[Senate Hearing 107-857]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 107-857


                       PREDATORY MORTGAGE LENDING
                        PRACTICES: ABUSIVE USES
                        OF YIELD SPREAD PREMIUMS

=======================================================================

                                HEARING

                               before the

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

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                                   ON

THE ISSUES SURROUNDING THE USES AND MISUSES OF YIELD SPREAD PREMIUMS IN 
 LIGHT OF THE DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT'S ANNOUNCED 
INTENTION OF PUTTING OUT A PROPOSED RULE ON THE REAL ESTATE SETTLEMENT 
                             PROCEDURES ACT

                               __________

                            JANUARY 8, 2002

                               __________

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


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                            WASHINGTON : 2003
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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

                  Jonathan Miller, Professional Staff

                      Patience Singleton, Counsel

                    Daris Meeks, Republican Counsel

            Geoff Gray, Republican Senior Professional Staff

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        TUESDAY, JANUARY 8, 2002

                                                                   Page

Opening statement of Chairman Sarbanes...........................     1
    Prepared statement...........................................    40

                               WITNESSES

Beatrice Hiers, of Fort Washington, Maryland.....................     4
Rita Herrod, of Clarksburg, West Virginia........................     6
Susan M. Johnson, of Cottage Grove, Minnesota....................     7
    Prepared statement...........................................    41
Howell E. Jackson, Finn M.W. Caspersen and Household 
  International
  Professor of Law and Associate Dean for Research and Special 
    Programs,
  Harvard University School of Law...............................    14
    Prepared statement...........................................    54
    Response to written question of Senator Sarbanes.............    85
John Courson, Chairman-elect, Mortgage Bankers Association and
  President and Chief Executive Officer, Central Pacific Mortgage 
    Company
  Folsom, California.............................................    18
    Prepared statement...........................................    59
Joseph L. Falk, President, National Association of Mortgage 
  Brokers........................................................    20
    Prepared statement...........................................    64
    Response to written question of Senator Schumer..............    89
Ira Rheingold, Executive Director, National Association of 
  Consumer
  Advocates......................................................    22
    Prepared statement...........................................    70
David Olson, Managing Director, Wholesale Access Mortgage 
  Research
  and Consulting, Inc............................................    24
    Prepared statement...........................................    78
David R. Donaldson, Counsel, Donaldson & Guin, LLC...............    26
    Prepared statement...........................................    81
    Response to written questions of:
        Senator Sarbanes.........................................    92
        Senator Schumer..........................................    94

              Additional Material Supplied for the Record

Statement of ABN AMRO Mortgage Group, Inc........................   105
``Another View of Predatory Lending'' by Jack Guttentag, dated
  August 21, 2000................................................   125
``Kickbacks or Compensation: The Case of Yield Spread Premiums'' 
  by
  Howell E. Jackson and Jeremy Berry.............................   155
Mortage Broker Fee Agreement submitted by John Courson...........   172
Letter submitted by the National Association of Mortgage Brokers.   173
Letter of Clarification submitted by Bren J. Pomponia on behalf 
  of
  Rita Herrod, dated January 23, 2002............................   175
Comsumer Analysis of HUD's 2001 Policy Statement on Lender 
  Payments
  to Mortgage Brokers by Margot Saunders.........................   177

                                 (iii)

 
                       PREDATORY MORTGAGE LENDING
                        PRACTICES: ABUSIVE USES
                        OF YIELD SPREAD PREMIUMS

                              ----------                              


                        TUESDAY, JANUARY 8, 2002

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

    The Committee met at 9:40 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. Let me call this hearing to order.

    There are a number of people outside waiting. Are there any 
empty seats out there? We are going to try to move a few more 
people in. We may have them standing in the back. But if there 
is any way for people who are already in to tighten up a bit, 
we would appreciate that. And to the extent that we can add 
some others and they can stand in the back, we will try to do 
that as well in order to accommodate people.

    This morning the Committee on Banking, Housing, and Urban 
Affairs will hold its third hearing on the subject of predatory 
lending. Our previous two hearings on this subject focused 
largely on the predatory loans and practices which have 
resulted in stripping hard-earned equity away from many low-
income homeowners. These include folding high points and fees, 
as well as products such as credit insurance, into the loan. We 
examined in those hearings held this past July how unscrupulous 
lenders and mortgage brokers target low-income, elderly, and 
uneducated borrowers as likely marks for predatory loans.

    Today, we are going to focus on the role of the broker in 
the lending process and specifically, we are going to focus on 
the use and misuse of what are referred to as yield spread 
premiums.

    Let me start by addressing briefly how yield spreads are 
used in the marketplace. Typically, a mortgage broker will 
offer to shop for a mortgage on behalf of a consumer, the 
prospective borrower. In many cases, that broker will promise 
to get the borrower a good deal, meaning low rates and fees. 
Borrowers pay the broker a fee for this service, either out of 
their savings or with the proceeds of the loan. Unbeknownst to 
the borrower, however, that broker may also be paid a yield 
spread premium by the lender if he can get the borrower to sign 
up for a loan at a higher rate than the borrower qualifies for. 
The higher the mortgage rate, the higher the payment. And we 
will hear about such cases this morning.
    Yield spread premiums, properly used, can be a tool in 
helping a homebuyer or homeowner offset all or some of the 
closing costs associated with buying or refinancing a home. 
When used properly, the broker discloses his total fee to the 
consumer. The consumer may then choose to pay that fee, and, 
perhaps other closing costs as well, by accepting a higher 
interest rate and having the lender pay the fee to the broker. 
In such cases where the borrower makes an informed choice the 
payment helps families overcome a barrier to homeownership--
namely, the lack of funds for closing costs.
    It is very important that this be transparent and that the 
borrower know exactly what their options are. But it appears 
that in practice, perhaps in widespread practice, yield spread 
premiums are not used to offset closing costs or broker fees. 
Instead, these premiums are used to pad the profits of mortgage 
brokers, without any regard to any services they may provide to 
the borrowers.
    Let me quote from a report issued by the Financial 
Institutions Center at the Wharton School of Business at the 
University of Pennsylvania. Professor Emeritus Jack Guttentag, 
discussing the problem of rebate pricing--that is, payments by 
lenders to brokers of yield spread premiums,writes:

    In most cases, rebates can be pocketed by the broker, 
unless the broker commits to credit them to the borrower, which 
very few do. Rebate pricing--that is, yield spread premiums--
has been growing in importance, and one of the reasons is that 
it helps mortgage brokers to conceal their profit on a 
transaction.

