 
Shea?
    [Laughter.]
    I think we understand the context.
    Mr. Shea. I think you do.
    Chairman Sarbanes. Let me say on that point because it is 
one that runs through a number of issues, I understand the 
industry argument that they operate nationwide and in 50 States 
and, therefore, 50 different standards are difficult for them 
to meet and present administrative problems. Therefore, they 
constantly are referencing Federal preemption.
    But it seems clear to me that if you start to entertain 
Federal preemption, intimately interrelated with that question 
is the question of the substantive protections that would be 
provided under the Federal standard.
    The notion of preemption at an inadequate Federal standard 
I find totally unacceptable. I think that needs to be 
understood up-front. You really have to address at the same 
time the question of the standard and how adequately that deals 
with the problem and protects the consumer.
    Otherwise, it seems to me, there is no basis to deal the 
States out of the picture. Now many of the States feel strongly 
that they should not be dealt out of the picture in any event. 
And given that we have a Federal system and the role of the 
States in our system, that is not a minor question. That is a 
very important question that would have to be looked at. But 
the notion that they should be dealt out with a standard that 
is inadequate to deal with the problem, is seems to me is a 
complete nonstarter. And I just thought that I would lay that 
out as we draw the hearing to a close.
    Thank you all very much for coming. We really appreciate 
it.
    The hearing is adjourned.
    [Whereupon, at 1:15 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
             PREPARED STATEMENT OF SENATOR PAUL S. SARBANES
    Today is the Committee's second hearing on Predatory Lending: The 
Problem, Impact, and Responses. Yesterday, we heard some very eloquent 
statements of the problem from four Americans who worked all their 
lives to attain the dream of homeownership, to build a little wealth, 
only to have it slowly, bit-by-bit, loan-by-loan, taken away from them.
    These people were targeted by unscrupulous lenders because they 
were elderly homeowners that had a lot of equity in their homes. In the 
case of one woman from West Virginia, she owned her home free and 
clear, paid off her mortgage with the proceeds of her husband's life 
insurance policy, only to end up losing her home altogether because of 
a series of six or seven flips in the space of less than 2 years.
    What struck me about these four stories was that many of the 
practices that harmed these witnesses--the repeated flipping of the 
loans, the high points and fees rolled into the loan, and the mandatory 
arbitration clauses that kept some of them from effectively pursuing a 
legal remedy--are all legal.
    Let me reiterate what I said yesterday. I support actions by 
regulators to utilize their authority under existing law to expand 
protections against predatory lending. I support stronger enforcement 
of current protections by the Federal Trade Commission and other 
regulators. I applaud campaigns to increase financial literacy and 
industry efforts to establish best practices. I know a number of 
witnesses at this morning's hearing will tell us about such efforts.
    But those who take the position that stronger regulatory and/or 
more aggressive enforcement of existing laws will be adequate have a 
special burden, particularly in light of yesterday's testimony, to make 
sure that regulatory and enforcement tools are adequate to the job.
    To that end, in my view, they should support the Federal Reserve 
Board's proposed regulation on HOEPA, as Ameriquest has done. They 
should support the Fed's effort to gather additional information 
through an expanded HMDA.
    And they should support the regulatory and enforcement agencies 
such as the FTC, the Treasury, and HUD in their recommendations for 
more effective enforcement. I sincerely hope that today's witnesses 
will take these positions.
    But I want to be clear: neither stronger enforcement, nor literacy 
campaigns, nor best practices are enough. Too many of the practices we 
heard about in yesterday's testimony, while extremely harmful and 
abusive, are legal. And while we must aggressively pursue financial 
education, we must also recognize that education takes time to be 
effective, and thousands of people are being hurt every day.
    As I did yesterday, I want to recount what Fed Governor Roger 
Ferguson said in his confirmation hearing: ``legislation, careful 
regulation, and education are all components of the response to these 
emerging consumer concerns.'' I ascribe to that view.
    Before turning to my colleagues and the witnesses, I want to take a 
moment to explain that we have had far more requests to testify than we 
have openings, as I think the tightly packed witness table makes 
abundantly clear.
    We have offered to include statements from these and other 
organizations in the record of today's hearing.
                               ----------
             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
    Mr. Chairman, I am glad to be back for a second day of hearings on 
the problem of unscrupulous lending practices in the subprime market. 
Yesterday was a moving and important opportunity to hear from victims 
of predatory lending. The story of Carol Mackey from Michigan as well 
as the other hard working people on our panel of predatory lending 
victims illustrates clearly why we need to act on this problem.
    It is my sincere hope that something can be done to rectify the 
untenable situation these citizens find themselves in. I think that 
would be an important step by key participants in this debate over 
predatory lending. Obviously, however, fixing these four terrible 
lending situations will not address the problems that thousands of 
other consumers have encountered while trying to get a loan, but it is 
a start.
    Mr. Chairman, speaking of a positive step forward, I should take a 
moment to note the decisions, over the last few weeks, by some of the 
major lenders. As many of my colleagues on the Committee pointed out 
yesterday, the recent decision by some companies to stop selling 
single-premium credit insurance was significant and a positive step in 
the right direction.
    I have had serious reservations about this product and fear that it 
is usually not in the best interests of consumers. I am glad to see 
companies are responding to these concerns; their actions are 
responsible and appreciated.
    Today, we are going to hear from an array of spokespeople 
representing the civil rights community, consumer interests, seniors, 
low-income families, as well as some representatives from the subprime 
industry. I welcome all of them to the discussion we are having here 
and I know many of them have worked very hard on this issue in 
different capacities for quite some time.
    I am sure that their expertise and differing perspectives will be 
extremely helpful to our Committee--especially because the issues 
before us are complex and different parties have different ideas about 
how to stop predatory lending.
    In the months ahead, we are going to have to grapple with such 
issues as loan flipping, mandatory arbitration disclosures, prepayment 
penalties, the definition of a ``high-cost'' loan, the role of 
regulation, and effective ways of promoting financial education--to 
name just a few.
    In the midst of this forthcoming discussion, working through the 
details and debating the policy merits of different proposals, I hope 
we keep in mind what this entire discussion is about. I said it 
yesterday, and I will say it again today: this discussion is about 
homeownership and the right for people to build a secure future for 
themselves and their families. And, as we heard so vividly yesterday, 
it is about people like Carol Mackey, Mary Ann Podelco, Paul Satriano, 
and Leroy Williams.
    Thank you, Mr. Chairman.
                               ----------
                  PREPARED STATEMENT OF WADE HENDERSON
       Executive Director, Leadership Conference on Civil Rights
                             July 27, 2001
    Mr. Chairman and Members of the Committee, I am Wade Henderson, 
Executive Director of the Leadership Conference on Civil Rights. I am 
pleased to appear before you today on behalf of the Leadership 
Conference to discuss the very pressing issue of predatory lending in 
America.
    The Leadership Conference on Civil Rights (LCCR) is the Nation's 
oldest and most diverse coalition of civil rights organizations. 
Founded in 1950 by Arnold Aronson, A. Philip Randolph, and Roy Wilkins, 
LCCR works in support of policies that further the goal of equality 
under law. To that end, we promote the passage of, and monitor the 
implementation of, the Nation's landmark civil rights laws. Today the 
LCCR consists of over 180 organizations representing persons of color, 
women, children, organized labor, persons with disabilities, the 
elderly, gays and lesbians, and major religious groups. It is a 
privilege to represent the civil rights community in addressing the 
Committee today.
Predatory Lending Is A Civil Rights Issue
    Some may wonder why the issue of predatory lending raises civil 
rights issues, but I think the answer is quite clear.
    Shelter, of course, is a basic human need--and homeownership is a 
basic key to financial viability. While more Americans own their homes 
today than any time in our history, minorities and others who 
historically have been underserved by the lending industry still suffer 
from a significant homeownership gap.
    The minority homeownership rate climbed to a record-high 48.8 
percent in the second quarter of 2001, Housing and Urban Development 
Secretary Mel Martinez said yesterday. About 13.2 million minority 
families owned homes in this period, up from 47.6 percent in the same 
quarter last year, HUD said. However, the rate for minorities still 
lagged behind the overall homeownership rate in the second quarter this 
year, which, at 67.7 percent, tied a high first set in the third 
quarter of 2000. Nationally, 72.3 million American families owned their 
homes.
    Unequal homeownership rates cause disparities in wealth since 
renters have significantly less wealth than homeowners at the same 
income level. To address wealth disparities in the United States and 
make opportunities more widespread, it is clear that homeownership 
rates of minority and low-income families must rise. Increasing 
homeownership opportunities for these populations is, therefore, 
central to the civil rights agenda of this country.
    Increasingly, however, hard-earned wealth accumulated through 
owning a home is at significant risk for many Americans. The past 
several years have witnessed a dramatic rise in harmful home equity 
lending practices that strip equity from families' homes and wealth 
from their communities. These predatory lending practices include a 
broad range of strategies that can target and disproportionately affect 
vulnerable populations, particularly minority and low-income borrowers, 
female single-headed households and the elderly. These practices too 
often lead minority families to foreclosure and minority neighborhoods 
to ruin.
    Today, predatory lending is one of the greatest threats to families 
working to achieve financial security. These tactics call for an 
immediate response to weed out those who engage in or facilitate 
predatory practices, while allowing legitimate and responsible lenders 
to continue to provide necessary credit.
    As the Committee is aware, however, subprime lending is not 
synonymous with predatory lending. Moreover, I would ask you to remain 
mindful of the need for legitimate ``subprime'' lending. We should be 
careful that it is not adversely impacted by efforts directed at 
predators.
    The subprime lending market has rapidly grown from a $20 billion 
business in 1993 to a $150 billion business in 1998, and all 
indications are that it will continue to expand. The enormous growth of 
subprime lending has created a valuable new source of loans for credit 
strapped borrowers. Although these loans have helped many in an 
underserved market, the outcome for an increasing number of consumers 
has been negative.
    On a scale where ``A'' represents prime, or the best credit rating, 
the subprime category ranges downward from ``A''-minus to ``B,'' ``C,'' 
and ``D.'' Borrowers pay more for subprime mortgages in the form of 
higher interest rates and fees. Lenders claim this higher consumer 
price tag is justified because the risk of default is greater than for 
prime mortgages. Yet even with an increased risk, the industry 
continues to ring up hefty profits and the number of lenders offering 
subprime products is growing.
    Some have suggested that subprime lending is unnecessary. They 
contend that if an individual does not have good credit then the 
individual should not borrow more money. But as we all know, life is 
never that simple. Even hard working, good people can have impaired 
credit, and even individuals with impaired credit have financial needs. 
They should not be doomed to a financial caste system, one that both 
stigmatizes and permanently defines their financial status as less than 
``A.''
    Until a decade ago, consumers with blemishes on their credit record 
faced little hope of finding a new mortgage or refinancing an existing 
one at reasonable rates. Without legitimate subprime loans, those 
experiencing temporary financial difficulties could lose their homes 
and even sink further into red ink or even bankruptcy.
    Moreover, too many communities continue to be left behind despite 
the record economic boom. Many communities were ``redlined,'' when the 
Nation's leading financial institutions either ignored or abandoned 
inner city and rural neighborhoods. And, regrettably, as I discussed 
earlier, predators are filling that void--the payday loan sharks; the 
check-cashing outlets; and the infamous finance companies.
    Clearly there is a need for better access to credit at reasonable 
rates, and legitimate subprime lending serves this market. I feel 
strongly that legitimate subprime lending must continue. I am concerned 
that if subprime lending is eliminated, we will go back to the days 
when the only source of money available to many inner-city residents 
was from finance companies, whose rates are often higher than even 
predatory mortgage lenders. It was not long ago that these loan sharks 
walked through neighborhoods on Fridays and Saturdays collecting their 
payments on a weekly basis and raising havoc for many families. We do 
not want to see this again. However, predatory lending is never 
acceptable, and it must be eradicated at all costs.
    Believing that there may have been an opportunity for a voluntary 
response to the predatory lending crisis, several national leaders 
within the prime and subprime lending industry, as well as the 
secondary market, came together last year with civil rights, housing, 
and community advocates in an attempt to synthesize a common set of 
``best practices'' and self policing guidelines. Although the group 
achieved consensus on a number of the guidelines, several tough issues 
remained unresolved. These points of controversy surrounded such issues 
as prepayment penalties, credit life insurance, and loan terms and 
fees, which go to the very essence of the practice by contributing to 
the equity stripping that can cause homeowners to lose the wealth they 
spend a lifetime building. In the end, we failed to achieve a consensus 
within our working group largely because industry representatives 
believed they could be insulated politically from mandatory compliance 
of Federal legislation.
    Given the industry's general reluctance to grapple with these tough 
issues on a voluntary basis, it seems clear that only a mandatory 
approach will result in a significant reduction in predatory lending 
practices.
Direct Action Has Led to Changes, But More Is Needed
    At the outset, I think it is important to recognize that many 
persons and organizations have been actively combating predatory 
lending practices, and with some success. I give credit to Maude Hurd 
and her colleagues at ACORN who have been able to persuade certain 
lenders to eliminate products like single-premium credit life 
insurance. I think Martin Eakes of Self-Help, who testified before the 
Committee yesterday, should also be recognized for his efforts in 
crafting a comprehensive legislative package in North Carolina, the 
first such measure among the States. These groups, including the 
National Community Reinvestment Coalition and others you have heard 
from in these hearings have forced real change. But they need help.
    Recent investigations by Federal and State regulatory enforcement 
agencies, as well as a series of lawsuits, indicate that lending abuses 
are both widespread and increasing in number. LCCR is therefore pleased 
to see that regulators are increasingly targeting their efforts against 
predatory practices. For example, we note that the Federal Trade 
Commission (FTC) has taken several actions aimed at predatory actions. 
These include a lawsuit filed against First Alliance Mortgage that 
alleges a series of deceptive marketing practices by the company, 
including a marketing script designed to hide the trust cost of loans 
to the borrower.
    More recently, the FTC filed a comprehensive complaint against the 
Associates First Capital alleging violations of a variety of laws 
including the FTC Act, the Truth in Lending Act, and the Equal Credit 
Opportunity Act. Among other things, the suit claims that Associates 
made false payment savings claims, packed loans with credit insurance, 
and engaged in unfair collection activities.
    In addition to the activity at the Federal level, various States 
Attorneys General have also been active in this area and I know the 
issue is of great concern to them.
    Many have observed that certain practices cited as predatory are 
already prohibited by existing law. I agree, and therefore urge 
regulatory agencies to step up their efforts to identify and take 
action against predatory practices. At a minimum, this should include 
increased efforts to ensure lenders are fully in compliance with HOEPA 
requirements, particularly the prohibition on lending without regard to 
repayment ability. In addition, we strongly support continued efforts 
to combat unfair and deceptive acts and practices by predatory lenders.
State Legislation Has Addressed Some Practices
    I think much can be learned from the actions of State legislators 
and regulatory agencies. At last count, roughly 30 measures to address 
predatory lending have been proposed and more than a dozen have been 
enacted. The first of these was the North Carolina statute enacted in 
July 1999, that Martin Eakes has described to the Committee. Following 
this statute, a number of other statutes, regulations and ordinances 
have been adopted, several of which are summarized below.
Connecticut
    Connecticut H.B. 6131 was signed into law in May 2001 and is 
effective on October 1, 2000. The new statute addresses a variety of 
predatory lending concerns by prohibiting the following provisions in 
high-cost loan agreements: (i) balloon payments in mortgages with a 
term of less than 7 years, (ii) negative amortization, (iii) a payment 
schedule that consolidates more than two periodic payments and pays 
them in advance from the proceeds; (iv) an increase in the interest 
rate after default or default charges that are more than 5 percent of 
the amount in default; (v) unfavorable interest rebate methods; (vi) 
certain prepayment penalties; (vii) mandatory arbitration clauses or 
waivers of participation in a class action, and (viii) a call provision 
allowing the lender, in its sole discretion, to accelerate the 
indebtedness.
    In addition to these prohibitions, the statute addresses certain 
lending practices by prohibiting: (i) payment to a home improvement 
contractor from the proceeds of the loan except under certain 
conditions; (ii) sale or assignment of the loan without notice to the 
purchaser or assignee that the loan is subject to the Act; (iii) 
prepaid finance charges (which may include charges on earlier loans by 
the same lender) that exceed the greater of 5 percent of the principal 
amount of the loan or $2,000; (iv) certain modification or renewal 
fees; (v) lending without regard to repayment ability; (vi) advertising 
payment reductions without also disclosing that a loan may increase the 
number of monthly debt payments and the aggregate amount paid by the 
borrower over the term of the loan; (vii) recommending or encouraging 
default on an existing loan prior; (viii) refinancings that do not 
provide a benefit to the borrower; (ix) making a loan with an interest 
rate that is unconscionable, and (x) charging the borrower fees for 
services that are not actually performed or which are not bona fide and 
reasonable.
City of Chicago
    Chicago's predatory lending ordinance was effective November 13, 
2000. It requires an institution wishing to hold city funds to submit a 
pledge affirming that neither it nor any of its affiliates is or will 
become a predatory lender, and provides that institutions determined by 
Chicago Chief Financial Officer or City Comptroller to be predatory 
lenders are prohibited from being designated as a depository for city 
funds and from being awarded city contracts. Cook County also has 
enacted an ordinance closely modeled to the one in Chicago.
    Under the Chicago ordinance, a loan is predatory if its meets an 
APR or points and fees threshold and contains any of the following: (i) 
fraudulent or deceptive marketing and sales efforts to sell threshold 
loans (loan that meets the APR or points and fees threshold to be 
predatory but does not contain one of the enumerated triggering 
criteria); (ii) certain prepayment penalties; (iii) certain balloon 
payments; (iv) loan flipping, that is the refinancing and charging of 
additional points, charges or other costs within a 24 month period 
after the refinanced loan was made, unless such refinancing results in 
a tangible net benefit to the borrower; (v) negative amortization; (vi) 
financing points and fees in excess of 6 percent of the loan amount; 
(vii) financing single-premium credit life, credit disability, credit 
unemployment, or any other life or health insurance, without providing 
certain disclosures; (viii) lending without due regard for repayment 
ability; (ix) payment by a lender to a home improvement contractor from 
the loan proceeds, unless the payment instrument is payable to the 
borrower or jointly to the borrower and the contractor, or a third-
party escrow; (x) payments to home improvement contractors that have 
been adjudged to have engaged in deceptive practices.
District of Columbia
    The District of Columbia has amended its foreclosure law, effective 
August 31, 2001 or 60 days after the effective date of rules 
promulgated by the Mayor, to address predatory practices. In summary, 
the amendment prohibits: (i) making ``home loans'' unless lenders 
``reasonably believe'' the obligors have the ability to repay the loan; 
(ii) financing single-premium credit insurance; (iii) refinancings that 
do not have a reasonable, tangible net benefit to the borrower; (iv) 
recommending or encouraging default on any existing debt that is being 
refinanced; (v) making, brokering, or arranging a ``home loan'' that is 
based on the inaccurate or improper use of a borrower's credit score 
and thereby results in a loan with higher fees or interest rates than 
are usual and customary; (vi) charging unconscionable points, fees, and 
finance charges on a ``home loan''; (vii) post-default interest; (viii) 
charging fees for services not actually performed or, which are 
otherwise ``unconscionable''; (ix) failing to provide certain 
disclosures; (ix) requiring waivers of the protections of the Predatory 
Lending Law; (x) financing certain points and fees on certain 
refinancings; and (xi) certain balloon payments.
Illinois
    The State of Illinois has enacted a predatory lending law that was 
effective on May 17, 2001. The Illinois law prohibits: (i) certain 
balloon payments; (ii) negative amortization; (iii) disbursements 
directly to home improvement contractors; (iv) financing ``points and 
fees,'' in excess of 6 percent of the total loan amount; (v) charging 
points and fees on certain refinancings unless the refinancing results 
in a financial benefit to the borrower; (vi) loan amounts that exceed 
the value of the property securing the loan plus reasonable closing 
costs; (vii) certain prepayment penalties; (viii) accepting a fee or 
charge for a residential mortgage loan application unless there is a 
reasonable likelihood that a loan commitment will be issued for such 
loan for the amount, term, rate charges, or other conditions set forth 
in the loan application and applicable disclosures and documentation, 
and that the loan has a reasonable likelihood of being repaid by the 
applicant based on his/her ability to repay; (ix) lending based on 
unverified income; (x) financing of single-premium credit life, credit 
disability, credit unemployment, or any other credit life or health 
insurance; and (xi) fraudulent or deceptive acts or practices in the 
making of a loan, including deceptive marketing and sales efforts.
    In addition, the statute requires lenders to: (i) provide notices 
regarding homeownership counseling and to forbear from foreclosure when 
certain counseling steps have been taken; and (ii) report default and 
foreclosure data to regulators.
Massachusetts
    Massachusetts adopted regulations that were effective on March 22, 
2001. Those regulations prohibit the following in high-cost loans: (i) 
certain balloon payments; (ii) negative amortization; (iii) certain 
advance payments; (iv) post-default interest rates; (v) unfavorable 
interest rebate calculations; (vi) certain prepayment penalties; (vii) 
financing points and fees in an amount that exceeds 5 percent of the 
principal amount of a loan, or of additional proceeds received by the 
borrower in connection with the refinancing; (viii) charging points and 
fees on some refinancings; (ix) ``packing'' of certain insurance 
products or unrelated goods or services; (x) recommending or 
encouraging default or further default on loans that are being 
refinanced; (xi) advertising payment savings without also noting that 
the ``high-cost home loan'' will increase both a borrower's aggregate 
number of monthly debt payments and the aggregate amount paid by a 
borrower over the term of the ``high-cost home loan''; (xii) 
unconscionable rates and terms; (xiii) charging for services that are 
not actually performed, or which bear no reasonable relationship to the 
value of the services actually performed; (xiv) requiring a mandatory 
arbitration clause or waiver of participation in class actions that is 
oppressive, unfair, unconscionable, or substantially in derogation of 
the rights of consumers; (xv) failing to report both favorable and 
unfavorable payment history of the borrower to a nationally recognized 
consumer credit bureau at least annually if the creditor regularly 
reports information to a credit bureau; (xvi) single-premium credit 
insurance, including credit life, debt cancellation; (xvii) call 
provisions; and (xviii) modification or deferral fees.
    Massachusetts also requires credit counseling for any borrower 60 
years of age or more. The counseling must include instruction on high-
cost home loans. Other borrowers must receive a notice that credit 
counseling is available.
New York
    In June 2000, the New York State Banking Department adopted Part 41 
of the General Regulations of the Banking Board. This regulation, which 
was effective in the fall of 2000, was designed to protect consumers 
and the equity they have invested in their homes by prohibiting abusive 
practices and requiring additional disclosures to consumers. Part 41 
sets lower thresholds than the Federal HOEPA statute, covering loans 
where the APR is greater than 8 or 9 percentage points over U.S. 
Treasury securities, depending on lien priority, or where the total 
points and fees exceed either 5 percent of the loan amount.
    The regulations prohibit lending without regard to repayment 
ability and establish a safe harbor for loans where the borrower's 
total debt to income ratio does not exceed 50 percent. The regulations 
address ``flipping'' by only allowing a lender to charge points and 
fees if 2 years have passed since the last refinancing or on new money 
that is advanced. The regulations also limit financing of points and 
fees to a total of 5 percent and require reporting of borrower's credit 
history. The regulations prohibit (i) ``packing'' of credit insurance 
or other products without the informed consent of the borrower; (ii) 
call provisions that allow lenders to unilaterally terminate loans 
absent default, sale, or bankruptcy; (iii) negative amortization; 
(iv) balloon payments within the first 7 years; and (v) oppressive 
mandatory arbitration clauses.
    Finally, Part 41 requires additional disclosures to borrowers, 
including the statement ``The loan which will be offered to you is not 
necessarily the least expensive loan available to you and you are 
advised to shop around to determine comparative interest rates, points, 
and other fees and charges.''
Pennsylvania
    Pennsylvania has recently enacted predatory lending legislation 
that prohibits a variety of practices. These include: (i) fraudulent or 
deceptive acts or practices, including fraudulent or deceptive 
marketing and sales efforts; (ii) refinancings that do not provide 
designated benefits to borrowers; (iii) certain balloon payments; (iv) 
call provisions; (v) post-default interest rates; (vi) negative 
amortization; (vii) excessive points and fees; (viii) certain advance 
payments; (ix) modification or deferral fees; (x) certain prepayment 
penalties; (xi) certain arbitration clauses; (xii) modification or 
deferral fees; (xiii) certain prepayment penalties; (xiv) lending 
without home loan counseling; and (xv) lending without due regard to 
repayment ability.
Texas
    Texas has enacted predatory lending prohibitions that are effective 
on September 1, 2001. Among other things, the Texas law prohibits: (i) 
certain refinancings that do not result in a lower interest rate and a 
lower amount of points and fees than the original loan or is a 
restructure to avoid foreclosure; (ii) certain credit insurance 
products unless informed consent is obtained from the borrower; (iii) 
certain balloon payments; (iv) negative amortization; (v) lending 
without regard to repayment ability; and (vi) certain prepayment 
penalties.
    For certain home loans, the lender must also provide disclosures 
concerning the availability of credit counseling.
Virginia
    Virginia has enacted provisions that are effective July 1, 2001. 
These provisions prohibit: (i) certain refinancings that do not result 
in any benefit to the borrower; and (ii) recommending or encouraging a 
person to default on an existing loan or other debt that is being 
refinanced.
Federal Legislation Is Necessary
    While LCCR commends State and local initiatives in this area, we 
believe they are clearly not enough. First, State legislation may not 
be sufficiently comprehensive to reach the full range of objectionable 
practices. For example, while some State and local initiatives impose 
restrictions on single-premium credit life insurance, others do not. 
This, of course, leaves gaps in protection even for citizens in some 
States that have enacted legislation. Second, while measures have been 
enacted in some States, the majority of States have not enacted 
predatory lending legislation. For this reason, LCCR supports the 
enactment of Federal legislation, of the sort that has been proposed by 
the Chairman, to fill these gaps.
    The Predatory Lending Consumer Protection Act of 2001 contains key 
protections against the types of abusive practices that have been so 
devastating to minority and low-income homeowners. They include the 
following: (i) Restrictions on financing of points and fees for HOEPA 
loans. The bill restricts a creditor from directly or indirectly 
financing any portion of the points, fees, or other charges greater 
than 3 percent of the total sum of the loan, or $600; (ii) Limitation 
on the payment of prepayment penalties for HOEPA loans. The bill 
prohibits the lender from imposing prepayment penalties after the 
initial 24 month period of the loan. During the first 24 months of a 
loan, prepayment penalties are limited to the difference in the amount 
of closing costs and fees financed and 3 percent of the total loan 
amount; and (iii) Limitation on single-premium credit insurance for 
HOEPA loans. The bill would prohibit the up-front payment or financing 
of credit life, credit disability, or credit unemployment insurance on 
a single-premium basis. However, borrowers are free to purchase such 
insurance with the regular mortgage payment on a periodic basis, 
provided that it is a separate transaction that can be canceled at any 
time.
    The Leadership Conference strongly supports the Predatory Lending 
Consumer Protection Act of 2001 and urges its swift enactment.
Conclusion
    Let me finish where I began. ``Why is subprime lending--why is 
predatory lending--a civil rights issue?'' The answer can be found in 
America's ongoing search for equal opportunity. After many years of 
difficult and sometimes bloody struggle, our Nation and the first 
generation of America's civil rights movement ended legal segregation. 
However, our work is far from finished. Today's struggle involves 
making equal opportunity a reality for all. Predatory lending is a 
cancer on the financial health of our communities. It must be stopped.
    Thank you.
                               ----------
                PREPARED STATEMENT OF JUDITH A. KENNEDY
     President, National Association of Affordable Housing Lenders
                             July 27, 2001
    Good morning. Thank you for the chance to appear before you today. 
My name is Judith Kennedy. I am President of the National Association 
of Affordable Housing Lenders, or NAAHL, the national association 
devoted to supporting private capital investment in low- and moderate-
income communities. NAAHL represents 200 organizations, including 85 
insured depository institutions and more than 800 individuals. Formed 
more than 11 years ago, NAAHL's members are the pioneering 
practitioners of community investment. They include banks, 
corporations, loan consortia, financial intermediaries, pension funds, 
foundations, local and national nonprofits, public agencies, and allied 
professionals.
    Ever since NAAHL's 1999 Chicago conference, where we heard about 
predators' activities in that city, we have been convinced that if we 
are not part of the solution to predatory lending, we are a part of the 
problem. It is clear that while we remain committed to increasing the 
flow of capital into underserved communities, we must be equally 
concerned about access to capital on appropriate terms.
    In March, we sponsored a symposium that brought together experts on 
this issue: regulators, researchers, advocates, for-profit and 
nonprofit lenders, and secondary market participants. We were pleased 
to include as speakers, Martin Eakes of Self-Help, who testified before 
you yesterday, and Margot Saunders of the National Consumer Law Center. 
NAAHL's goal was to accelerate progress in stopping the victimization 
that strips equity from peoples' homes and, all too often, triggers 
foreclosures. This victimization is not only wrong in itself, but as 
the Mayor of Chicago succinctly put it: ``It is all down the drain if 
we cannot stabilize the communities that were stable until these 
foreclosures started to happen.''
    The symposium was very productive, and today we are releasing the 
summary of these proceedings which is attached to my statement.\1\ Our 
findings are as follows.
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    \1\ Held in Senate Banking Committee files.
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    First, a profile of predatory lending emerged. Loan flipping, home 
improvement scams, asset-based and unaffordable mortgage loans, 
repetitive financings with no borrower benefit, packing single-premium 
credit life insurance, and other products into the loan amount, all of 
these can strip equity and trigger foreclosures.
    Second, more needs to be done at the Federal level. More is, of 
course, being done, and as New York State Banking Commissioner 
Elizabeth McCaul and Chairman Sarbanes have both emphasized, it is 
critical to balance the need for credit with the need to end abuses. 
NAAHL, like many others, has commented on the Federal Reserve's 
proposals in this area. But as the Federal Reserve has pointed out, a 
significant amount of mortgage lending is not covered by a Federal 
framework. For example, Governor Gramlich reported that only about 30 
percent of all subprime loans are made by depository institutions that 
have periodic exams. Even if the Fed were to do periodic compliance 
exams of the subsidiaries of financial holding companies, that would 
only increase the percentage to about 40 percent.
    It is not surprising, then, that of the 21 completed Federal Trade 
Commission investigations into fair lending and consumer compliance 
violations, 19 involved in-
dependent mortgage companies and two involved subsidiaries of financial 
holding companies. None were Federally examined. If the Fed's recent 
proposal to expand reporting under the Home Mortgage Disclosure Act to 
more lenders is adopted, it will encompass only those whose mortgage 
lending exceeds $50 million per year. Many of the proposed changes to 
HMDA will only create a more uneven playing field by putting additional 
burden and costs on responsible lenders while the worst lenders go 
unexamined.
    To stop the predators, we need to close the barn doors on 
examination and reporting. A level playing field in oversight and 
enforcement is key. Insured Depository Institutions (IDI) engaging in 
the best practices in the subprime lending market 
do extensive due diligence of their brokers to ensure fair lending 
practices. They maintain data on their loans and are rigorously 
examined by the bank regulatory agencies.
    But the majority of lenders are not subject to the same regulatory 
oversight, do not have the same level of compliance management, and 
often do not even file HMDA reports. If they do file, there is very 
little oversight of their disclosure. In a town with no sheriff, the 
bandits are in charge. Unscrupulous brokers who are rejected by 
legitimate lenders, simply go to others who have no knowledge of the 
loan terms, or reputational or compliance concerns about funding 
predatory loans.
    Some States like New York are conducting vigorous exams of their 
licensed mortgage companies, but unfortunately many States lack 
sufficient resources. Some States and municipalities believe that 
stricter laws and ordinances will solve the problem of predatory 
practices. Many NAAHL members believe that the plethora of local laws 
and ordinances may only drive out the responsible lenders who will 
choose not to offer what may become ``high-cost loans'' under a crazy 
quilt of new rate and fee restrictions.
    Third, our symposium also confirmed that subprime lending is an 
important source of home finance. For many consumers, subprime loans 
may be the only way available to finance the American Dream--a home of 
their own. And many, many programs exist, in both the private and 
public sectors, to help subprime borrowers achieve prime borrower 
status--a worthy financial goal. Cutting off access to credit on 
appropriate terms would not be constructive. As OTS Director Ellen 
Seidman has warned, legislation must be very clear so as not to chill 
``the operation of the legitimate subprime market. The flow of 
responsibly delivered credit to underserved markets is critical to 
their survival and any legislative or enforcement solutions . . . must 
proceed with this caution in mind.''
    Fourth, we also heard that vigorous enforcement, at all levels of 
Government, works. We heard from people actively involved in combating 
predatory lending at the city and State levels. Increased Government 
investigations, criminal prosecutions to the fullest extent of the law, 
and revocations of mortgage brokers' licenses all help to eradicate 
predatory lending. State bank supervisors coordinating across State 
lines on a single company and its practices will also accelerate 
progress.
    Fifth, consumer education is key. Our experts recommend that 
financial literacy education must begin early, down to and including 
the high school level. The NAAHL symposium also confirmed that both the 
public and private sectors, on all levels, are undertaking consumer 
education and outreach campaigns, to stop predatory lending before it 
even happens, with good results. For example, New York residents can 
easily use State government information to shop for competitive 
mortgage rates. Chicago borrowers can call 1-866-SAVE-HOME to receive 
counseling and legal assistance, funded by banks and city government. 
Lenders across the country fund financial literacy programs to help 
borrowers with debt management, the implications of signing contracts, 
and tips on how to avoid stalkers who offer financing on predatory 
terms.
    Increased Federal resources for targeted counseling in 
neighborhoods that are vulnerable to predators could greatly extend 
these efforts. Education may not solve the entire problem. As Martin 
Eakes points out, ``the Department of Education says that 24 percent of 
adult Americans are illiterate.'' But counseling can go a long way. As 
Governor Gramlich proposed, ``the best defense is if people really know 
what they are doing.''
    Overall, our symposium confirmed once again that predatory lending 
is a complex issue requiring a multifaceted solution. It takes a 
combination of responses from both the public and private sectors, 
including a broader Federal framework establishing a level playing 
field for legitimate lenders, more vigorous enforcement of existing 
laws, and more resources devoted to consumer education to deal with it.
    But, as our closing speaker, the Honorable Mel Martinez, Secretary 
of the Department of Housing and Urban Development put it, ``juntos 
podemos'': together we can.
    As the President of an organization whose members have spent years 
trying to increase the flow of private capital into underserved 
communities, I say, ``together we must.'' Equity stripping, foreclosure 
triggering loans lead to family tragedies, foreclosures, and 
destabilized neighborhoods. They must be stopped. We at NAAHL commit to 
help you in any way we can.
                               ----------
              PREPARED STATEMENT OF ESTHER ``TESS'' CANJA
           President, American Association of Retired Persons
                             July 27, 2001
    Good morning, Chairman Sarbanes, Ranking Member Gramm, and Members 
of the Senate Banking, Housing, and Urban Affairs Committee. My name is 
Esther ``Tess'' Canja. I live in Port Charlotte, Florida, and I serve 
as President of AARP.
    AARP is actively engaged in efforts to protect consumer rights and 
interests. The Association has been directly involved since the early 
1990's in researching issues, litigating cases, and working with 
Federal and State regulatory agencies and legislative bodies to expose, 
hold accountable, and seek redress from those who are responsible for a 
wide range of exploitive financial practices.
    AARP appreciates this opportunity to bring into greater focus one 
of the most troubling forms of these exploitive financial practices--
which is making unjustifiable high-cost home equity loans to older 
Americans. For most Americans, home equity accumulation is a factor of 
time (for many a ``working lifetime''), and therefore is highly 
correlated with age. For older Americans, the most abusive loans are 
often the refinancing and equity-based home modification loans because 
they target the value of the home--frequently the owner's largest 
financial asset. These forms of abusive lending are particularly 
devastating when the older homeowner is living on a modest or fixed 
income.
    It has been AARP's long-standing view that loans become predatory 
when they:

 take advantage of a borrower's inexperience, vulnerabilities 
    and/or lack of information;
 are priced at an interest rate and contain fees that cannot be 
    justified by credit risk;
 manipulate a borrower to obtain a loan that the borrower 
    cannot afford to repay; and/or defraud the borrower.\1\
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    \1\ On January 31, 2001, the OCC, FRB, FDIC, and the OTS expanded 
the examination guidance for supervising subprime lending activities, 
limited to institutions under their respective jurisdictions, which 
recognizes ``. . . that some forms of subprime lending may be abusive 
or predatory . . . designed to transfer wealth from the borrower to the 
lender/loan originator without commensurate exchange of value.''

    The investment in homeownership among older Americans is 
substantial. For example, based on American Housing Survey data for 
1999, the median mortgage Loan to Value ratios (LTV's) steadily 
decrease from 74.8 for those under 35 years of age, to 31.7 for those 
age 65 and older.\2\ That is to say, the median homeowner's equity 
increases by more than two-and-one-half times by age 65 and older. The 
U.S. Census reports that American homeownership averaged an all-time 
high of 67.4 percent for the year 2000.
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    \2\ See attachment 1, ``Homeownership Rates and Loan to Value 
(LTV), 1999.
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    What is it about older American homeowners that makes them 
particularly attractive to predatory lenders? \3\ Older homeowners are 
often targeted for mortgage refinancing and home equity loans because 
they are more likely to live in older homes in need of repair, less 
likely to perform repairs themselves, and are likely to have 
substantial equity in their homes to draw on. Many of them are nearing 
or are in retirement, and therefore are more likely to be living--or 
are preparing to live--on a reduced or fixed income. In this context, 
some of AARP's most recent research, litigation, and advocacy 
activities focus on abuses found in home repair and modification loans.
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    \3\ Projections by the U.S. Census Bureau estimate that by the year 
2020, the number of persons age 65 and older will grow to over 53 
million--representing a 55 percent increase from the 34 million 
estimated for 1998. Changes in the age distribution of the Nation's 
older population are also occurring. Presently, the aging of the older 
population is driven by large increases in the number of persons age 75 
and older.
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    With some obvious qualifications, this means that the longer a 
homeowner lives in his/her home, building up equity as they pay down 
their mortgages, the greater the risk that they will be subject to 
lenders seeking excessive financial advantage through one of these 
loans. AARP has worked to educate its members as well as the public-at-
large about how consumers can better protect themselves against such 
financial risks.\4\ We believe consumer education to be a necessary 
part of a multilevel approach.
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    \4\ Attachment 2 provides an overview of AARP's decade-long 
campaign against predatory lending practices through December 2000.
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    AARP also recognizes that the damage done by predatory practices is 
not limited to those who have lost, or are at risk of losing their 
home--as devastating as these losses clearly are. It also includes 
those older Americans who need and desire access to competitive, 
realistic risk-based home loans, but are reluctant or unwilling to 
pursue financial services and products due to their fear of potential 
exploitation. Ultimately, all forms of commerce--including financial 
services--are based on trust that each party to a transaction has been 
treated fairly, and disagreements resolved equitably. Whenever it 
occurs, predatory home lending undercuts the very essence of this basic 
tenet of commerce.
    Consider these findings from an AARP-sponsored study, released in 
May 2000, entitled ``Fixing to Stay''.\5\ For Americans age 45 and 
over:
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    \5\ Attachment 3, which is an Executive Summary of the AARP-
sponsored national survey of housing and home modification issues, 
entitled: ``Fixing to Stay,'' May 2000.

 more than 4-in-5 say they would like to stay in their current 
    residence for as long as possible; more than 9-in-10 age 65 or over 
    feel this way; and
 almost 1-in-4 anticipates that they or someone else in their 
    household will have difficulty getting around their home in the 
    next 5 years.

    When asked why they have not modified their home, or have not 
modified as much as they would have liked, respondents cited a number 
or reasons, including:

 not being able to do it themselves (37 percent);
 not being able to afford it (36 percent);
 not trusting home contractors (29 percent);
 not knowing how to find a good home contractor or company that 
    modifies homes (22 percent).

    In most areas, the results of this national survey, when compared 
to its sample of minority individuals (that is, African-Americans and 
Hispanics) were similar. However, there were a few important 
differences:

 among those who have refinanced their home or taken out a 
    mortgage against their home, minorities are more likely to say they 
    did so to obtain funds for home maintenance or repairs (50 percent 
    minorities versus 35 percent national sample);
 however, minorities are also more likely than the national 
    sample to be very or somewhat concerned about:

          being able to afford home modifications that would enable 
        them to remain at home (44 percent versus 30 percent);
          finding reliable contractors or handymen (41 percent versus 
        28 percent);
          finding information about home modifications (34 percent 
        versus 21 percent).\6\

    \6\ HUD's detailed study of almost 1 million--mostly refinancing--
mortgages reported under HMDA in 1998, entitled: ``Unequal Burden: 
Income and Racial Disparities in Subprime Lending in America,'' found a 
disproportionate concentration of subprime loans in minority and low-
income communities.
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    AARP's efforts to address these problems--whether through the 
sentinel effects of its litigation, its legislative, and regulatory 
advocacy, or its counseling and education programs--are directed at 
improving credit market performance, not limiting consumer access to 
credit for those with a less-than-perfect credit history. AARP believes 
that our--and other--consumer financial literacy campaigns are an 
important and necessary component of public and private sector efforts 
to make consumers their own first line of defense.\7\ However, while 
consumer education and counseling programs are necessary, they are not 
sufficient.
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    \7\ In April 2001, AARP launched a State-based campaign effort 
that, over the course of this year, will focus on consumer education 
and advocacy efforts.
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    AARP submitted comments on March 9, 2001, supporting the Federal 
Reserve Board's (the Board) proposal to strengthen the Home Ownership 
and Equity Protection Act (HOEPA) regulations in an effort to reduce 
abusive lending practices targeted at the most vulnerable borrowers. In 
its comments on the proposed regulatory amendments, AARP suggests that 
the Board use its current statutory authority to: lower the annual 
percentage rate (APR) trigger, expand the definition of points and 
fees, and prohibit certain unfair practices such as the use of 
``riders'' to change the terms of a consumer agreement.
    In addition, the Board solicited proposals for making legislative 
changes that address predatory lending practices. AARP recommended 
three statutory amendments to HOEPA that we believe are worthy of 
consideration by the Board for submission to the Congress. We 
recommended:

 inclusion of all fees and points in the loan's finance 
    charges;
 inclusion of open-ended credit and purchase money loans within 
    HOEPA's coverage; and
 the elimination of the ``pattern or practice'' requirement for 
    HOEPA protection; that is, the borrower would only have to 
    establish that a lender has made an unaffordable loan under HOEPA--
    not that the lender has engaged in a pattern or practice of such 
    lending.

    AARP agrees with the Board's assessment of the beneficial impact of 
its proposed amendment, that by expanding the coverage to an additional 
group of high-cost loans it will ``ensure that the need for credit by 
subprime borrowers will be fulfilled more often by loans that are 
subject to HOEPA's protections against predatory practices.'' AARP 
believes that the Board should issue the final HOEPA amendment as soon 
as prudently possible.
    Chairman Sarbanes, and Members of the Committee, the problems 
associated with abusive home equity-related lending practices are 
complex. To date, agreement on a comprehensive reform of the mortgage 
finance system to address these problems has proven elusive. Therefore, 
we are encouraged by the Committee's continued efforts to call 
attention to predatory mortgage lending and to establish effective 
deterrents. AARP is committed to working with this Committee, the 
Congress, and the Bush Administration to address the problems posed to 
the elderly by these devastating lending practices.
    Thank you. I will try to answer any questions you may have.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
                 PREPARED STATEMENT OF JOHN A. COURSON
        Vice President, Mortgage Bankers Association of America
 President & CEO, Central Pacific Mortgage Company, Folsom, California
                             July 27, 2001
    Good morning Mr. Chairman and Members of the Committee. My name is 
John Courson, and I am President and CEO of Central Pacific Mortgage 
Company, headquartered in Folsom, California. I am also Vice President 
of the Mortgage Bankers Association of America (MBA),\1\ and it is in 
that capacity that I appear before you today. This morning I have been 
asked to testify before your Committee to present MBA's views on the 
very serious issue of predatory mortgage lending.
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    \1\ MBA is the premier trade association representing the real 
estate finance industry. Headquartered in Washington, DC, the 
association works to ensure the continued strength of the Nation's 
residential and commercial real estate markets, to expand homeownership 
prospects through increased affordability, and to extend access to 
affordable housing to all Americans. MBA promotes fair and ethical 
lending practices and fosters excellence and technical know-how among 
real estate professionals through a wide range of educational programs 
and technical publications. Its membership of approximately 3,100 
companies includes all elements of real estate finance: mortgage 
companies, mortgage brokers, commercial banks, thrifts, life insurance 
companies, and others in the mortgage lending field.
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    First, I want to thank you for inviting the MBA into this very 
important discussion on a very urgent matter. I commend the Committee's 
leadership in calling for these hearings, as we believe that a full 
understanding of the issues is the only responsible way to finding 
solutions to the scourge of abusive mortgage lending.
    As Vice President of the trade association that represents the real 
estate finance industry, and as President of a mortgage company, I am 
deeply troubled by the continuing reports of predatory and abusive 
lending practices that persist in our industry. It is imperative that 
you know, from the outset, where MBA stands on this issue. We condemn 
these practices in the strongest possible terms. The MBA recognizes 
that this is a problem that is real, and one that carries real 
repercussions for those communities that are affected. Although so-
called predatory lending practices are difficult to measure and 
quantify, there is no hiding from the fact that certain rogue lenders 
and certain unscrupulous brokers continue to prey on our most 
vulnerable populations. Nor can we hide from our responsibility--as 
members of the finance industry--to act in the face of this continuing 
problem.
    For over 80 years, the MBA has stood for integrity and fairness in 
mortgage lending. Our members have helped millions of Americans achieve 
the dream of homeownership. In so doing, we have established a 
tradition of encouraging the highest standards of responsible lending.
    We, therefore, want to make clear that ending unfair lending 
practices is a major priority for our association. We have devoted 
substantial amounts of attention and time to this issue. We want to 
state in no uncertain terms that it is time to address the problems of 
predatory lending head-on, and in a way that does not constrict the 
flow of capital to credit-starved communities. Today, I will address 
the MBA's views on what needs to be accomplished to bring lasting and 
effective solutions to these abuses.
``Subprime'' Lending
    Before I do so, however, I think it is important to set forth some 
background on the nature and recent growth of the so-called 
``subprime'' lending, since most of the reports of mortgage abuse 
appear to stem from this segment of the market. In general terms, that 
sector of the mortgage market that has become known as the ``subprime 
market'' serves customers that do not qualify for conventional, prime 
rate loans. The reasons why such consumers do not qualify are varied, 
but generally, these borrowers may have blemished credit records, or 
perhaps unproven credit or income histories.
    A further element of this market, and of subprime loans generally, 
is that they tend to be more expensive in terms of fees and rates. This 
is so because they generally carry extensive due diligence costs and 
require hands-on servicing, and because they are inherently riskier 
than loans made in the prime market.
    It is imperative to note that subprime lending has been extremely 
beneficial to thousands of families in the last couple of years. 
Subprime lending has opened up new markets and helped many consumers 
that would not have received needed funds but for the special products 
available in this sector of the market. The subprime market provides a 
legitimate and much needed source of credit for many families. As the 
Department of the Treasury and the Department of Housing and Urban 
Development acknowledged in a more recent report, ``[b]y providing 
loans to borrowers who do not meet the credit standards for borrowers 
in the prime market, subprime lending provides an important service, 
enabling such borrowers to buy new homes, improve their homes, or 
access the equity in their homes for other 
purposes.'' \2\
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    \2\ U.S. Department of the Treasury and Department of Housing and 
Urban Development, Curbing Predatory Home Mortgage lending: A Joint 
Report, June 2000 (HUD/Treasury Report).
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Defining the Problem
    It is unfortunate, however, that as the subprime market has 
expanded, the reports of predatory and abusive lending have apparently 
increased as well. We note that the problem of abusive lending is not 
really new nor limited to the subprime market alone. State regulators 
report that they have been dealing with these types of issues for a 
long time, and that what was once called ``mortgage fraud'' is now 
being dubbed ``predatory lending.'' \3\ Regardless of the name, a major 
part of the challenge that we face in finding solutions to this problem 
is that it has proven quite difficult to answer the threshold question 
of how to define ``predatory lending'' or what constitutes ``abuse'' in 
the general context of mortgage lending. Surely we can identify 
examples of practices that everyone would agree are ``abusive,'' but 
the problem we face is that these examples could be both underinclusive 
and overinclusive, depending upon the full circumstances of the loan 
transaction. Thus, often identified ``predatory'' practices could 
include the following: excessive fees and points that are often 
financed as part of the loan; loan ``flipping'' or ``churning,'' in 
which a loan is repeatedly refinanced in a way that degrades the 
owner's equity in the property; intentionally making a loan that 
exceeds the borrower's ability to repay; and overly aggressive sales 
techniques that deliberately mislead the borrower.
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    \3\ See Statement of John L. Bley, Director of Financial 
Institutions, State of Washington before the Federal Reserve Hearing on 
Home Equity Lending (September 7, 2000).
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    It is important to note that in every example noted, the full 
context of the transaction must be analyzed to properly assess whether 
an abuse has occurred. It is impossible, for example, to identify 
``excessive'' fees without knowing the nature and difficulty of the 
service provided in exchange for that fee. Nor can we recognize repeat 
refinances that are meant to strip equity without looking at the fee 
structure of the transaction and the equity of the consumer. In order 
to determine that a consumer has been ``deliberately misled,'' we have 
to study the disclosures and the oral representations made in the 
context of the specific transaction at hand. Since every loan is unique 
and every transaction is tailored to specific needs and conditions, the 
answer of whether mortgage abuse has occurred in any given situation is 
dependent upon the totality of the circumstances of the borrower and 
the transaction. It is daunting, therefore, to isolate the specific 
``bad acts'' that are employed by unscrupulous lenders in a way that 
allows for appropriate regulation.
    We also note that even those regulatory agencies with jurisdiction 
over mortgage credit practices have not provided any clear guidance on 
the topic. Those agencies that have attempted to provide a definition 
have uniformly avoided the real issue, opting instead to provide either 
``categories'' under which the abuses ``tend to fall,'' \4\ or simply 
advancing descriptive examples and anecdotes of the more common abuses 
that they may have observed in the market.\5\ Under either approach, 
the fundamental definitional issues are left unanswered. Sometimes the 
terms ``predatory lending'' and ``subprime lending'' are used 
interchangeably. This confusion and lack of adequate definitions at 
Federal and State levels, and the problem of lack of organized and 
coordinated data on predatory lending, is confirmed and described at 
length in a recent report issued by the Senate Banking Committee staff 
to Chairman Gramm, released in August 2000.
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    \4\ See, for example, HUD/Treasury Report, at p. 2.
    \5\ See Board Notice of Public Hearings and Request for Comments, 
at p. 3.
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Source of Problem
    MBA believes that predatory lending is a problem that has various 
sources. As we attempt to tackle this problem, it is necessary to 
isolate these sources, as they must be addressed individually before we 
can be successful in crafting lasting solutions. In short, the MBA 
believes that the three fundamental sources that need 
to be attacked jointly are the complexity of the laws, lack of 
education, and lack of enforcement.
Complexity of Mortgage Laws/Process
    First and foremost, we believe that a fundamental root problem 
leading to abusive lending is the confusion created by the complexity 
of the mortgage process. Any consumer that has ever been through a 
settlement closing knows how confusing and cumbersome the process can 
be. Mortgage disclosures are voluminous and often cryptic, and 
consumers simply do not understand what they read nor what they sign. 
In addition, the mandated forms lack reliable cost disclosures, making 
it difficult for prospective borrowers to ascertain true total closing 
costs and renders comparison shopping virtually impossible.
    There are various confirmations of this core problem. In a recent 
report prepared by the Federal Reserve Board and the Department of 
Housing and Urban Development, these Federal agencies ascertained that 
most consumers do not understand the relation between the contract 
interest rate and the Annual Percentage Rate (APR) listed in the Truth 
in Lending disclosures. The agencies explain that ``the [consumers'] 
belief was based on misconceptions about what the disclosures 
represent. For example, consumers believed the APR represents the 
interest rate . . . and the amount financed represents the note amount. 
. . .'' \6\ These are fundamental misunderstandings that can lead to 
very serious repercussions for unwary or unsophisticated shoppers. In 
fact, there are reports that these cryptic forms, and the public's 
misunderstanding of them, make the Federally required Truth in Lending 
disclosures a very useful tool for predators to confuse and defraud 
consumers.\7\
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    \6\ See Board of Governors of the Federal Reserve System and 
Department of Housing and Urban Development, Joint Report on the Real 
Estate Settlement Procedures Act and Truth in Lending Act, July 17, 
1998 (Appendix A).
    \7\ There are various examples noted by regulators. One of them 
consists of a dishonest lender that may reveal to consumers that they 
are borrowing $50,000 when, in effect, the total amount borrowed is 
$60,000. This occurs because, under unique TILA rules, the ``Amount 
Financed'' number is derived by taking the amount of the note and 
subtracting ``Prepaid Finance Charges.'' These subtracted charges 
include the lender's own loan origination fees and other fees. Under 
this scenario, the unscrupulous lender can rely on the ``Amount 
Financed'' disclosure to mislead the consumer into believing that they 
have a much smaller loan than they actually commit to at the closing 
table.
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    We can name a myriad of other examples, but simply put, the 
complexity of the current system is the camouflage that allows 
unscrupulous operators to hide altered terms and conceal crucial 
information without fear of the consumer discovering or even 
understanding the import of the masked or undisclosed items. In light 
of 
this complexity, confounded borrowers often have no choice but to turn 
to the loan officer for advice and explanation of the contents of the 
disclosures. In instances of abusive lenders, the consumer's reliance 
closes the loop of deception--the victims of these scams are completely 
blinded to the realities and repercussions of the transaction. These 
problems are exacerbated ten-fold in instances of uneducated or 
illiterate consumers.
Lack of Consumer Awareness/Education
    The complexity of the mortgage process leads directly to, and is 
intertwined with, the second source of predatory lending--lack of 
consumer awareness and education. It is a reality today that even well-
educated consumers tend to lack basic understanding of the mortgage 
shopping and home buying processes. For example, the borrower surveys 
conducted by the Federal Reserve Board revealed that over 20 percent of 
those surveyed contacted only one single source of credit. I already 
mentioned that consumers do not understand the meaning and importance 
of the APR figure. Nor do mortgage shoppers entirely comprehend that 
the early Good Faith Estimate disclosures are not final. Often, 
homebuyers believe that ``listing'' real estate agents carry fiduciary 
responsibilities vis-a-vis the purchaser. They generally do not. Again, 
all these misperceptions have real repercussions in the market, and 
they all stem from basic misunderstandings of the real estate and 
mortgage finance market.
Lack of Enforcement
    The third problem creating a favorable environment for abusive 
lenders is the general absence of real enforcement in this area. It is 
important to understand that the mortgage lending industry is one of 
the most heavily regulated industries today. Mortgage lending is 
subject to pervasive State regulation and must comply with a wide array 
of Federal consumer protection laws including the Truth in Lending Act, 
Real Estate Settlement Procedures Act, Fair Housing Act, Fair Credit 
Reporting Act, Equal Credit Opportunity Act, Fair Credit Billing Act, 
Home Mortgage Disclosure Act, Federal Trade Commission Act, and Fair 
Debt Collection Practices Act. Many of the ``predatory'' abuses 
reported today either violate current law or result from lack of 
disclosures that violate current laws. We note that in practically all 
instances, these predatory loans also involve outright fraud and 
deception. We have to set a new priority to aggressively enforce the 
multitude of existing laws.
    MBA believes that these root causes must be addressed in order to 
fully erase the pernicious lending practices that are occurring today. 
Any approach that does not address these three basic prongs--
simplification, education, and enforcement--will merely deal with the 
effects and not with the underlying causes of the problem. Anything 
short of this full approach will fail to resolve the crisis.
Looking Ahead
    I reiterate that there is general agreement that there is a problem 
with abusive lending in many markets today. While there is some 
disagreement as to how to eliminate these practices, I believe that the 
mortgage industry, policy makers, and consumer representatives all 
share a sincere desire to end the abuses. I believe that we are all 
gathered here today to engage in a serious dialogue as to what needs to 
be done to advance real solutions to this problem.
    Let me then address some steps we can all take to bring an end to 
this problem. As I mentioned before, we all share in the responsibility 
to ensure that predatory lending is eliminated.
Consumers
    First, as outlined above, education of consumers is a most basic 
step in the struggle to push predators out of our neighborhoods. MBA 
believes that an educated consumer is the best prophylactic to 
predatory abuse.
    Presently, MBA is assembling a workgroup to develop a series of 
resources aimed specifically at consumers that believe that they are 
being victimized by predatory lenders. The objectives of this 
initiative is to develop advice and materials that can be accessed 
directly and immediately by consumers seeking protection from unfair 
activities. To this end, the workgroup is developing a full list of 
legal rights and ethical norms that all consumers should expect from 
honest and reputable lenders. This list will be made available to the 
general public and disseminated to Government officials, consumer 
protection agencies, and consumer advocates to ensure that all 
prospective borrowers fully understand their rights in the transaction.
    In connection with this document, the workgroup will also develop a 
system whereby affected consumers can obtain direct access to an 
enforcement agency or other source of immediate assistance on items 
pertaining to their loan situation. MBA believes that this direct 
access is crucial to protecting vulnerable borrowers. Again, the goal 
under this system is to provide immediate help to those consumers that 
feel they are being victimized by loan predators. This system would 
include a method for identifying ``warning signs'' of possible abuses 
that would alert consumers that they may be dealing with less than 
honest operators. Once a consumer identifies certain suspicious signs--
that is, aggressive solicitations, unexplained changes at the closing 
table, requests to leave line items blank on material forms--then that 
consumer would be empowered to seek further immediate advice from a 
trusted third party before completing the transaction. We note that 
there is 
no system today that effectively delivers help and useful information 
that a victim requires at the very point where the abuse is occurring. 
We are trying hard to 
create a structure of support that works effectively and that can be 
implemented immediately. We hope to report back to you very soon with 
good news on our 
advancements.
Industry
    The MBA has always been proactive in the fight against 
``predatory'' lending abuses. As lenders and brokers, we share a strong 
responsibility to fight predatory abuses on various fronts. I will 
outline some of the examples of positive industry activities that are 
making a difference in this endeavor.
    First, our association was the first, and remains the only national 
trade association to sign a ``fair lending/best practices'' agreement 
with HUD. This agreement was signed in 1994 and renewed in 1998. In 
this agreement, MBA committed to a number of steps that will promote 
fair lending and assist the industry in reaching underserved groups in 
our society.
    Recently, MBA developed a set of ``Best Practices'' for our 
members. These Best Practices encourage members to conduct their 
business according to the standards contained therein and participate 
in periodic audits to test for compliance. These guidelines are 
designed to ensure that all customers are given fair and equitable 
treatment.
    Further, MBA entered into a contractual relationship with the 
Mortgage Asset Research Institute (MARI) to create a national database 
of companies and individuals that have been identified by law 
enforcement or regulatory bodies as having engaged in illegal or 
improper behavior.
    In 1998, MBA founded the Research Institute for Housing America 
(RIHA) and currently funds its projects, which support research and 
other activities to help determine how discrimination occurs in home 
buying process, and to eliminate discrimination. RIHA projects also 
endeavor to develop useful research on meeting consumer demand for 
mortgage financing in underserved markets and to measure the societal 
benefits and costs of homeownership.
    As mentioned above, we believe that consumer awareness and 
education are among the most effective tools available for combating 
predatory lending practices. In this area, we think that industry 
participants can do much to develop educational tools and programs that 
will enable consumers to make more informed choices. For example, MBA 
is a founding and active member of the Board of the American Homeowner 
Education and Counseling Institute (AHECI). The purpose of AHECI is to 
provide training and certification to the homeownership counseling 
industry. As a founding member of this organization, MBA provided 
$100,000 in startup funds.
    MBA has worked with the National Council on Economic Education 
(NCEE) over the past several years to educate school children around 
the country in understanding the importance of good credit and the need 
for sound financial planning and management skills, as well as how to 
go about purchasing and financing a home. Recently, MBA partnered with 
NCEE with a donation of $130,000 to promote a program that will educate 
high school youth and adult consumers on the perils of abusive lending.
    Last, MBA is currently engaged in discussions with lending 
organizations and other groups to determine how to best provide useful 
and complete information and education for homebuyers, with a special 
emphasis on subprime borrowers.
Government
    MBA believes that there is much that Government can do to put an 
end to predatory lending abuses. First and foremost, MBA strongly 
believes that much more must be done to enforce the laws that are 
currently on the books. In the past quarter century, both Federal and 
State Governments have put in place a far-reaching body of laws 
designed to prevent abuse of consumers in credit transactions. 
Generally, there is a myriad of laws that exist in the different States 
that could effectively address the abuses that are occurring in the 
market today. These laws include prohibitions against unfair and 
deceptive trade practices; prohibitions against discrimination and 
redlining in finance transactions; limitations on specific terms of 
consumer and mortgage credit; limitations on insurance products; 
penalty provisions for noncompliance; prohibitions of deception 
misrepresentation, nondisclosure and concealment; and common law rules 
against fraud.
    Before any additional laws are adopted, policymakers must realize 
that it does no good to legislate against practices that are already 
illegal in all jurisdictions. More laws will inevitably increase the 
complexity and costs of lending without a corresponding increase in 
consumer protection. Simply piling on more prohibitions will not 
resolve a crisis that today is caused by actors that operate at the 
outer fringes of the law. To be serious about solutions, we must pledge 
a full commitment to engage in serious enforcement of the laws.
    MBA fully understands that enforcement actions are not an easy 
undertaking. They require much time, careful examinations, 
documentation of disclosures and documents, documentation of sales 
techniques, interviews with parties involved, among other things. In 
the end, however, this is the most effective way to stamp out these 
pernicious practices. To this end, MBA calls for increased funding of 
consumer protection agencies to accord them with all necessary 
resources so that we may begin to, once and for all, clamp down on 
unscrupulous actors in earnest.
    Second, MBA believes that, in order to fight predatory lending, it 
is absolutely essential to enact comprehensive reform of the current 
mortgage lending laws. As mentioned above, predatory lending is in many 
ways a symptom of larger problems that have evolved from complicated 
and outdated mortgage laws. Without broad changes to existing laws and 
comprehensive reform of current cost disclosures, any efforts to 
address predatory lending will merely deal with the effects and not 
with the underlying causes of the problem. If the process remains 
confusing and perplexing, consumers will continue to be tricked and 
deceived. MBA has worked tirelessly to come up with a system that 
improves the consumer's opportunities to shop and allows for timely and 
effective disclosure of settlement costs and vital information to 
consumers.
    Under MBA's comprehensive reform package, lenders would be allowed 
to provide mortgage applicants with an early price guarantee that 
permits consumers to effectively shop for mortgage products in the 
market. Under this plan, the closing cost guarantee to be provided to 
consumers would include all the costs required by the lender to close 
the loan, This guaranteed disclosure system would let consumers know, 
early in the mortgage application process, the maximum settlement costs 
a lender could charge. Under MBA's plan, the cost guarantee would be 
binding and enforceable.
    MBA's reform proposal also seeks to streamline all current Federal 
loan disclosures so that they provide home shoppers with clearer and 
more concise information without the confusion inherent in the current 
forms. We envision a system where disclosures and educational 
materials, including advising consumers of the availability of 
counseling, would be provided to the consumer very early in the 
mortgage application process, in effect. We believe that these 
educational materials must be rewritten and restructured to make them 
more understandable and much friendlier to consumers. For example, MBA 
believes that interactive resources or the use of media other than 
booklets would go a long way in augmenting the accessibility and the 
use of these materials. And, unlike the current RESPA materials, these 
materials would contain full and comprehensive advice regarding 
mortgage abuse, including possible sources of counseling.
    We note also that by streamlining the current legal and regulatory 
landscape, we also make it easier to identify abuses and prosecute 
unscrupulous players. If we 
remove all the gray areas from the current process, and provide for 
clear penalties and remedies that punish violators, we will make it 
easier to regulate, examine, and enforce.
    Last, and in connection with previous statements, MBA believes that 
Governmental agencies everywhere must do more to promote consumer 
awareness and education. To this end, we support expanded funding for 
the development of counseling programs and counseling certification 
systems that assure that consumers receive all information they need to 
protect themselves in this very complex transaction.
Conclusion
    In summary, the MBA believes that the continuing search for 
solutions to this problem must expand to comprehensively include all 
the underlying factors that allow predatory lending to flourish. We can 
no longer afford to focus on Band-Aids that merely cover up the harms. 
We must address predatory lending through direct attacks on three 
fronts--a commitment to full enforcement, robust education, and a 
simplification of existing laws. Nothing short of that will suffice.
    Thank you for the opportunity to appear before the Committee. I 
look forward to answering your questions.














