    Moreover, this does not just affect subprime borrowers, as 
do most of the other egregious practices we heard about in our 
previous hearings. The misuse of yield spread premiums affects 
prime borrowers, FHA borrowers, VA borrowers. But, because of 
the lack of openness and competition in the subprime market, it 
hits subprime borrowers hardest of all. Even for those with the 
best credit, yield spread premiums can cost thousands of 
dollars in increased financing costs.
    Yield spread premiums, when they are misused in this 
manner, fall directly into the category of the kind of referral 
fees or kickbacks that were so prevalent in the settlement 
business prior to the passage of RESPA--the Real Estate 
Settlement Procedure Act--enacted by Congress in 1974, after 
years of hearings and reports, and specifically designed to 
outlaw side payments of this kind because they increase the 
costs of homeownership for so many Americans. Indeed, the plain 
language of the law, the regulations, the 1998 Congressional 
instructions to HUD to formulate a policy on this issue, and 
the 1999 HUD policy statement, particularly when taking the 
legislative history into account, all make it clear that RESPA 
was intended to prohibit all payments that are not demonstrably 
and specifically for actual services provided. That is to say, 
each fee collected by the broker should be for a corresponding 
service actually provided.
    Because the majority of home loans are now originated 
through brokers, lenders have less and less direct access to 
borrowers. This means they must compete for the broker's 
attention to gain access to the ultimate consumer--the 
borrower. This competition means that, too often, lenders pay 
yield spread premiums to the brokers simply for the referral of 
business. As all of us know, this is prohibited under the law 
precisely because it raises the cost of homeownership to the 
consumers.
    Regrettably, HUD's recent clarification of its 1999 policy 
statement on the issue of yield spread premiums will open the 
door to new and ongoing abuses of low- and moderate-income 
homebuyers. Despite the Secretary's statement at his 
confirmation hearing that he finds predatory lending 
``abhorrent,'' I fear that the new policy statement will 
facilitate the predatory practice of steering homeowners to 
higher interest rate loans without their knowledge and, more 
importantly, without any effective means of redress.
    Now, Secretary Martinez has made increasing minority 
homeownership a primary goal of his Administration. However, a 
study done by Howell Jackson of the Harvard Law School, who 
will be testifying on the second panel this morning, shows that 
while the current use of yield spread premiums imposes extra 
costs on all homebuyers, the burden falls especially heavy on 
minorities. In other words, yield spread premiums, when they 
are used in this abusive fashion, put the dream of 
homeownership further out of reach for minority Americans. 
Those who still manage to achieve the dream of homeownership 
are forced to pay thousands of dollars in increased interest 
costs over the life of their loans.
    Many find themselves in more precarious financial positions 
than they should be, thereby putting them at greater risk of 
falling prey to the kind of repeated refinancing that we have 
seen leading to equity stripping or even the loss of the home.
    HUD has indicated both in testimony before this Committee 
in December, and in a general announcement, that it intends to 
publish a proposed regulation on this matter by the end of this 
month. These issues are of such importance that they call for a 
public airing at this time, and that is the purpose of this 
hearing, so that the Department can take into consideration 
today's testimony as it considers formulating the new 
regulation.
    We have two panels this morning. Let me just say in 
reference, and then I will introduce them in greater detail 
when they arrive, the second panel will consist of a number of 
experts from the academic world, consumer advocates, and from 
the business interests involved in the issues before us this 
morning.
    The first panel that we will now turn to involves three 
witnesses who will testify about how their brokers steered them 
into higher rate mortgages in exchange for payments of yield 
spread premiums from the lenders. These are the mortgage 
brokers that each of these consumers went to and in the course 
of that process, they led them into a higher rate mortgage than 
they otherwise would have had to undertake. And the difference 
as a consequence was paid from the lender to the broker, not to 
the benefit of the consumers.
    Beatrice Hiers is a Supply Management Representative for 
the General Services Administration and resides in Fort 
Washington, Maryland. Susan Johnson lives in Cottage Grove, 
Minnesota, outside of Minneapolis, and is a Manager at K-Mart. 
And Ms. Rita Herrod is retired and lives with her daughter and 
grandchildren in Clarksburg, West Virginia.
    Before we take your testimony, let me express my very deep 
appreciation to all of you for your willingness to leave your 
homes and come here and be with us this morning and your 
willingness to speak publicly about your stories. I know that 
this can be a 
difficult thing to do. I just hope you understand how much we 
appreciate your willingness to contribute to a process that I 
hope will lead to some action to stop the kinds of practices 
that caused each of you such heartache, such difficulty, and 
such trouble.
    I want to point out that these three witnesses include a 
prime borrower, a subprime borrower, and an FHA borrower. It is 
important to mention this so that everyone understands how the 
abuse of yield spread premiums can affect people, whatever 
their credit rating and whatever type of mortgage they receive.
    Now, I will turn to you, Ms. Hiers. We will hear from you 
first and then we will go to Ms. Herrod and then Ms. Johnson. 
We will just move right across the panel, and we will hear from 
each of you first before I go to any questions.
    Again thank you very much for coming and being with us this 
morning.
    Ms. Hiers, I think if you pull that microphone closer to 
you and talk right into it, it will be more audible.

                  STATEMENT OF BEATRICE HIERS

                   FORT WASHINGTON, MARYLAND

    Ms. Hiers. Good morning. I am Beatrice Hiers, and thank you 
for inviting me here today.
    I am 43 years old and live in Fort Washington, Maryland. I 
have two children, Ebony, 22, and Zachary, 11. In addition, 
prior to their recent deaths, my elderly parents lived with me. 
I have worked hard and overcome many obstacles to purchase my 
own home.
    I grew up in Prince George's County, Maryland. My family 
lived in a neighborhood that was not racially mixed. In fact, 
we were the first blacks on the street. In 1974, I received a 
general equivalency degree and went to work for Prince George's 
County Department of Social Services. In 1979, I began working 
for the Federal Government as a clerk/typist. Over the past 20 
years, I have worked my way up to my current position as a 
Supply Management Representative for the General Services 
Administration.
    Prior to purchasing my own home in August 1997, I struggled 
financially. I was a single parent and also helped support my 
parents. I began to think about moving and buying a home 
because the neighborhood in which I lived had become a ``drug 
haven.'' I felt that it was important for my children and 
parents to get into a new environment that offered safety and 
security.
    In June 1997, after house hunting for close to a year, I 
finally found a house that I wanted. I signed a contract to 
purchase the house for $159,750, but was told by my real estate 
agent that I needed to obtain my own financing. Because I was 
inexperienced with real estate transactions, I engaged the 
services of Homebuyers Mortgage Company, a mortgage broker 
located in Prince George's County, and asked them to find me a 
7 percent or better ``fixed'' rate FHA mortgage loan, a rate 
equal to what another lender--Countrywide Home Loans--was 
willing to offer me.
    The closing on the home was scheduled for August 29, 1997. 
As the settlement approached, I became increasingly nervous 
because Homeowners had not confirmed that it had located a 
mortgage for me. As late as just 2 days before the closing, 
Homebuyers told me that a firm commitment on financing was not 
yet available. Even though mortgage rates were low and 
favorable in August 1997, on the day of closing, Homebuyers 
finally told me that it had arranged a 7 percent ``adjustable 
rate'' FHA insured mortgage loan through Inland Mortgage 
Company, which is now Irwin Mortgage Company. Homebuyers told 
me that Inland was providing me with the best rate and most 
favorable financing terms that they could secure. Reluctantly, 
and believing that I had no other options, I entered into the 
mortgage loan transaction.
    Homebuyers charged me extraordinary fees and points. My 
HUD-1 Settlement Statement reveals that Homebuyers charged me 
the FHA maximum 1 percent origination point, $1,544, plus loan 
discount points of 3 percent, $4,736. On top of these fees, 
Homebuyers also collected a yield spread premium from Inland of 
nearly 3 percent--an astonishing $4,538.87. In other words, I 
paid 3 discount points to reduce my interest rate and the 
broker was paid 3 percent by Inland to increase my interest 
rate.
    Almost a year after I entered into the mortgage loan 
transaction, I learned that Homebuyers had not obtained for me 
the most favorable financing terms. In fact, I learned that 
Homebuyers was paid the $4,538.87 Yield Spread Premium by 
Inland Mortgage solely because Homebuyers was able to deliver 
my mortgage well above par--that is, Inland would have been 
willing to underwrite my mortgage loan at a lower interest 
rate. Moreover, I learned that Homebuyers' yield spread premium 
was increased because Homebuyers delivered the mortgage loan 
with a short lock in period. Irwin's rate sheet, in fact, shows 
that I qualified for the same loan at about 5\1/2\ percent 
interest rate with no yield spread premium to the broker.
    What truly amazes me is that for the small amount of work 
performed for me, Homebuyers collected more than $10,800, 
including the yield spread premium. Moreover, had I known that 
Homebuyers had secured for me a mortgage with an above-par 
interest rate, I would have secured other financing.
    Eventually, because the payments under Inland's adjustable 
rate mortgage were becoming prohibitive, I engaged the services 
of another mortgage broker, Allied Mortgage, to assist me in 
the refinancing of my loan. I have since learned that this 
transaction included the payment of a yield spread premium, and 
resulted in my receiving another loan at a higher interest rate 
than I qualified for.
    After completing these two mortgage transactions, I learned 
what yield spread premiums are and how they affected my 
mortgage loan and increased my monthly mortgage payments. As a 
result, I recently refinanced my home a second time, but this 
time directly with a lender. Because of my experiences with 
mortgage brokers and yield spread premiums, I will never go to 
a mortgage broker again.
    Thank you again for inviting me and for your attention to 
these important issues.
    Chairman Sarbanes. Well, thank you very much for your 
statement. It is a very clear statement of the problem that we 
are quite concerned about.
    You actually paid extra to try to get a lower rate, 
interest rate, discount points, at the same time that your 
broker led you into a higher interest rate in order to get the 
yield spread premium. Is that correct?
    Ms. Hiers. Correct.
    Chairman Sarbanes. Ms. Herrod, we would be happy to hear 
from you.