               PREPARED STATEMENT OF NEILL A. FENDLY, CMC
   Immediate Past President, National Association of Mortgage Brokers
                             July 27, 2001
    Mr. Chairman and Members of the Committee, I am the Immediate Past 
President of the National Association of Mortgage Brokers (NAMB), the 
Nation's largest organization exclusively representing the interests of 
the mortgage brokerage industry. We appreciate the opportunity to 
address you today on the subject of abusive mortgage lending practices.
    NAMB currently has over 12,000 members and 41 affiliated State 
associations nationwide. NAMB provides education, certification, 
industry representation, and publications for the mortgage broker 
industry. NAMB members subscribe to a strict code of ethics and a set 
of best business practices that promote integrity, confidentiality, and 
above all, the highest levels of professional service to the consumer.
    In these hearings, the Committee will hear a number of individual 
stories as well as comments from advocates about some egregious, and in 
our view inexcusable, mortgage lending practices. You will also hear 
from others in the mortgage industry about possible solutions, which 
NAMB supports and is actively involved in developing. My testimony 
today will briefly outline some of these. But I would like to focus 
this testimony on helping the Committee understand the important and 
unique role of mortgage brokers in the mortgage marketplace, and offer 
the unique perspective of mortgage brokers in examining the problem of 
predatory lending.
    Today, our Nation enjoys an all-time record rate of homeownership. 
While many factors have contributed to this record of success, one of 
the principal factors has been the rise of wholesale lending through 
mortgage brokers. Mortgage brokers have brought consumers more choices 
and diversity in loan programs and products than they can obtain from a 
branch office of even the largest national retail lender. Brokers also 
offer consumers superior expertise and assistance in getting through 
the tedious and complicated loan process, often finding loans for 
borrowers that may have been turned down by other lenders. Meanwhile, 
mortgage brokers offer lenders a far less expensive alternative for 
nationwide product distribution without huge investments in ``brick and 
mortar.'' In light of these realities, it is no surprise that consumers 
have increasingly turned to mortgage brokers. Today, mortgage brokers 
originate more than 60 percent of all residential mortgages in America. 
The rise of the mortgage broker has been accompanied by a decline in 
mortgage interest rates and closing costs, an increase in the 
homeownership rate, and an explosion in the number of mortgage products 
available to consumers. These positive developments are not mere 
coincidences. They would not have been possible without the advent of 
wholesale lending through mortgage brokers.
    Mortgage brokers now have an extremely important role in our 
economy. With the collapse of the savings and loan industry in the 
1980's, followed by the rapid consolidation of mortgage banking firms 
in the 1990's, today we find that in many communities, particularly in 
central cities and small towns, people might have a hard time finding a 
retail bank branch or retail mortgage lending branch. But they can 
usually find a mortgage broker right in their community that gives them 
access to hundreds of loan programs. Mortgage brokers are generally 
small business people who know their neighbors, build their businesses 
through referrals from satisfied customers, and succeed by becoming 
active members of their communities.
    The recent expansion in subprime lending, which has been noted by 
the Committee in these hearings and others, has also relied heavily on 
mortgage brokers. Mortgage brokers originate about half of all subprime 
loans. Many mortgage brokers are specialists in finding loans for 
people who have been turned down by other lenders. These are hard-
working people who, for one reason or many reasons, do not fit the 
profile that major lenders prefer for their customers. Each of them is 
unique. Some lenders just do not want to be bothered with such 
customers that take a little more time and effort to qualify. Some do 
not want to accept the risk of lending to someone who may have had a 
bankruptcy, an uneven employment history, or a problem with a previous 
creditor.
    Mortgage brokers can usually find a loan for someone who has been 
turned down by others. Most mortgage brokers who originate subprime 
loans do so primarily because they enjoy helping people. Certainly 
these loans can be profitable, and borrowers do pay higher rates and 
fees because of the increased risk, but subprime loans are also time-
consuming and often very difficult to arrange.
    Mortgage brokers often do an amazing amount of work on these loans. 
They work with borrowers, sometimes for weeks, to help them understand 
their credit problems, work out problems with other creditors, clean up 
their credit reports when possible, and review many possible options 
for either purchasing a home or utilizing their existing home equity as 
a tool to improve their financial situation. The brokers are rewarded 
with the knowledge that they have enabled a hard-working family to buy 
its first home, avoid foreclosure, get out from under a crushing load 
of high-rate credit card debt, finance their children's education, pay 
delinquent taxes, repair their homes, and help their parents pay off 
their mortgages and health care bills.
    People of all income levels may end up in situations that leave 
them unable to qualify for the lowest mortgage rates and fees. But they 
still need, and deserve to have, access to mortgage credit. It is a 
lifeline for those who are drowning in debt, facing a huge medical 
bill, trying to survive a layoff. It is the least expensive source of 
credit for those who may have made some mistakes or had some misfortune 
in the past and now need money to improve their home, finance their 
children's education, or even start a business. They need to have the 
widest possible range of choices when they are buying a home or need a 
second mortgage. And today they do. It is important for them, and for 
others like them in the future, that Congress be very careful to avoid 
measures that will rob them of choices they deserve and the tools they 
need to manage and improve their financial situation.
    One of the most important choices available to consumers with low-
incomes, little or no cash, and/or impaired credit is the ``no- or low-
cost'' loan. Mortgage brokers have originated thousands of loans for 
people who were able to buy a home, refinance, or obtain a home equity 
loan with little or no upfront closing costs or broker fees. These 
costs are financed through an adjustment to the interest rate. Retail 
lenders offer ``no- or low-cost'' loans at adjusted rates as well. When 
a mortgage broker arranges a loan like this, the broker is compensated 
by the lender from the proceeds of the loan. This kind of payment goes 
by many names, but is often called a ``yield spread premium.'' These 
payments are perfectly legitimate and legal under Federal law, the Real 
Estate Settlement Procedures Act, so long as they are reasonable fees 
and the broker is providing goods, services, and facilities to the 
lender. These payments to mortgage brokers are also fully disclosed to 
borrowers on the Good Faith Estimate and the HUD-1 Settlement 
Statement, and are included in the interest rate. Retail lenders, 
however, are not required to disclose their profit on a loan that is 
subsequently sold in the secondary market, as most mortgages are today. 
This method of enabling consumers to obtain loans through mortgage 
brokers with little or no upfront costs is now under assault in the 
courts. Despite Statement of Policy 1999-1, issued at the direction of 
Congress by the Department of Housing and Urban Development in 1999, 
which clearly set forth the Department's view that the legality of 
mortgage broker compensation must be judged on a case-by-case basis, 
trial lawyers across America have continued to file and pursue class 
action lawsuits claiming that all such payments are illegal and 
abusive.
    Recently, the 11th Circuit agreed with the plaintiff in one of 
these suits and allowed a class action to be certified. Although at 
first glance this appears to be only a procedural decision, it has 
resulted in a flood of new litigation against mortgage brokers and 
wholesale lenders, and caused a great deal of uncertainty and anxiety 
in the mortgage industry. The cost of defending these class actions is 
staggering. The potential liability could run to over a billion 
dollars. The prospect of a court deciding that the prevalent method of 
compensation for over half the mortgage loans in America is illegal is 
chilling, to say the least.
    If these lawsuits succeed, some lawyers will benefit at the expense 
of the mortgage industry. Their clients might get small refunds, or a 
few dollars off the cost of their next loan. But the real losers will 
be tomorrow's first time home buyers, tomorrow's working families, 
tomorrow's entrepreneurs who will not be able to get a mortgage without 
paying hundreds of dollars upfront. And, further down this road, many 
small businessmen and women may not be able to stay in business as 
mortgage brokers without being able to offer these ``no-cost'' loans. 
As competition decreases, all potential mortgage borrowers will suffer 
higher costs and fewer choices. This illustrates the unintended 
consequences that can come from litigation, regulation, or legislation 
that singles out one part of the mortgage industry, places blanket 
restrictions or prohibitions of certain types of loan terms or 
products, or places unreasonable restrictions on interest rates and 
fees. We have ample reason to believe that such measures will increase 
the cost of homeownership, restrict consumer choice, and reduce the 
availability of credit, primarily to low- and moderate-income 
consumers.
    To further illustrate the problem with blanket restrictions on loan 
terms, consider the balloon loan. A balloon term in a given loan could 
be abusive if the borrower has not been advised that the loan contains 
such a feature and is not prepared for the practical ramifications. 
Further, it may be that the borrower's situation does not make such a 
feature appropriate. Yet, very often, a balloon is a valuable tool to 
help a borrower obtain a lower interest rate and lower monthly payments 
that are affordable. If the borrower's circumstances are such that a 
refinance loan should be reasonably feasible at some time in the 
future, and possibly even at a lower interest rate because the borrower 
has improved his or her credit standing in the meanwhile, then a 
balloon term can be a desirable feature. Many reputable, mainstream 
lenders offer balloon loans to customers in all credit grades, and many 
borrowers freely choose such loans, because they are good options in 
many cases.
    The same is true for other loan terms or conditions frequently 
cited as abusive, including negative amortization, prepayment 
penalties, financing of closing costs, and even arbitration clauses. In 
certain circumstances, each of these may be abusive, but in the 
majority of cases they provide the consumer with a feature that fits 
his or her unique circumstances, such as a reduced interest rate or 
lower monthly payment. Virtually no loan terms are always abusive, and 
almost any loan term that is offered in the market today can be 
beneficial to some consumers. Whether a loan is abusive is a question 
that turns on context and circumstances, from case to case. This is the 
primary reason why NAMB and the mortgage industry have opposed 
legislation or regulation that would impose new, blanket restrictions 
or prohibitions on loan terms. We believe such measures will increase 
the cost of homeownership, restrict consumer choice, and reduce the 
availability of credit, primarily to low- and moderate-income 
consumers.
    NAMB believes that the problem of predatory lending is a threefold 
problem of abusive practices by a small number of bad actors; lack of 
consumer awareness about loan terms; and the complexity of the mortgage 
process itself. We believe all three of these areas must be addressed, 
together and with equal force, if the problem is to be solved without 
the unintended consequences mentioned earlier. The mortgage industry is 
working vigorously in all three areas, and NAMB wants to continue 
working with Congress to address all these areas--in particular, reform 
and simplification of the mortgage process.
Addressing Abusive Practices
    Those of us who are hard-working, reputable mortgage originators 
want nothing more than to get the bad actors out of our industry. We do 
not like competing against people who fraudulently promise deceptively 
low rates or costs and do not disclose their fees, thereby making those 
of us who obey the law appear more expensive. We do not like the bad 
publicity our industry receives from media stories about lenders or 
brokers who take advantage of senior citizens and poor people. We know 
the long-term survival of our industry depends on having satisfied 
customers and maintaining the trust people have in us as professionals, 
so we cannot afford to have anyone making loans that hurt consumers and 
violate that trust.
    All types of institutions have bad actors among their ranks. This 
is not an issue that is confined to lenders, mortgage brokers, 
depository institutions, or independent companies. Bad actors are found 
among all of these types of entities. We wish to emphasize in 
particular that mortgage brokers are not the only ones involved; we 
have observed that many have blurred the distinction between mortgage 
brokers and various other types of companies.
    A popular misconception is the belief that abusive lenders operate 
within existing regulatory guidelines. Rather, most of them choose to 
ignore laws and regulations that properly apply to them. There is a 
small minority of institutions that do not obtain State licensure as 
required. Some ignore State consumer protection laws. They do not 
observe the existing restrictions in the Federal HOEPA. They may even 
violate basic disclosure rules under RESPA and TILA. In many cases they 
are committing outright fraud, which violates yet other State and 
Federal statutes. And, in general, they do not join industry groups 
such as NAMB or the comparable organizations for their respective 
industries.
    There are many tools at our disposal now to deal with these people 
and companies. Laws already exist at the Federal and State level that 
give regulators and prosecutors the authority to revoke licenses, 
impose fines, and even pursue criminal prosecution of lenders or 
brokers that commit fraud, charge unreasonable fees, and otherwise 
violate HOEPA, RESPA, TILA, and other Federal statutes. The Federal 
Trade Commission has brought enforcement actions under HOEPA. These 
enforcement actions do have a deterrent effect on others. The 
Department of Housing and Urban Development is improving its own lender 
approval and enforcement policies for FHA lending. Many States have 
toughened their licensing laws, usually with the full support of our 
affiliated State mortgage broker associations.
    The industry is also taking steps to address practices and 
behaviors in the market that can be eliminated and thereby maintain 
trust in our industry. We note that one of these, the sale of single-
premium credit life insurance, has been dramatically curtailed in 
recent weeks by the major companies involved with that product. In 
another example, a major subprime lender recently stopped using several 
hundred mortgage originators that did not meet its standards of 
professional practice. NAMB supported this effort and continues to 
encourage wholesale lenders to use their broker agreements to ensure 
sound origination practices. NAMB and other major mortgage lending 
organizations have adopted Codes of Ethics and Best Business Practices 
guidelines, and we all encourage consumers to make sure that their 
lender or broker is a member of one of these national organizations.
    Another unacceptable practice is loan flipping. NAMB supports 
reasonable measures that would stop this kind of abusive practice, but 
still allow people to refinance their loans when they need to. For 
example, we support the proposal by the Federal Reserve to limit the 
amount of fees that can be charged in a refinance of a HOEPA loan by 
the existing lender to the new money financed. Some subprime lenders 
are addressing this practice by discouraging frequent refinancing of 
their existing customers. One major subprime lender just this week 
announced new measures to ensure that refinances truly benefit the 
borrower. We think this is a great step that other lenders should and 
will soon follow. Many of the consumer groups here today are working 
with major lenders on these industry initiatives.
Consumer Education
    The second part of addressing predatory lending is improving 
consumer awareness. An informed consumer is almost never a victim of a 
predatory loan. Every organization coming before the Committee today is 
involved in some way with consumer education. NAMB encourages its 
members to never originate a loan to an uninformed consumer. NAMB's 
website includes extensive consumer information and links to sites that 
provide consumers a wealth of information they can use to make informed 
mortgage choices. The NAMB Mortgage 101 Center provides consumers with 
information from one of the mortgage industry's most popular and 
reliable online resources. The website provides consumers with 
information, in an unbiased manner, about completing applications, the 
purpose of an appraisal, bankruptcy and its alternatives, mortgage 
calculators, down payments, FHA loans, loan programs, refinancing, 
relocation, second mortgages, VA loans and many other topics. This 
website provides consumers with unbiased answers to many basic 
questions and many more specific issues.
    Fannie Mae, with its ``Consumer Bill of Rights'' campaign and 
Freddie Mac with its ``Don't Borrow Trouble'' campaign are putting 
millions of dollars into educating people about how to choose a good 
mortgage loan and avoid being victims of predatory lending. AARP has 
launched a great education campaign aimed at seniors, who are often the 
target of predatory lenders. NAMB supports these efforts.
    It is also important for consumers to understand how to use credit, 
and the impact of their credit on their ability to obtain a mortgage at 
the lowest cost. There are also industry efforts underway in this area, 
and we understand Senator Corzine and others on this Committee are 
looking at ways to use Federal education programs and dollars to 
promote financial education in the public schools. NAMB supports the 
education of consumers in broader financial issues, such as managing 
money, managing credit card debt, and other important issues. Ideally, 
these areas should be taught routinely as part of the standard junior 
high school or high school curricula in schools. NAMB has also 
dramatically increased educational programs offered to its members, and 
revamped its certification program, to encourage all mortgage brokers 
to be well informed about current laws, regulations, and ethical 
business practices.
Comprehensive Mortgage Reform
    The third part of the solution is one into which NAMB has put a 
tremendous amount of effort. That is a comprehensive overhaul of the 
statutory framework governing mortgage lending. We cannot emphasize 
enough to this Committee how badly this framework needs to be changed, 
and how important this is to curtailing abusive lending.
    The two major statutes governing mortgage lending were enacted in 
1968 and 1974. The disclosures required under these laws are confusing 
and overlapping. The laws actually prevent consumers from being as well 
informed as they could be, and put consumers at a decided disadvantage 
in the mortgage process. For example, in most cases the borrower does 
not know the exact amount of the closing costs until he/she arrives at 
the closing, because the law requires only that costs be estimated 
early in the process. The way the interest rate, terms, and monthly 
payments on a mortgage are calculated and disclosed is confusing and 
makes it impossible for consumers to effectively compare different 
types of mortgage products. Mortgage brokers are required to itemize 
their profit on each loan, but retail lenders are not.
    This is all terribly confusing to consumers. The entire process is 
much too complicated in a modern world of instant communications and 
one-click transactions. Mortgage brokers are confronted every day with 
the frustrations of our customers about the many confusing, and largely 
useless, disclosures and paperwork. And we know better than anyone that 
unscrupulous lenders take advantage of this complexity and confusion to 
deceive and mislead borrowers, hide onerous loan terms in pages of fine 
print, and load up unnecessary fees at closing when the borrower feels 
pressured and unable to walk away. Confused consumers, oftentimes 
desperate for cash or credit, are more likely to simply rely on the 
word of an unscrupulous loan officer and not question their loan terms, 
rates, or fees.
    If the mortgage process were simplified, as we have proposed, 
consumers could more effectively shop for loans. They could easily 
compare fixed-rate, adjustable-rate, balloon loans, etc. They would 
have simple disclosures without a lot of fine print that can hide 
deceptive fees or onerous loan terms. They would easily be able to 
question and change terms and fees with which they do not agree, well 
before closing. In addition, a simplified process would reduce costs 
for originators, and the savings would be passed on to consumers. These 
changes would put the consumer in a stronger position with more 
information, thereby drastically decreasing the opportunities for 
abusive lending.
    NAMB has been engaged from the beginning in efforts to reform the 
laws regulating mortgage originations. We participated in the 
Negotiated Rulemaking convened by HUD in 1995, which sought to resolve 
the issues surrounding mortgage broker compensation under RESPA. 
Following that effort, it became apparent to NAMB that the entire 
statutory framework governing mortgage lending needed an overhaul. In 
1996, NAMB was the first major industry group to form an internal task 
force on mortgage reform and begin developing a proposal for 
comprehensive reform of RESPA and TILA. We participated in the Mortgage 
Reform Working Group in 1997 and 1998, which sought to reach a 
consensus among industry and consumer advocates on how to reform RESPA 
and TELA. And we participated in the HUD-Treasury Department joint task 
force on predatory lending convened by the previous Secretaries of HUD 
and Treasury, in which we continued to press the case for comprehensive 
reform.
    NAMB remains committed to the goal of comprehensive mortgage reform 
and simplification. We urge this Committee in the strongest terms to 
work with our industry on reform legislation. We ask the consumer 
advocates here to reengage with us in developing a reform proposal. 
Without comprehensive statutory reform and simplification of the entire 
process, consumers will still be too confused and too vulnerable to 
deceptive disclosures and unnecessary fees at closing. Legislation that 
seeks only to restrict or prohibit certain loan terms or pricing will 
only add to the complexity of the process and reduce the availability 
of credit.
Conclusion
    In conclusion, I want to reiterate that NAMB supports measures by 
the industry and regulators to curb abusive practices, punish those who 
do abuse consumers, and promote good lending practices. We support 
legislation that would reform and simplify the mortgage process, and 
believe this is the legislation that is most needed to empower 
consumers. We believe the problem of predatory lending can only be 
solved through a three-pronged approach of enforcing existing laws and 
targeting bad actors; educating consumers; and reforming and 
simplifying the mortgage process. In considering any new legislation, 
we urge Congress to apply this fundamental principle: Expanding 
consumer awareness and consumer power, rather than restricting consumer 
choice and product diversity, should be the goal of any new legislation 
affecting the mortgage process.
    Thank you for this opportunity to express our views. We look 
forward to working with the Committee in the future.
                               ----------
                 PREPARED STATEMENT OF DAVID BERENBAUM
      Senior Vice President, Program and Director of Civil Rights
               National Community Reinvestment Coalition
                             July 27, 2001
    Good morning Chairman Sarbanes, Senator Gramm, and Members of the 
Committee. My name is David Berenbaum, and I am Senior Vice President--
Program and Director of Civil Rights of the National Community 
Reinvestment Coalition (NCRC). NCRC is a national trade association 
representing more than 800 community based organizations and local 
public agencies who work daily to promote economic justice in America 
and to increase fair and equal access to credit, capital, and banking 
services to traditionally underserved populations in both urban and 
rural areas.
    NCRC thanks you for the opportunity to testify today on the subject 
of predatory lending. In particular, I will focus our testimony on:

 Defining predatory lending;
 Identifying why existing statutory and regulatory consumer 
    protections are inadequate; and
 Strongly endorsing new public policy legislation and private 
    sector initiatives to eliminate the practices that perpetuate the 
    dual lending market in our Nation.

    With all due respect to the representatives from the subprime 
lending industry who are testifying in these series of hearings, it is 
important to ``cut to the chase'' and to challenge the myths associated 
with subprime lending. First, subprime lending is not responsible for 
the all time high levels of homeownership in the United States. Second, 
subprime lending is not responsible for ending redlining in our 
communities. Third, responsible subprime lenders will not stop 
underwriting mortgage loans in our neighborhoods simply because new 
legislation prompts industry ``best practices'' to replace ``predatory 
practices'' in our cities and counties. And fourth, unfortunately 
existing law--and certainly industry suggestions of consumer education 
alone--are not adequate to foster greater compliance on a voluntary, 
statutory or regulatory level.
    The Community Reinvestment Act and fair lending laws have been 
responsible for leveraging tremendous increases in loans and 
investments for underserved communities. For example, vigorous 
enforcement of existing CRA and fair lending laws encourage depository 
institutions to compete for business in minority and lower-income 
communities--precise areas predatory lenders target. Unfortunately, 
financial modernization legislation has opened the doors for too many 
nondepository lending institutions and affiliates of depository 
institutions to escape the scrutiny of regular CRA and fair lending 
reviews. One of the unintended consequences of financial 
modernization has been to allow some lenders to operate in an 
unregulated en-
vironment, fearless of oversight and in a predatory manner. By itself, 
regulatory enforcement cannot ensure that the millions of annual 
lending transactions are free of abusive and predatory terms and 
conditions.
    Mr. Chairman, Senator Gramm, there are lenders and brokers in the 
marketplace engaged today, not only in deception and fraud, but also 
discrimination. They need to be held accountable. While they masquerade 
as good neighbors, bankers, brokers, and legitimate business people, 
these ``predators'' systematically defraud innocent individuals out of 
their money and property. They accomplish their illicit purposes by 
means of fraudulent loans and high-pressure, unscrupulous methods. 
Using these loans, predatory lenders extract unconscionable and unjust 
fees from their victims until there is no money left to extract; then 
they expropriate their victims' homes through foreclosures which, in 
many cases, the loans were specifically designed to facilitate. 
Predatory subprime lenders intentionally misuse and exploit the 
weaknesses in existing laws and regulations to their benefit and injure 
our communities every day. This was powerfully addressed by the victims 
of predatory lending who testified at yesterday's hearing.
    The collective efforts of the advocates at this table and others 
around the Nation are responsible for 2001 heralding the death of 
single-premium credit life--Citigroup, Household, American General and 
several other companies and their respective trade associations have 
abandoned the product.
    It is our hope that 2001 will also be the year that Congress and 
the President, in cooperation with the GSE's, the industry and 
community organizations, will enact protections to ensure equal 
professional service, fair lending and equal access to credit based 
upon risk, not race and community demographics, in the subprime lending 
market. New law is needed to cover both loan origination and purchases 
made in the secondary market. In partnership with the GSE's and 
responsible lenders we can create funds to refinance predatory loans 
and realize sensible and profitable market corrections. Freddie Mac's 
and Fannie Mae's recent entry into the subprime market is prompting 
subprime loan originators to review problematic products and policies, 
that is, credit life, through monitoring of portfolios and clear 
subprime underwriting guidelines. Through new legislation, 
reinvigorated use of existing laws, enlightened regulatory oversight, 
and consumer empowerment and sunshine concerning the issues of credit 
scoring in loan origination and automated underwriting, we can make 
2001 truly a remarkable year.
Definitions
    A subprime loan is defined as a loan to a borrower with less than 
perfect credit. In order to compensate for the added risk associated 
with subprime loans, lending institutions charge higher interest rates. 
In contrast, a prime loan is a loan made to a creditworthy borrower at 
prevailing interest rates. Loans are classified as ``A,'' ``A-minus,'' 
``B,'' ``C,'' and ``D'' loans. ``A'' loans are prime loans that are 
made at the going rate while ``A-minus'' loans are loans made at 
slightly higher interest rates to borrowers with only a few blemishes 
on their credit report. The so-called ``B,'' ``C,'' and ``D'' loans are 
made to borrowers with significant imperfections in their credit 
history. ``D'' loans carry the highest interest rate because they are 
made to borrowers with the worst credit histories that include 
bankruptcies.
    In contrast, a predatory loan is defined as an unsuitable loan 
designed to exploit vulnerable and unsophisticated borrowers. Predatory 
loans are a subset of subprime loans. They charge more in interest and 
fees than is required to cover the added risk of lending to borrowers 
with credit imperfections. They contain abusive terms and conditions 
that trap borrowers and lead to increased indebtedness. They pack fees 
and products onto loan transactions that consumers cannot afford. They 
do not take into account the borrower's ability to repay the loan. They 
prey upon unsophisticated borrowers who rely in good faith on the 
expertise of the loan originator or their agent. Ultimately, predatory 
loans strip equity and wealth from communities.
Recent Trends In Subprime Lending
    Since predatory lending is a subset of subprime lending, it is 
important to take a closer look at the subprime market and its growth 
to better understand the growth of the predatory lending problem facing 
underserved communities today. Increasingly, subprime lending is 
becoming the only option of all too many low-income and minority 
borrowers. This reality sadly documents the continued existence of the 
race line in America and the continued existence of the dual lending 
market in the United States. Whereas before, African-Americans were 
openly denied access to credit, today the ``race tax'' is more 
sophisticated, more costly--and equally exploitative. Where once 
redlining undermined communities, today ``reverse redlining'' has 
become the norm and threatens to undermine our communities' economies, 
social services, and tax base. On an individual level, the emotional 
and financial cost of predatory lending cannot even be calculated, and 
endangers every family's investment in their home and future. If, for 
example, an African-American female head of household who lives in 
Baltimore, Maryland, with good credit refinances a $150,000 loan at 
6.75 percent for 30 years, the cost to the consumer in interest is 
$200,240. If, however, this same African-American female is pressured 
or coerced into refinancing with a subprime loan at 14.75 percent for 
30 years, the total interest paid over the life of the loan will be 
$522,015--a difference of $321,775. These are funds that the mortgage 
holder could have used for home improvements, a college education, to 
start a small business or for financial security. This is how the dual 
lending market imposes a ``race tax'' upon our communities. In fact, 
predators have made the ``race tax'' situation worse for our victim by 
charging her closing costs in excess of four points, tying in a high 
interest credit card, and including an exorbitant prepayment penalty 
fee--all standard predatory practices.
    Sadly, an analogy to racial profiling is appropriate here. We have 
all become familiar with the term ``Driving While Black.'' Subprime 
predatory lending has become the equivalent of ``Borrowing While 
Black.''
    The attached exhibits, which map subprime and conventional lending 
patterns using census data, vividly reveal lending disparities in 
predominantly white and predominantly minority census tracts. For 
example, the map of Trenton, New Jersey shows that minority 
neighborhoods in 1999 were 4 times more likely to receive subprime 
refinance loans. Subprime lenders made more than 43 percent of loans in 
Trenton minority census tracts but only 11 percent in predominantly 
white tracts. The disparity in subprime market share by minority level 
of neighborhood in Austin, Texas and Baltimore, Maryland was also very 
large. In Austin, subprime lenders' market share in minority 
neighborhoods was about 3.5 times greater than their market share in 
predominantly white neighborhoods. And in Baltimore, subprime lenders 
issued approximately 50 percent of all the conventional refinance loans 
issued in minority neighborhoods in 1999. When subprime lenders 
dominate the refinance market in minority and low-income neighborhoods, 
they are apt to take advantage of their dominance and make abusive 
loans. Stronger antipredatory laws combined with stepped up CRA 
enforcement of prime lenders is necessary to eliminate abuses and 
increase competition and choices of loan products in these 
neighborhoods. The appendix to the NCRC testimony provides data tables 
and maps showing lending disparities across States including New 
Jersey, New York, Texas, and Maryland. These maps easily could 
represent disparities in any urban community in the United States 
today. The practices which gave rise to these lending patterns 
undermine our Nation's commitment to fair lending, CRA and corporate 
responsibility and best practices.
    A national poll conducted for NCRC in 2000 by the bi-partisan team 
of Jennifer Laszlo and Frank Luntz; found that Americans overwhelmingly 
support fairness in lending. Of those surveyed, 92 percent said they 
believed that every creditworthy person should, by law, be given 
information about the best loan rate for which they qualify. With 
abusive subprime and predatory lending, this is not the practice.
    NCRC, and our members, have documented over 30 widespread lending 
practices that despite existing legal protections have contributed to 
the problem of predatory lending. These predatory practices, which I 
will now identify, include issues relevant to the marketing, sale, 
underwriting, and maintenance of subprime loans.

    Marketing:

 Aggressive solicitations to targeted neighborhoods
 Home improvement scams
 Kickbacks to mortgage brokers (Yield Spread Premiums)
 Racial steering to high rate lenders

    Sales:

 Purposely structuring loans with payments the borrower can not 
    afford
 Falsifying loan applications (particularly income level)
 Adding insincere cosigners
 Making loans to mentally incapacitated homeowners
 Forging signatures on loan documents (that is, required 
    disclosure)
 Paying off lower cost mortgages
 Shifting unsecured debt into mortgages
 Loans in excess of 100 percent LTV
 Changing the loan terms at closing

    The loan itself:

 High annual interest rates
 Product packing
 High points or padded closing costs
 Balloon payments
 Negative amortization
 Inflated appraisal costs
 Padded recording fees
 Bogus broker fees
 Unbundling (itemizing duplicate services and charging 
    separately for them)
 Required credit insurance
 Falsely identifying loans as lines of credit or open end 
    mortgages
 Forced placed homeowners insurance
 Mandatory arbitration clauses

    After closing:

 Flipping (repeated refinancing, often after high-pressure 
    sales)
 Daily interest when loan payments are late
 Abusive collection practices
 Excessive prepayment penalties
 Foreclosure abuses
 Failure to report good payment on borrower's credit reports
 Failure to provide accurate loan balance and payoff amount

    Congress, therefore, on a bipartisan basis, should pass the 
strongest legislation possible to end these practices and establish law 
that the industry, regulators, State attorneys general, advocates, and 
consumers can use to safeguard the public interest. In 2001 to date, 31 
States have introduced over 60 legislative measures attempting to 
combat predatory lending practices. Additionally, nine major 
metropolitan cities and counties have introduced local ordinances to 
deal with predatory lending. Surely, a meaningful national standard is 
preferable.
    Keeping in mind our definition of a predatory loan--an unsuitable 
loan designed to exploit vulnerable and unsophisticated borrowers--
enacting relevant consumer protections becomes a straightforward 
legislative policy exercise which clarifies and complements existing 
civil rights, consumer protection, and disclosure laws.
The Truth Behind the Statistics
    Over the past several years, there has been a tremendous explosion 
in subprime lending. According to the Department of Housing and Urban 
Development (HUD), subprime refinance lending increased almost 1,000 
percent from 1993-1998. The backing of Wall Street investment firms has 
helped fuel much of the explosion in subprime lending in recent years. 
As a relevant New York Times/ABC News investigation revealed, from 1995 
to 1999 the amount of money raised on Wall Street for subprime lenders 
rose from $10 billion to nearly $80 billion annually.
    NCRC has serious concerns about this exponential rise, especially 
given its disproportionate growth among low-income and minority 
neighborhoods. Again, HUD documents that individuals in low-income 
neighborhoods are three times more likely to receive subprime refinance 
loans than those living in high-income neighborhoods. In African-
American neighborhoods, HUD's analysis shows that borrowers living 
there are five times more likely to receive subprime refinancing than 
those living in white neighborhoods.
    National data analysis done by NCRC shows that 67 percent of all 
subprime refinance loans made in 1998 were sold to private investment 
firms and other financiers, compared to just 20 percent of all prime 
home refinance loans. The most recent manifestation of this widespread 
practice is financial service corporations that only purchase subprime 
loans on the secondary market in order to avoid complying with the 
Community Reinvestment Act, minimize HOEPA and related consumer 
protections--such as the Truth In Lending Act (TILA) and the Real 
Estate Settlement Procedures Act (RESPA)--and to avoid compliance with 
our Nation's civil rights protections.
    Thus, while some maintain that subprime lending has been 
responsible for the surge in homeownership among minorities and low- 
and moderate-income borrowers, NCRC believes that increased prime 
lending by CRA-covered banks has played the major role in the increase 
in homeownership. Proponents of subprime lending caution against 
aggressive antipredatory lending regulation and legislation, saying 
that such efforts will choke off credit in underserved communities. 
NCRC, in contrast, asserts that antipredatory legislation and 
regulation will not constrain home mortgage lending to traditionally 
underserved communities and is needed to protect communities from 
unscrupulous actors.
    These very extreme disparities in subprime lending by race and 
income cannot be solely related to the credit history or risk of the 
borrower. In fact, as Freddie Mac and Fannie Mae have estimated, 
anywhere between 30 and 50 percent of subprime borrowers could qualify 
for prime loans. This is product steering or ``reverse redlining'' at 
its worst. Mr. Chairman, there are lenders and brokers out there 
engaged not only in deception and fraud, but also discrimination, who 
need to be held accountable. However, with the exception of a handful 
of actions brought by the Federal Trade Commission, the recommendations 
of recent HUD/Treasury Report go unfulfilled. Over the past 5 years 
thousands of seniors, African-Americans, Latinos, and women have been 
victimized by predatory lending practices. As a result, public opinion 
has developed into consensus. Predatory lending, payday lending, 
predatory insurance, and credit cards are all receiving ``strict 
scrutiny'' from public and private sector ``attorneys general.''
    A recent study by the Research Institute for Housing America (RIHA) 
concludes that minority borrowers are more likely to receive subprime 
loans after controlling for credit risk factors. RIHA cautions against 
a conclusion that price discrimination alone explains this since 
minority borrowers may have different techniques of searching for 
lenders--or access to credit limited only to subprime lenders. However, 
when one considers the totality of the research by NCRC, HUD, Fannie 
Mae, Freddie Mac, RIHA, and others, it seems fair to say that the 
burden of proof lies with those who assert that discrimination and 
predatory lending is the exception to the rule and not the norm in the 
subprime market.\1\
---------------------------------------------------------------------------
    \1\ Anthony Pennington-Cross, Anthony Yezer, and Joseph Nichols, 
Credit Risk and Mortgage Lending: Who Uses Subprime and Why? Working 
Paper No. 00-03, published by the Research Institute for Housing 
America.
---------------------------------------------------------------------------
    In late October 2000, the incoming Chairman of America's Community 
Bankers told an American Banker reporter that ``We need to be very 
careful that subprime lending, which has a useful place, does not get 
confused with predatory lending . . . because lending to borrowers with 
imperfect credit history . . . is one of the reasons we have increased 
homeownership to record levels in the United States.'' \2\
---------------------------------------------------------------------------
    \2\ New Leader After Year of Upheaval at ACB, American Banker, 
October 30, 2000.
---------------------------------------------------------------------------
    The home mortgage lending data do not support the contention that 
subprime lending has driven the surge in homeownership for 
traditionally underserved populations. In 1990, low- and moderate-
income borrowers (LMI borrowers have up to 80 percent of area median 
income) received 18.5 percent of all home mortgage loans made in the 
country (loans to borrowers with unknown incomes were excluded from the 
calculations). By 1995, LMI borrowers received 26.9 percent of all home 
mortgage loans, or 8.4 percentage points more than they had in 1990. By 
1999, LMI loan share had increased to 30.7 percent or only 3.8 more 
percentage points than in 1995. The surge in subprime lending occurred 
from 1995 to 1999, yet LMI borrowers experienced the largest gains in 
home mortgage lending from 1990 to 1995. The first part of the decade 
witnessed a tremendous increase in conventional and affordable prime 
loans as depository institutions worked in partnership with community 
organizations to make CRA-related home mortgage loans.
    The story is similar for home mortgage lending trends to African-
Americans and Latinos. African-Americans and Latinos received 10.1 
percent of the home mortgage loans in 1990 made to African-Americans, 
Latinos, and Whites. The African-American and Latino loan share climbed 
to 14.4 percent in 1995 and to 16.1 percent in 1999. The share of home 
mortgage loans made to African-Americans and Latinos increased by 4.3 
percentage points from 1990 to 1995, but only 1.7 percentage points 
from 1995 to 1999. Pundits and proponents of subprime lending talk 
about how it has made homeownership accessible, but the statistics show 
the biggest gains for minorities occurred in the first part of the 
decade when CRA-related lending surged--as opposed to the second part 
of the decade when subprime lending soared.
    The RIHA study cited earlier concludes, ``Yet there is little 
evidence to support the idea that subprime lending (primarily) serves 
lower-income households or households with little wealth to use as a 
down payment.'' And RIHA should know what it is talking about, since it 
is a research institute founded by mortgage banks and their trade 
association, the Mortgage Bankers Association of America.
    NCRC acknowledges that responsible subprime lenders play a role in 
the marketplace. However, most predatory lenders are primarily consumer 
lenders and should not be confused with CRA-covered lenders that have 
done the most work in making the American Dream of homeownership 
possible. Despite this, even a portion of CRA-covered loans has become 
predatory since the onset of financial modernization. In particular, 
price discrimination, or charging higher interest rates than is 
necessary to cover risk, by subprime mortgage divisions of banks has 
become all too common.
    Next, opponents of tighter control of subprime lending suggest that 
improved disclosure of terms and conditions of loans will provide the 
needed protections against predatory lending. Loan transactions, 
particularly mortgages, can be the most complex transaction in a 
typical consumers lifetime, making it difficult for the average 
American to understand loan terms, choice of products, and that 
counseling or consumer protections may be available. I offer that 
consumers not only need the disclosures, but also need assistance 
safety net of new legislative protections.
Legislative Remedies
    NCRC believes that current law and regulation are weak and err on 
the side of allowing exploitative practices that are not economically 
justified in terms of being necessary to make loans profitable. Steep 
prepayment penalties on high interest loans, high balloon payments, 
repeated flipping, credit insurance, and fee and product packing were 
not necessary for profitable home mortgage loans made to first time 
homebuyers during the tremendous homeownership expansion in the 1990's, 
especially in the first half of the decade. These products and 
practices remain inappropriate today in the current economy of 
supercharged loan origination, refinance and home improvement. Instead, 
these abusive terms and conditions trap and exploit unsophisticated 
borrowers. Their unsuitability to the borrower and lender is 
demonstrated by higher foreclosures associated with predatory 
lending.\3\ Indeed, the FDIC has found that although subprime lenders 
constitute about 1 percent of all insured financial institutions, they 
account for 20 percent of depository institutions that have safety and 
soundness problems.\4\
---------------------------------------------------------------------------
    \3\ Analyzing Trends in Subprime Originations and Foreclosures: A 
Case Study of the Atlanta Metro Area, Abt Associates Inc., February 
2000.
    \4\ Department of the Treasury, Office of the Comptroller of the 
Currency, Federal Reserve System, Federal Deposit Insurance 
Corporation, Proposed Agency Information Collection Activities 
(Collecting subprime lending information on call reports), Federal 
Register, May 31, 2000, pages 34801-34819.
---------------------------------------------------------------------------
    In order to protect consumers and the lending industry from unsafe 
and predatory practices, NCRC favors Federal antipredatory legislation 
that builds and expands the Homeownership and Equity Protection Act of 
1994 (HOEPA). HOEPA defines loans that exceed a certain interest rate 
and fee threshold as high interest loans. It then outlaws various terms 
and conditions on high interest loans. The shortcoming with HOEPA is 
not its structure but its high interest rate and fee thresholds. The 
current interest rate threshold, for example, is 10 percentage points 
above Treasury bill rates which currently translates into interest 
rates of 16 percent and higher. The HUD/Treasury Task Force on 
Predatory Lending estimates that the current HOEPA interest rate 
threshold covers only about 1 percent of subprime loans.\5\
---------------------------------------------------------------------------
    \5\ HUD-Treasury Curbing Predatory Lending report, p. 85.
---------------------------------------------------------------------------
    NCRC strongly supports the Predatory Lending Consumer Protection 
Act of 2001 (H.R. 1051) introduced by Representative LaFalce and soon 
to be introduced by Senator Sarbanes. Many of the provisions and 
protections included in the legislation are what NCRC has been 
advocating for tighten up HOEPA. NCRC believes that HOEPA should be 
amended in the following manner:

 Coverage--HOEPA should be expanded to cover home mortgage 
    lending, reverse mortgage lending, and open-ended transactions 
    secured by real estate. Currently, HOEPA applies only to closed-
    ended consumer transactions secured by a borrower's home. In order 
    for HOEPA's protections to be comprehensive, it is time to extend 
    it to all lending secured by a borrower's principal dwelling.
 Interest Rate Threshold--The interest rate threshold should be 
    lowered from 10 percentage points above Treasury bill rates to 4 
    percentage points above Treasury rates. Using the figures in the 
    HUD/Treasury report, NCRC estimates that this would cover about 70 
    percent of all subprime lending, or the percentage of subprime 
    lending which is estimated to contain prepayment penalties.
 Fees--NCRC believes that the fee threshold should be lowered 
    from 8 percent of the loan amount to 3 percent of the loan amount. 
    Fannie Mae has indicated that it will not purchase loans with fees 
    exceeding 5 percent of the loan amount. This is a significant 
    policy statement from a major secondary market player indicating 
    that Fannie Mae does not believe that fees above 5 percent are 
    economically justified from a profitability point of view.\6\ In 
    addition, NCRC maintains that ``yield-spread'' premiums should be 
    included in the calculation of the fee threshold. NCRC also agrees 
    with the HUD/Treasury recommendation that for high interest rate 
    loans, a ceiling should be established on the percentage of fees 
    that are financed and added to the loan amount instead of being 
    paid up-front. The HUD/Treasury recommendation is that fees 
    exceeding more than 3 percent of the loan amount must not be 
    financed.
---------------------------------------------------------------------------
    \6\ Fannie Mae Chairman Announces New Loan Guidelines to Combat 
Predatory Lending Practices, Fannie Mae News Release of April 11, 2000.
---------------------------------------------------------------------------
 Flipping--NCRC agrees with the HUD/Treasury recommendation 
    that refinances of high interest rate loans that occur within 18 
    months of the original loan should be prohibited unless a tangible 
    net benefit accrues to the borrower. Such a benefit should include 
    a reduction in the loan interest rate of 1.5 percentage points.
 Prepayment penalties--HOEPA currently allows prepayment 
    penalties in the first 5 years. HOEPA must be changed to either 
    eliminate prepayment penalties altogether on loans that exceed the 
    interest rate and fee threshold or at least prohibit prepayment 
    penalties beyond the first year after the origination of a high 
    interest loan.
 Balloon payments--HOEPA prohibits balloon payments on high 
    interest loans within the first 5 years of origination. NCRC agrees 
    with the HUD/Treasury recommendation that balloon loans must be 
    prohibited until 15 years after the issuance of high interest rate 
    loans. A shorter time frame invites flipping as predatory lenders 
    convince borrowers facing steep balloon payments to refinance, 
    usually at higher interest rates and added fees.
 Single-premium credit insurance--This is an abuse that must be 
    ended on all loans. Fannie Mae and Freddie Mac have indicated that 
    they will not purchase loans with single-premium credit 
    insurance.\7\ Congress should follow their lead and prohibit 
    single-premium insurance. If financial institutions wish to sell 
    credit insurance, it should be on a monthly basis and must allow 
    the borrower to cancel it at any time.
---------------------------------------------------------------------------
    \7\ Fannie Mae April 11 press release and letter to the editor of 
the American Banker by David Andrukonis of Freddie Mac on April 6, 
2000.

    Additional HOEPA reforms should outlaw mandatory arbitration 
clauses and prohibit high interest rate loans with negative 
amortization and/or which exceed 50 percent of the borrower's income. 
With such changes, public policy will respond to the pervasive abuses 
occurring in the marketplace that cannot be addressed solely through 
improved disclosures or more extensive financial literacy and 
prepurchase counseling.
    Further, NCRC recommends that this Committee strongly consider 
amending the Home Mortgage Disclosure Act (HMDA) to include loan terms 
and conditions, and the CRA and fair lending exams should be improved 
to help stamp out predatory lending. Disclosures of annual percentage 
rates (APR's) will be vital for fair lending enforcement to ensure that 
minorities and/or women of similar income levels and buying homes of 
similar values (or refinancing similar dollar amounts) are not charged 
significantly higher amounts than whites and/or males.
    The Senate Banking Committee should also strongly consider the 
Community Reinvestment Modernization Act of 2001 (H.R. 865), introduced 
by Representatives Barrett and Gutierrez with 34 cosponsors. This 
legislation will allow the Community Reinvestment Act to keep pace with 
the tremendous changes taking place in the financial industry by 
extending CRA to all lending affiliates of financial holding companies. 
Mortgage companies, insurance agents, and other nontraditional lending 
affiliates of holding companies would be required to comply with CRA. 
Lenders would be penalized on CRA exams for making predatory loans. In 
addition, the bill would extend CRA-like requirements to insurance 
companies and securities firms. Insurance companies would be required 
to publicly disclose data on the race, income, and gender of their 
customers. Mergers between depository and nondepository institutions 
would be subject to public comment periods with regulatory agency 
decisions based on CRA, fair lending, safety and soundness, and 
antitrust factors.
Regulatory Responses and Remedies
    There are regulatory steps that can be taken today by the Federal 
banking agencies, particularly the Federal Reserve Board, to combat 
predatory activities. The Board has direct jurisdiction over the 
practices of those subprime lenders that are bank holding company 
subsidiaries. In addition, the Board also has jurisdiction over many 
companies that underwrite, purchase, and service mortgage-backed 
securities based on subprime loans by nonbank lenders.
    The Federal Reserve Board can conduct examinations, including fair 
lending examinations, of any bank holding company subsidiary, including 
subprime lenders--and it should start doing so. It should be noted that 
the Federal Reserve, in its July 2, 2001 approval order concerning the 
Citigroup-European American Bank merger, did commit to conduct a 
thorough examination of CitiFinancial. However, the Board still refuses 
to routinely conduct such examinations. The General Accounting Office 
(GAO) and the HUD/Treasury Report have both recommended that the 
Federal Reserve Board conduct such examinations. Another important way 
the Board has jurisdiction over the portion of the subprime market that 
is predatory is through its supervision of companies which underwrite, 
purchase, and service mortgage-backed securities based on subprime 
loans by nonbank lenders and companies that make warehouse loans to, or 
do underwriting, servicing or trustee/custodian work for, other 
subprime lenders.
    It is quite clear, Mr. Chairman, that while all of the regulatory 
action recommended by NCRC is necessary to combat predatory lending, it 
is not sufficient. To truly end this scourge, Congress must pass strong 
antipredatory lending legislation that significantly strengthens and 
expands current consumer protection provisions under HOEPA. Even if the 
Federal Reserve adopted its Regulation Z proposal to lower the HOEPA 
interest rate threshold to 8 percentage points above Treasury 
securities, only 5 percent of subprime loans would be covered under the 
Federal Reserve's own admission. Congress alone can change the HOEPA 
statute to make the interest rate threshold lower. The Predatory 
Lending Consumer Protection Act of 2001 would lower it to 6 percentage 
points above Treasury securities, and cover about 25 percent of 
subprime loans as estimated by HUD. In addition, the Federal Reserve 
does not believe that it has the power to eliminate credit insurance on 
subprime loans. The current predatory lending bill includes such 
provisions, which are needed to prohibit these practices.
    Federal banking regulators must also increase their scrutiny of 
subprime lending during CRA exams and accompanying fair lending 
reviews. CRA has been instrumental in leveraging a tremendous increase 
in safe and sound lending to traditionally underserved communities. It 
is one of the most important means by which to stimulate conventional 
lending institutions to compete against predatory lenders in lower-
income and minority communities. But for CRA to succeed in this 
endeavor, it must be enforced rigorously.
    Recently, disturbing evidence indicates that some CRA examiners are 
giving depository institutions CRA ``credit'' or points for payday 
lending and other suspect activities without scrutinizing the terms and 
conditions of this lending. The Federal Deposit Insurance Corporation 
has just publicly indicated that it will not count predatory loans for 
CRA credit. The Office of Thrift Supervision recently failed a thrift 
that was making abusive payday loans. NCRC is also pleased that the 
Federal banking agencies just updated their interagency CRA Question 
and Answer document to indicate that bank CRA ratings will be 
downgraded if they make predatory loans in violation of the Truth in 
Lending Act, the Real Estate Settlement Procedures Act, and HOEPA. We 
urge the Federal banking agencies to codify this during the CRA 
regulation review that is just starting. Too many other questionable 
subprime and payday lenders have passed their CRA exams--and NCRC can 
provide examples upon request. There are signs that this will be 
changing; increased scrutiny from Capitol Hill will help make sure that 
unscrupulous lenders will fail their CRA and fair lending exams.
    NCRC and its members, working with fair lending experts and its 
nationwide membership, have crafted a model antipredatory lending bill 
as part of our efforts to eliminate the problem. It is attached as an 
exhibit to this testimony. NCRC is pleased that many of the provisions 
included in its model bill are also included in the various 
antipredatory lending bills currently circulating in Congress.
Conclusion
    NCRC acknowledges the fact that subprime lending does play a role 
in expanding access to credit for those with blemished credit records. 
However, a growing portion of this industry is responsible for the 
``balkanization of credit,'' whereby vulnerable low- and moderate-
income, minority, and elderly individuals are being targeted by 
predatory lenders whose only intent is to deceive and dispossess them 
of their property and wealth. Senators Sarbanes, Schumer, and 
Representatives LaFalce and Schakowsky have consistently and forcefully 
echoed this concern, and are to be commended for their leadership in 
proposing strong legislation to combat predatory practices. 
Representatives Barrett and Gutierrez should also be applauded for 
their sponsorship of the Community Reinvestment Modernization Act of 
2001 in the House.
    Stronger legislation and regulation are needed to end the scourge 
of predatory lending. Noble attempts have been made at the State and 
local level to implement legislative and regulatory protections against 
predatory lending. NCRC applauds these initiatives and supports them. 
However, a comprehensive HOEPA statute, accompanied by stronger 
regulations, is needed to establish uniformity and prevent predators 
from preying upon borrowers in States with weak laws. A uniform 
national framework will promote competition from prime lenders and 
responsible subprime lenders. It will benefit communities and lenders 
alike by prohibiting unsafe and unsound lending that is designed to 
exploit borrowers and neighborhoods and strip them of their wealth. It 
will empower Federal and State regulators and enforcement agencies to 
use the law effectively to stem the tide of predatory lending.
    Mr. Chairman, under the law, if a person holds someone up at 
gunpoint and robs them of their possessions, that person goes to jail. 
However, if a lender uses deception, high-pressure sales tactics, and 
other abusive means to steal another person's home--their most prized 
possession--the lender profits. Predatory lending is no different than 
robbery at gunpoint, and both our laws and regulations must adequately 
reflect that fact.


















































                PREPARED STATEMENT OF GEORGE J. WALLACE
            Counsel, American Financial Services Association
                             July 27, 2001
    Good morning. I represent the American Financial Services 
Association (AFSA). AFSA is a trade association for a wide variety of 
market-funded lenders, many of whom make both prime and subprime loans 
to American consumers. AFSA looks forward to working with the Committee 
to examine the issues raised by the hearings held yesterday and today.
    Allegations of predatory lending, particularly in the subprime 
mortgage market, have received a significant level of attention in 
recent months. Advocates of increased regulation have claimed that 
stepped up fraudulent or ``predatory'' marketing practices have 
persuaded vulnerable consumers to mortgage their homes in unwise loan 
transactions. Some consumer advocates have gone considerably farther 
and asserted that various loan products and features common to the 
mortgage market are ``predatory'' and should be outlawed.
    Most of the regulatory changes sought have a common, very 
troubling, approach. They impose significantly restrictive new 
regulation on all mortgage loans, or all loans over a designated 
interest rate or points threshold, even if there is no evidence of 
fraudulent marketing. This approach confuses the symptoms with the 
causes and its adoption would be a serious mistake, because it fails to 
recognize or address the real causes of the problem, and would 
seriously undercut the important goal of maintaining the availability 
of credit for working American families.
    Much of this proposed regulation seeks to control credit prices, 
directly or indirectly, by limiting or discouraging points, fees, and 
higher interest rates. Some proposals also restrict credit terms or 
require burdensome new compliance steps, such as extended new 
disclosures. Several others aim at restricting marketing methods, 
particularly when refinancing is involved. Finally, several proposals 
have urged turning the already strong remedial and penalty provisions 
of present law into extremely broad punitive provisions.
    These proposals, taken as a whole, would dramatically reduce loan 
revenue, increase the risk, and/or increase costs the lender must bear. 
While initially the resulting burdens fall on the lenders who continue 
to make loans subject to new regulation, in the long term, the effects 
will almost always be felt directly by working American families, 
either because of decreased loan availability, higher credit prices or 
less flexible loan administration.
    Thus this call for increased regulation, well intended as it 
undoubtedly is, strikes at the very heart of the efforts over the last 
quarter century of Congress, many States, consumer advocacy groups, and 
the lending industry to make efficiently priced consumer credit 
available to working American families, including minorities, single 
parent families, and others who for so long were unable to obtain 
credit. In testimony before this Committee in 1993, Deepak Bhargava, 
Legislative Director for ACORN, spoke of ``a credit famine in low- and 
moderate-income and minority communities in urban and rural areas'' 
demonstrated by ``[a]bundant anecdotal and statistical evidence 
[pointing to] massive problems of credit access in many communities 
around the country, particularly in minority and low-income areas''.\1\ 
He also pointed out that ``[l]ack of access to credit thwarts community 
development efforts, and the creation of employment and housing 
opportunities for millions of American families.'' \2\
---------------------------------------------------------------------------
    \1\ Hearings on S. 1275, Community Development Banking and 
Financial Institutions Act of 1993 before the Senate Banking, Housing, 
and Urban Affairs Committee, 103d Cong., 1st Sess., 168 (1993) (Written 
Testimony by Deepak Bhargava, Legislative Director, ACORN on behalf of 
ACORN, Center for Community Change, Consumer Federation of America, 
Consumers Union and National Council of LaRaza).
    \2\ Id.
---------------------------------------------------------------------------
    In 1993, subprime credit was a very small part of the credit 
market. Today, subprime credit is approximately 25 percent of home 
equity credit outstanding, and a very significant part of purchase 
money credit. Yet some of the legislative proposals advanced by 
consumer advocates this year would unwisely impose stringent new 
regulations and disclosures, including what amounts to strict price and 
terms limitations, on virtually all of that credit. Even the pending 
Federal Reserve Board proposals would impose heavy additional 
regulatory burdens. A study of AFSA member loans originated over the 
last 5 years suggests that the pending Federal Reserve Board proposal 
would increase the number of first mortgages covered by HOEPA from 12.4 
percent today to 37.6 percent, and second mortgages from 49.6 percent 
to 81.1 percent.\3\ The effect, if not the goal, of these proposals 
will likely be to substantially shrink the subprime mortgage market, a 
point underlined by Freddie Mac's announcement in the spring of 2000 
that it would not purchase any HOEPA loan, a policy now mirrored by 
Fannie Mae.\4\, \5\
---------------------------------------------------------------------------
    \3\ Michael E. Staten and Gregory Elliehausen, The Impact of The 
Federal Reserve Board's Proposed Revisions to HOEPA on the Number and 
Characteristics of HOEPA Loans, 5-6 (July 24, 2001).
    \4\ See editorial by David A. Andrukonis, Chief Credit Officer, 
Freddie Mac, ``Freddie Mac Defends Purchase of Subprime Mortgages,'' 
American Banker, April 6, 2000, also available at www.freddiemac.com/
newsanalysisambankerlet.html.
    \5\ A study of the impact on the loan market in North Carolina of 
impact recent loan legislation there had on the availability of credit 
to low- and moderate-income borrowers likewise suggests that the 
approach to reform urged by the advocates is counterproductive. In 
North Carolina, loans made by 9 AFSA companies to borrowers with 
incomes under $50,000 shrunk dramatically in the first 6 months after 
the North Carolina legislation went into effect. Michael E. Staten and 
Gregory Elliehausen, The Impact of The Federal Reserve Board's Proposed 
Revisions to HOEPA on the Number and Characteristics of HOEPA Loans, 
1418 (July 24, 2001).
---------------------------------------------------------------------------
    Subprime lenders, spurred on by Congress, have been enormously 
successful in delivering efficiently priced consumer credit to working 
American families, regardless of race, ethnicity, or background. Such 
families use mortgage credit for many purposes, among them acquiring 
homes, working their way out of credit difficulty by consolidation and 
refinancing, making home improvements, and college education. We are 
proud to report that during the last 5 years, 96 percent of those who 
have borrowed from AFSA members using subprime mortgage loans have used 
the credit successfully. Eighty five percent of those subprime 
borrowers paid in full and on time. The remaining 11 percent, in 
varying degree, may have missed a payment here and there, but 
ultimately used the credit successfully.\6\ It is true, of course, that 
subprime lending does experience higher losses than conventional 
lending. That is why it is priced as it is. But the basic point is that 
most Americans who use subprime credit use it successfully. Under what 
policy prescription would the Government deny to Americans with less 
than first class credit access to all the benefits of credit that 
middle class Americans enjoy? The 96 percent of Americans 
who use the credit extended by AFSA members successfully are not asking 
for that interference.
---------------------------------------------------------------------------
    \6\ Analysis of approximately 1.3 million mortgage loans originated 
between 1995 and July 1, 2000 by 9 AFSA members. The percentages stated 
in the text are based on all loans in the pool with relevant variables.
---------------------------------------------------------------------------
    There are some people who have been the victims of fraudulent, 
deceptive, illegal, and unfair practices in the marketing of mortgage 
loans. Advocates have mistakenly focused on loan products and features 
as the reason why these victims experienced such adverse outcomes, and 
reached the faulty conclusion that if regulation just barred certain 
loan features, the harm would have been avoided. Pursuing that mistaken 
reasoning, they have tried to label as ``predatory,'' highly regulated 
loan products and features, which are entirely legal (such as credit 
insurance, prepayment penalties, balloon payments, arbitration, and 
higher rates and fees). However, most of the loan features called 
``predatory'' are not generally known as ``predatory'' practices--they 
are legitimate, legal, and common in mainstream prime and subprime 
lending. Any legitimate consumer good or service can be marketed 
fraudulently. Indeed, the scam artist prefers to use legitimate 
products, like loans, as a cover because consumers want and need the 
product. The illegality comes in the fraudulent marketing of the good 
or service, not in the good or service itself.
    We urge that Congress not confuse the loan products that consumers 
want and need, with the fraudulent marketing practices that a few 
isolated operators have used to prey upon the unfortunate. Predatory 
lending is fundamentally the result of misleading and fraudulent sales 
practices already prohibited by a formidable array of Federal and State 
laws, including Section 5 of the Federal Trade Commission Act, criminal 
fraud statutes, State deceptive practices statutes, and civil rights 
laws. Aggressive enforcement efforts by the FTC, HUD, and the Civil 
Rights Division of the Justice Department, as well as by the States' 
Attorney Generals are underway. The existing array of State and Federal 
regulation of fraudulent practices is already sufficient to deal with 
the deceptive, fraudulent, and unfair practices that make up 
``predatory lending,'' and we suggest that there is no better deterrent 
to this type of behavior than successful prosecution. On the other 
hand, the subprime market is already very heavily burdened with 
restrictions and requirements imposed at the State and Federal levels. 
Additional regulation of the type advocates have proposed will hurt the 
vast majority of working American families by raising credit prices and 
reducing credit availability. That is simply not a desirable policy 
outcome, particularly when it is not likely to deal with the real 
problem.
    If fraudulent and deceptive practices are the root of the problem, 
what is the appropriate policy to address predatory lending?

 First, Congress should do no harm to the present system which 
    has been extremely successful in delivering consumer credit to 
    America's working families. As said before, more restrictions on 
    credit prices, terms, and practices does not address the fraud 
    which is the root of the problem, and it results in taking away 
    from working American families the lending products they desire and 
    it has been the goal of Congress to provide. Remember that over a 5 
    year period, 96 percent of those who used subprime lending from 
    AFSA members did so successfully. Such policy prescriptions as 
    lowering HOEPA thresholds and forbidding such features as balloon 
    payments, financed single-premium life, accident, and health 
    insurance and prepayment fees in more and more loans is not 
    appropriate policy, because it takes away legitimate tools to shape 
    credit to the needs of America's working families.
 AFSA has been a leader in developing educational programs to 
    help meet the enormous need American consumers have for greater 
    financial literacy. As a founding member of the Jump Start 
    Coalition, a coalition of industry, Government, and private groups 
    dedicated to increasing financial literacy, it has for several 
    years pushed strongly for increased efforts to educate Americans 
    about credit. We urge Congress to support these and other efforts, 
    because they hold the greatest promise to help over the long run. 
    As we all know, the best defense against fraudulent sales practices 
    is the informed consumer, and informed consumers can best evaluate 
    whether they want or can afford to borrow more.
 Industry self regulation likewise plays an important role. 
    AFSA has developed ``Best Practices'' which its member companies 
    have voluntarily adopted. They address the controversial terms 
    which consumer advocates have often targeted, and they strike a 
    balance between reasonable limits and providing legitimate consumer 
    benefits in appropriate circumstances. Other associations of 
    lenders, including the Mortgage Bankers Association, have adopted 
    ``Best Practices'' as well, and they hold a great deal of promise. 
    A copy of AFSA's best practices on home equity lending (Statement 
    of Voluntary Standards for Consumer Mortgage Lending) is attached 
    as Appendix A.
 Government's role is appropriately the vigorous enforcement of 
    the deceptive practices and civil rights laws. Any objective 
    analysis of these laws must reach the conclusion that they provide 
    powerful tools to address both fraudulent sales practices and 
    discrimination. Strong enforcement is appropriate because it 
    addresses the real problem, the fraudulent and discriminatory 
    practices that make an otherwise legitimate loan ``predatory,'' 
    without affecting the overall ability of lenders to make loans 
    available to working American families with less than perfect 
    credit. That is the appropriate policy balance between dealing with 
    the real misfortunes which a few borrowers have experienced and the 
    continued availability of credit to working American families. We 
    urge Congress to encourage that an appropriate balance be 
    maintained.

    Thank you for the opportunity to address the Committee, and I look 
forward to any questions you may have.