                    STATEMENT OF RITA HERROD

                   CLARKSBURG, WEST VIRGINIA

    Ms. Herrod. I am glad to have the chance to come here today 
and tell what happened to me so that others are not treated the 
way I have been treated. My name is Rita Herrod, and I am a 62-
year-old mother, grandmother, and now, great-grandmother. I am 
currently disabled and unable to work. I live with my daughter 
and grandchildren, and I own my home with my daughter.
    In July 1994, I bought a house in Clarksburg, West 
Virginia, for $22,000 for my daughter, Jennifer, and her 
children. About 4 years later, when I divorced my husband of 34 
years, I moved into the house with my daughter and 
grandchildren, and I live there today.
    In 1999, my daughter and I took out a loan to make 
improvements on the house. We got a decent loan from a local 
bank for 15 years with a variable rate beginning at 7.8 
percent. I would end up not getting much benefit of this loan.
    In early 2000, my troubles started when we encountered a 
mortgage broker we thought we could trust, Earl Young. My 
daughter Jennifer was working for Heilig Myers, where she met 
Mr. Young. Mr. Young, who worked for First Security, 
distributed his card to my daughter for her to distribute to 
others. Because my daughter knew Mr. Young and we had some 
bills to pay, we responded to his solicitation in April 2000.
    Mr. Young told us he would get us a home loan with a lower 
interest rate on our current loan. He told us he was going to 
search and find for us the best deal he could.
    Mr. Young arranged for an appraisal of our house. He said 
not to worry that I was not working and not to worry about the 
rumors that my daughter would be laid off in the near future. 
The appraisal he got for my house, I found out later, was for 
far more than it was worth.
    We closed the loan the next month. We had to meet at Mr. 
Young's office. He seemed to have taken care of everything. He 
told us he was giving us a good deal. He said that our 
appraisal did not come back at what they wanted, so he agreed 
to cut his own fees to work the deal.
    I wonder now what part of his fees Mr. Young cut. He 
charged us an origination fee of $4,000, a broker fee of 
$2,600, and I learned from my lawyer that he got a kickback 
from the mortgage company of $3,304 for getting me into a 
higher interest rate.
    My loan was for just under $85,000, and I ended up paying 
over $10,000 in fees to Mr. Young. Now, I say that Mr. Young 
appeared to take care of everything, but I do not think he did 
$10,000 worth of work on my loan. He took our information and 
arranged for an appraisal. I do not know what else he did, but 
I know the mortgage company faxed him all the papers. I had no 
idea I was going to have to pay him so much, and I cannot for 
the life of me figure out what I got in return. And while I 
guess Mr. Young charged me $4,000 commission for finding the 
loan, and $2,600 for his fees, I have no idea what he did to 
earn the extra $3,304. Had I known $10,000 was going to be 
tacked onto the loan, I would never have done it. Had the 
broker not taken a kickback, I would have at least had a rate 
of 8.5 percent, maybe lower. Instead, I got a loan up near 10 
percent.
    I now have a loan that far exceeds the value of my house, 
making it so I cannot take advantage of lower interest rates 
and refinance. I am stuck with this loan, which requires that I 
make over $275,000 in payments at an APR of almost 10 percent. 
At the very worst, I could have stayed with my old loan, 
avoided the extra fees, and dealt some other way with my bills 
instead of putting them into my home.
    I do not have any problem with people helping folks find a 
loan to help them out of a bind, or get them a good deal. But I 
do not think it is right for a broker to take a secret kickback 
of over $3,300, when they already are getting almost $7,000 in 
other fees. And I do not think it was worth $10,000 to get a 
loan that is worse than what I had, when there are much better 
deals out there. We trusted Mr. Young, because we thought it 
was his job to find us the best deal. But instead, he cheated 
us out of a lower interest rate and $10,000.
    Thank you.
    Chairman Sarbanes. Thank you very much, Ms. Herrod. We 
appreciate your very powerful testimony.
    Ms. Johnson.