                   PREPARED STATEMENT OF LEE WILLIAMS
                 Chairperson, State Issues Subcommittee
                 Credit Union National Association, and
     President, Aviation Association Credit Union, Wichita, Kansas
                             July 27, 2001
    Good morning, Chairman Sarbanes and Members of the Committee. I am 
Lee Williams, President of Aviation Associates Credit Union, a $38 
million State-chartered credit union in Wichita, Kansas. I am 
testifying this morning on behalf of the Credit Union National 
Association (CUNA), which represents over 90 percent of the 10,500 
State and Federal credit unions nationwide. In my capacity as chair of 
CUNA's State Issues Subcommittee, I have had the privilege of carefully 
considering issues surrounding the abusive practices of predatory 
lending and appreciate the opportunity to present some of our findings.
    The credit union system abhors the predatory lending practices that 
are being used by some mortgage brokers and mortgage lenders across the 
country. America's more than 10,000 credit unions--member owned, not-
for-profit cooperatives--strive to help their 80 million members create 
a better economic future for themselves and their families.
    Predatory lending is a complex and difficult issue to resolve, as 
evidenced by the many witnesses that have testified before this 
Committee over the past 2 days. The primary targets of predatory 
lenders are subprime borrowers. Subprime borrowers are consumers who do 
not qualify for prime rate loans because of a poor credit history, or 
in some cases, simply a lack of a credit history. This segment of the 
population is of particular interest to the credit union industry 
because historically it is that population that has turned to credit 
unions for our flexibility and wide range of credit options.
    CUNA is concerned that the term ``predatory'' has become synonymous 
with ``subprime'' in the minds of some policymakers. We believe it is 
important to distinguish the difference between subprime loans and 
predatory lending practices when formulating laws or regulations to 
eliminate predatory lending practices. If sub-
prime lending is unintentionally restricted through efforts to prohibit 
predatory lending practices, the result could be a significant decrease 
in available credit to borrowers with blemished credit histories.
Credit Unions Are Not Predatory Lenders
    Credit unions do not engage in predatory practices. Credit unions 
are nonprofit, cooperatively owned financial institutions. All profits 
are returned to the credit union members, after expenses and 
distribution to reserves. To participate in any activity that would 
take advantage of our members, who are also our owners, would be 
counterproductive to our operations, our structure, and our philosophy.
    Credit unions are not in business to make money by providing 
financial services. In part, they are in business to provide financial 
services because people need them and, all too often, cannot obtain 
them at reasonable costs and terms. As the so-called ``fringe'' banking 
industry, such as payday lenders, pawn shops, and check cashers, has 
significantly expanded over the past decade, credit unions have been 
out in front to combat the devastating effects of these high-cost money 
brokers by offering alternative services at reasonable rates.
CUNA Combats Predatory Lending
    America's credit unions support the elimination of lending 
practices that are intentionally structured in a manner that is 
deceptive and disadvantageous to borrowers. CUNA and credit unions 
across the country have been establishing programs to help our members 
fight back against the effects of high-cost and predatory loans.
    At Aviation Associates Credit Union, we recently initiated the 
``Take Control'' program, which provides resources for our members 
allowing them to take control of their financial well-being and 
effectively deter the success of payday lenders and the predatory 
mortgage lenders in our community.
    Let me provide an example. Members with high interest mortgage 
loans acquired from a mortgage broker have asked our credit union for 
help because they cannot make their monthly payments. My initial 
response is to refinance these onerous loans and reduce the interest 
rate. But often that is no solution. Typically, these types of loans 
have been initially packed with so many fees--paid up front and 
financed--that the Loan to Value ratio is pushed as high as 125 
percent. My credit union, and few others, can refinance such a loan.
    Even in such a dire situation, our ``Take Control'' program can 
improve the member's financial circumstances. Our program does so 
through member education.
    With the help of an on-site consumer credit counselor (available 
twice a week), members can learn how to pay down loans faster, obtain 
lower fees and rates, and--even in the grip of such a ``predatory 
mortgage loan''--learn how to build equity faster so that the credit 
union can eventually refinance the loan.
    This is only a Band-Aid on a serious injury. When the credit union 
refinances for the member, the predatory lender wins. At Aviation 
Associates Credit Union, we believe our members must never fall victim 
to predatory lenders in the first place. That is why the ``Take 
Control'' program includes a significant education component to teach 
our members how to avoid the predatory mortgage trap. We are convinced 
that education is a critical tool in our efforts to obtain financial 
independence for our members.
    On a national level, CUNA and credit unions are active on several 
fronts to combat predatory lending. Last summer, CUNA developed 
``Mortgage Lending Standards and Ethical Guidelines'' to be adopted by 
credit unions across the country. These guidelines were designed to 
help emphasize credit unions' concern for consumers and further 
distinguish credit unions as institutions that care more about people 
than money.
    The guidelines prohibit:

 interest rates that are significantly above market rates and 
    which are not justified by the degree of risk involved in providing 
    the credit
 excessive balloon payments that require refinancing at a rate 
    that is more than the rate on the existing note
 lending without regard to whether the borrower has the ability 
    to repay
 requirements for frequent refinancing of the loan resulting in 
    additional costs to the borrower and significant erosion of the 
    borrower's equity;
 repayment penalties, in excess of actual costs incurred and 
    unpaid
 exorbitant fees and insurance premiums that the borrower may 
    be required to finance, further jeopardizing equity
 misleading or false advertising

    A copy of these guidelines are attached to this statement.
    One of the most important programs CUNA is currently promoting to 
combat predatory lending practices is financial education of our 
Nation's youth. Credit unions believe that by educating our young 
people in the area of personal finance they will learn to make sound 
financial decisions and choose not to use high-cost or predatory 
lenders.
    CUNA has partnered with the National Endowment for Financial 
Education (NEFE) and the Cooperative Extension Service (CES) to expand 
financial education among teens throughout America. Through this 
partnership CUNA, NEFE, and CES provide an educational curriculum and 
materials to high schools across the country to combat financial 
illiteracy.
    In addition to providing necessary materials, credit unions 
actively participate in the classrooms. During the 1999-2000 school 
year credit unions conducted over 5,000 financial education 
presentations reaching approximately 130,000 students nationwide.
    Because credit unions are an important component of the solution to 
predatory lending--not part of the problem--CUNA has supported 
regulatory proposals that would strategically address predatory lending 
concerns without unduly burdening credit unions in the process. For 
example, CUNA supports the Federal Reserve Board's proposed change to 
Regulation Z, which is targeted only to high-cost loans under the scope 
of the Home Ownership and Equity Protection Act. CUNA has not supported 
regulatory proposals that are not carefully constructed to address only 
predatory lending problems, such as the Fed's proposed changes to amend 
Regulation C, Home Mortgage Disclosure Act (HMDA). This proposal would 
require all covered lenders, whether they make high-cost loans or not, 
to face additional, significant and costly reporting burdens not 
required by the HMDA. CUNA will continue working with the regulators to 
develop strategies that will protect consumers without imposing broad-
based requirements that divert them from their primary mission of 
serving the financial needs of their members.
Credit Unions Often Use Subprime Lending Programs
To Improve Consumers' Credit
    A growing number of credit unions offer subprime loans to members 
who do not qualify for a prime rate loan. Subprime loans are offered to 
members at rates above the prime rate to offset the higher risk of 
lending to members with poor credit histories. Credit union subprime 
loans are not predatory. They are a necessary tool that gives borrowers 
with poor credit histories the ability to build, or rebuild, their 
credit.
    To help illustrate some of the alternative subprime lending 
programs offered by credit unions, CUNA created the Equitable Subprime 
Lending Task Force last February. The Task Force has recently completed 
a handbook entitled: Subprime Doesn't Have to Be Predatory--Credit 
Union Alternatives, which is included as an attachment to this 
statement.
    Some credit union subprime loan programs, such as Aberdeen Proving 
Ground Credit Union's ``Credit Builder'' program in Aberdeen, Maryland, 
are designed to help borrowers improve their credit standing. This 
program offers subprime loans at 2 percent or 4 percent above normal 
rates, depending on collateral, but these higher rates automatically 
drop when the borrower makes 12 on-time payments.
    In this program, the borrower is well informed that if he or she 
has one payment that is over 30 days past due any time during the first 
year of the loan, then the borrower is locked into the higher rate for 
the life of the loan. But, if the borrower makes the first 12 payments 
on time, the loan rate will automatically drop to the prime rate. 
However, the borrower must continue the timely payments for the life of 
the loan to retain the lower rate. If, after the first year of on-time 
payments, the borrower misses a payment, then the rate reverts to the 
higher rate again for the life of the loan. This loan is structured as 
an incentive to make on-time payments.
    In Seattle, Washington, the Washington State Employees Credit Union 
all too often saw single income families struggling to make ends meet 
while the American Dream of homeownership remained beyond their grasp. 
To help more consumers buy homes, the credit union developed the 
``First Step'' program. This program requires only percent down, an 
interest rate of .50 percent above the standard Fannie Mae 30 year 
fixed rate, and certification that the borrower has attended a 
homebuyer education seminar by a local agency or group. To qualify for 
this loan, the borrower's income cannot be above a certain level and 
the purchase price of the home must be below maximum limits.
    The credit union staff work closely with these borrowers through 
the life of the loan offering financial guidance and budgeting 
assistance to promote success for this program, as well as for the 
borrowers.
    The credit union has allocated $20 million to this program and has 
been very successful getting people into homes that could not 
ordinarily qualify for a mortgage anywhere else.
    And Antioch Schools Federal Credit Union, located in California, 
offers its subprime borrowers several ways to reduce their interest 
rates, while picking up smart credit habits in the process. This ``Rate 
Reduction'' program includes:

 a \1/2\ percentage rate reduction for attending one consumer 
    credit counseling class;
 a 1 percent rate reduction for attending more than one 
    consumer credit counseling class;
 a 1 percent rate reduction for each year of the term of the 
    loan that there are no draws or escalation of debt during that 
    year;
 and to promote savings, the Antioch Schools Credit Union will 
    drop a subprime borrower's rate one half percent if the borrower 
    makes a deposit of at least $15 a month to a savings account and 
    keeps it on deposit for a year.

    With the many positive programs being developed in the subprime 
lending market to assist consumers of all economic circumstances, 
credit unions urge policymakers to address the abuse of lending 
practices rather than complete prohibition of practices that, when used 
legitimately, provide flexibility and credit options to meet individual 
borrowers' needs.
Credit Unions Urge: Eliminate Predatory Practices, Not Subprime Lending
    Credit unions urge policymakers to use a scalpel, not an elephant 
gun, when drafting legislation to eliminate predatory lending 
practices. Subprime borrowers need to be served. Credit unions do not 
want to lose their ability to create flexible subprime loan programs.
    For example:

 Bona Fide Discount Points Should Not Be Eliminated. Credit 
    unions are concerned that a definition of ``high-cost mortgage'' 
    that includes ``total points and fees'' and lowers the HOEPA 
    threshold to 5 percent could restrict the use of discount points, 
    which in many cases borrowers pay for the purpose of reducing the 
    interest rate or time-price differential applicable to the loan. 
    This is an important loan option for some borrowers who intend to 
    stay in their home for a long time.

          CUNA recommends that bona fide buy down points be excluded 
        from the definition of ``high-cost mortgage'' where the 
        borrower has a completely free choice among a set of interest 
        rate and point combinations.

 Legitimate Balloon Notes Should Not Be Prohibited. Credit 
    unions are concerned that strictly prohibiting balloon payments 
    will eliminate a legitimate credit option for lenders who wish to 
    extend loans without holding excessive interest rate risk or for 
    borrowers, under specific circumstances, to obtain lower monthly 
    payments.

          CUNA recommends that balloon payments be allowed if the 
        borrower has the option of continuing the loan at the then 
        current interest rate available from that lender for similar 
        borrowers with no additional costs or fees.

 Financing Points and Fees Should Be Allowed When in the Best 
    Interest of the Borrower. There may be cases where it is in the 
    consumer's best interest to refinance an existing high-cost 
    mortgage. Credit unions are concerned that a strict prohibition of 
    the financing of certain points and fees could limit borrowers' 
    options and in many cases, access to credit.

          CUNA recommends that legislation restricting the financing of 
        points and fees include an exception for transactions in which: 
        (a) the action provides a material benefit to the consumer, and 
        (b) the amount of the fee or charge does not exceed, (i) an 
        amount equal to 1.0 percent of the total loan amount, or (ii) 
        $600 in any case in which the total loan amount of the mortgage 
        does not exceed $60,000.

    Again, let me say that I am very pleased you are holding these 
hearings. Credit unions are very anxious to see the abusive practices 
of predatory lending eliminated. Credit unions have taken positive 
steps in that direction through their voluntary efforts to educate 
their members and provide them with fair and sound alternative 
products. It is our hope that we will have allies in our efforts to 
assure that all consumers have access to credit products that do not 
unfairly take advantage of their circumstances.
    Thank you, and I will be happy to answer any questions.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
                    PREPARED STATEMENT OF MIKE SHEA
                   Executive Director, ACORN Housing
                             July 27, 2001
    Good morning, Chairman Sarbanes and Members of the Banking 
Committee. My name is Mike Shea, and I am Executive Director of ACORN 
Housing Corporation, which has worked for the past 17 years to build 
equity through increased homeownership in low- and moderate-income 
communities and communities of color. We have been fighting to allow 
people in our neighborhoods to buy their own homes, and worked with 
some of the major banks to make that happen. AHC now has offices 
providing housing counseling in 27 cities across the country and last 
year alone helped 9,400 families close on home purchase loans.
    The subprime industry likes to claim credit for increasing 
homeownership among minorities and low- and moderate-income families. 
but the vast majority of their business is in refinancing loans and 
making second mortgages, not helping people buy homes. According to 
last year's HUD/Treasury report, of first-lien mortgages made by 
subprime lenders. Eighty two percent were refinances.
    The increased rates of homeownership among underserved populations 
over the last decade are due almost entirely to banks starting to live 
up to their obligations under the Community Reinvestment Act. That is 
happening for a variety of reasons--continued pressure from community 
organizations like ACORN, somewhat more effective monitoring of CRA 
preformance, and, most importantly, the banks' realization that they 
had been neglecting good business opportunities. Do not get me wrong--
there is a tremendous amount yet to be done and many banks that receive 
passing grades are not living up to their CRA obligations, but we have 
made progress and that needs to be recognized.
    Increasingly, however, we are finding that predator lending abuses 
are threatening that progress. As soon as families in our communities 
start to build up some equity, they are bombarded with offers to 
refinance their mortgages or take out additional debt--receiving three 
or four letters a week and regular phone calls.
    We know people have heard the numbers before, but we really need to 
seriously think through the consequences of more than half of refinance 
loans in communities of color being made by subprime lenders. Now not 
all subprime lending is predatory, but it is a sad fact that abusive 
practices are running rampant in the subprime 
industry.
    When you consider that number in combination with the observations 
that Fannie Mae and Freddie Mac and others have made about the market--
that 30 percent, 40 percent, or more of borrowers in subprime loans 
could have qualified for ``A'' loans, you are clearly talking about an 
incredible drain of equity from those communities which can least 
afford it. At a minimum, these numbers represent huge numbers of 
borrowers paying interest rates 2 to 3 percent higher than they would 
be if they instead had gotten an ``A'' loan. Over the life of a 30 year 
mortgage for $100,000, the difference in payments between interest 
rates of 8 percent and 10.5 percent is over $65,000.
    Too often, however, predatory features make this bad situation even 
worse--by stripping the equity from borrowers homes with high financed 
fees, prepayment penalties, and add-ons like financed single-premium 
credit insurance. Borrowers are effectively trapped in unfair high-rate 
loans by these features, or they lose tens of thousands of dollars of 
equity from the encounter. Sometimes, they even lose their homes 
entirely. The lender wins and wins, the borrower loses and loses.
    There is a desperate need for Federal legislation to prevent the 
abuses, cut down on the stripping of equity, and help families keep 
their homes. While it is impossible to prevent every bad loan, good 
legislation could solve a lot of the problems in the subprime industry 
and make a huge difference in protecting homeowners.
    If we want a subprime market that works for consumers' interests, 
we cannot have huge fees financed into home loans--six times what banks 
are charging for providing the same service. We cannot have long 
extended prepayment penalties for several thousand dollars that trap 
borrowers in high-cost loans. As more lenders are recognizing in 
response to public pressure, we cannot have single-premium credit 
insurance policies that strip equity and tack on additional interest 
charges to an already overpriced product. If we want a market that 
works for borrowers, we cannot have loans being flipped over and over. 
That means taking away the current incentive for lenders to keep 
profiting from huge fees and other add-ons and make lenders' income 
streams more dependent on their loans actually being repaid.
    In short, we have to get rid of all the tricks and hidden practices 
that make it impossible for borrowers to know what kind of loan they 
are getting into. What you have now is a situation where it is very 
difficult for even trained loan counselors sometimes to understand all 
the damaging bells and whistles in many subprime loans--let alone a 
borrower trying to look for their own interests. That should not be how 
getting a home loan should work. It is not what happens in the ``A'' 
market. But that is what happens everyday in the subprime market. And 
despite the industry's substantial public relations efforts, the market 
has not taken care of it. We need a strong, clear set of rules that 
will allow homeowners to navigate the subprime market with some basic 
assurances of safety. Without such rules, large numbers of borrowers 
will not stand a chance.
    We hear the argument that we do not need legislation, but just more 
education and financial literacy for borrowers. We certainly support 
financial literacy efforts--in fact I would venture that we have, in 
fact, done more to inform people in lower-income and minority 
communities about these issues than most. Part of what we have learned 
from this experience, though is what the limits of this approach are. 
First, there is the question of resources--until we are ready to spend 
the $1,500 to $2,000 per borrower that lenders can spend hawking their 
products we will never catch up. And second, no advertisement, or bus 
billboard, or even workbook, is going to compete with the one-on-one 
sales pitch of a lender--who still knows more about the process.
    We have also heard the argument that all that is needed is better 
enforcement of existing laws. We see a lot of borrowers in 
heartbreaking situations, and we have tried to use current laws to help 
protect them, applying all the pressure we know how to get it enforced. 
But by and large, this has not worked. HOEPA covers only a tiny 
fraction of loans, and even there it mostly requires disclosures--as 
long as the right paper was slipped somewhere into the pile, there is 
often little the borrower can do. Fraud and deceit are against the law, 
but they have also been extraordinarily difficult to prove. It turns 
into a matter of ``he said, she said'' and when the lender knows more 
about the transaction, and has the paperwork, the borrower loses. And 
when we hear certain industry groups suggest the solution is better 
enforcement of current law, we are left wondering how they expect that 
to happen if they routinely include mandatory arbitration clauses in 
their loans.
    What we need are some basic rules covering a broader group of high-
cost loans that create a level playing field where a borrower in the 
subprime market, like a borrower in the ``A'' market, has a set of 
understandable options to choose between.
    Buying or refinancing a home is a lot more like buying medicine 
than like buy-
ing a pair of shoes; if you are misled and buy the wrong one, the 
consequences are pretty serious. We do not expect every patient to read 
the New England Journal of Medicine and evaluate for themselves which 
drugs are safe and which are not. Instead, the FDA makes some rules 
about what is too dangerous to be sold. And then inside that relatively 
safer space, patients still have plenty of work to do to figure out 
what is best for them. We need to make some rules in the same way about 
home loans.
    With regard to regulation, I should add that we were pleased that 
the Federal Reserve Board issued a proposed rule on HOEPA and one on 
HMDA. And that we are now growing extremely concerned about their 
silence since then. The Board needs to issue their rule, and they need 
to insist on the limited steps laid out in the proposed version--like 
improving the collection of HMDA data to include APR information. That 
said, the proposed rules were silent on many crucial areas crying out 
for action, and which we need legislation to address.
    In the spirit of comity, I will end on an issue of clear agreement 
with the lending industry. We share the industry's belief that a 
variety of State and local anti-
predatory lending legislation is not the ideal solution. We would like 
to see Federal protections for all Americans, and that is why we 
strongly support legislation the Chairman will be introducing in the 
near future.
    As long as there is not Federal legislation, though, it is clear to 
us that our members, and community residents and State and city 
officials around the country will not, and cannot, sit by idly while 
borrowers are so badly hurt by predatory loans. The list of States and 
localities where antipredatory lending measures have been considered, 
or are presently being considered, include California, New York, 
Massachusetts, North Carolina, Philadelphia, Sacramento, DeKalb County 
(Georgia), and the list will keep growing. Just on Tuesday, the Oakland 
city council voted unanimously for a strong local ordinance restricting 
predatory lending practices, and there are many more like that to come. 
We are going to keep pushing our Senators and Representatives to get on 
board, but we are not going to wait for you. The stakes are too high.
































RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM JUDITH A. 
                            KENNEDY

Q.1. Is there a definition for predatory lending? Or do you 
know it when you see it?

A.1. NAAHL recently conducted a symposium for advocates, 
lenders, and policymakers on developing workable solutions to 
predatory lending. Based on remarks at the symposium, a profile 
of predatory lending emerged. Loan flipping, home improvement 
scams, asset-based and unaffordable mortgage loans, repetitive 
financings with no borrower benefit, packing single-premium 
credit life insurance and other products into the loan amount, 
all of which can strip equity and trigger foreclosures.

Q.2. What can be done about the unregulated brokers and home 
improvement contractors who are bad actors?

A.2. More needs to be done at the Federal level. Currently, a 
significant amount of mortgage lending is not covered by a 
Federal framework. As the Federal Reserve has pointed out, only 
about 30 percent of all subprime loans are made by depository 
institutions that have periodic exams. To stop the predators, 
we need to close the barn doors on examination and reporting. 
In addition, increased Federal resources for expanding existing 
public and private sector consumer education programs in 
neighborhoods that are 
vulnerable to predators could be extremely helpful in combating 
predators.

Q.3. In the securities industry, there is a ``suitability 
standard'' for brokers putting clients into appropriate 
brokerage activities. What do you think about applying a 
suitability standard for brokers/lenders who put low-income 
borrowers into subprime loans?

A.3. We believe such standards would be appropriate. In NAAHL's 
comment letter earlier this year to the Federal Reserve on 
proposed changes to the Homeowners Equity Protection Act 
(HOEPA), we supported a number of proposals by the Fed that 
would help ensure that subprime loans are appropriate for 
borrowers. Frequent refinancings, commonly known as ``loan 
flipping,'' generally are not in the borrower's best interest. 
Therefore, we strongly supported the proposed prohibition on 
refinancing loans within the first 12 months, unless the 
creditor can demonstrate that the refinancing is in the 
borrower's best interest.
    Similarly, we are in favor of the proposed prohibition on 
refinancing zero-rate or other low-cost loans within 5 years 
unless the creditor can demonstrate that the refinancing is in 
the borrower's best interest. In addition, we believe there is 
merit in the proposal to require creditors to demonstrate a 
consumer's ability to repay HOEPA loans to mitigate the 
practice of making asset-based HOEPA loans. We also supported 
the proposed prohibition on HOEPA demand loans and the 
structuring of what, in reality, are closed-end loans into 
open-end financing merely to avoid HOPEA restrictions on asset-
based loans.

Q.4. Why are better disclosures and/or financial education not 
sufficient remedies for predatory lending problems?

A.4. NAAHL's recent symposium on solutions to predatory lending 
showed that predatory lending is a multifaceted problem 
requiring a multifaceted response. Better disclosure and 
additional financial education are certainly part of the 
solution, but the problem is broader. As I indicated earlier, 
the Federal Reserve estimates that only 30 percent of subprime 
loans are made by institutions that have periodic exams. If the 
Federal Reserve were to do periodic compliance exams of the 
subsidiaries of financial holding companies, that would take it 
up to about 40 percent. Nonetheless, the majority of subprime 
loans still would not be covered. In a town with no sheriff, 
the bandits are in charge.

Q.5. I understand Philadelphia enacted a city ordinance 
regarding predatory lending and the Pennsylvania legislature 
passed a law preempting county and/or city ordinances. What do 
you think about State legislatures preempting county and/or 
city ordinances regarding predatory lending?

A.5. The broader issue is the need for a level playing field in 
oversight and enforcement. Insured depository institutions, the 
vast majority of whom engage in best practices in the subprime 
lending market, are of course subject to regulatory oversight 
and compliance. But the majority of subprime lenders are not 
subject to the same regulatory oversight, do not have the same 
level of compliance management and often do not even file HMDA 
reports. The growing plethora of widely varying State and local 
laws only exacerbates this disparity--and threatens to drive 
out responsible lenders who will choose not to offer legitimate 
subprime loans. The 
solution is to bring all lenders under a uniform Federal 
framework that eliminates predatory practices without turning 
off the flow of legitimate subprime credit.

Q.6. Is your concern about SPCLI related to the product or the 
marketing of the product?

A.6. We are concerned with the product itself, which has been 
associated with high-cost loans that strip equity from the 
home.

    If I can provide any additional information, please call 
me. Our members are very committed to working with policymakers 
on addressing this critical problem, and we would be happy to 
help you in any way.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM ESTHER 
                         ``TESS'' CANJA

Q.1. Is there a definition for predatory lending? Or do you 
know it when you see it?

A.1. Conceptually, a higher-interest rate premium paid by an 
appropriately classified subprime borrower should be 
proportionate to the added risk the borrower may pose to a 
lender. Anything in excess of that proportionate premium is 
exploitive. Of course, to misrate a borrower as being a 
subprime risk when in fact the borrower should be ``A''-minus 
rated, would also be exploitive and thus predatory in nature. 
In direct response to your question: The four principal Federal 
banking regulators (FRB, OCC, RTS, and FDIC) issued guidance to 
their examiners in January 2001 in which they provide a common 
threshold definition of predatory lending as:

 making loans that a borrower will be unable to repay;
 inducing borrowers to refinance a loan in order to 
    charge high fees or points (so-called ``loan flipping''); 
    and
 engaging in fraud or deception to conceal the true 
    nature/features of a loan.

    While AARP believes that this definition is too narrow in 
scope, it does identify the core features of a predatory loan.

Q.2. What can be done about the unregulated brokers and home 
improvement contractors who are bad actors?

A.2. Older homeowners have lost their homes because of home 
repair or consolidation loans made at exorbitant interest rates 
and fees by unscrupulous lenders and brokers. AARP believes 
that the U.S. Department of Housing and Urban Development's 
regulations should require that lenders disclose to consumers 
the amount and source of mortgage broker fees before any 
agreement is reached. Special premiums or other kickbacks paid 
by lenders to mortgage brokers for steering customers to 
higher-yield loans should be outlawed or, at a minimum, 
disclosed upfront before consumers apply for a loan. Clearly, 
new protections need to be enacted for home improvement 
borrowers victimized by contractor nonperformance or 
malfeasance.

Q.3. In the securities industry there is a ``suitability 
standard'' for brokers putting clients into appropriate 
brokerage activities. What do you think about applying a 
suitability standard for brokers/lenders who put low-income 
borrowers into subprime loans?

A.3. The notion of a suitability standard for brokers and 
lenders has some appeal if it is based on concrete protective 
provisions. Specifically, mortgage brokers and lenders should 
be required to comply with fair-lending rules addressing, among 
other things, interest rates, fees, marketing, service areas 
and application acceptance procedures. Mortgage brokers/lenders 
should be required to provide a binding offer of mortgage terms 
and costs that would be good for a set period of time after 
issuance. The binding offer would include the principal amount 
of the loan; the interest rate, points, and any other costs; 
the type and term of the mortgage; a consolidated rate or price 
tag similar to an annual percentage rate; and the amount of the 
monthly payment. A lock-in of terms (as reflected in the 
binding offer) should be required once a consumer applies for 
the loan.
    In addition to these standards, AARP believes that the Home 
Ownership and Equity Protection Act of 1994 (HOEPA) should be 
strengthened by lowering current trigger mechanisms (interest 
rates, points, and fees) so that the protections of the Act 
apply to more loans. More effective measures should be enacted 
for policing unscrupulous loan practices that typically target 
older homeowners with low incomes. And finally, enhanced 
protections and remedies need to be created to make the 
standards effective.

Q.4. Why are better disclosures and/or financial education not 
sufficient remedies for predatory lending problems?

A.4. AARP does believe that both better disclosures and 
financial education are important and necessary tools that can 
help many consumers avoid being victimized by predatory 
lenders. However, better disclosure and education alone are not 
sufficient remedies for preventing the financial exploitation 
of many of those who are among the most vulnerable. Limiting 
the remedy to disclosures and nonmandatory, nonstandardized 
financial literacy campaigns would have the effect of shifting 
the burden for prevention to a portion of the population with 
the fewest skills to benefit from these remedies, that is, 
those with the least formal education.
    Consider the complexity of mortgage finance documentation 
and processes and the frequent disconnect between the level and 
timing of and limits of exposure to financial literacy 
campaigns. On the other hand, what part of the remedy would 
hold the predatory lender accountable? The right to protection 
against predatory lending practices should be equally valid for 
all consumers who have or may be victimized, and lenders/
brokers that use these tactics should be held accountable for 
their acts and for harm done.

Q.5. I understand Philadelphia enacted a city ordinance 
regarding predatory lending and the Pennsylvania legislature 
passed a law preempting county and/or city ordinances. What do 
you think about State legislatures preempting county and/or 
city ordinances regarding predatory lending?

A.5. On the issue of preemption, AARP recognizes that cities 
and counties derive their authority from the State government. 
The State of Pennsylvania can and did act. We are disappointed, 
however, that after looking at the apparent prevalence of 
predatory lending practices in the Philadelphia area, the State 
did not move to protect vulnerable consumers--especially the 
elderly, throughout the State. It is the gaps in State level 
protection of consumers across the Nation from the practices of 
predatory lenders that is stimulating the desire for minimum 
Federal standards.

Q.6. Is your concern about single-premium credit life insurance 
(SPCLI) related to the product or the marketing of the product?

A.6. Both. On the one hand, we are concerned that brokers and 
lenders be prohibited from engaging in unfair, deceptive, or 
unconscionable practices in connection with a consumer credit 
transaction. And on the other hand, we have questions about why 
SPCLI is needed and how SPCLI is being financed. The packing of 
``lump-sum'' insurance products is a commonly used tactic of 
high-cost lenders to inflate the mortgage loan amount, and 
thus, the monthly payments of at-risk borrowers, while evading 
HOEPA's reach. This practice is particularly problematic 
because this type of insurance is generally packed onto 
mortgage loans without the borrower's knowledge or actual 
consent. Moreover, credit insurance can be the most expensive 
component of the loan.

Q.7. If SPCLI is removed from the marketplace, what are 
subprime borrowers to do when they wish to insure their 
financial obligations and monthly alternatives have not been 
approved in their States?

A.7. AARP believes that credit insurance and insurance 
substitutes should be optional, but if accepted as part of the 
loan, should be included in the HOEPA points and fees trigger. 
In the latter case, however, one important issue would remain: 
If the borrower were given the ability to cancel the insurance 
and receive a ``full refund,'' it would still not adequately 
address the problem of insurance packing. Unless the refund is 
structured so that the refund is applied to reduce the amount 
of the loan, the borrower continues to pay interest on it over 
the life of the loan. It is AARP's view that if the borrower 
truly wants insurance, it can be sold on a monthly basis--
easily cancelable--and without HOEPA implications.

Q.8. Yesterday [July 26], we had a lively discussion about the 
cost of SPCLI. One witness said that if you go to a Monthly 
Outstanding Balance basis it is more expensive than over the 
term of the loan. Another witness disputed that. Do you have a 
view on this issue?

A.8. We have not done the calculations, and so do not have a 
recommendation to offer. As we mentioned above, AARP's 
principal concern is that this type of insurance or its 
substitutes be optional, and that it not be financed as part of 
a home equity loan.

Q.9. I have heard that SPCLI is a better deal for consumers 
over 41 years of age because it is cheaper and it is generally 
more available than the traditional term life insurance. Would 
anyone care to comment on that view?

A.9. AARP believes that borrowers must first be informed of any 
requirement and/or need for SPCLI or its substitutes as part of 
securing a home equity loan, their options and alternatives, 
before cost comparisons become meaningful.

   RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM IRV 
                           ACKELSBERG

Q.1. Is there a definition for predatory lending? Or do you 
know it when you see it?

A.1. Much like the term ``unfair and deceptive practices,'' 
predatory lending encompasses a range of abusive activities 
that, when present, enable someone who knows what to look for, 
to ``know it when he sees it.'' But it certainly can be 
defined, to varying degrees of precision, with the 
understanding that no definition could ever exhaust all 
imaginable lending abuses. A recent New Jersey appellate 
decision adopted a simple guidepost: predatory lending is the 
``target[ing] of certain populations for onerous credit 
terms.'' Associates Home Equily Services, Inc. v. Troup, 2001 
N.J. Super. LEXIS 318 (decided July 25, 2001). This is a good 
place to start. Predatory lending encompasses lending that 
takes advantage of certain borrowers, involving both targeting 
of vulnerable ``prey,'' and credit products that carry onerous 
terms. This definition can be refined by looking, 
alternatively, at each of these two perspectives, (1) the 
targeting behavior of the lenders and (2) credit terms that are 
``onerous'' under agreed upon standards.
    Regarding the use of targeting, it is important to 
distinguish targeting from marketing. Often, a predatory 
lending scenario involves an offer of money that seeks out a 
borrower, rather than a borrower with a particular credit need 
who is shopping for the best product. Predatory lenders tend to 
target rather than market, identifying individuals or 
neighborhoods as having characteristics that make them 
vulnerable. For example, many lenders or brokers target 
borrowers who already have a subprime mortgage recorded on 
their property, a fact that identifies a consumer who might be 
vulnerable to sales pitches laced with promises to improve on 
the existing loan and to ``put cash in your pocket.'' Sometimes 
the targeting is done by intermediaries, such as brokers, 
contractors, or collectors, rather than by the lenders. For 
example, in depositions of Equicredit employees we have learned 
that this lender regards the ``customer'' as the broker who 
brings it the loan, not the borrower, with whom the lender has 
no direct communications at all prior to a closing.
    From the perspective of the loans themselves, a predatory 
loan involves a mismatch between the cost of the credit, on the 
one hand, and the risk to the lender or the needs of the 
borrower, on the other. These loans tend to be extremely 
costly, containing price components that are well in excess of 
any calculated risks. Often, loans that are already priced with 
rates that reflect higher risk are also packed with excessive 
points, fees, and insurance products. Fannie Mae and Freddie 
Mac have determined that a substantial segment of the subprime 
mortgage market actually involves borrowers who have credit 
decent enough to qualify for prime products. This mismatch 
between cost and risk can also be apparent in loan terms other 
than price, where, for example, balloon clauses, prepayment 
penalties and ``no doc'' income verifications are imposed in 
clearly inappropriate circumstances. In addition to seeing 
loans containing costs and terms disproportionate to risk, we 
also see costs disproportionate to the actual benefit obtained 
by the consumer. Every day we see cases of borrowers paying 
extremely high transaction costs for credit that is providing 
them with little or no discernible benefit, as for example, 
when borrowers refinance to higher rates, or consolidate 
obligations that they have no reason to pay, such as utility 
bills deferred by low-income assistance programs.
    Finally, predatory lending can also be defined in terms of 
the ``equity stripping'' that results from including excessive 
fees and charges in loan principals and from unnecessary 
consolidations of unsecured debt. This effect is multiplied 
each time a refinancing 
occurs.

Q.2. What can be done about the unregulated brokers and home 
improvement contractors who are bad actors?

A.2. One clear thing that could be done would be to pin 
responsibility for their bad acts on the lenders who utilize 
these intermediaries as ``bird dogs.'' Section 3(f)(2) of S. 
2415 would subject ``any assignee or holder'' of a covered 
mortgage ``which was made, arranged, or assigned by a person 
financing home improvements'' to all claims and defenses which 
the consumer could assert against the contractor and, if a 
broker were involved, to claims against the broker, as well. I 
describe this issue at some length in my written testimony. In 
analyzing the problem of bad brokers, one additional obstacle 
to developing consumer remedies is the insistence of many 
mortgage brokers--often supported by State regulators--that 
they have no fiduciary obligations toward borrowers. Indeed, I 
have frequently heard the brokers claim that they are neither 
agents of the borrowers or the lenders and that they somehow 
are representing only themselves. Congress could certainly put 
a stop to such claims by requiring brokers to represent either 
the borrower or the lender and to disclose the nature of their 
role.

Q.3. In the securities industry there is a ``suitability 
standard'' for brokers putting clients into appropriate 
brokerage activities. What do you think about applying a 
suitability standard for brokers/lenders who put low-income 
borrowers into subprime loans?

A.3. Your question directly addresses the ``mismatches'' in 
predatory lending scenarios that I discussed in response to 
your first question, namely, the need to do something about the 
clash between credit terms that are imposed and what seems 
appropriate under the circumstances. I am familiar with 
proposals to impose a ``suitability standard'' on brokers and 
or lenders. I think each of these actors should be looked at 
separately.
    There certainly is a need to make explicit the legal 
responsibility of mortgage brokers toward the borrowers whose 
loans they are arranging. The simplest way to do this is make 
clear that brokers have fiduciary relationships with borrowers. 
If Congress were to do that, there would be ample common law on 
the duty of fiduciaries that would then be applicable to 
mortgage brokers. While a Federal suitability standard would be 
an improvement over the current state of affairs, I fear that 
``suitability'' would be regarded similarly as the 
``unconscionability'' doctrine in contract law, namely, a vague 
standard that would give little comfort to lenders and judges 
who are generally looking for more bright lines to guide their 
decisions. I realize that ``fiduciary relationship'' has some 
vagueness to it as well, but I believe that the extensive 
common law development of this concept would lend itself to be 
a more effective tool. I also suspect that lenders would prefer 
this approach because if a broker were a fiduciary of a 
borrower, a court would likely not characterize the broker as 
an agent of the lender.
    While lenders are not ordinarily viewed as having 
fiduciary-like obligations toward applicants for credit, I do 
believe that lenders should be more accountable for the credit 
terms they impose in the case of loans that exceed agreed upon 
levels of cost. This is the existing approach under HOEPA, and 
is much easier to apply to lenders than a ``suitability'' 
standard. Any lender that prices a loan beyond statutory cost 
thresholds should simply be prohibited from including certain 
features in a loan, like, for example, repayment terms that the 
borrower cannot verifiably afford.

Q.4. Why are better disclosures and/or financial education not 
sufficient remedies for predatory lending problem?

A.4. The best way I can answer this is to make the comparison 
to other dangerous products in the marketplace. Should consumer 
education about the danger of SUV's tipping over on the highway 
be a sufficient response to manufacturer greed and negligence? 
Should a ``just say no'' campaign be the only policy response 
to the drug pushers on urban streetcomers? Predatory loans are 
poisonous. While we need to educate vulnerable homeowners about 
the dangers, we should also be attempting to address the 
abusive practices directly.
    As for improving the disclosures that are part of the 
paperwork in a mortgage transaction, it is difficult for me to 
see this as an effective strategy. Presently there are about 
five or six pieces of paper in a typical transaction that 
contain Federally mandated disclosures. These papers are among 
the 30 or so loan documents presented to a borrower at a loan 
closing, in a paperwork stack at least an inch thick, and their 
usefulness is often undermined by the order of signing and the 
oral explanation that is provided by the party conducting the 
closing. Tinkering with the five or six disclosure documents is 
not going to effect the size or readability of the entire 
stack, or these other contextual impediments to the information 
in the disclosures actually getting to the consumers.
    From my experience, the bad actors would be very happy to 
see Congress impose new disclosures and support consumer 
education, while leaving them free to continue the stripping of 
equity out of vulnerable communities.

Q.5. I understand Philadelphia enacted a city ordinance 
regarding predatory lending and the Pennsylvania legislature 
passed a law preempting county and/or city ordinances. What do 
you think about State legislatures preempting county and/or 
city ordinances regarding predatory lending?

A.5. For me the important question is whether Government is 
adequately protecting those consumers who are in need of 
protection, not whether this protection comes from local, State 
or Federal policymakers. Uniform protections are better than 
local ones, but local protections are better than none.
    In April 2001, the Philadelphia City Council unanimously 
enacted antipredatory lending to protect the homeowners of 
Philadelphia. Philadelphia is a home rule city that retains the 
power to legislate in all areas not preempted by State 
legislation. In June, the legislature passed preemption 
legislation on the last night of the legislative session; they 
did so as an amendment to an already passed bill, without any 
study and without any public hearing. The State legislation 
does nothing to protect vulnerable homeowners. It duplicated 
the coverage and protection under HOEPA, and limited consumer 
remedies to a damage action that must prove ``pattern and 
practice'' and actual intent to violate the law. Thus, for 
example, a consumer who gets a balloon payment prohibited by 
the law cannot do anything to undo the transaction. Because the 
State su-
perceded strong local legislation with nonexistent State 
protections, the preemption ended up hurting Philadelphia 
consumers under the banner of ``uniformity.''
    The Pennsylvania lesson is an important one for Congress. 
State and local laws that protect consumers should not be 
preempted without ensuring that adequate Federal restrictions 
and remedies are in place to combat predatory practices.

Q.6. Is your concern about single-premium credit life insurance 
(SPCLI) related to the product or the marketing of the product?

A.6. Both. The product itself is overpriced because its pricing 
builds in too much profit for the middlemen. Further, it is not 
even really known how overpriced it is, because in addition to 
upfront commissions, there are back-end revenue sharing 
mechanisms, which may not show up as commissions. State 
insurance departments have a difficult time in monitoring the 
true reasonableness of the rates, because the insurers 
sometimes ``fog'' the data and, because of insufficient 
enforcement resources, credit insurance ends up being a lower 
priority for those limited resources than the much larger 
standard life, health, and property insurance.
    Until there is pricing reform on the product itself, 
marketing reforms will not work, as three decades of effort in 
that regard have proven. When the profit is too great, a way 
will be found to sell the product. Indeed, it is not even 
accurate to refer to the selling as ``marketing,'' given the 
ever-present ``packing'' of insurance products into the loans 
of lenders who have been most involved in the sale of SPCLI. 
Affidavits from former employees of The Associates, for 
example, have made very clear that loan officer job performance 
and compensation were dependent on their getting borrowers to 
sign up for SPCLI, just like car salesmen are expected to sell 
``extras'' like rustproofing or service contracts.

Q.7. If SPCLI is removed from the marketplace, what are 
subprime borrowers to do when they wish to insure their 
financial obligations and monthly alternatives have not been 
approved in their States?

A.7. Few borrowers who truly understood the full financial 
impact of SPCLI, and the often limited benefits it provides, 
would choose to purchase it. It is only because the full cost 
and the limited benefits are obscured, or because borrowers are 
fooled into purchasing it, that the product is sold. Even, an 
industry-financed study indicated that fully 40 percent of 
borrowers thought that SPCLI was required, strongly urged, or 
that there would be delays if they did not buy it. 
Consequently, the number of borrowers who do purchase it 
cannot, with statistics like that, be considered a valid 
indicator of ``demand.''
    As for alternatives, noncredit term life insurance is more 
value for the dollar, and most objective advisors (for example 
those who do not make money from the product) advise to use the 
noncredit insurance. As for delays in State approvals of 
monthly alternatives to SPCLI, it is typically the providers 
who approach the insurance departments for approval when they 
want to sell the monthly alternative. And, once this occurs, 
there is no reason to expect long delays. On the contrary, for 
example, when Household Finance announced last month that it 
would stop selling SPCLI in favor of monthly premium insurance, 
it announced at the same time that it already had obtained the 
approval of 34 States to offer this monthly alternative.

Q.8. Yesterday [July 26], we had a lively discussion about the 
costs of SPCLI. One witness said that if you go to a Monthly 
Outstanding Balance basis it is more expensive than over the 
term of the loan. Another witness disputed that. Do you have a 
view on this issue?

A.8. The witness who made that claim never explained his 
calculations, and, quite frankly, I do not believe he had any 
supportable basis for that claim. Paying the real price of 
something without paying interest on it will always be less 
expensive than paying that price with interest, especially at 
rates that range from 10 percent to 22 percent. If his point 
was that it is cheaper to spread out the cost of 5 years of 
coverage for an extra 15 years after the insurance has lapsed, 
ask yourself whether anyone would freely choose to pay an extra 
$66,000 of interest to purchase $10,000 of insurance for 14 
years after it no longer protects the borrower. My 
understanding is that is exactly what happened in the case 
described by Iowa Attorney General Miller in his testimony.

Q.9. I have heard that SPCLI is a better deal for consumers 
over 41 years of age because it is cheaper and it is generally 
more available than the traditional term life insurance. Would 
anyone care to comment on that view?

A.9. I sincerely doubt that SPCLI is ever a better deal and 
would suggest that you look carefully at the calculations of 
anyone making this claim. (Obviously, you also have to make 
sure that you are comparing apples to apples. Often, unlike 
term insurance which provides benefits in a fixed amount, SPCLI 
is structured to provide declining benefits over time, 
sometimes at a rate that results in benefits not high enough to 
pay off the outstanding balance.). It can only be cheaper when 
you do not factor in the time value of the money paid for 
future insurance coverage and when you do not factor in the 
cost of financing it. This latter point is particularly 
important. When an insurance premium is added to the principal 
of the loan, the borrower pays two ways in addition to the 
inflated cost of the insurance itself. First, when the cost of 
the premium is added to the principal, then percentage-based 
fees (``points'' and broker fees) are also increased. Second, 
interest is then applied, over the life of the loan to that 
extra principal. As for SPCLI being ``more available,'' that 
argument is usually predicated on lenders not conducting 
underwriting before they sell the insurance. This argument 
ignores the fact that the insurers often engage in post-claim 
underwriting by denying coverage and then refunding the 
premium. Thus, the ``availability'' advantage can be little 
more than an illusion.

 RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM NEILL A. 
                          FENDLY, CMC

Q.1. Is there a definition for predatory lending? Or do you 
know it when you see it?

A.1. There is no generally accepted, succinct definition of 
``predatory lending.'' Whether or not an individual loan can be 
considered ``predatory'' depends on a number of circumstances 
and even then is largely in the eye of the beholder. While some 
consumer advocates believe that certain loan terms and products 
are always ``predatory,'' mortgage professionals generally 
believe that ``predatory lending'' is a problem of deceptive 
sales practices, not products. Predatory practices could 
include, but are not necessarily limited to, such practices as 
fraudulent and deceptive marketing of loans; deliberate failure 
to provide disclosures of costs and loan terms to the customer 
as required by law; and high-pressure sales tactics that cause 
consumers to accept loans, especially repeated and frequent 
refinancings, that are offered to the borrower primarily to 
generate more fees for the lender or broker and may not be 
beneficial to the borrower given his/her financial 
circumstances and goals. Responsible mortgage professionals do 
not engage in such practices.

Q.2. What can be done about the unregulated brokers and home 
improvement contractors who are bad actors?

A.2. Mortgage brokers are regulated, by State licensing laws in 
all but two States and by more than 10 Federal statutes. 
Mortgage brokers in most States are subject to regular 
examinations, and many States recently have enacted new laws 
requiring basic and continuing education and minimum experience 
requirements for mortgage brokers. NAMB and its State 
affiliates have been at the forefront of efforts to impose and 
strengthen State mortgage broker licensing laws.
    Eliminating ``bad actors'' is largely a function of 
enforcing these existing laws. NAMB is working with the 
National Association of Attorneys General and the American 
Association of Residential Mortgage Regulators to improve 
enforcement of State laws, and State enforcement of Federal 
laws such as RESPA. NAMB also supports increased enforcement of 
existing Federal laws, including RESPA, TILA, HOEPA, and the 
FTC Act, all of which address most types of abusive lending 
practices.

Q.3. In the securities industry there is a ``suitability 
standard'' for brokers putting clients into appropriate 
brokerage activities. What do you think about applying a 
suitability standard for brokers/lenders who put low-income 
borrowers into subprime loans?

A.3. While the concept of a ``suitability standard'' may have 
some intuitive appeal, in fact such a standard would be 
impossible to 
develop for mortgages. In the investment market, customers are 
looking for only one thing--a certain return on their 
investment, consistent with their tolerance for risk. It is 
relatively easy to set standards of risk for various 
investments and then to determine whether a particular 
investment is suitable for an investor given his/her assets and 
risk tolerance. On the other hand, people may seek mortgages 
for a variety of reasons, including obtaining cash quickly, 
reducing monthly debt payments, financing home improvements, 
etc., and therefore people judge the suitability of a mortgage 
according to their own needs and financial goals. For example, 
a borrower may choose a higher-rate subprime mortgage even if 
he qualifies for a lower rate, because he does not want to 
reveal all the sources of his income as is required by most 
conforming mortgage lenders. A borrower may choose to accept a 
prepayment penalty because the loan with the penalty has a 
substantially lower 
interest rate and lower monthly payments than does the loan 
without the penalty, and the borrower's only goal is to reduce 
his monthly payments as much as possible. Mortgages can be 
structured with various terms, lengths, documentation 
requirements, and other features that are tailored to the needs 
and goals of almost any borrower, even though some of these 
mortgages might appear to others as ``unsuitable.'' Thus the 
suitability of a particular mortgage product for an individual 
borrower can really be defined only by the borrower, and it is 
impossible to impose a ``bright-line test'' for mortgages. Any 
attempts to impose an arbitrary suitability standard for 
subprime mortgages would necessarily involve prohibiting or 
limiting certain loan terms, and this would have a perverse 
effect of reducing choices for borrowers and reducing the 
availability of credit to low- and moderate-income borrowers.

Q.4. Why are better disclosures and/or financial education not 
sufficient remedies for predatory lending problems?

A.4. These are, in fact, very important parts of the overall 
solution to abusive lending problems. Simpler and more 
meaningful disclosures will empower consumers to be better 
shoppers, reduce the ability of unscrupulous lenders to hide 
fees and onerous terms in ``fine print'' and prevent lenders 
from surprising consumers with large fees at the closing table. 
More consumer education will also help people avoid being 
victims of unscrupulous lenders and better understand their 
rights to disclosures, limitations on fees, and their right to 
rescind certain types of loans even after closing. Congress can 
be most effective in eliminating abusive lending by simplifying 
the mortgage lending disclosure statutes and encouraging more 
financial education in Federally funded education programs.
    However, the third element we believe must be addressed is 
better enforcement of existing laws, at the State and Federal 
level. Even if consumers are fully informed and armed with 
better disclosures, there may still be unscrupulous people who 
will continue to try to hide excessive fees, trick people into 
buying unnecessary ancillary products, and deceive or pressure 
people into borrowing more than they really want at higher 
costs. Existing laws prohibit such practices but need to be 
better enforced to send the message to these people that they 
cannot continue to abuse consumers.

Q.5. I understand Philadelphia enacted a city ordinance 
regarding predatory lending and the Pennsylvania legislature 
passed a law preempting county and/or city ordinances. What do 
you think about State legislatures preempting county and/or 
city ordinances regarding predatory lending?

A.5. NAMB strongly supported the Pennsylvania legislation and 
supports other efforts, including litigation, to overturn other 
similar local ordinances. It is absurd for local governments to 
decide that arbitrary city or county borders should govern 
whether or not someone can get a certain kind of mortgage. Such 
regulation of financial services and products has never been 
considered the purview of local governments. Consumer advocates 
are supporting these ordinances only because they have failed 
to win the restrictive legislation they want at the Federal or 
State levels. If any of these ordinances succeed, all they will 
do is drive mainstream subprime lenders out of those localities 
and leave borrowers within the localities far fewer choices for 
home financing. In fact, some major lenders have already 
stopped making certain subprime loans in localities that have 
passed these ordinances, including DeKalb County, Georgia.

Q.6. Is your concern about single-premium credit life insurance 
(SPCLI) related to the product or the marketing of the product?

A.6. Mortgage brokers generally do not sell credit life 
insurance of any kind and so NAMB does not offer an opinion on 
the value of the product. However, it seems clear that there 
have been some abuses in marketing this product, and other 
forms of credit life insurance may be available or developed 
soon that offer equally good protection to borrowers without 
eating up so much of their equity.

Q.7. If SPCLI is removed from the marketplace, what are 
subprime borrowers to do when they wish to insure their 
financial obligations and monthly alternatives have not been 
approved in their States?

A.7. The fact is that if this occurs, some consumers will not 
have the choices they want. Low-income people are generally 
underinsured and credit life insurance can be a good product 
for them. If monthly premium products are not available, a 
borrower could be at risk of losing the home if a coborrower 
passes away and had no other form of life insurance. This 
illustrates the problem with complete prohibition of any 
products or terms in the subprime market. Almost no product or 
term is always abusive, and a wide range of product choices 
most helps consumers at all income levels to achieve their 
financial goals and minimize their risks.

Q.8. Yesterday [July 26] we had a lively discussion about the 
cost of SPCLI. One witness said that if you go to a Monthly 
Outstanding Balance basis it is more expensive than over the 
term of the loan. Another witness disputed that. Do you have a 
view on this issue?

A.8. We have no opinion on this issue, except that we believe 
consumers should have choices of different types of products 
and payment plans and choose for themselves which one is most 
cost-effective for them.

Q.9. I have heard that SPCLI is a better deal for consumers 
over 41 years of age because it is cheaper and it is generally 
more available than the traditional term life insurance. Would 
anyone care to comment on that view?

A.9. We would answer this question the same as question 8.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM DAVID 
                           BERENBAUM

Q.1. Is there a definition for predatory lending? Or do you 
know it when you see it?

A.1. Contrary to industry representation, there is a definition 
of predatory lending. It is important, however, to first 
clarify and distinguish between subprime lending and predatory 
lending. A subprime loan is defined as a loan to a borrower 
with less than perfect credit. In order to compensate for the 
added risk associated with subprime loans, lending institutions 
charge higher interest rates. In contrast, a prime loan is a 
loan made to a creditworthy borrower at prevailing interest 
rates. Loans are classified as ``A,'' ``A-minus,'' ``B,'' 
``C,'' and ``D'' loans. ``A'' loans are prime loans that are 
made at the going rate while ``A-minus'' loans are loans made 
at slightly higher interest rates to borrowers with only a few 
blemishes on their credit report. The so-called B, C and D 
loans are made to borrowers with significant imperfections in 
their credit history. ``D'' loans carry the highest interest 
rates because they are made to borrowers with the worst credit 
histories that include bankruptcies.
    In contrast, a predatory loan is defined as an unsuitable 
loan 
designed to exploit vulnerable and unsophisticated borrowers. 
Predatory loans are a subset of subprime loans. They carry 
higher in-
terest rates and fees than is required to cover the added risk 
of lending to borrowers with credit imperfections. They contain 
abu-
sive terms and conditions that trap borrowers and lead to 
increased 
indebtedness. They have fees and products packed onto loan 
transactions that consumers cannot afford. They do not take 
into account the borrower's ability to repay the loan. They 
prey upon 
unsophisticated borrowers who rely in good faith on the 
expertise of the loan originator or their agent. Ultimately, 
predatory loans strip equity and wealth from communities.

Q.2. What can be done about the unregulated brokers and home 
improvement contractors who are bad actors?

A.2. While it is extremely important to combat unregulated bad 
actors, it is important to focus on the more overt problem of 
brokers and contractors who fall within the existing State and 
local regulatory framework. Currently, mortgage brokers 
originate over 50 percent of subprime loans, yet only about 41 
States regulate mortgage lending and brokering. State 
regulations for mortgage brokers are minimal and are in most 
cases promulgated with little to no enforcement authority. Some 
States only require brokers to be registered while others go 
far in requiring licensing, brick and mortar, education and 
experience. The result is a very complex statutory and 
regulatory framework that unfortunately allows the bad actors 
to conduct business virtually unchecked.
    During the question and answer portion of the hearing, NCRC 
addressed the issue of mortgage brokers from a slightly 
different perspective: the collusion factor. From the 
initiation of the transaction, borrowers are immediately thrown 
into a realm of bad actors all working together to bilk 
individuals of their money and property. The real estate agent, 
the appraiser, the mortgage broker, and the subprime lender all 
work together on the same predatory transaction. In most cases, 
these collaborators operate under the radar of existing fair 
lending laws, particularly as it applies to the nondisclosure 
of brokers fees and compensation prior to the Good Faith 
Estimate (GFE).
    NCRC believes that although Federal fair lending laws 
(Equal Credit Opportunity Act, Truth in Lending Act, Home 
Ownership and Equity Protection Act and Real Estate Settlement 
Protection Act) have established a framework to protect certain 
consumers, they by no means go far enough to protect all 
consumers. It is our position that the only way to combat bad 
actors is to expand the scope of current legislation/regulation 
to cover their business lines together with enacting some 
comprehensive antipredatory lending legislation.

Q.3. In the securities industry there is a ``suitability 
standard'' for brokers putting clients into appropriate 
brokerage activities. What do you think about applying a 
suitability standard for brokers/lenders who put low-income 
borrowers into subprime loans?

A.3. NCRC has strongly supported the prohibition under HOEPA of 
making loans without regard for the consumer's ability to pay. 
We would favor a ``suitability standard'' that takes into 
account whether or not a particular loan is suitable for a 
particular 
borrower and helps meet his/her needs without undue financial 
hardship.
    NCRC also has advocated for policy that affords protections 
against a borrower being misled regarding his/her ability to 
qualify for a prime loan. In that regard, we would disagree 
with a standard limited to brokers/lenders who put low-income 
borrowers into subprime loans. Suitability should be afforded 
to all borrowers in both prime and subprime markets.

Q.4. Why are better disclosures and/or financial education not 
sufficient remedies for predatory lending problems?

A.4. NCRC has strongly supported increased financial education 
and better disclosures; in fact, our financial education 
program is highly regarded by industry and community groups 
throughout the country. However, it is our longstanding 
position that education and disclosure, in and of themselves, 
are not adequate to foster compliance of existing fair lending 
laws on a voluntary, statutory, or regulatory level.
    Financial education is invaluable, but much like the car 
owner who relies on the mechanic for his/her technical 
expertise and professional judgement and guidance, mortgage 
applicants too must rely on the honesty and knowledge of the 
officer processing the loan. No amount of financial education 
can equip a mortgage applicant to combat predatory lending; it 
can only help the consumer identify what might be predatory 
practices. Financial education may help alert the consumer that 
he/she is not being treated fairly, but without any enforcement 
of regulation of unfair practices, the only recourse left for 
the consumer is to refuse the offer of the predatory loan, 
leaving the consumer no access to credit. The consumer is left 
to hope that free-market forces will eventually force predatory 
lenders to change their practices. Relying on financial 
education and disclosure alone, without regulatory and/or 
statutory enforcement, diffuses the responsibility of 
enforcement to consumers. Financial education must be 
accompanied by strong regulatory and/or statutory enforcement 
policies.

Q.5. I understand Philadelphia enacted a city ordinance 
regarding predatory lending and the Pennsylvania legislature 
passed a law preempting county and/or city ordinances. What do 
you think about State legislatures preempting county and/or 
city ordinances regarding predatory lending?

A.5. To date in 2001, 31 States have introduced over 60 
legislative measures attempting to combat predatory lending 
practices. Additionally, nine major metropolitan cities and 
counties have introduced local ordinances to deal with 
predatory lending. In that 
regard, NCRC supports a national standard and strongly 
advocates for Congress, on a bi-partisan basis, to pass the 
strongest legislation possible to end the unscrupulous lending 
practices of predatory lenders.
    A very similar situation to what happened in Philadelphia 
has now started in DeKalb County. In both cases, the American 
Financial Services Association filed lawsuits to stay effective 
dates of 
already enacted local legislation. In its Philadelphia suit, 
AFSA stated: ``the ordinance is an attempt by the municipality 
to directly 
regulate the lending activity of financial institutions.'' In 
commenting on the suit, AFSA's president stated: ``Financial 
services legislative activity must be remanded to the 
appropriate venue of the State legislature or, where 
appropriate, to the U.S. Congress or appropriate Federal 
agency.''
    Local predatory lending ordinances are important examples 
of where policymakers at one level are tired of waiting for 
another level to take action in protecting consumers. And 
perhaps the same can be said true of the increase in State 
legislative measures--actions initiated as a result of neglect 
by the Federal Government.

Q.6. Is your concern about SPCLI related to the product or the 
marketing of the product?

A.6. NCRC is very concerned about both the marketing of SPCLI 
and the product itself. It is our position that credit 
insurance which is paid through a single up-front payment and 
financed into the total loan amount is a serious abusive 
lending practice (that is, predatory).
    NCRC does not take issue with credit insurance when 
presented to the consumer as an option and choice: up-front 
lump sum or monthly pay option. And when it is presented in 
such a manner that the consumer can compare the final/total 
costs of both products prior to closing.
    Our opposition to the SPCLI product is that in the majority 
of cases, the consumer's monthly payment for the financed SPCLI 
is more than the monthly payment under monthly options. The 
only scenario in which the SPCLI monthly payment is less than 
the month-to-month product is when the period of coverage is 
significantly shorter than the term of the loan (that is, a 5 
year SPCLI term on a 30 year loan). NCRC strongly supports 
Martin Eakes' testimony that cost savings calculations 
comparing SPCLI and month-to-month almost never favor SPCLI, 
and SPCLI almost always results in a bad deal for consumers.
    Scenario: The 1999 average subprime loan in the United 
States to a low- to moderate-income borrower is $91,000 via a 
30 year mortgage. Using a typical subprime rate of 12 percent, 
the total interest cost of that loan would be $245,973.
    But if the lender sells the consumer a $5,000, 5 year SPCLI 
policy rolling that amount into the mortgage balance, the total 
interest cost rises $13,516, which is almost three times the 
effective cost of the insurance.
    We oppose SPCLI marketing because in the majority of 
predatory lending victims we work with, the following practices 
are regular occurrences:

 The consumer did not know he/she purchased credit 
    insurance.
 The consumer was never told it was an option and not 
    required to close the loan.
 The consumer was pressured into agreeing to SPCLI 
    because he/she was told they would not get the loan without 
    it.
 The consumer was coerced by the lender/broker saying: 
    ``If you die, will your spouse have the income to make the 
    monthly payments? Would you want your family to assume your 
    financial obligations? You need this product to protect 
    your family.''
 The consumer was never told that the SPCLI was a 
    policy with a term significantly shorter than the duration 
    of the loan.
 The consumer could not cancel the insurance product.

Q.7. If SPCLI is removed from the marketplace, what are 
subprime borrowers to do when they wish to insure their 
financial obligations and monthly alternatives have not been 
approved in their States.

A.7. The major players in subprime lending market have sent a 
collective signal supporting consumer rights on this issue via 
the discontinuation of SPCLI products. CitiFinancial, who 
dropped its SPCLI in June, has since gained approval in 35 
States to sell its monthly premium policy. In July, Household, 
the Nation's largest issuer of subprime loans, also dropped its 
SPCLI on real estate secured loans and has gained approval in 
34 States. These major subprime lenders are actively working 
with State insurance departments to secure approval for their 
consumer choice products.
    If SPCLI is removed from the marketplace and the borrower 
would like the financial security of a credit insurance product 
in a State where monthly payment options are not approved, one 
solution could be to refer the consumer to an outside insurance 
counselor who can then work with the consumer on buying life 
insurance for the loan amount.

Q.8. Yesterday, [July 26], we had a lively discussion about the 
cost of SPCLI. One witness said that if you go to a Monthly 
Outstanding Balance basis over the term of the loan it is more 
expensive. Another witness disputed that. Do you have a view on 
this issue?

A.8. It is NCRC's position that, if the borrower chooses to 
purchase credit life insurance, the monthly outstanding balance 
(MOB) payment option is the only viable option. After reviewing 
the written testimony of both witnesses in addition to studies 
from other organizations, frankly, we do not understand the 
assertion made by Charles Calomiris that ``the monthly cost of 
single-premium insurance is much lower than the cost of monthly 
insurance.''
    For example, assume a credit insurance policy is purchased 
that covers the entire loan period of 10 years with a total 
premium of $10,000. With MOB, monthly payments will be 
calculated as the premium divided by the number of months 
covering the term of the loan, or $83.33 per month. With any 
single-premium policy, the amount paid each month will increase 
because the numerator is increased based on the interest rate, 
yet the denominator remains the same. For a loan just under the 
HOPEA threshold at 15.5 percent, the monthly payment would 
increase to $164, almost twice the amount paid with MOB. When 
comparing the same premium amount over the same term, it is 
impossible for a payment method that charges any interest to be 
less expensive than one that charges zero interest. (See 
Exhibit 1).
    Only in a situation where the term of the credit insurance 
is substantially shorter than the term of the mortgage can 
SPCLI have monthly payments lower than MOB. Even so, payments 
on the truncated credit insurance over the longer life of the 
loan in no way offsets the nominal monthly savings to the 
borrower because of the interest payments. (See Exhibit 2). The 
borrower is covered for a period of time much shorter than the 
life of the loan, yet continues to pay off the credit insurance 
for the remainder of the loan.
    SPCLI also precludes the borrower from canceling the 
insurance. With monthly payments, the borrower pays each month 
and is covered for that month. The borrower can choose to 
continue or cancel the insurance each month. Because credit 
insurance can only be purchased from the lender and not an 
outside party, the borrower has but one choice. With MOB, the 
borrower has more choice, such as traditional life insurance. 
With SPCLI, because the premium is paid in full upfront and 
financed, the borrower is locked in for the life of the 
insurance. Canceling SPCLI entitles the borrower to a refund 
much lower than the remaining value of the insurance because of 
the interest owed on the policy. Additionally, a report issued 
by the Coalition for Responsible Lending entitled Single 
Premium Credit Insurance Should be Banned Outright notes that 
for SPCLI ``in most States, lenders are not obligated to cancel 
credit insurance coverage after a grace period, generally 30 
days.'' If a borrower finds that he/she cannot pay for credit 
insurance for a particular month, under MOB, he/she can cancel 
the policy. With SPCLI, the borrower is delinquent on the 
mortgage payment and risks foreclosure.
    Lenders have no monetary incentive to offer borrowers 
credit insurance on the most favorable terms to the borrower. 
Underwritten by an insurer, credit life insurance is structured 
as a group policy sold to the lender who in turn issues the 
insurance to the borrower, the ultimate consumer of the 
insurance. Credit insurers market their products to lenders, 
not borrowers. Borrowers generally have no say in the choice of 
insurance products, and certainly have no voice in negotiating 
the terms of the insurance. They can either accept or decline 
the credit insurance package offered by the lender.
    The lender sells the insurance on behalf of the insurer, 
and receives compensation for each sale in the form of a 
commission, which in some cases is based on the profitability 
(higher rates) of the insurance. Most States establish prima 
facie rates that are the maximum rates that can be levied on 
credit insurance and these are generally the rates that are 
charged. According to a joint report published by Consumers 
Union and the Center for Economic Justice in 1999, entitled 
Credit Insurance: The $2 Billion A Year Rip-Off, ``creditor 
compensation averaged more than 30 percent of the premium 
dollar for credit life.'' The report further notes that in some 
cases, the lender was rewarded additional compensation in the 
form of personal computers, software, and calculators.
    While the lenders and the insurers are benefiting from the 
sale credit life insurance, the Consumers Union/Center for 
Economic Justice report found that borrowers have been 
excessively overcharged. The report notes that the loss ratio 
on credit life insurance nationally was 41.6 percent in 1997. 
The National Association of Insurance Commissioners sets a 60 
percent loss ratio threshold as the minimum level considered to 
provide reasonable benefits to consumers. In Georgia, the loss 
ratio in 1997 was slightly better than the national figure at 
48.9 percent. With the reverse competition prevalent in the 
credit insurance market, it is always the borrower who pays the 
most dearly.

Q.9. I have heard that SPCLI is a better deal for consumers 
over 41 years of age because it is cheaper and it is generally 
more available than the traditional term life insurance. Would 
anyone care to comment on that view?

A.9. Through our research on the available options for a given 
41-year old male borrower living in Georgia, we found that term 
life insurance is generally a better option than credit life 
insurance. Assuming that the borrower is a nonsmoker, a 
$100,000 policy for a 10 year term will cost between $12 and 
$17 a month (quotes obtained from term life insurance broker 
Term.com at www.term.com.
    Applying the Georgia prima facie rate of $.45 per annum per 
$100 of indebtedness for decreasing term credit life insurance, 

the borrower would be charged a total premium of $11,610.25 for 
a 10 year policy on a $100,000, 30 year mortgage with an 
interest 
rate of 10 percent. With MOB, monthly payments would be $96.75, 
while for a single-premium payment financed into the loan, 
monthly payments would be $101.89. Traditional term life 
insurance is clearly a much better deal. Even for those 
borrowers with health problems who may not qualify for premium 
health insurance rates and credit life insurance is the only 
available option, MOB payments make more sense than SPCLI. (See 
Exhibit 3).
    Additionally, with credit life insurance, the bank is named 
the beneficiary of the policy. If the borrower dies, the lender 
is repaid the remainder of the loan. Under tradition term life 
insurance, the insured designates a beneficiary. It is possible 
that the beneficiary would not want to pay off the loan 
balance, but would prefer to continue monthly loan payments and 
apply the insurance benefits elsewhere. Traditional term life 
insurance provides a great deal more flexibility for the 
beneficiaries of the estate.






   RESPONSE TO WRITTEN QUESTIONS OF SENATOR MILLER FROM LEE 
                            WILLIAMS

Q.1. Is there a definition for predatory lending? Or do you 
know it when you see it?

A.1. We define predatory loans as those that are high-rate, 
high-fee home equity products that are intentionally structured 
in a manner that is deceptive and disadvantageous to borrowers.

Q.2. What can be done about the unregulated brokers and home 
improvement contractors who are bad actors?

A.2. They should be licensed and regulated.

Q.3. In the securities industry, is there a ``suitability 
standard'' for brokers putting clients into inappropriate 
brokerage activities. What do you think about applying a 
suitability standard for brokers/lenders who put low-income 
borrowers into subprime loans?

A.3. We would agree with this if we are correct in assuming 
that a ``suitability standard'' requires brokers to explain to 
consumers fully that they must obtain a subprime loan instead 
of a prime rate.

Q.4. Why are better disclosures and/or financial education not 
sufficient remedies for predatory lending problems?

A.4. While financial education may not be a sufficient remedy 
for predatory lending problems in the short run, we are 
convinced that, combined with disclosure, it will be an 
extremely important tool in combating this problem over the 
long run. As stated in our Ethical Guidelines that are attached 
to our written testimony, we also support voluntary and other 
means of prohibiting some abusive practices.

Q.5. I understand Philadelphia enacted a city ordinance 
regarding predatory lending and the Pennsylvania legislature 
passed a law preempting county and/or city ordinances. What do 
you think about State legislatures preempting county and/or 
city ordinances regarding predatory lending?