                 STATEMENT OF SUSAN M. JOHNSON

                    COTTAGE GROVE, MINNESOTA

    Ms. Johnson. Good Morning. My name is Susan Johnson and I 
am from Cottage Grove, Minnesota. I am pleased to have the 
opportunity to be able to address----
    Chairman Sarbanes. I think you are going to need to pull 
that microphone closer to you because it does not pick up very 
well unless you get it right up close to you.
    Ms. Johnson. I am pleased to have the opportunity to be 
able to address the Senate Banking Committee today about the 
$1,620 yield spread premium that was secretly paid by my 
lender, ABN AMRO Mortgage Group, to my mortgage broker, 
Allstate Mortgage, at my expense.
    In April 2000, my husband David and I had just moved back 
to the Twin Cities from Colorado Springs and were looking to 
buy a house. Through a real estate agent, we were introduced to 
David Schultz, the owner of Allstate Mortgage, a mortgage 
broker in Plymouth, Minnesota. After meeting Mr. Schultz at a 
local restaurant, we hired him to find us a mortgage loan.
    From the outset, we were told by Mr. Schultz that he would 
find us a loan with the best possible rate. Mr. Schultz 
specifically told us that the fee of processing the loan would 
be 1 percent of the loan amount. We signed a written broker 
agreement with Mr. Schultz which allowed for a 1 percent broker 
fee. No other fees were ever demanded by Mr. Schultz, 
discussed, or agreed to.
    When the closing occurred on May 23, 2000, to our surprise, 
the interest rate was higher than we understood it would be and 
the fees were far greater than the 1 percent fee we had agreed 
to. In fact, the total fees were nearly four times that amount, 
$5,242. This included what we only later came to learn after 
the closing was a yield spread premium--a $1,620 payment from 
the lender to our broker that was really paid by us since it 
was tied to an inflated interest rate on our loan.
    While we were upset about the fees, we had no choice but to 
go through with the closing or risk losing the house, being 
found in default of the purchase agreement; and forfeiting the 
$5,000 earnest money down we had already given the sellers. 
While we objected to the fees and higher interest rate, there 
was no way for us to find another loan and still close on time. 
We were stuck and the broker knew it.
    As our HUD-1 Settlement Statement shows, we were charged 
the following fees at closing, none of which was disclosed, or 
agreed to, beyond the initial 1 percent origination fee: $1,296 
loan origination fee; $1,292 loan discount fee; $395 processing 
fee; $200 underwriting fee; $150 doc prep fee; $40 funding fee; 
$350 commitment fee; and $285 admin fee.
    Only after the closing did we discover the significance of 
the $1,620 yield spread premium which was assessed to us 
through an inflated above-par interest rate of 8.75 percent. At 
the time of the closing, we had no idea what this premium was 
because it was only vaguely disclosed on our HUD-1 Settlement 
Statement as a Deferred Premium POC. In sum: The $1,620 yield 
spread premium was not disclosed, discussed, or agreed to 
before the closing; my husband and I were never informed that 
our loan had an above-par interest rate because of the premium 
payment from ABN AMRO to the broker; the broker never explained 
how the yield spread premium affected our interest rate or that 
our monthly mortgage payments would be any higher because of 
the premium; no rate sheet or other document showing the direct 
relationship between the inflated interest rate and the yield 
spread premium payment from the lender to the broker was ever 
shown to us; the yield spread premium did not offset or reduce 
any fee we ever owed to the broker; the broker received all 
fees that we owed and agreed to--and far more--directly in cash 
from us at the closing.
    After the closing, I wrote to the State of Minnesota 
Department of Commerce complaining about the transaction. After 
reviewing my letter, the Department of Commerce advised us to 
seek private legal counsel. The matter remains pending in court 
in Minnesota. In that case, we have agreed to be 
representatives of other borrowers whose loans had yield spread 
premiums paid by the same lender in the same manner as ours.
    In conclusion, the $1,620 yield spread premium on our loan 
was nothing more than a bonus paid by the lender to the broker 
for securing a bad deal for my husband and me, and referring a 
better deal to the lender. This conduct should be illegal 
because: The yield spread premium was not paid in exchange for 
any service fee we owed to the broker; We received no benefit 
from the premium the lender paid at our expense, such as an 
offsetting credit against any closing fees or costs we actually 
owed, and the money was simply a kickback to the broker 
referring our loan to the lender with a higher interest rate.
    The standard for evaluating the legality of this practice 
should not merely be whether the broker's total compensation, 
including the yield spread premium and other fees we never 
agreed to, is somehow reasonable based on the broker's after-
the-fact attempt to justify the higher fees he has already 
taken. Rather, the true nature of the disputed premium should 
be evaluated: That is, what was the premium actually paid in 
exchange for.
    To allow as lax a standard as ``reasonableness'' of total 
broker compensation to govern these transactions will only 
allow lenders and brokers like ABN AMRO and Mr. Schultz to 
continue ripping-off unknowing consumers like us, with a catch-
us-if-you-can attitude. It will encourage brokers and lenders 
to continue to try to slip additional bonus fees into mortgage 
transactions regardless of what was agreed and without 
providing any actual credit to the consumer bearing the cost. 
If lenders are paying bonuses and incentives to brokers simply 
for referring high-rate loans to them, that should be illegal 
without concern for whether the broker or lender thought the 
secret referral fee was reasonable.
    Thank you again for giving me the opportunity to speak 
today.
    Chairman Sarbanes. Thank you for coming this morning.
    One thing I find very interesting about all three of your 
stories is that, in each case, you were led to believe that the 
mortgage broker would work to find a loan that was in your best 
interest. You all proceeded ahead on the impression or, really, 
the understanding, that this broker was going to do the best 
that he could for your interest. Is that correct?
    Ms. Johnson. [Nods in the affirmative.]
    Ms. Hiers. [Nods in the affirmative.]
    Ms. Herrod. [Nods in the affirmative.]
    Chairman Sarbanes. So you placed confidence in the broker. 
You did not see the broker as a party on the other side of the 
table. You actually saw him on your side of the table. Is that 
correct?
    Ms. Hiers. [Nods in the affirmative.]
    Ms. Johnson. [Nods in the affirmative.]
    Ms. Herrod. [Nods in the affirmative.]
    Chairman Sarbanes. You had better say yes because he cannot 
get nods.
    [Laughter.]
    Ms. Hiers. Yes.
    Ms. Johnson. Yes.
    Ms. Herrod. Yes.
    Chairman Sarbanes. Now each of you ended up paying a higher 
interest rate than you would otherwise qualify for, in addition 
to paying substantial upfront costs.
    And one of the things, your statements outline the extra 
fees and charges involved at the time of settlement. We have 
not gone into the extra cost to you over the life of the loan 
as a consequence that you would be paying a higher interest 
rate. That makes a very significant difference in your monthly 
payment and your overall payment through the cost of the loan, 
whether you got the lower or the higher interest rate.
    So another cost to you that is not reflected in the 
statement, one would have to calculate it out by what the 
difference was in the interest rates and the amount of your 
loan. But in any event, it is clear that there is a substantial 
additional charge to each of you over the life of the loan 
because you are paying at a higher interest rate than you 
otherwise might have had available to you.
    Now, I want to make sure that I understand what each of you 
paid in fees for your loans.
    Ms. Hiers, let me start with you first. When you went to 
the mortgage broker, I gather you understood that you could 
qualify for a 7 percent fixed-rate loan with another lender. Is 
that correct?
    Ms. Hiers. That is correct.
    Chairman Sarbanes. And when you decided to move forward 
with this broker, I take it it was in the belief that the 
mortgage broker was going to get you a better rate and be able 
to do better for you than that. Is that correct? That is why 
you went ahead with using the broker.
    Ms. Hiers. That is correct.
    Chairman Sarbanes. Now, in the end, this broker got you an 
adjustable-rate loan at 7 percent, not a fixed-rate loan. Is 
that correct?
    Ms. Hiers. That is correct.
    Chairman Sarbanes. Which I gather was about one and a half 
points above what you might have qualified for, as you 
understood it, later understood it.
    Ms. Hiers. At an adjustable rate, yes.
    Chairman Sarbanes. Now, you did not know you would be 
getting a less favorable loan until just before the closing. Is 
that right?
    Ms. Hiers. The day of closing.
    Chairman Sarbanes. The day of closing.
    Ms. Hiers. In the 12th hour.
    Chairman Sarbanes. And, of course, at that point, I gather 
you did not feel that you were in any position to walk away 
from this and try to find another loan. Correct?
    Ms. Hiers. Correct.
    Chairman Sarbanes. I mean, did you find it out right at 
closing?
    Ms. Hiers. At closing.
    Chairman Sarbanes. Right at closing.
    Ms. Hiers. Right at closing.
    Chairman Sarbanes. Did you know prior to closing that 
because you were getting a loan at such a high interest rate, 
the mortgage broker was being paid a yield spread premium of 
almost 3 percent? Did the broker ever discuss this yield spread 
premium with you and explain what the premium was for?
    Ms. Hiers. No. No.
    Chairman Sarbanes. That was just over $4,500 in the yield 
spread premium that the broker was getting from the lender.
    Ms. Hiers. Exactly.
    Chairman Sarbanes. And, of course, you did not know about 
that.
    Ms. Hiers. I was not aware of it.
    Chairman Sarbanes. Now, you say that you also paid 3 
discount points as well. Did the broker explain to you that 
these discount points would bring down the interest rate on 
your loan, that that was the purpose of the discount points?
    Ms. Hiers. The broker did not explain any of the fees to 
me. The day that I was supposed to go to settlement, my loan 