A.5. We are pleased that the State legislatures are recognizing 
the importance of this issue and passing Statewide legislation 
to combat predatory practices in our communities.

Q.6. Is your concern about SPCLI related to the product or the 
marketing of the product?

A.6. Both--the product is unnecessarily expensive, and in some 
cases it is included without any disclosure to the borrower.

Q.7. If SPCLI is removed from the marketplace, what are 
subprime borrowers to do when they wish to insure their 
financial obligations, and monthly alternatives have not been 
approved in their States?

A.7. One alternative might be the purchase of term life 
insurance or reliance on existing life insurance; another 
option may be to work with the State legislatures to provide a 
monthly alternative as a way to combat predatory lending 
practices.

Q.8. Yesterday [July 26], we had a lively discussion about the 
cost of SPCLI. One witness said that if you go to a Monthly 
Outstanding Balance basis, it is more expensive that over the 
term of the loan. Another witness disputed that. Do you have a 
view on this issue?

A.8. It would seem that the witness arguing that single-premium 
credit life is cheaper than the monthly alternative was in 
error.

Q.9. I have heard that SPCLI is a better deal for consumers 
over 41 years of age because it is cheaper and it is generally 
more available that the traditional term life insurance. Would 
anyone care to comment on that view?

A.9. If that is true, then the consumer, with a little 
knowledge and perhaps disclosure, would seem to have a viable 
alternative, but this does not indicate if SPCLI for those over 
41 years of age is cheaper than the monthly alternative, which 
is always a better deal for the consumer.
            STATEMENT OF THE AMERICAN LAND TITLE ASSOCIATION
                             JULY 27, 2001
    The American Land Title Association (ALTA) membership is composed 
of more than 2,000 title insurance companies, their agents, independent 
abstracters and attorneys who search, examine, and insure land titles 
to protect owners and mortgage lenders against losses from defects in 
titles. Many of these companies also provide additional real estate 
information services, such as tax search, flood certification, tax 
filing, and credit reporting services. These firms and individuals 
employ nearly 100,000 individuals and operate in every county in the 
country.
    ALTA appreciates the concerns that have prompted the Committee to 
engage in oversight hearings on the issue of ``predatory lending'' and 
the introduction of the Predatory Lending Consumer Protection Act of 
2000 (S. 2415; H.R. 4250) and other legislation. Predatory lending 
practices can be a source of substantial claims loss to title insurers. 
In general, we support reasonable legislative and regulatory action to 
address the problems and abuses that may exist with regard to 
``predatory'' lending practices targeted at vulnerable consumers. We 
recognize that there is a fine line between subprime and predatory 
lending. We are therefore concerned that Congress, in reducing the 
thresholds for determining when loans are subject to the additional 
limitations and restrictions imposed by the HOEPA (Homeownership and 
Equity Protection Act) amendments to the Truth in Lending Act (TILA) 
and in eliminating the current exclusion for ``residential mortgage 
transactions,'' does not inadvertently reduce the availability of 
legitimate financing to low income or less-than-prime borrowers.
    We hope that the Congress, the agencies, and the lending industry 
develop a fair, reasonable, solution to these problems. Because we are 
clearly not central to the lending decisions, and only see the results 
of these loans at closing, or in limited situations, where claims 
arise, we are limiting our comments to those provisions of S. 2415, one 
of the major proposals before the Committee, which directly affect the 
title insurance industry.
    If the Committee ultimately concludes that legislation is needed, 
we would like to draw your attention to three aspects of the 
``Predatory Lending Consumer Protection Act of 2000'' (S. 2415) which 
cause concern.
    First, we do not believe that the current exclusion for 
``residential mortgage transactions''--transactions in which the loan 
is being used to acquire or construct the dwelling--contained in the 
current language of TILA Sec. 103(aa)(1) should be eliminated. The 
concerns raised about predatory lending practices have related to 
refinance and second mortgage transactions. There is simply no reason 
to extend HOEPA to potentially millions of purchase money mortgage 
transactions in which there has been no evidence of the kind of abuses 
to which HOEPA is addressed.
    Second, the bill eliminates a current provision of HOEPA that we 
believe should be retained. Under the current law, a second mortgage or 
loan refinance is subject to the HOEPA requirements if it bears a high 
annual percentage rate (that is, more than 10 percentage points higher 
than the yield on Treasury securities having a comparable maturity) or 
if ``the total points and fees payable by the consumer at or before 
closing will exceed the greater of (i) 8 percent of the total loan 
amount; or (ii) $400.'' \1\ In determining what constitutes ``points 
and fees'' for purposes of this provision, HOEPA provides that certain 
settlement charges, including ``[f]ees or 
premiums for title examination, title insurance, or similar purposes'' 
are not in-
cluded if:
---------------------------------------------------------------------------
    \1\ TILA, Sec. 103(aa)(1).

 the charge is reasonable;
 the creditor receives no direct or indirect compensation; and
 the charge is paid to a third party unaffiliated with the 
    creditor.\2\
---------------------------------------------------------------------------
    \2\ TILA, Sec. Sec. 103(aa)(4)(C) and 106(e).

    ALTA believes that this current exclusion is both reasonable and 
appropriate. Some ALTA members do engage in independent operations, and 
participate in affiliated business arrangements, and we do recognize 
the policy rationale behind the inclusion of affiliated business 
arrangement fees under current law. As the Senate Banking Committee 
report on the 1994 HOEPA legislation made clear, the purpose of 
imposing a trigger based on points and fees charged in the transaction 
was to ``prevent unscrupulous creditors from using grossly inflated 
fees and charges to take advantage of unwitting customers.'' \3\ On the 
other hand, if the lender is not benefiting from the charge, the charge 
is made by an unaffiliated third party, and the charge is reasonable, 
the charge does not affect in any way whether the loan is 
``predatory.'' Congress concluded in 1994, that there was no reason why 
such charges should be included in determining the trigger for HOEPA 
coverage. We hope that the Committee keeps in mind that title insurance 
fees are regulated in most States, and that these fees are based on 
costs and risk, and that adherence is required to ensure solvency and 
consumer protection.
---------------------------------------------------------------------------
    \3\ S. Rep. 103-169 at 24 (1993).
---------------------------------------------------------------------------
    Unfortunately, S. 2415, eliminates this aspect of HOEPA. In fact, 
the rationale for maintaining the current language is even stronger in 
light of the other changes made to HOEPA by S. 2415. S. 2415 would 
modify the total amount of points and fees that triggers HOEPA coverage 
from 8 percent of the loan, or $400, whichever is higher, to 5 percent 
of the total loan amount, or $1,000, whichever is higher. The reduction 
from 8 percent to 5 percent would mean that, on a $50,000 refinance 
loan or second mortgage (for example), total fees and points of $2,500 
would trigger HOEPA coverage, whereas under current law the total 
points and fees would have to exceed $4,000 before the loan would be 
deemed a ``high-cost'' loan triggering HOEPA coverage.
    While Congress may conclude that this reduction is justified where 
the lender is pocketing the $2,500 in points and fees (and therefore 
may have an incentive to engage in equity stripping and repetitive 
refinancings), there is no justification in also eliminating the 
current exclusion for reasonable third-party charges in which the 
lender does not participate. Indeed, by reducing the trigger amount and 
eliminating that exclusion, S. 2415 risks converting many nonpredatory, 
nonabusive loans into HOEPA-covered loans. This prospect could 
adversely affect the availability of financing to higher-risk 
borrowers.
    Accordingly, we recommend that Sec. 2(b)(3) of the bill, to the 
extent that it eliminates the third-party charge exemption from the 
current language of Sec. 103(aa)(4)(C) of TILA, be changed so as to 
leave in place the current language of Sec. 103(aa)(4)(C).
    Our third concern relates to new Sec. 129(k) of TILA that would be 
added by section 4(a) of S. 2415. The new provision would prohibit a 
creditor, in connection with a HOEPA-covered mortgage loan, from 
charging a borrower for credit insurance or a debt cancellation 
contract on a single premium basis through an upfront charge paid by 
the borrower at the outset of the loan. We express no views on whether 
such a prohibition is desirable or appropriate. What we are concerned 
about is that 
the language of new Sec. 129(k)(1) states that ``no creditor or other 
person may require or allow'' the collection of such premiums. The ``no 
. . . other person may . . . 
allow'' language is unnecessary, ambiguous, and would set a 
questionable legislative precedent.
    The language is unnecessary because the provision, without the 
additional words, would still prohibit lenders from collecting single 
premiums for credit insurance. The language is ambiguous, because it 
imposes obligations on unidentified ``other persons'' not to 
``allow''--whatever that means--lenders to collect such premiums. 
Finally, it would set an unfortunate precedent for Congress, when it 
imposes direct obligations or requirements on particular parties (in 
this context, on lenders), to extend such obligations to ``other 
persons'' who may be deemed to have ``allowed'' an action to take 
place.
    Our members are involved in the closing of mortgage loans. 
Accordingly, we are concerned about impractical obligations being 
imposed on us because title companies who close loans or who issue 
title insurance policies to lenders might be viewed as ``other 
persons'' who have ``allowed'' the lender to obtain the single premium 
in connection with the transaction. Neither TILA, nor indeed other 
comparable consumer protection statutes, have sought to impose such 
obligations on third parties, and Congress should not start down that 
road in this bill. Further, in some States, mortgage loans are ``net 
funded'' and checks are not written for the lender items. In addition, 
in many instances, there may not be enough detail for a closing agent 
to determine that there is a single-premium credit insurance premium. 
There is no need for this additional language and we urge the Committee 
to delete the reference to ``or other person'' on page 14, line 24, of 
the bill.
    We thank the Chairman and the Committee for the opportunity to 
submit this statement.
                               ----------
             STATEMENT OF THE CONSUMER BANKERS ASSOCIATION
                             July 27, 2001
    The Consumer Bankers Association (CBA) is pleased to submit this 
testimony to the Committee on Banking, Housing, and Urban Affairs of 
the U.S. Senate, in response to the hearings entitled ``Predatory 
Mortgage Lending: The Problem, Impact, and Responses.''
    CBA was founded in 1919 and represents the majority of the major 
banks engaged in consumer lending. It provides leadership and 
representation on retail banking issues such as privacy, fair lending, 
and consumer protection legislation and regulation. Member institutions 
are the leaders in consumer home equity finance, electronic retail 
delivery systems, bank sales of investment products, small business 
services, and community development. The CBA comprises the Nation's 
largest bank holding companies. CBA members hold two-thirds of the 
industry's total assets and make billions of dollars of loans to 
borrowers who could not qualify for prime loans. Our membership 
actively participates in the nonprime lending industry in the United 
States. We are proud of the role our members have played in expanding 
the availability of mortgage credit to borrowers not qualified for 
conventional mortgage financing due to little or poor credit 
experience.
    We appreciate the opportunity to share with this Committee the 
position of our members with respect to the complex issues and 
challenges facing the mortgage lending industry. We are hopeful that 
the spotlight this Committee is placing on these issues will be helpful 
to our membership as they seek to continue to expand home ownership 
opportunities through fair and nondiscriminatory lending practices.
    The growth in responsible nonprime lending over the last decade has 
been celebrated as ``the democratization of credit'' by Federal Reserve 
Board Chairman Alan Greenspan and lauded as ``one of the great success 
stories of American economics'' by Director of the Office of Thrift 
Supervision Ellen Seidman.\1\ It has enabled many consumers to obtain 
home loans who previously would have had limited, if any, access to the 
credit market due to impaired credit histories. This access to credit 
is instrumental to helping borrowers purchase and improve their homes, 
access equity for emergencies, and obtain basic goods and services.
---------------------------------------------------------------------------
    \1\ See Remarks of Ellen Seidman, Director, Office of Thrift 
Supervision, The Financial Service and E-Commerce Practice Group of the 
Federalist Society Presents A Lunch Exchange on the Predatory Lending 
Debate: ``Are Banks Empowering or Robbing Customers?'' October 20, 
2000; Kathleen Day, Raising the Roof on Riskier Lending, The Washington 
Post, February 6, 2001, at 2 (quoting Alan Greenspan).
---------------------------------------------------------------------------
    Nonprime lending is generally described as the extension of credit 
to borrowers exhibiting higher delinquency or default characteristics 
than those of traditional borrowers. For example, the U.S. Department 
of Housing and Urban Development and the U.S. Department of Treasury 
reports that nonprime mortgages were five times more likely to be 
delinquent than prime mortgages.\2\ Because of the fact that 
delinquency rises significantly as credit scores decline, interest 
rates in the nonprime market are tied to the risk of delinquency posed 
by nonprime borrowers.\3\ Thus, nonprime lending involves lending at 
rates above the prime rate to cover the increased risk and transaction 
costs of lending to borrowers who pose greater credit risks. When done 
the right way, the loan is structured to correlate with the borrower's 
income stream and promotes the borrower's ability to repay the loan.
---------------------------------------------------------------------------
    \2\ See Curbing Predatory Home Mortgage Lending: A Joint Report, 
U.S. Department of Treasury and U.S. Department of Housing and Urban 
Development, June 2000, at 33-35 (hereinafter ``HUD-Treasury Report'').
    \3\ See Robert E. Litan, Vice President and Director, Economic 
Studies Program, The Brookings Institution, A Prudent Approach to 
Preventing Predatory Lending, February 2001, at 9.
---------------------------------------------------------------------------
    In the last decade, lower-income and minority consumers, who 
historically had difficulty in getting mortgage credit, have been 
granted loans at unprecedented levels. Indeed, Federal Reserve Governor 
Gramlich recently observed that conventional home mortgage lending to 
low income borrowers between 1993 and 1998 increased nearly 75 percent, 
compared with a 52 percent increase for upper income borrowers. At the 
same time, conventional home mortgage lending to African-Americans 
increased 95 percent, and to Hispanics 78 percent, compared to a 40 
percent increase overall.\4\
---------------------------------------------------------------------------
    \4\ See Remarks of Edward M. Gramlich, Governor, The Federal 
Reserve Board, before the Federal Reserve Bank of Philadelphia, 
Community and Consumer Affairs Department Conference on Predatory 
Lending, December 6, 2000.
---------------------------------------------------------------------------
    Much of this democratization of credit can be attributed to the 
development of the nonprime mortgage market. Notably, in their Joint 
Report, the U.S. Department of Housing and Urban Development and the 
U.S. Department of Treasury indicate that the number of nonprime loans 
has gone from 80,000 in 1993 to 790,000 in 1998, an 880 percent 
increase.\5\ Nonprime loan originations increased from $35 billion in 
1994 to $160 billion in 1999, representing a 360 percent increase.\6\
---------------------------------------------------------------------------
    \5\ See HUD-Treasury Report at 29.
    \6\ See id. at 2.
---------------------------------------------------------------------------
    Unfortunately, these very positive developments have become 
overshadowed by the conduct of a few unscrupulous brokers and lenders, 
who in many cases are not subject to Federal supervision and oversight. 
These brokers and lenders sometimes impose unfair and unreasonable loan 
terms on vulnerable borrowers, often by deceit and misinformation. Our 
members are greatly concerned about the harm this causes to consumers. 
Furthermore, such conduct has tarred the entire lending community and 
is now undermining our members' efforts to expand credit access through 
fairly priced and adequately disclosed nonprime loan products. Thus, 
CBA joins this 
Committee in condemning these abusive sales practices and in seeking 
effective 
solutions.
    It would be unfortunate, however, if in the quest to root out the 
deplorable conduct of a relatively few unscrupulous lenders, continuing 
progress in the demo-
cratization of credit is halted. We are concerned that the current 
blurring in the 
distinction between the nonprime mortgage lending activities of 
responsible lenders and the lending practices of predatory lenders may 
cause such a result. It is critically important that this Committee 
recognize the need for responsible nonprime lending and the importance 
of expanding credit access from responsible nonprime lenders, such as 
those represented within the CBA membership.\7\ Abusive lending must be 
eradicated, but not at the cost of severely constricting responsible 
nonprime lending.
---------------------------------------------------------------------------
    \7\ See, for example, Remarks of Edward M. Gramlich, Governor, The 
Federal Reserve Board, before the Community Affairs Research Conference 
of the Federal Reserve System, Washington, DC, April 5, 2001, at 2; 
Press Release of Office of the Comptroller of the Currency, OCC 
Addresses Subprime Lending Risk Issues (quoting John D. Hawke, Jr., 
Comptroller), April 5, 1999; Jim Peterson, Lender Beware, American 
Banking Journal, Vol. 93, Issue 2, February 1, 2001, at 27 (quoting 
Senator Gramm).
---------------------------------------------------------------------------
    CBA members understand that they have an important role in ensuring 
the continuing availability of responsible nonprime loan products. Our 
members are good, well-intentioned companies who are committed to 
industry best practices. CBA members must, and will, lead by example.
    Three of the initiatives the CBA and its members have supported to 
enhance consumer protections and promote industry best practices are 
efforts to: (i) expand financial literacy; (ii) streamline and simplify 
mortgage lending; and (iii) improve oversight and registration of 
mortgage brokers and home improvement contractors.

          I. The CBA believes that comprehensive consumer financial 
        education is the key to consumer protection. Consumer education 
        and better consumer counseling can help consumers avoid 
        becoming the victims of abusive lending practices. Recent 
        studies, however, show that most American children and young 
        adults have not mastered the most basic personal financial 
        skills. For example, a survey of 12-year-olds conducted by 
        Consumer Reports in 1997 found that only 58 percent of the 
        respondents knew that if one borrowed $100 from a bank, one 
        would have to pay back a greater amount.\8\
---------------------------------------------------------------------------
    \8\ See Max Jarman, U.S. Youths Flunking Credit 101, The Arizona 
Republic, May 5, 1998 
at 1.

    Many consumers tend to be unfamiliar with financial concepts, lack 
an understanding of the loan products offered on the market and do not 
understand the benefit of shopping for mortgage credit. According to a 
University of Michigan Survey of Consumers, at least 40 percent of 
mortgage borrowers do not understand the relationship between the 
contract interest rate and the annual percentage rate (APR).\9\ In 
another survey, 12 percent of nonprime borrowers said they were not 
familiar with basic financial terms such as the interest rate and the 
principal of the loan. One-third of nonprime borrowers said they were 
not familiar with the types of mortgage products available.\10\
---------------------------------------------------------------------------
    \9\ See Jinhook Lee and Jeanne M. Hogarth, The Price of Money: 
Consumers' Understanding of APR's and Contract Interest Rates, 18 J. 
Publ. Pol'y & Mkt. 66, April 1, 1999, at 1.
    \10\ See Curbing Predatory Home Mortgage Lending: A Joint Report, 
U.S. Department of Treasury and U.S. Department of Housing and Urban 
Development, June 2000, at 59 (citing Howard Lax, Michael Manti, Paul 
Raca and Peter Zom, Subprime Lending: An Investigation of Economic 
Efficiency (unpublished paper), February 25, 2000).
---------------------------------------------------------------------------
    The CBA believes that industry regulators and consumer groups 
should work 
together on this issue to ensure that borrowers understand the mortgage 
lending process and the terms of their loans. We believe that an 
uninformed consumer is more likely to fall victim to an unscrupulous 
lender than one who has even a basic understanding of the products and 
services available. Thus, it follows that the more consumers understand 
finance, the better equipped they will be to make informed judgments.
    Congress has clearly taken an interest in financial literacy as 
well, and CBA has been a supporter of efforts to provide funding in 
this area. For example, CBA supports the concepts in the education 
reform bills, S. 1 and H.R. 1, which have passed their respective 
Houses and are expected to go to Conference. Both contain language 
authorizing the use of funds to promote financial literacy in a number 
of ways. We also support a variety of Government financial literacy 
initiatives that are under consideration by the Federal Reserve Board, 
the Federal Trade Commission, and the U.S. Department of Treasury, and 
others.
    Moreover, CBA is releasing a report examining banking industry 
financial education initiatives for consumers. A copy of the report is 
attached to this testimony. (This report is held in the Senate Banking 
Committee files.) It documents the types of programs and products banks 
routinely offer, in an effort to educate consumers on managing their 
finances. It shows that CBA member institutions are substantially 
engaged in various financial literacy efforts, including mortgage, 
credit, and foreclosure prevention counseling to borrowers, small 
business development training, and financial literacy for students in 
grades K-12 and college. Virtually all of the 48 banks that 
participated in the survey, representing more than half of the banking 
industry's assets, said they contribute to financial literacy efforts 
in some way. In particular, 98 percent offer mortgage or homeownership 
counseling and affordable mortgage programs with flexible terms, 
typically for lower income, first-time homebuyers. Most of the banks 
that responded serve as the primary sponsor of some homeownership 
counseling programs, and many also indicated that they 
financially support literacy programs delivered by nonprofit and/or 
community organizations. Further, some banks have created full-time 
positions within their institutions to manage financial literacy 
efforts. CBA will continue to track the activities of banks in this 
area, to encourage further efforts, and to share with the entire 
lending industry examples of bank programs that prove effective.

          II. The CBA has long believed that a more streamlined 
        mortgage process, with a greater opportunity to shop for credit 
        terms, would eliminate some of the possibility of abuse by 
        making mortgage loans more transparent to consumers. For 
        instance, CBA was an active participant in the broad-based 
        ``Mortgage Reform Working Group'' that worked toward just such 
        a goal. This group, comprising many industry and consumer 
        representatives, sought to refine various reform options in the 
        financial services industry to streamline the lending process. 
        A key recommendation that emerged from the process--endorsed at 
        the time by the Federal Reserve Board and many consumer 
        advocates--is to permit lenders to provide a guaranteed closing 
        cost disclosure early in the application process, giving the 
        consumers better information on which to shop for credit.

    In press reports, HUD Secretary Martinez has recently expressed 
support for efforts to make the mortgage lending process more 
accessible to consumers. CBA will continue to work on this effort, so 
that the complexity of the mortgage lending process cannot be used by 
unscrupulous brokers and lenders to further their aims, and so that the 
information can be better used by consumers to shop for credit.

          III. Many of the abusive practices in our industry appear to 
        involve mortgage brokers or home improvement contractors, yet 
        we believe insufficient attention has been paid to this part of 
        the marketing and sale of mortgage loans. CBA supports efforts 
        to improve the oversight of these entities. For example, we 
        recommend that States adopt minimum licensing requirements for 
        brokers and contractors, which might be encouraged by Federal 
        law. Such licensing criteria might include, among other things: 
        demonstration of financial responsibility and specified net 
        worth, continuing education requirements, and a restriction on 
        licensing of persons with criminal or civil judgments within 
        certain time periods for fraud, dishonesty, or deceit. CBA also 
        supports a national registry for mortgage brokers and home 
        improvement contractors. This would allow the States, consumers 
        and community organizations to monitor individual mortgage 
        brokers and home improvement contractors so that ``bad actors'' 
        are identified, even if they move from State to State. Further, 
        CBA members support consumer education efforts that include 
        information on the role of mortgage brokers and home 
        improvement contractors in the mortgage lending process.

    For these reasons, we believe the activities of CBA members, 
including reputable nonprime mortgage lending and efforts to protect 
consumers through outreach and education, are part of the solution--not 
the problem. CBA and its members are committed to working with this 
Committee and the regulatory community to resolve the challenges we 
face. We recognize that the mortgage lending system is not perfect and 
that additional steps are necessary to root out predatory lending 
practices.
    Later this year, CBA will be sponsoring an industry forum, at which 
a cross-section of industry representatives with knowledge and 
experience in this area, will be invited to convene. One of the goals 
of the forum will be to permit a wide array of industry participants to 
share information, in order to learn about those best practices and 
innovative programs that are working in communities to combat abusive 
practices. We will discuss financial literacy, community development 
programs, regulatory oversight or enforcement, and other activities. By 
facilitating the sharing of such information among industry 
participants from all over the country, we hope to allow the more 
effective steps to be replicated.
    In closing, the CBA is proud of the contribution it and its members 
have made to expanding mortgage credit access to Americans who, until 
recently, had few opportunities in the financial services industry. We 
encourage this Committee to proceed with caution when reviewing any 
proposal for new legislation or regulatory change in this area. It is 
important to remain mindful, as recognized by Governor Gramlich and 
others, that expansive regulatory action may have the unintended 
consequence of discouraging or even prohibiting legitimate lenders from 
providing nonprime loans and could impede access to credit in the 
nonprime market.\11\ While there may be disagreement about what 
regulatory changes and enforcement efforts are desirable in this 
industry, we welcome the opportunity to work with you to develop 
appropriate solutions.
---------------------------------------------------------------------------
    \11\ See Remarks of Edward M. Gramlich, before the Community 
Affairs Research Conference, supra note 7, at 2.
---------------------------------------------------------------------------
                               ----------
              STATEMENT OF THE CONSUMER MORTGAGE COALITION
                             July 27, 2001
    The Consumer Mortgage Coalition (CMC), a trade association of 
national residential mortgage lenders and servicers, appreciates the 
opportunity to submit its written testimony concerning predatory 
mortgage lending to the Senate Committee on Banking, Housing, and Urban 
Affairs.
    In considering the problem and impact of, and possible responses 
to, ``predatory lending,'' we emphasize the following key points:

 Many abusive practices are the result of outright fraud. As we 
    examine the anecdotal descriptions of borrowers being abused, it is 
    clear that many of the abuses resulted from misrepresentation, 
    deception and other practices that violate existing laws. New laws 
    are not needed to address these problems. Rather, there must be a 
    renewed emphasis on devoting the necessary resources to enforce 
    existing law.
 Predatory lending is hard to define. Practices (other than 
    those constituting current illegal conduct) that are often labeled 
    predatory can have both adverse and beneficial consequences for 
    consumers. As policymakers consider restricting in-
    dividual terms and provisions, such as prepayment penalties and 
    yield spread 
    premiums, they must understand that these terms have legitimate 
    uses that can benefit consumers, for example, by reducing interest 
    rates or upfront costs.
 It is not in the interests of lenders and servicers to make 
    loans, whether prime or subprime, which result in default or 
    foreclosure. Lenders and services do not benefit from defaulted 
    loans. Rather they lose money often significant amounts. Simply 
    put, a lender whose loans that go into default represent more than 
    a small proportion of its total loans will not long be in the 
    lending business. In fact, because subprime borrowers by definition 
    present a greater risk, subprime lenders must devote additional 
    resources to ensuring that they will not end up with a defaulted 
    loan.
 The goal of policymakers in addressing ``predatory lending'' 
    should be to educate and empower consumers to make appropriate 
    decisions about their financial 
    affairs, not to restrict consumers' option. The CMC is convinced 
    that both consumers and lenders are better off if lenders have the 
    freedom to offer and consumers have the freedom to choose from the 
    widest range of financial options. Consumers, however, must be put 
    in a position to make an informed decision that is most appropriate 
    for their needs and situation.
 Current regulatory requirements do not allow consumers to 
    understand their choices. They often act as barriers to competition 
    that could reduce costs. Studies have shown that the innumerable 
    disclosures required by a variety of Federal and State laws often 
    confuse, and sometimes mislead, consumers who are attempting to 
    shop for loans. In addition, while lenders compete on their 
    offerings based on interest rate and points, because of regulatory 
    restrictions, there is little incentive to compete on the basis of 
    ancillary settlement costs.

    The CMC, working with other trade groups, has developed a five-part 
program that we believe best addresses ``predatory lending'' without 
unduly restricting consumer's options or unduly burdening the efficient 
operation of the mortgage market. The program consists of the 
following:

 Adequate enforcement of existing law
 A nationwide licensing registry that allows constant 
    monitoring by state regulators and consumers of licensing 
    complaints, suspensions and revocations
 A comprehensive public awareness and education campaign
 Implementation of Federal regulators' existing authority to 
    address predatory practices
 Reform of mortgage origination regulatory requirements to give 
    consumers simpler, more uniform disclosures that allow them to 
    understand and effectively comparison shop for loans, to give 
    lenders the ability to offer ancillary settlement services at lower 
    cost, and to provide certain substantive protections.

    Following a brief note describing our coalition, we examine each 
component of this comprehensive solution. In addition, in Tab 1 of this 
testimony, we describe the subprime market. In Tab 2, we describe the 
products and practices that often are labeled ``predatory,'' and show 
how they can be used to the benefit of borrowers and how our solutions 
would mitigate any abuses they could cause. Finally, in Tab 3, we 
describe the mortgage origination process, its participants and the 
compensation each receives for their role.
About the CMC
    The CMC was formed, in large part, to pursue reform of the mortgage 
origination process. From our perspective, one of the principal goals 
of mortgage reform is to streamline the mortgage origination process so 
that consumers would be better informed when making credit choices. 
Complementary to our goal of streamlining the mortgage origination 
process is the goal of reducing abusive lending practices. We believe 
that better disclosures and substantive protections can enhance 
consumer protection. The goal should be to allow consumers to make 
educated choices in the credit market.
    We commend the Committee for its continued attention to the issue 
of predatory lending. The CMC is particularly concerned because of the 
damage caused by deceptive lenders to consumers and to the image of our 
industry. We support the goal of protecting consumers from unscrupulous 
lending practices and recognize that some elderly and other vulnerable 
consumers have been subjected to abuses by a small number of mortgage 
lenders, brokers and home contractors. We share the Committee's 
objective of developing approaches that prevent predatory lending 
practices without restricting the supply of credit to consumers or 
unduly burdening the mortgage lending industry.
The CMC's Alternative: A Comprehensive Solution to Predatory Lending
    Rather than further restrictions on products, terms and provisions, 
the CMC 
favors a multitiered, comprehensive solution to predatory lending, 
including increased enforcement of existing prohibitions against fraud 
and deception, coordinated, nationwide enforcement of licensing 
requirements, and better consumer education on the mortgage process.
    Most significantly, the CMC believes that comprehensive reform of 
the regulation of the mortgage origination process is needed so that 
all consumers, but particularly those most vulnerable to predatory 
lending practices, can better protect themselves. As noted above, our 
solution has five parts.
Part I: Devoting Adequate Resources To Enforcing Existing Laws
    We agree with Federal Reserve Board Chairman Alan Greenspan's 
comments that enforcement of existing laws is the first step that 
should be taken. Many examples of predatory lending involve fraudulent 
practices that are clearly illegal under current law. Adequate 
resources at both the Federal and State levels of government need to be 
devoted to pursuing those committing fraud. Therefore, the appropriate 
Federal and State agencies should advise policymakers of the resources 
they need to combat mortgage fraud.
Part II: A Nationwide Licensing Registry
    We recommend that all mortgage brokers and companies be licensed, 
and that a Federal system be established to ensure that if a broker or 
company loses its license in one State as a result of predatory 
practices, all licenses would be revoked, suspended, or put on 
regulatory alert nationally. A ``Consumer Mortgage Protection Board'' 
could be established to maintain a clearinghouse to identify mortgage 
brokers and companies whose licenses have been revoked or suspended in 
any State.
    The goal of this recommendation is to prevent those engaging in 
predatory practices from being able to move from one jurisdiction to 
the next and continuing to prey upon vulnerable consumers while keeping 
one-step ahead of law enforcement authorities in prior jurisdictions.
    This new Consumer Mortgage Protection Board could also be 
responsible for, among other things, reviewing all new and existing 
Federal regulations and procedures relating to the mortgage origination 
process and make recommendations that will simplify and streamline the 
lending process and make the costs of the process more understandable 
to consumers. The Board could also be used to initiate and oversee 
public awareness media programs (described below) that will help 
consumers evaluate the terms of loan products they are considering.
Part III: Increasing Public Awareness and Improving Consumer Education
    Consumer advocates have long advised industry and Government 
officials that certain consumers, particularly elderly seniors, were 
not able to clearly understand the loan terms disclosed in the 
innumerable disclosures provided to consumers during the mortgage 
process.
    We recommend a three-step program to increase public awareness and 
improve consumer understanding of their loan obligation:

          1. Public Service Campaign. Federal policymakers should 
        implement an ongoing, nationwide public service campaign to 
        advise consumers, but particularly the more vulnerable such as 
        senior citizens and the poorly educated, that they should seek 
        the advice of an independent third party before signing any 
        loan agreements. Public service announcements could be made on 
        radio and television, and articles and notices could be run in 
        local newspapers and selected publications.
          2. Public Awareness Infrastructure. Once alerted, consumers 
        will need to be able to avail themselves of counseling services 
        from unbiased sources. Those sources can always include family 
        and friends and industry participants. In addition, however, a 
        nationwide network should be put in place to ensure that all 
        consumers can easily access advice and counseling to help them 
        determine the loan product that best fits their financial 
        needs. A public awareness infrastructure could be built out 
        that would include 1-800 numbers with independent counselors, 
        using sophisticated computer software, to help consumers talk 
        through the loan product they are considering. In addition, 
        programs could be developed with community organizations and 
        other organizations serving senior citizens to provide on-site 
        counseling assistance at local senior and community centers and 
        churches. HUD's 800 number for counseling could be listed on 
        required mortgage disclosures as an initial step to increase 
        awareness of available advice.
          3. ``Good Housekeeping Seal of Approval'' for On-Line 
        Mortgage Calculators. The Joint Report on the Real Estate 
        Settlement Procedures Act and Truth in Lending Act of the Board 
        of Governors of the Federal Reserve System and the Department 
        of Housing and Urban Development, issued in 1998 (Joint Fed/HUD 
        Report) recommended that the Government develop ``smart'' 
        computer 
        programs to help consumers determine the loan product that best 
        meets their individual needs. Since this idea was first 
        discussed in the Mortgage Reform Working Group,\1\ mortgage 
        calculators or ``smart'' computer programs have become 
        available online. Since these computer programs were already 
        developed by the private sector and are widely available, a 
        more appropriate role for the Government today would be for the 
        Federal Government to approve a limited and unbiased generic 
        mortgage calculator module that could be incorporated into any 
        online site that helps consumers evaluate various loan 
        products. (Legislation may be needed to advance this 
        initiative. But there may be resources in agencies' current 
        budgets that could be tapped to implement this recommendation.)
---------------------------------------------------------------------------
    \1\ The Mortagage Reform Working Group (MRWG) was an ad hoc group, 
comprised of over 20 trade associations and consumer advocate 
organization, that was organized at the request of Former Congressman 
Rick Lazio (R-NY) with the goal of reaching a compromise on a 
conprehensive mortgage reform proposal that would streamline and 
simplify the mortgage process for consumers while simultaneously 
reducing the liability for the industry. While all parties did not 
reach an agreement, many of the recommendations that were developed in 
that process formed the basis for the recommendations made in the Joint 
Report issued by the Federal Reserve Board and the Department of 
Housing and Urban Development.
---------------------------------------------------------------------------
Part IV: Use Existing Federal Regulatory Authority to
Stop Abusive Practices
    Regulators may have existing authority to implement changes to 
existing regulations to prevent loan flipping and other questionable 
practices. Where such authority exists, action should be taken to 
change existing regulations. Regulators may also be able to use their 
rulemaking powers under existing law to implement some of the mortgage 
reform proposals discussed in Part V.
Part V: Comprehensive Mortgage Reform
    The Joint Fed/HUD Report found that consumers do not understand the 
disclosures required by the current TILA and Real Estate Settlement 
Procedures Act (RESPA). There is widespread agreement that the mortgage 
loan origination process is overly complex and that the current legal 
structure is often an obstacle to improving that process.
    Comprehensive mortgage reform would reduce confusion and improve 
competition, lowering prices for all consumers while discouraging 
predatory lending. The CMC has been at the forefront of industry 
efforts to reform and improve the laws and regulations governing the 
home mortgage origination process in this country. The mortgage reform 
that we, along with others in the industry, have advocated would 
directly address many of the weaknesses in current law that allow 
predatory lenders to operate. We note that some of these reforms can be 
achieved through regulatory changes while others will require 
legislation.
    Some of the features of mortgage reform that bear directly on the 
predatory lending problem include:

 Early disclosure of firm closing costs, leading to greater 
    certainty for consumers on closing costs and increased price 
    competition for both loans and ancillary services required to make 
    the loan. A common feature of most allegations of predatory lending 
    is that the borrower was either confused or deliberately misled 
    about the amount of closing costs that he or she would have to pay. 
    The central feature of mortgage reform is a proposal that mortgage 
    originators disclose to consumers the firm, not estimated, costs of 
    the ancillary services needed to make the loan for which the 
    consumer has applied. If the borrower receives a clear disclosure 
    of 
    firm closing costs early in the transaction, it will be more 
    difficult for an abusive lender or broker to misrepresent the terms 
    of the loan and the borrower will have time to seek financing from 
    other sources if the terms are unfavorable.
    Offering guaranteed closing cost packages will not work without a 
    corresponding exemption from Section 8 of RESPA for arrangements 
    negotiated between the lender or mortgage broker and the providers 
    of ancillary services whose costs are included in the firm closing 
    costs disclosure. Thus, for example, lenders would be free to 
    negotiate volume discounts or other pricing arrangements with their 
    service providers without the restrictions of Section 8. If a 
    lender or broker charged more than the total listed on the firm 
    closing costs disclosure, other than those few items, such as taxes 
    and per diem interest, which are not included in the disclosure, it 
    would risk losing its Section 8 exemption. Under current law, the 
    constraints imposed by Section 8 give lenders little incentive to 
    reduce third-party closing costs.
 Simplified, understandable disclosures of key information 
    about the loan. Mortgage reform would consolidate and highlight 
    disclosures of the key terms of a mortgage credit product so that 
    applicants could easily comparison-shop for loans. It would 
    eliminate confusing disclosures such as the ``Amount Financed,'' 
    which has actually been used to mislead consumers about the true 
    amount of the obligation. The disclosure of firm closing costs, 
    noted above, would include any mortgage broker fee paid by the 
    borrower.
 Proportional remedies so that lenders are the targets of less 
    litigation over harmless or minor errors while consumers can be 
    compensated for actual harms. The remedies in the mortgage reform 
    proposal, in contrast to current law, are structured to ensure that 
    the borrower receives a loan on the terms that were disclosed. 
    Lenders that detect and correct errors quickly will not be 
    penalized, while those that engage in knowing and willful 
    violations will be penalized more severely than under current law.
 Substantive protections against loan flipping to protect the 
    most vulnerable consumers from abusive loans. The focus of the 
    mortgage reform effort is on reforming the mortgage process for all 
    consumers, but we include an enhancement to the Home Ownership and 
    Equity Protection Act (HOEPA) in the form of protections against 
    loan flipping. Under the proposal, when making a HOEPA loan that 
    refinances an existing mortgage loan and that is entered into 
    within 12 months of the closing of that loan, the originator may 
    not finance points or fees payable to the originator or broker that 
    are required to close the loan in an amount that exceeds 3 percent 
    of the loan amount. This limitation does not apply to voluntary 
    items such as credit insurance, nor to taxes and typical closing 
    costs for settlement services such as appraisal, credit report, 
    title, flood, property insurance, attorney, document preparation, 
    and notary and closing services provided by a third party, whether 
    or not an affiliate.
    Limiting the financing of points will mean that borrowers would 
    have to bring cash to closing to pay high points and fees. This 
    will mean that borrowers of HOEPA loans will be less likely to be 
    ``flipped'' numerous times. Consistent with regulations adopted by 
    the New York State Banking Department, the limit on refinancing 
    points does not apply to typical third-party closing costs. 
    Significantly, this restriction is not limited to refinances by the 
    same lender and would thus apply to a much broader number of loans 
    that may not be in the category of ``flipped'' loans. For this 
    reason, it is appropriate that a reasonable amount of points and 
    fees be eligible to be financed in order to meet real credit needs.
 Substantive protections affecting prepayment penalties. On 
    non-HOEPA loans, no prepayment penalty would be permitted after 5 
    years from the date of the loan. However, prepayment penalties 
    would be authorized during this 5 year period, notwithstanding 
    State law. Any prepayment penalty permitted would be limited to a 
    maximum of 6 months' interest on the original principal balance.
 Foreclosure reforms to provide additional protections to 
    borrowers facing the loss of their home without reducing the value 
    of lender's security interest in the property. Lenders and 
    servicers have in recent years significantly changed their 
    procedures for dealing with delinquent borrowers. Workouts, 
    forbearance, and other loss mitigation tools are employed and 
    foreclosure is increasingly seen as an expensive (for everyone) 
    last resort. In addition to this business trend, we would support 
    the enactment of a new Homeowner's Equity Recovery Act (HERA), 
    which would apply at the time lender notifies consumer of 
    consumer's default and rights under HERA.

          HERA protections would apply if the consumer's indebtedness 
        (origination balance and interest, junior liens, etc.) is not 
        more than 80 percent of the origination valuation. A consumer 
        would have the right to list the property with a real estate 
        broker or otherwise make a good faith effort to sell the 
        property.

    We believe that the consumer protections made available through 
    HERA strike a reasonable balance between the rights of lenders and 
    investors for repayment of amounts owed and the consumer's right to 
    ``breathing room'' if the consumer is attempting to resolve the 
    default. However, we do not support the expansion of mandatory 
    judicial foreclosure because it is costly both to the consumer and 
    lender, and is too time consuming, which, among other things, puts 
    the collateral at risk. In addition, we note that the Federal tax 
    code (REMIC provisions), under which loans are sold to the 
    secondary market, places limitations on types of compromise that a 
    lender can offer to a defaulting borrower.
 Substantive protections affecting collection practices. Under 
    the proposal, the prohibitions contained in Section 806 of the Fair 
    Debt Collection Practices Act (FDCPA) concerning harassment and 
    abuse would be extended to the collection of mortgage loan debts by 
    a creditor or its affiliates. The law would be clarified to ensure 
    that loan servicers that collect debts as part of their servicing 
    function would not be treated as debt collectors.
 Federal preemption of State laws so that lenders can comply 
    with a uniform set of disclosure requirements that will adequately 
    protect consumers and result in lower costs to lenders and lower 
    rates for borrowers. Imposing uniform laws and regulations ensures 
    that consumers--across the Nation--are afforded the same 
    protections. Preemption would also reduce the number of documents 
    to be signed by consumers at closing. ``Information overload'' is 
    an almost universal feature of complaints about predatory lending.
    Federal preemption is particularly important because the need for 
    uniformity has never been greater. There has recently been a 
    proliferation of State and local legislation to combat predatory 
    lending practices. Although well-intentioned, these initiatives can 
    be counterproductive because they can impose very high-costs on 
    lenders in comparison to the potential number of loans affected.
    In one recent example, the city of Philadelphia enacted 
    antipredatory-lending legislation that was so broad in its sweep 
    that it threatened to cut off much legitimate, mainstream lending 
    as well as the practices at which it was targeted. Last-minute 
    legislative intervention at the State level was necessary to 
    prevent this legislation from taking effect and shutting down most 
    mortgage lending in Philadelphia.
    Another example of the unintended negative effects of State and 
    local regulation has recently occurred in Chicago, where the city 
    of Chicago, Cook County, and the State of Illinois have all enacted 
    new laws aimed at preventing predatory lending. Name-brand, well-
    capitalized lenders and servicers are reluctant to put their 
    capital and reputation at risk to make new loans in Chicago because 
    of the risk that they could be found to be making predatory loans 
    under one of the three, varying, and sometimes conflicting and/or 
    unclear definitions (or under the Federal HOEPA).
    If the Committee decides that clarification of the existing 
    legislation prohibiting abusive practices is needed, we strongly 
    urge that it create a single, nationwide standard that cannot be 
    undermined by myriad local initiatives.

    The CMC appreciates the opportunity to submit its views on the 
problem of, and appropriate responses to, ``predatory lending.'' We 
look forward to working with the Committee on constructive, practical 
solutions to address abuse practices without restricting the 
availability of credit, reducing consumers' options, or burdening the 
efficient operation of the mortgage market.












































































                     STATEMENT OF RICHARD STALLINGS
            President, National Neighborhood Housing Network
                             July 27, 2001
    Mr. Chairman and Members of the Committee on Banking, Housing, and 
Urban Affairs, I appreciate the opportunity to submit testimony to the 
Committee on Banking, Housing and Urban Affairs on behalf of the 
National Neighborhood Housing Network (NNHN).
    First I would like to thank Senator Sarbanes for holding hearings 
on predatory lending--an issue that is of great concern to all of 
NNHN's members. The purpose of my testimony is to raise awareness of 
the growing presence of predatory lenders in low income urban and rural 
communities and to encourage Congress to take action to curtail their 
activity. I also want to clarify the differences between subprime and 
predatory lending and discuss the importance of making sure that low- 
and moderate-income consumers have access to home mortgage credit and 
other forms of financing through responsible lenders.
National Neighborhood Housing Network
    As the president of NNHN, I represent a network of 120 community-
based organizations including my own, Pocatello Neighborhood Housing 
Services in Pocatello, Idaho. NNHN is a nonprofit organization that 
advocates for better neighborhoods and housing for low to moderate 
income Americans. The NNHN organization is made up of 120 
NeighborWorks' organizations (NWO's) who use Neighborhood 
Reinvestment Corporation's funds to leverage private dollars to create 
new homeowners, revitalize distressed communities, and build single 
family and multifamily housing for low- to moderate-income families. 
NWO's are nonprofit organizations dedicated to helping families buy and 
maintain homes. We are committed to assisting low- and moderate-income 
Americans recognize the dream of becoming homeowners and living in safe 
and stable neighborhoods.
    Owning a home can lead to not only stability and security for 
individuals and families but can also contribute to the greater 
stability and security of communities as the tax base is strengthened, 
the business environment stabilizes and wealth in the community grows. 
However, the full benefit of home ownership accrues to communities only 
if these homes become secure investments with the potential for asset 
accumulation for the homeowner. Our mission, as affordable housing 
providers, is to ensure that communities receive the full benefits of 
home ownership and we do this by creating strong, educated consumers as 
well as default-resistant owners.
Subprime Versus Predatory Lending
    There is a distinct difference between subprime lending and 
predatory lending. Whereas subprime lending takes a borrower's 
potential risk into account and provides manageable lending rates, 
predatory lending includes tactics which purposefully damage a 
borrower's equity and credit, enabling the lender to take advantage of 
the borrower. These tactics include inflated points and fees, and 
encouraging loans that rely on home equity rather than the borrower's 
income and ability to pay. These tactics often end in borrowers? losing 
their homes.
    In my own community I have witnessed the damage that predatory 
lenders can have. In fact, I have seen an increase in the presence of 
predatory lenders over the last 5 years. In part these lenders have 
moved in to fill the vacuum left by conventional lenders who have moved 
out of the area. Unfortunately, we are usually contacted by homeowners 
after they have fallen prey to predatory lending schemes and we can do 
little to rectify the situation.
    Predatory loans can have any number of abusive or deceptive 
characteristics and frequently these loans include one or more of the 
following features:

 carry excessive interest rates, fees and closing costs, which 
    are often hidden in fine print;
 impose onerous conditions and terms of repayment, such as 
    penalties for paying off the loan early or large balloon payments 
    at the end of the loan term;
 involve mortgage loans to homeowners without verification of 
    income or regard to whether they can afford to pay the loan back; 
    and
 are marketed through deceitful or unfair practices, such as 
    last minute changes to loan terms or inadequate disclosure of the 
    loan terms.

    Let me stress that it is not just the presence of these loan 
features that qualifies a loan as a predatory loan--but also the manner 
in which the financing is marketed and targeted specifically to 
vulnerable consumers.
    Once locked into a predatory loan, a homeowner may be forced to 
borrow still more money to stay afloat, and all too often may be forced 
to give up the home to foreclosure. Predatory lending is believed to be 
a major factor in the dramatic 300 percent increase in home mortgage 
foreclosures since 1980. Predatory lenders will make loans to 
homeowners with little or no attention to the borrowers ability to 
repay, but instead focus on the amount of equity they have in the home 
and how that can be drained. If left unchecked, these practices will 
cost American homeowners billions of dollars in home equity over the 
next several years.
    A recent study completed by the Neighborhood Reinvestment 
Corporation and the NeighborWorks' Campaign for Home 
Ownership 2002 documents a significant increase in subprime lending in 
the Boston metropolitan area. This study, Analyzing Trends in Subprime 
Originations: A Case Study of the Boston Metro Area, analyzed Home 
Mortgage Disclosure (HMDA) data from eight counties in the Boston 
metropolitan area from 1994 to 1998. The study found that loan 
originations by subprime lenders grew by 435 percent as compared to the 
growth of all conventional loan originations by 119 percent. The growth 
of subprime lending was much more significant for properties located in 
low-income and minority neighborhoods than for properties in other 
parts of the city. The study revealed that the market share of subprime 
lenders is significantly higher in low income largely minority 
communities where they accounted for 13 percent of the overall 
originations which is more than three times their share for the entire 
metropolitan area. The study also found that subprime lending activity 
in minority and low-income communities is especially concentrated in 
the refinancing market where much of the predatory lending practices 
are put to use.
    The National Training and Information Center (NTIC) in Chicago 
recently conducted a similar study looking at the increase of subprime 
lending and the number of foreclosures in Chicago. According to the 
NTIC study, high interest rate lenders made more than 50,000 loans in 
1997 in the Chicago area which is 15 times greater than the number of 
loans they made in 1991. In addition, the number of foreclosures tied 
to these predatory loans rose dramatically. In 1993 subprime lenders 
were responsible for 1.4 percent of all foreclosures in the city and in 
1998 they were responsible for 36 percent of the years foreclosures.
    NTIC's study also describes the effects that predatory lending 
practices have on neighborhoods. By looking at a 36 block area in the 
Chicago Lawn neighborhood, NTIC was able to demonstrate that predatory 
lending activity was directly responsible for the increase in 
foreclosures and vacant buildings in the area. Specifically NTIC found 
that 40 of the 72 foreclosures were initiated by subprime lenders. In 
addition, NTIC found that an additional 22 abandoned properties in the 
target area were foreclosures submitted by subprime lenders.
Promoting Responsible Subprime Lending
    I do want to stress that NNHN supports the increased flow of 
mortgage credit into low income and minority communities. The NNHN 
network is made up of organizations that are committed to working with 
low and moderate income individuals who for a variety of reasons, 
including poor or nonexisting credit histories or unstable employment 
backgrounds, are unable to secure conventional mortgage financing. As 
responsible subprime lenders, NWO's work to provide these consumers 
with a range of financial services and products to enable them to 
become homeowners. We do this both as direct lenders as well as by 
working with conventional lenders.
    Responsible subprime lending entails working with a consumer to 
come up with a loan product at a price and with terms that 
appropriately compensate the lender for any risk taken on, inclusion of 
reasonable return for the lender, and understandable by and appropriate 
for the borrower. Our concern is that the credit and other financing 
tools be made available to low- and moderate-income individuals in a 
responsible manner and that these consumers become educated and 
empowered through the process of becoming a homeowner.
    NNHN supports curtailing the practices of predatory lenders through 
legislation and we believe this legislation must:

 prohibit points and fees from being financed as part of a 
    homeowner's loan
 prohibit equity stripping where lenders make loans based on 
    the equity a homeowner already has in the home as opposed to the 
    borrower's ability to repay the loan
 prohibit abusive lending practices such as ``flipping'' the 
    repeated refinancing 
    of a home so the lender can collect upfront fees and eat away at 
    the equity in the home or ``insurance packing,'' when unnecessary 
    and overpriced insurance is 
    financed as part of the financing package often without properly 
    informing the consumer.

    NNHN also feels that consumer education is a critical component to 
any strategy aimed at eliminating predatory lending practices and 
curtailing unnecessary foreclosures. Such education needs to focus on 
building the financial literacy skills of consumers and homeowners to 
empower them to make sound borrowing decisions.
Predatory Lending In Maryland
    As you know, predatory lending is a nationwide problem. I would 
like to give you some examples of predatory lending in your home State 
of Maryland, Mr. Chairman, and describe to you the responses by the 
NNHN members there. As I have mentioned, those homeowners who have 
become victims of predatory lending often come to the 
NeighborWorks' Organizations when it is already too late. We 
have, however, been able to prevent many homeowners from ever falling 
prey by educating them beforehand and being available to them for 
advice following the education.
    The first example in Maryland that I wish to share is the Salisbury 
Neighborhood Housing Services, Inc. There is one particularly sad story 
of an elderly woman who went to the organization after being on the 
verge of losing her home. In 1993, she had purchased a home in the 
Westside neighborhood using owner financing from her landlord. Her 
landlord, a local attorney, sold her the house for $30,000 and set up a 
balloon payment.
    The house was in disrepair when he sold it to her and because of 
the monthly payment she could not afford to fix up the house. When she 
was cited by the city for the condition of her house, the landlord 
agreed to refinance the home for her and to add funds to the original 
loan amount to fund the cost of some of the repairs. He charged her 
additional fees and closing costs and added them into the loan amount. 
Under the pretense of helping her he then refinanced the loan yet again 
through the Ford Consumer Finance Company in 1995. By the time she went 
to Salisbury Neighborhood Housing Services, she owed $55,000 on her 
house, and the contractor's estimate to bring the house up to code was 
$53,000. In 1997, less than 2 years from the time she took out the loan 
with Ford, she signed a Deed in Lieu of foreclosure and lost her home.
    Another example, which worked out somewhat better, comes from the 
Neighborhood Housing Services of Baltimore, Inc. A couple of years ago 
over 100 families became victims of predatory lending in the 
neighborhood of East Baltimore, near Patterson Park. The Neighborhood 
Housing Services of Baltimore first heard about these problems of loan 
flipping and fraudulent loan documents from an individual case of a 
woman who went to them for help. The NHS discerned problems with the 
documents immediately, and quickly learned of the other families 
plagued by the same lender. The NHS worked in collaboration with other 
East Baltimore nonprofit organizations and a local attorney to file a 
class action suit against the lender. The case never went to court; the 
lender is currently settling with the plaintiffs. One of the aspects of 
the settlement, which has already taken effect, is the reduction of 
principal balances on some of loans. The NHS is currently working with 
many of the families to provide loan packaging and rehabilitation. The 
city has also contributed some funds to assist these families.
    In both of these cases, predatory lenders have caused irreparable 
damage to homeowners and their credit histories.
    Mr. Chairman, on behalf of the National Neighborhood Housing 
Network, I applaud your past efforts in addressing this problem that is 
destroying families and neighborhoods. This country has made great 
strides in increasing homeownership nationwide and your commitment to 
this issue ensures that this is not in vain. The Government's own funds 
are at stake when Federal Housing Administration (FHA) mortgages and 
Neighborhood Reinvestment Corporation loans fall prey to unregulated 
lenders.
    These hearings are a wonderful opportunity to find out exactly what 
is happening in our communities. We hope that with the overwhelming, 
indisputable evidence that you find here, you will reintroduce the 
important legislation that you proposed last year, S. 2415 Predatory 
Lending Consumer Protection Act of 2000. As stated, the bill will 
``amend the Home Ownership and Equity Protection Act of 1994 and other 
sections of the Truth in Lending Act to protect consumers against 
predatory practices in connection with high cost mortgage transactions 
[and] to strengthen the civil remedies available to consumers under 
existing law.''
    I would like to invite you and your colleagues to visit the 
NeighborWorks' Organizations in Maryland and nationwide. I 
know you are already familiar with our work, and I hope that we will be 
able to work together in the future to achieve our mutual goals of 
curtailing predatory lending practices and strengthening the 
availability of responsible credit to all low- and moderate-income 
individuals.
    I wish to thank the Committee again for this opportunity to submit 
testimony regarding predatory lending.
                      STATEMENT OF MARIAN B. TASCO
    Councilwoman, Ninth District, City of Philadelphia, Pennsylvania
                             July 26, 2001
    I want to thank Chairman Sarbanes and the Members of the Banking, 
Housing, and Urban Affairs Committee for this opportunity to submit my 
remarks on predatory lending. My name is Marian Tasco and I represent 
the Ninth Councilmanic District in the City Council of Philadelphia. I 
am the sponsor of the landmark legislation passed by the Philadelphia 
City Council to stop the epidemic of predatory lending currently 
ravaging Philadelphia's neighborhoods.
    I know that you have already heard testimony from Leroy Williams, a 
homeowner victimized by predatory lending in Philadelphia and from his 
attorney, Irv Ackelsberg, the managing attorney from Community Legal 
Services who has been leading the legal assault against predatory 
lending not only in Philadelphia but also around the State and the 
Nation. I do not intend to repeat what they have already eloquently 
presented to your Committee concerning the devastating effects of 
predatory lending both in our city and throughout the country.
    Instead I want to share with the Committee the story of how we in 
Philadelphia came to pass the Nation's strongest antipredatory lending 
laws and how the predatory lending industry, along with the legitimate 
financial institutions in Pennsylvania, thwarted our efforts by 
convincing the State Legislature and Governor to completely preempt 
municipalities in Pennsylvania from regulating lending practices within 
their borders.
    The legislation passed by a unanimous Philadelphia City Council on 
April 5, 2001 closely mirrors Senator Sarbanes's pending legislation. 
Under our legislation we set the thresholds for covered loans at 4.5 
percent over the applicable Treasure rate for first lien mortgages and 
6.5 percent over the applicable Treasury rate for junior mortgages. 
Threshold loans are not prohibited per se under the Ordinance, unless 
they are issued without the consumer first receiving home loan 
counseling or if they are issued without regard to the consumer's 
ability to repay. Our definition of high-cost loan closely mirrors the 
triggers of Senate Bill 2415. While we lacked the legal authority to 
directly prohibit the making of high-cost loans, our legislation seeks 
to discourage the making of high-cost loans by bringing economic 
sanctions upon any high-cost lender or its affiliate which seeks to do 
business with the city.
    We often hear that it is difficult to define predatory lending, but 
the Philadelphia Ordinance makes definite progress in itemizing the 
characteristics of predatory loans. We can take direction from the 
Supreme Court on this one. As with obscenity, a definition may be 
elusive, but we know it when we see it; and we are beginning to see it 
more than we would like. We defined a predatory loan as any threshold 
or high-cost loan with any one of thirteen characteristics. The list 
roughly approximates the same terms as are contained in Senate Bill 
2415 except that under the Philadelphia Ordinance home loan counseling 
is mandatory for all threshold loans and no loans are allowed to have 
prepayment penalties.
    The Philadelphia Ordinance adopts a dual approach to the stopping 
predatory lending practices. For those persons over which the city of 
Philadelphia has the home rule authority to exercise its regulatory 
police powers, the ordinance prohibits those persons from issuing, 
arranging, or assisting others in making predatory loans, making any 
threshold loan without home loan counseling and directly paying home 
improvement loan proceeds to home repair contractors. The Philadelphia 
Ordinance also requires home repair contractors to provide a warning 
notice to all customers and requires all lenders and brokers to file a 
certification of compliance with the new law for recording with the 
mortgage instrument.
    In addition to the regulatory approach, we also sought to use 
Philadelphia's substantial financial power as a market participant to 
bring economic sanctions to bear on the predatory lenders preying upon 
our residents and their affiliates. Toward that end the Philadelphia 
Ordinance cuts off the ability of high-cost or predatory lenders or 
their affiliates to enter into city contracts, removes city deposits 
from any depository financial institution engaged directly or through 
affiliates in predatory or high-cost lending practices, prohibits the 
bundling of city administered Federal CDBG funds with any loans 
originated by a high-cost or predatory lender or its affiliate and 
divests city pension funds from any securities issued by a high-cost or 
predatory lender or its affiliate, including predatory loan backed 
mortgage securities.
    The process to draft Philadelphia's antipredatory lending began 
several years ago. I first became aware of this predatory lending issue 
in the winter of 1999 through a segment on ``Good Morning America.'' We 
had had some earlier problems in my Councilmanic District. The segment 
told the lamentable story of a homeowner who had obtained a loan for 
housing improvements. The loan had so many complicated terms and costs 
which the homeowner had not expected and could not pay, she lost her 
home in foreclosure. During hearings on Philadelphia's Community 
Development Block Grant application for fiscal year 2001, several 
representatives from home and loan counseling agencies testified as to 
how the practices had entered into the Philadelphia market and was 
creating havoc for our residential homeowners. The witnesses indicated 
that some protections and safeguards had to be put in place 
immediately. Northwest Counseling Services set up a variety of 
community meetings to discuss the issue. Congressman Bob Brady and I 
made the rounds of the sessions to alert consumers to possible pitfalls 
in the home mortgage process, and this is still a much-needed message.
    Out of the same Community Development Block Grant hearing, I began 
a conversation with ACORN, which expressed an interest and willingness 
to participate in drafting a piece of legislation based on their case 
files, both locally and nationally. In the fall of 2000, I supported 
the establishment of a local predatory lending task force under the 
direction of Michelle Lewis of Northwest Counseling Services. Jeff 
Ordower, the local organizer for ACORN took the issue to the editorial 
board of the Philadelphia Daily News. I am most grateful to both of 
these organizations in their leadership for their involvement and 
commitment to this project and for keeping it on the front burner.
    I also called together an ad hoc task force composed of leading 
housing counseling agencies, ACORN, the Urban League, and the city's 
Office of Housing and Community Development, to draft comprehensive 
municipal legislation based upon the following understandings:

 Philadelphia is experiencing an epidemic of foreclosures and 
    equity stripping in its minority and distressed neighborhoods 
    resulting from a dramatic rise in predatory lending practices.
 Most but not all of the predatory loans resulted from direct 
    solicitations of homeowners from home repair contractors, mortgage 
    brokers or mortgage lenders.
 Most but not all of the predatory loans were taken out by 
    existing homeowners wishing to cash in on their home's equity.
 Legal advocates for the victims of predatory lending have 
    insufficient resources to address this growing epidemic because 
    existing Federal and State statutes are inadequate in providing 
    effective means to stop this epidemic.
 Philadelphia has the largest network of housing counseling 
    agencies which can be trained to provide antipredatory lending 
    counseling to every borrower at risk of predatory lending 
    practices.
 While the city has limited power to regulate the financial 
    services and lending industry due to Federal and State statutory 
    preemptions it has unlimited power to regulate home repair 
    contractors and mortgage brokers, which are the prime forces behind 
    the predatory lending epidemic in the city.
 The city has unlimited market powers to determine with whom it 
    chooses to contract, deposit funds, invest its pension fund or 
    bundle its governmental financial assistance. While the city has no 
    direct business relationships with most predatory lenders or 
    brokers, the city does have such relationships with affiliates of 
    these entities. By leveraging the desire of these affiliates to 
    maintain their lucrative relationships with the city, the city can 
    exercise enormous pressure on their affiliated predatory and high-
    cost lenders to cease their practices within the city.

    I have always maintained that the cooperation of the lending 
community is crucial to the ultimate success of any legislative effort 
to stamp out the abusive and harmful practice of predatory lending. 
Throughout the process of drafting the legislation we met numerous 
times with organizations representing the financial lending industry, 
many of which testified before this Committee. We held a special public 
meeting solely designed to solicit their input which was attended by 
over 100 lenders, brokers, and home repair contractors.
    At every meeting I called upon the industry to propose constructive 
legislative proposals which would benefit the homeowners of 
Philadelphia. Unfortunately, for the most part we received proposals 
designed to gut our legislation or to enact special exemptions to 
remove one or another of the financial institutions from the regulatory 
or economic sanctions portions of the bill.
    The greatest disappointment for me was the complete unwillingness 
of the banking community to engage in a constructive dialogue on the 
legislation. Rather than sit down to design a bill that would allow 
legitimate lending activities to flourish and discourage only those 
which are abusive and deceptive, the bankers locked arms with the 
predatory lenders for a total defeat of our legislation. Swarms of 
lobbyists descended on City Hall disseminating falsehoods about the 
scope and impact of the legislation. Fortunately, we were able to mount 
an immediate and effective response to each deceptive claim. It turned 
out that our greatest weapon against the bankers lobby, surprisingly, 
was not the strength of our arguments as much as the weakness of 
theirs. Even Councilmen sympathetic to the bankers' messages concluded 
that their opposition to the legislation lacked any credibility. The 
bankers could not articulate why they were opposed to legislation which 
exempted them from coverage and which regulated a practice which banks 
do not engage in.
    In the end, our legislation passed by a unanimous vote of 16 to 0, 
with Republicans joining Democrats in a clear and unmistakable message 
to the financial industry: You have utterly failed to police yourselves 
and through your failure to act you have given a green light to the 
unscrupulous predators to strip the wealth from the hard working 
citizens of our city. The only proper and credible response to this 
crisis was swift and decisive Government action.
    Only weeks after our legislative victory, the financial industry 
launched a two-pronged assault on the Philadelphia Ordinance. The 
American Financial Services Association, which in its testimony before 
this Committee called the massive explosion of predatory lending ``[a] 
system which has been extremely successful in delivering consumer 
credit to America's working families,'' brought suit against the city 
seeking to enjoin the implementation of the Ordinance on the grounds 
that the State legislative scheme regulating mortgage lenders and 
brokers preempts the Ordinance by implication and that the city 
exceeded its powers under its home rule charter. Perhaps fearing that 
their arguments of an implied State preemption would not carry the day, 
the predatory lending industry, led by Household Finance, and the 
Pennsylvania Bankers Association drafted State legislation containing 
the broadest preemption language ever proposed in Harrisburg. The 
legislation, Senate Bill 377, was practically secretly passed by 
overwhelmingly majorities in the Republican controlled House and Senate 
on the second day after it was introduced, without any opportunity for 
hearings or floor debate.
    The preemption language of Senate Bill 377 is so wide sweeping that 
it not only prohibits Philadelphia and all municipalities from 
regulating predatory lending practices, but also attempts to prevent 
any local community from determining whether or not to enter into 
contracts, deposit funds or invest pension funds based upon the lending 
practices of the private business or an affiliate. To make matters 
worse, the legislation prohibits municipalities from even passing any 
resolutions concerning lending practices.
    Mr. Chairman, Senate Bill 377 is the poster child for the need for 
strong and effective Federal legislation to stop predatory lending. Not 
only has our State legislature stripped the home rule powers which 
Philadelphia sought to invoke to stop the scourge of predatory lending 
in our midst, but they have given the predators the green light to 
continue robbing Philadelphia's home owners of their hard earned 
wealth. Congress is our last and best hope for a legislative solution 
that will bring real and immediate relief to the past and future 
victims of predatory lending not only in our city, but also throughout 
the country.
    I applaud your efforts to pass meaningful legislation and pledge 
our support to you.
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