was not approved. It was not approved. It was a Friday evening. 
My loan was not approved until about 4:00 in the afternoon. The 
sellers had to go to settlement also that day and there was 
nothing explained. Everything was held until the 12th hour. 
Everything was held and none of the fees were explained to me. 
I later found out about the yield spread premiums.
    Chairman Sarbanes. And it was only subsequently that you 
discovered that they had not gotten the most favorable 
financing terms and that they had been paid a yield spread 
premium.
    Ms. Hiers. Right.
    Chairman Sarbanes. So what happened to you, in effect, is 
you took on this broker. You had a contract to purchase the 
home for just under $160,000. The broker charged you a 1 
percent origination point, the FHA maximum, I take it, at the 
time, for $1,500. You paid these loan discount points of 3 
percent, $4,736. That, of course, was to get your interest rate 
down. Then the broker turned around and he got a nearly 3 
percent yield spread premium from the lender, which was worth 
to him $4,538.
    So your broker got almost $11,000 out of this arrangement. 
And the upshot of it was to put you into a significantly 
higher-rate mortgage than would otherwise have been the case. 
Is that correct?
    Ms. Hiers. That is correct.
    Chairman Sarbanes. In addition, I have a work sheet that we 
have prepared here that indicates that over the life of this 
mortgage, you will pay an extra $56,000 in interest, from what 
you would have paid if you had had the interest rate for which 
you qualified.
    I know it is a little awkward to lay all of this out like 
this, but I think it is important to do it because there are 
lots of people out there that are subject to the same thing and 
we want to send a very strong warning signal and we appreciate 
your coming this morning to help us do that.
    Now, Ms. Herrod, let me ask you just a few questions about 
your situation. First of all, you are currently disabled. But I 
gather that previously, you were working. Is that correct?
    Ms. Herrod. Correct.
    Chairman Sarbanes. What did you do, Ms. Herrod?
    Ms. Herrod. I was a buyer at a pharmacy, customer service, 
and buying and inventory. I had to have surgery on Valentine's 
Day of 2000. And when I told my employer, I asked him if he had 
any compensation for me. He said, no. He said, I have to make 
some cuts, economic cuts, and I was one of the higher-paid 
employees. So, I was given a 3 months severance pay, which 
ended May 31. And I had told Mr. Young in April, I said, I am 
going to be out of income next month. And he said, it does not 
matter, as long as you have income today.
    Chairman Sarbanes. Ms. Hiers, you worked for your general 
equivalency degree and then worked for the Department of Social 
Services in Prince George's County.
    Ms. Hiers. That is correct.
    Chairman Sarbanes. And then went to work for the Federal 
Government, beginning as a clerk/typist, I gather.
    Ms. Hiers. Yes.
    Chairman Sarbanes. But then you worked your way up, and now 
you are a Supply Management Representative for the General 
Services Administration. Correct?
    Ms. Hiers. That is correct.
    Chairman Sarbanes. Ms. Johnson, were you employed?
    Ms. Johnson. Yes.
    Chairman Sarbanes. What were you doing? Or what do you do?
    Ms. Johnson. I am a Unit Pricing Manager at K-Mart.
    Chairman Sarbanes. Okay. I ask these questions only to 
underscore the fact that you are all three hard-working people 
who have been gainfully employed and contributing to the 
economy and, in a sense, playing by the rules and trying to own 
a home and realize that, make things better for your family and 
so forth and so on. It is extremely distressing to see these 
efforts at exploiting you.
    Now, Ms. Herrod, you had a variable rate loan which started 
at 7.8 percent. Correct? In the beginning.
    Ms. Herrod. In the beginning.
    Chairman Sarbanes. You wanted to refinance, hopefully to 
bring down your payments. And also, you wanted to consolidate 
some debts and pay them off. Is that correct?
    Ms. Herrod. Yes.
    Chairman Sarbanes. But the loan that Mr. Young, your 
broker, got--I am not sure I should call him your broker. The 
loan that Mr. Young, the broker, got for you was close to 10 
percent. Is that right?
    Ms. Herrod. Right. I think it was 9, maybe 9 point 
something.
    Chairman Sarbanes. Yes. Did you understand prior to the 
closing that your interest rate was going to be so much higher 
than the loan you already had?
    Ms. Herrod. No.
    Chairman Sarbanes. Now in addition to paying this higher 
interest rate, I see you paid Mr. Young an origination fee of 
$4,000, while also paying a broker fee of $2,600.
    Ms. Herrod. Right.
    Chairman Sarbanes. Is that correct?
    Ms. Herrod. Yes.
    Chairman Sarbanes. So, $6,600 in all. Did you know at the 
time you closed that he was also going to get another $3,300 
from the lender for leading you into a higher-rate interest?
    Ms. Herrod. No, we found that out from the attorney after 
the fact when we were faced with losing our home.
    Chairman Sarbanes. When you agreed to work with Mr. Young 
at the beginning, after you met him, did you believe that he 
would find you the best deal on a mortgage? Is that what was 
indicated?
    Ms. Herrod. Yes. I had excellent credit, above and beyond. 
It was irreproachable.
    Chairman Sarbanes. So, you thought that he was really going 
to look after your interests.
    Ms. Herrod. Correct.
    Chairman Sarbanes. That is the assumption you worked on 
when you went into this arrangement. Instead, he ended up 
getting $10,000 out of this arrangement and you got a loan at 
10 percent interest. Correct?
    Ms. Herrod. Correct.
    Chairman Sarbanes. Now, Ms. Johnson, I see you paid a large 
amount of fees in addition to the broker receiving a yield 
spread premium in your instance.
    Ms. Johnson. Yes.
    Chairman Sarbanes. He told you, the broker at the outset, 
that his fees were 1 percent of the loan amount, or that is 
what you understood. Is that correct?
    Ms. Johnson. Yes, it is.
    Chairman Sarbanes. And it was your understanding that this 
would be what he received out of his efforts, 1 percent of the 
loan amount. Correct?
    Ms. Johnson. Correct.
    Chairman Sarbanes. But, then, when you got to closing, you 
found that the fees were far greater than the 1 percent that 
you had agreed to.
    Ms. Johnson. Yes.
    Chairman Sarbanes. In fact, they were over $5,000, the 
fees.
    Ms. Johnson. Yes, they were.
    Chairman Sarbanes. You did not know those extra fees were 
coming. In fact, you were operating on the premise that the 
broker fee would be 1 percent of the loan amount. Correct?
    Ms. Johnson. Yes.
    Chairman Sarbanes. Now, were you aware that the broker was 
also over and above this $5,200 receiving a yield spread 
premium from the lender because he was leading you into a loan 
with a higher interest rate than what you qualified for?
    Ms. Johnson. No, he never----
    Chairman Sarbanes. You did not know that. And so, later on, 
you found out that that was the case, that he was getting that 
yield spread premium as well.
    Ms. Johnson. Yes.
    Chairman Sarbanes. You also, I take it, believed that the 
broker was working on your side to put together the best 
financing arrangement that he could on your behalf. Were you 
proceeding on that assumption?
    Ms. Johnson. Yes. We asked him to, and he said he had 
several places he could go to and he would do the best for us.
    Chairman Sarbanes. Well, I want to thank all three of you 
for coming this morning. These, in a way, are very sad stories 
because they are a very dramatic illustration of people being 
exploited, in my view, being the victims of abusive practices.
    People are entitled to get a fair return for services that 
they provide. Brokers, along with everyone else, are entitled 
to that. But they are not entitled to take advantage of people, 
to abuse people, to lead people in placing their confidence in 
them and then exploiting that confidence to gain an egregious 
return at your expense, and that is what we are setting out to 
try to accomplish with these hearings.
    Not only to charge you these high fees, but by getting the 
yield spread premium, about which none of you knew anything 
about, leading you into a higher interest rate mortgage than 
otherwise would have been the case and saddling you, then, with 
those extra costs and charges over the life of the mortgage.
    In each instance, I gather, all of you were in a sense 
sacrificing or pushing yourselves to the limit in order to be a 
homeowner, which of course would help you to meet very 
important family responsibilities. And yet, you had people who 
were in effect almost shoving you over the line in terms of 
your ability to handle--I guess all of you, really, found 
yourselves in a much more constrained financial position as a 
consequence of these abuses that you were subjected to.
    So thank you very much for coming this morning and giving 
us this very powerful testimony. We appreciate it very much.
    Ms. Johnson. Thank you.
    Ms. Herrod. Thank you.
    Ms. Hiers. Thank you.
    Chairman Sarbanes. We will now turn to the second panel and 
we will excuse our three witnesses.
    [Pause.]
    I want to welcome the second panel here this morning. 
Because this is a relatively large panel, I will introduce each 
witness separately, just before we hear from them. We will move 
across the panel and take the testimony of all the witnesses 
before we turn to the question period.
    Your full statements will be included in the record and if 
you can abbreviate it orally to something in the range of 5 
minutes or so, we would appreciate that very much, although we 
are anxious that you feel that you have had an opportunity to 
make your major points. That is the prime objective, not the 
time restraint. But we are trying to balance the two here this 
morning.
    Our first witness is Howell Jackson. Mr. Jackson is 
Associate Dean for Research and Special Programs and the Finn 
M.W. Caspersen and Household International Professor of Law at 
Harvard Law School.
    His research currently deals with problems in consumer 
finance, comparative cost benefit analysis of financial 
regulation and other topics.
    Prior to joining the Harvard Law School faculty in 1989, 
Professor Jackson served as Law Clerk to U.S. Supreme Court 
Justice Thurgood Marshall and practiced law in Washington. He 
received his law degree and an MBA from Harvard University in 
1982.
    Mr. Jackson, we would be happy to hear from you.

                 STATEMENT OF HOWELL E. JACKSON

        FINN M.W. CASPERSEN AND HOUSEHOLD INTERNATIONAL

                      PROFESSOR OF LAW AND

        ASSOCIATE DEAN FOR RESEARCH AND SPECIAL PROGRAMS

                HARVARD UNIVERSITY SCHOOL OF LAW

    Mr. Jackson. Thank you very much, Chairman Sarbanes.
    I am pleased to be here and what I would like to do with my 
oral comments is just to summarize my written testimony and, in 
a sense, build on the testimony that we have already heard this 
morning.
    The impetus of today's hearings is the HUD's Statement of 
Policy regarding yield spread premiums. What I want to talk 
about initially is their factual assumptions about what was 
going on in the industry with yield spread premiums.
    They have a view that yield spread premiums are a 
legitimate financing tool that is particularly useful for 
borrowers who are short on cash and need to use the tool to 
finance upfront costs.
    This morning's witnesses have already demonstrated that 
that is certainly not always the case, that there are often 
instances when the yield spread premiums are often used to 
raise the cost for individual borrowers.
    But what I would like to talk about is a study that I have 
conducted that looks at the practice more broadly. And in 
brief, what my study shows is these witnesses are not atypical, 
that this is actually going on on a widespread basis, across 
the industry, and harming substantial numbers of consumers.
    Let me just begin by saying that I would reiterate the 
statements of the witnesses that yield spread premiums are not 
being presented as an option to borrowers. The HUD consumer 
guidance, the industry discussions of the subject, it is just 
clear that these payments are not being described as optional 
sorts of financing for particular consumers. They are being 
imposed without consumers 
understanding what is going on. I think that is fairly clear.
    It is also fairly clear from my study that they are not 
specialized sorts of financing that are used upon occasion. 
Their practice is widespread. In my study, between 85 and 90 
percent of consumers were paying some yield spread premiums. 
The average amount of these payments was $1,800 per consumer, 
which is a large amount of money.
    They are the most substantial source of compensation for 
the mortgage broker industry, according to my study. So, they 
are very significant and they are very substantial for the 
industry.
    It is also the case that it is clearly not being limited to 
borrowers who lack cash to pay upfront costs. Just the number 
of 85 to 90 percent shows that there are many borrowers who 
could pay the upfront costs in other ways, were they told that 
that is what was going on. But we also examined the loans in 
question and many of the borrowers could simply have increased 
the loan amount. It would have been a much more efficient way 
to finance their settlement costs, their costs of closing. Yet, 
the brokers still steered them into yield spread premiums. So 
this is not limited to a small number of borrowers. It is a 
widespread practice and our study I think demonstrates that 
quite clearly.
    Another point that is important to understand is the 
mortgage broker industry cannot be indifferent to yield spread 
premiums. The HUD policy statement suggests that it is just 
another kind of financing. But our analysis indicates that 
mortgage brokers make substantially more money on loans with 
yield spread premiums. The average amount of additional 
compensation, according to our study, is over $1,000, $1,046 of 
extra compensation from mortgage brokers receiving this kind of 
payment than the compensation they would receive on other kinds 
of loans without yield spread premiums. So the amount of money 
is quite substantial. And I think that explains why this issue 
is so hotly contested.
    Now as an economic matter, one of the interesting questions 
about the yield spread premiums is are they being used to 
offset other costs? The additional compensation I just 
mentioned would suggest that is not going on, and certainly 
this morning's testimony, the witnesses we heard today, 
suggested in their cases they were not getting any reduction. 
In fact, it sounds like their other costs were quite high 
compared to industry averages.
    We did a large-scale study to see what the standard offset 
was in a sample of 3,000 loans. And what we discovered is the 
vast majority of yield spread premiums goes simply to increase 
the compensation of mortgage brokers. They do not go to reduced 
upfront costs.
    Our best estimate, and there are definitely different ways 
of doing this estimate, is that, on average, consumers get 25 
cents on the dollar for every dollar extracted in yield spread 
premiums.
    So 75 percent, the vast majority, go to the mortgage broker 
industry to increase their compensation. And I think that 
really indicates the nature of the practice.
    This is not a case of a small number of atypical consumers 
who are paying exorbitant fees. Certainly that is also going 
on. But the main point is, on average, the offset is very low. 
The value, if you will, to the consumer of yield spread 
premiums is very, very poor.
    Now the industry sometimes likes to characterize yield 
spread premiums as a form of financing as a way of financing 
upfront costs. And we did this calculation similar to the 
calculation that you were suggesting earlier--how much more in 
additional interest payments down the road are consumers taking 
on? What value are they getting for it? And if you work out the 
numbers, it is frankly embarrassing. The interest rate is 114 
percent per annum, according to our estimate. Maybe 90 percent 
per annum. It is just off the charts of acceptable interest 
rates. My study was dealing primarily with middle-class 
borrowers who would have excellent credit histories and be 
deserving of much lower interest costs. So as a form of 
financing, these payments are just usurious.
    Another factual point I would make about our study and its 
implications is, on average, yield spread premiums generate 
higher compensation and higher costs for borrowers. But it is 
also the case that there are a lot of examples of individuals 
who pay way more than average.
    If you try to look at the average compensation to mortgage 
brokers in these loans, it varies greatly. It seems to me that 
there is a lot of price discrimination going on here. There is 
a lot of picking off the soft targets--the less well-educated, 
the less financially sophisticated consumers, and using this 
disguise payment practice to charge them more. And this is 
something that I want to examine more, but you mentioned this 
aspect of my study and I just want to call the Committee's 
attention to it.
    If you look at the racial identity of the borrowers and 
measure it against mortgage broker compensation, you see that 
mortgage brokers are making a lot more money on minority 
borrowers.
    According to our study, African-Americans are paying about 
$474 more on average. Hispanic-Americans, paying about $580 
more on average than other borrowers. And that is after 
controlling for the credit quality, the credit score they got, 
the kind of loan they had, the loan-to-value ratio. It is 
controlling for the credit aspects. And it seems to be that 
these groups who are traditionally less well-educated, less 
financially sophisticated, are being picked off here, and I 
think that is one of the most disturbing things about our 
findings.
    Now the HUD policy statement goes on and talks about a 
number of legal issues. I am happy to deal with them in 
questions and answers. But I just want to focus on the 
connection between what I think is the Department's 
misunderstanding of the role of yield spread premiums and their 
legal analysis. They characterize these payments as a way of 
reducing upfront costs. And if the payment is for goods and 
services, it is tested under a relatively liberal standard, 
lenient standard, under the HUD rules.
    What my study shows and what the evidence you heard this 
morning suggests is these payments are not being used 
principally for goods and services or principally for reducing 
upfront costs. They are serving principally to increase 
compensation. And for that reason, I think a more stringent 
legal standard is appropriate.
    Fortunately, the Department is considering a number of 
rulemaking proposals to change practices to help consumers in 
the 
future. I think that there is a lot that can be done 
prospectively to improve things for consumers with the right 
changes. I have four changes, specific proposals in my 
testimony. Let me just highlight them in conclusion here.
    First, if mortgage brokers are going to be recommending 
loans with yield spread premiums, it should be presented as an 
option. The mortgage broker should also be required to say to 
Ms. Johnson and her colleagues that another loan is available 
at a lower rate. If it is going to be an option, it should be 
presented as an option and the Department should mandate that.
    Second, when a consumer chooses to take an above-par loan, 
and sometimes it might make sense, the proceeds of the extra 
interest, the yield spread premium, should be given to the 
borrower. The borrower can use it to pay for the house, to pay 
for other costs, to pay for other payments to the mortgage 
broker, or to take home in his or her pocket. But the money 
should be given to the borrower if it is used for the 
borrower's benefit. What that means is it has to become a 
credit on line 200 of the HUD-1 form.
    Chairman Sarbanes. The theory being that the borrower, in a 
sense, has paid for it by agreeing to a higher interest rate 
over the life of the loan. Is that correct?
    Mr. Jackson. That is exactly right. If the borrower is 
getting this money through paying for it, the borrower should 
receive it and then see specifically what services the broker 
is trying to charge for. I think this is a very important step 
that needs to be taken.
    There are other steps, too. I think the practice of 
mortgage brokers charging discount fees, as we saw in the case 
of Ms. Hiers and Ms. Johnson this morning, is simply 
misleading.
    The brokers are not using those discount points to lower 
interest rates. It is simply a disguised form of interest 
spread premium and I think the best solution to this problem is 
to ban it. There is an appropriate role for discount fees, but 
it is not to pay to brokers in these contexts.
    Chairman Sarbanes. Actually, if they do that, they can get 
the consumer going and coming--getting him on the discount fees 
and then they get him on the yield spread premiums. Right?
    Mr. Jackson. That is right. It is unbelievable that brokers 
are charging consumers fees for lowering interest rates on 
loans that have interest rates above par. It is just 
unfathomable how this practice could be tolerated, in my view.
    Finally, I think the Department needs to look also at 
direct lenders. There needs to be a quality in the industry 
between direct lenders and mortgage brokers. However, I would 
not let concerns about direct lenders stop the Committee and 
the Department from going forward today.
    Mortgage brokers are the primary supplier of mortgages in 
the United States at this time. They should be the primary 
focus of the HUD reforms. We should solve the problem here 
first and then we can take care of other aspects of the 
industry later. But I think the time is now to go forward.
    Thank you.
    Chairman Sarbanes. Thank you very much, sir.
    Now, we will hear from John Courson, President and Chief 
Executive Officer of Central Pacific Mortgage Company, and 
Chairman-elect of the Mortgage Bankers Association of America.
    Prior to assuming his current position, Mr. Courson served 
as President and Chief Executive Officer of Westwood Mortgage 
Corporation and as President and Chief Operating Officer of 
Fundamental Mortgage.
    Mr. Courson was a very helpful witness in previous hearings 
held by this Committee and I am pleased to welcome him back 
today.
    John, we would be happy to hear from you.

                   STATEMENT OF JOHN COURSON

          CHAIRMAN-ELECT, MORTGAGE BANKERS ASSOCIATION

             PRESIDENT AND CHIEF EXECUTIVE OFFICER

                CENTRAL PACIFIC MORTGAGE COMPANY

                       FOLSOM, CALIFORNIA

    Mr. Courson. Thank you, Mr. Chairman. It is good to see you 
again. And thank you on behalf of the Mortgage Bankers for the 
opportunity to testify again and present our views as you 
continue your series of hearings on the aspects of predatory 
lending. I would like to just briefly summarize some comments, 
if I may. I am going to really talk about three things--tools, 
rules, and disclosures.
    As you so eloquently said in your opening statement before 
that, used properly, yield spread premiums can be an important 
financing option. And we agree with that. It clearly is a 
borrower choice issue when used properly, based upon a 
borrower's individual financial goals, desires, and 
circumstances, in that, as they make those choices, there has 
been a wide use of yield spread premiums.
    We find people in the industry of all types of loans, as we 
have identified, be they conventional, be they FHA, VA, that 
take advantage of the opportunities to have a financial choice 
in how they want to use this tool to acquire their property or 
refinance their mortgage loan.
    It can be, and we know that one of the barriers to creating 
homeownership is certainly the availability of cash resources. 
And so it does provide an option for those who do lack the cash 
to finance or, if you will, to pay the cash cost of obtaining 
that mortgage, another alternative to achieve homeownership 
when used properly.
    As to the rules, we need rules in the lending business and 
the broker business to run our businesses. Tell us the rules so 
that we can conduct our business in accordance with the rules, 
and not have to learn the rules through the courts and through 
litigation, which is debilitating not only for us, but also for 
consumers and could in fact do damage to the marketplace.
    Tell us the rules and give us clarity. Give us some clarity 
where we can understand what the parameters are under which we 
can conduct our business appropriately--whether it is mortgage 
brokers or mortgage lenders.
    The Statement of Policy, both the 1999 and now the 2001, is 
a move by the Department to provide clarity for those in the 
mortgage origination business to conduct their business.
    As for disclosure, as you well know, Mr. Chairman, and we 
discussed in the last hearing, there are disclosures out there 
today that are structured to address some of the issues we have 
heard.
    We know, for example, that yield spread premiums are to be 
disclosed on a good faith estimate. We clearly know the issues 
with the good faith estimate as we have discussed before. We 
also know that yield spread premiums are to be included in 
calculation of the APR, which is a number that a consumer has 
to comparison shop, if you will.
    We also know, obviously, that they are on the HUD-1, which 
we have heard about. But having said that, in the 2001 
Statement of Policy, the Department clearly sets out, both in 
the Statement of Policy and in a mortgagee letter that was 
issued very shortly after the Statement of Policy, some clear 
guidelines for the disclosure of broker transactions and they 
set forth very specific criteria to be included in those 
disclosures.
    As a result of that information, the Mortgage Bankers 
Association, along with a coalition of other lending 
organizations, have prepared and did prepare a prototype, if 
you will, of a disclosure. And that disclosure is formatted to 
address the specific criteria that are included in the 
Statement of Policy and in the mortgagee letter. I would be 
happy to submit a copy of that draft, which we have submitted 
to HUD for their consideration for the record, if I may. And 
finally, having said all of this, and despite the comments and 
the specificity and the Statement of Policy, and in the 
mortgagee letter and our draft proposed form, we really can do 
better.
    Beyond all of this, one of the keys, regardless of the kind 
of disclosure we use in this specific instance, we have to 
simplify the transaction. We can do better than what we have 
done for the consumers out there with the myriad of paperwork 
and disclosures, small print, and confusing information given 
to them. Any predator likes that environment to deal in. It 
makes it easier to operate. We need to strip that out, strip 
the process down, simplify, and reform the mortgage process.
    Thank you very much.
    Chairman Sarbanes. Well, thank you very much.
    We will now turn to Joseph Falk, President of the National 
Association of Mortgage Brokers. Mr. Falk served as the 
President of the Florida Association of Mortgage Brokers in the 
mid-1990's. In addition to his activities with the National 
Association of Mortgage Brokers, Mr. Falk serves on the Fannie 
Mae National Advisory Council. He is currently President of 
Erie Mortgage Services, a mortgage brokerage business 
specializing in residential mortgage loans, regulatory 
compliance, and government affairs.
    Mr. Falk, we appreciate your coming to be with us this 
morning. We would be happy to hear from you.

             STATEMENT OF JOSEPH L. FALK, PRESIDENT

            NATIONAL ASSOCIATION OF MORTGAGE BROKERS

    Mr. Falk. Good morning, Mr. Chairman.
    My name is Joseph Falk and I am President of the National 
Association of Mortgage Brokers, the Nation's largest 
organization representing the interests of the mortgage 
brokerage industry. We appreciate this opportunity to be with 
you today.
    Mortgage brokers originate approximately 65 percent of all 
of the residential loans in the United States. There are 
hundreds of thousands of mortgage brokers, 23,000 licensed 
brokers in my home State of Florida.
    The market has spoken. Mortgage brokers are effectively 
meeting consumers' desires for convenience, choice, products, 
service, and very competitive prices. The industry originated a 
record volume of loans in 2001, enabling thousands of 
homeowners to refinance, reduce their monthly payments, and 
thousands of others to get in their homes.
    We are experiencing record homeownership rates in the 
United States today. Mortgage brokers in part have enabled this 
market to absorb this huge volume of transactions. Therefore, 
it is important to our homeowners and the economy that we avoid 
any new regulations, legislation, or unnecessary legal 
uncertainty that could impede the effective and efficient 
functioning of the wholesale mortgage market.
    The ability to obtain loans with little or no upfront cost 
is especially critical to consumers. Borrowers can finance some 
or all of their upfront costs through a slightly higher 
interest rate and the broker receives most or all of its 
compensation indirectly from the lender in the form of a yield 
spread premium. Such indirect compensation paid by lenders to 
brokers is legal under RESPA, so long as the broker's total 
compensation is reasonably related to the services performed, 
goods provided, and facilities furnished.
    Flexibility of indirect compensation allows mortgage 
brokers to stay competitive with and in some cases beat the 
prices of retail lenders. That is why the marketplace has 
spoken. Mortgage brokers are chosen, by and large, because they 
offer competitive prices to retail lenders.
    Retail lenders perform similar functions, earn similar 
income when they sell their loans in the secondary market. 
There is nothing inherently different about the way retail 
lenders and mortgage brokers earn their income. The only 
difference is that consumers know how much a mortgage broker is 
going to earn in a transaction because it is listed on the HUD-
1 and, of course, on the Good Faith Estimate form.
    Although consumers clearly prefer mortgage brokers to 
originate their loans, our industry is under attack. Over 150 
class action suits have been filed against virtually every 
major mortgage wholesaler claiming that all yield spread 
premiums are illegal. Defending these suits, Mr. Chairman, is 
difficult and managing the uncertainty that they impose is 
costly.
    On October 15, HUD issued policy statement 2001-1. We 
believe it is simply a restatement of existing policy requested 
by Congress in 1998 and originally issued in 1999. It has 
already been accepted as correct by two court rulings and we 
believe that others will follow suit. HUD's policy statement 
importantly maintains the individual's right to sue and it 
allows the marketplace to resume functioning normally. We 
support the HUD policy statement.
    We also support HUD's new RESPA enforcement policy. Illegal 
uses of yield spread premiums should be prosecuted to the 
fullest extent of the law.
    NAMB also supports HUD's new rulemaking initiative which 
improves disclosures to consumers. Better disclosures will put 
consumers in a stronger position with more information to be 
able to shop and compare, thereby decreasing the incidence of 
abusive lending practices of all types.
    NAMB has developed detailed proposals for this rulemaking 
and we have shared these with HUD and with this Committee. We 
support requiring a new disclosure to be provided by all 
originators. We developed the prototype of this form back in 
1998, together with MBA, and we have urged our members to use 
this form since 1998, clearing up a number of the concerns that 
we heard this morning. We support making this disclosure 
mandatory.
    We also support establishing tolerances for the Good Faith 
Estimates and requiring redisclosure if those tolerances are 
exceeded. This would also address the concerns we heard, the 
legitimate concerns we heard this morning in the first panel.
    In conclusion, Mr. Chairman, NAMB believes that HUD is 
acting responsibly by clarifying the legality of yield spread 
premiums, improving RESPA enforcement, and developing new and 
improved disclosures that will help consumers avoid abusive 
fees.
    Thank you for this opportunity to allow us to share our 
views with this Committee. I would be happy to answer your 
questions.
    Chairman Sarbanes. Thank you very much, sir. We appreciate 
your contribution.
    Our next witness is Ira Rheingold, who is the Executive 
Director of the National Association of Consumer Advocates. 
Previously, Mr. Rheingold worked at the Legal Assistance 
Foundation of Chicago as a Supervisory Attorney in charge of 
foreclosure prevention.
    The major focus of his litigation practice was the 
representation of senior and disabled homeowners victimized by 
mortgage brokers, lenders, and contractors who were targeting 
minority, low-income communities with high interest, high fee 
home equity loans.
    Prior to becoming a Legal Services Attorney, Mr. Rheingold 
worked as a Legislative Advocate for low-income community 
groups in southern Maryland. He is a graduate of Georgetown 
University Law Center.
    Mr. Rheingold, we are pleased to have you with us this 
morning.

         STATEMENT OF IRA RHEINGOLD, EXECUTIVE DIRECTOR

           NATIONAL ASSOCIATION OF CONSUMER ADVOCATES

    Mr. Rheingold. Thank you, Senator Sarbanes, it is my 
pleasure. And thank you so much for inviting us here to testify 
today.
    I had prepared remarks and I have submitted testimony which 
fully express our position in this matter. But instead of 
talking about what I was going to say, I am simply going to 
respond to some of the testimony I have heard today because 
sometimes as I sit here, I think I live in a parallel universe, 
that there are two universes--the people who deal with people 
on a real basis every single day, who see homeowners every 
single day, and then the theoretical universe out there about 
how the system is supposed to work. And we just do not see it.
    I was an attorney who represented homeowners for 5 years in 
the poorest communities of Chicago. I looked at loan document 
after loan document after loan document. What I heard here 
testified to today and what Professor Jackson said today was 
wonderful because it quantified what we saw and we know is 
true. It is not atypical.
    I never ever talked to a client who knew they had paid a 
yield spread premium. In fact, I never met a client who, until 
I sat down with them, showed them their HUD-1, and said, hey, 
did you look at this line over here? You are being charged 
$1,500. Did you know that? And they said, no. And I said to 
them, did you know that because that yield spread premium was 
paid, you had a higher interest rate? And they said, absolutely 
not.
    Nobody knows what is going on. You can give all the 
disclosures in the world--and there are disclosures. We look at 
the loan documents and there may be a disclosure about a yield 
spread premium being paid. It is not happening and it has no 
bearing on what consumers are seeing today. Point number one.
    Point number two I would like to address is the mortgage 
industry and their claim that there has not been clarity about 
this issue. I think that is particularly cynical when we look 
back at what HUD offered to us in 1999, when they issued their 
first Statement of Policy. I am just going to quote some of the 
language from this Statement of Policy, giving explicit 
directions to lenders. And this is in our testimony, but I 
think it is worth repeating.

    The most effective approach to disclosure would allow a 
prospective borrower to properly evaluate the nature of the 
services and all costs for a broker transaction, and to agree 
to such services and costs before applying for a loan. Under 
such an approach, the broker would make the borrower aware of 
the total compensation to be paid to the mortgage broker, 
including the amounts of each of the fees making up that 
compensation. If indirect fees are paid, the consumer would be 
made aware of the amount of these fees and their relationship 
to direct fees and an increased interest rate.

    I do not think it could be any more explicit than that. I 
think it was clear how the industry could comply with what HUD 
was going to do. But did the industry comply? They did not 
comply.
    Why didn't they comply? Because they were making a lot of 
money. They were making a lot of money continuing this practice 
and there was no enforcement going on that would stop them from 
engaging in this practice. So instead of changing their 
practices, engaging in behavior that would be legal, would be 
fair to the consumer, and creating a competitive marketplace, 
instead what they did was they spent all their money fighting 
lawsuits and obfuscating the policy statement and going into 
court and saying, dealing with small lawsuits like me, I would 
go to court and I would represent an individual homeowner and I 
would come in and I was a little gnat. We were little gnats. 
Here is a couple thousand dollars. Go away. We will not 
foreclose on this person's home. It was the cost of doing 
business. But it was a small cost of doing business because 
they were making enormous profits.
    The world changed for the mortgage industry when the 11th 
Circuit Court issued the Culpepper decision because, finally, a 
court found their hand, their arm, their elbow in the cookie 
jar. They said, look, this is so obvious.
    The thing that I find so interesting about this issue is it 
really is very, very simple. The court looked at it and said, 
in practice, the lender sends a mortgage broker a rate sheet 
and it says to the broker, if you bring me a loan--here's the 
par rate that the person qualifies for. If you bring me a loan 
higher than that, I am going to pay you this amount of money.
    Nowhere in that discussion is, if you bring me a higher 
interest rate and perform more services, I am going to pay more 
money. The sole source of whether or not the broker is getting 
compensated is what the interest rate is going to be. No one 
was looking at whether or not there were more services being 
offered 
because someone was getting a higher interest rate. The sole 
reason for compensation was the higher interest rate.
    The court said, what else do I need to know? And that 
enabled a class to be certified. The industry got scared. They 
got scared because, suddenly, the behavior that they had been 
engaged in, that they had measured the cost of and figured this 
is not going to cost us a lot of money, we are making so much 
profit, was now threatened because it was a class action case, 
which is an important enforcement mechanism we have in this 
country because there is no other source of enforcement going 
on. It will cost us real money and we will have to stop our 
behavior.
    But, again, did the industry stop its behavior? No, they 
turned to HUD and they gave HUD an opinion. We met with HUD and 
the industry met with HUD. And HUD, instead of coming down on 
the side of consumers and saying, hey, your behavior is wrong, 
stop it, let the Culpepper case go on. HUD came to the rescue, 
adopted a clarification, changed the way and gave protection to 
the industry. It said, no class actions allowed. It has to be 
done on an individual basis. And that is so important because 
individual cases cost the industry nothing. They are little 
gnats. A class action case makes them change their behavior. 
They do not want to change their behavior, and that is what is 
happened here.
    I will take questions later on about policy suggestions 
that we have made. We agree wholeheartedly with Professor 
Jackson's suggestions, but I just wanted to make those points 
right now.
    Chairman Sarbanes. Good. Thank you very much.
    We will now turn to David Olson, Managing Director of 
Wholesale Access Mortgage Research and Consulting, an 
independent research firm located nearby in Columbia, Maryland, 
that specializes in the mortgage industry. Mr. Olson has had 
over 30 years' experience in the mortgage industry conducting 
research for a variety of firms. He has served as Professor of 
Economics at the University of Michigan, Smith College, Johns 
Hopkins University, and the University of Maryland. He holds a 
BS degree from Northwestern University and a master's in 
economics from the University of Michigan.
    Mr. Olson, we are very pleased to have you with us this 
morning.

          STATEMENT OF DAVID OLSON, MANAGING DIRECTOR

                   WHOLESALE ACCESS MORTGAGE

                 RESEARCH AND CONSULTING, INC.

    Mr. Olson. Thank you very much, Senator Sarbanes, for 
inviting me and I am pleased to be here with a fellow 
Marylander.
    There has been a lot of assertions made today. I thought I 
would respond as others have done to some of the assertions. I 
have submitted a printed statement of my formal remarks.
    There are a lot of statements being made about how 
profitable brokers are and how profitable lenders are. My 
research has been partly in profitability. That is all our firm 
does. We have seven professionals. We have been studying 
various aspects of the mortgage industry and particularly 
brokers and lenders for over 10 years and, as I say, I used to 
be Director of Research at Freddie Mac and several other firms. 
I have been researching many aspects of this industry for over 
30 years. I started in 1969 with my first research project. So, 
I have looked at a lot of these questions and I have a lot of 
data. We have real data. One of the first points I will make, 
it is not very profitable. And if it were so profitable, why 
are we seeing a net exodus out of many areas of the field? 
There are firms pulling out because they cannot make profit.
    My initial research was, and in the Soviet bloc countries, 
I did 10 years of work in that area, and I saw first-hand, I 
spent time in the Soviet bloc and I saw what happens when you 
have over-government regulation, government in effect running 
everything, and it is a disaster. Consumers really lose out.
    Today, we have heard some abuses. I am not denying abuses. 
But we have to put it into context of the numbers. Last year, 
we estimate there were 16 million transactions. What was a 
representative transaction? Our research is mainly based on 
random samples. And just the last study we did on brokers, we 
interviewed 4,000 broker firms to find out what is actually 
going on there. How representative is this? Is there a lot of 
abuse? We would assert that there is not. And the reason that 
brokers came from nothing 20 years is that in fact they can do 
it cheaper. They have priced everyone else out of business.
    There are 8,000 lenders out there. Any consumer can always 
go into one of these 8,000 lenders and get a quote. What would 
it cost me to do this loan?
    There are really two numbers that a consumer needs--
interest rate and fees, what are the total fees? Everything 
else is really irrelevant. The other, of course, is will you do 
the loan, period? And that has been one of the problems in the 
industry. It is such a huge industry. There were $2 trillion of 
loans done. Just to get a loan done is very difficult in 
certain periods, such as last year.
    So, consumers have sought out brokers merely to get a loan. 
We have not looked at the alternative of no loan. What if the 
consumer got nothing? We were saying that it was high and then 
we are assuming that they could have gotten a better deal 
elsewhere.
    Well, why didn't they price it elsewhere? We have 33,000 
mortgage broker firms, according to our records right now, plus 
the 8,000 lenders. It is very easy to get a quote, find out 
what it costs to do a loan.
    Now, whether they will do your loan is the issue. Can they 
do your loan for this price? Was it cheaper or more expensive? 
We would always advise everyone, any consumer, to shop around 
and go get quotes. And our experience is that most consumers do 
get multiple quotes and make it difficult for brokers.
    Most brokers are just breaking even. If this were so 
profitable, we would have found that brokers would be staying 
in this industry. But in fact, the average firm lasts only 5 
years and then they are out because they go elsewhere. They 
find that they can do better elsewhere. It is not that 
profitable an industry. There has been this implication of how 
profitable it is.
    The same with mortgage lending. That field is not that 
profitable. And if it were not the case, we would not see this 
net exodus. Now, I will agree that there have been abuses in 
so-called subprime lending and I think that is what we have 
been really hearing. I can defend it from several reasons.
    We do not have enough lenders offering these loans. The 
less the competition, the more you will tend to find higher 
prices. What we need is really more competition, more people 
offering these loans. But what I have noticed--I publish a 
quarterly magazine on this issue. There has been a huge exodus 
out of subprime lending. Most of the major lenders that were in 
operation 3 years ago have shut down. They have been generating 
losses. They are still generating losses.
    If this is so profitable, why are they all generating 
losses? Why are we still seeing a net exodus? And so, I would 
assert that, unless we do something else, if you kick all the 
business out of the industry, who is going to be left to make 
these loans, and where will the consumer go?
    There has to be a real, live alternative for the consumer. 
We have been talking about abstract alternatives. We have to 
say, who offered you what? Could you have gotten something 
better? Then, the other cases, were these instances 
representative of the whole?
    From my point of view, we have great regulation, probably 
too much regulation. I would agree with some of the other 
witnesses that it is extremely complicated. And it is because 
it is so complicated that brokers have to do their job. Just to 
go through all of those sheets of paper and get them right, it 
costs about 2 points, 2 percent to do this job.
    Government has an opportunity to make it simpler. If it 
were so simple, it could be all done on the Internet for a 
fraction of that cost. I think that we would be better served 
by making it simpler and then this job of leading people 
through all this paperwork would not be necessary and it would 
be more transparent and it would be easier for everyone to 
understand and focus on what is the most important thing?
    We want the person in the house. We want a low interest 
rate and we want low points. That is the objective. Who can do 
the best job of getting us there? What is the best way?
    From my perspective as an independent observer, the best 
way is to get it as simple as possible, not put on another 
layer of regulations, and certainly not try to assault the 
industry through class actions. Our data shows that a typical 
class action lawsuit costs the lender $1 million per suit, and 
there are 150 suits. So that would add up to about $150 
million. That cost is picked up by the lender and then passed 
to the consumer. The lender does not operate for nothing. It is 
a huge cost, a huge tax that has been added on to the industry 
and is certainly unnecessary and incorrect.
    I would be happy to work with you in any way I can in my 
professional capacity, and thank you for inviting me today.
    Chairman Sarbanes. Thank you, sir.
    Our final witness this morning is David R. Donaldson, from 
the law firm of Donaldson & Guin, LLC.
    Mr. Donaldson has practiced law for over 20 years and has 
extensive experience in consumer protection and real estate 
litigation cases. He is a lecturer on topics related to lender 
liability under the Real Estate Settlement Procedures Act, a 
1975 graduate from the University of Alabama at Birmingham, and 
a Dean's Scholarship to the Cumberland School of Law, where he 
was an Associate Editor of the Cumberland Law Review.
    Mr. Donaldson, we are pleased to have you with us this 
morning. We would be happy to hear from you.

            STATEMENT OF DAVID R. DONALDSON, COUNSEL

                     DONALDSON & GUIN, LLC

    Mr. Donaldson. Thank you, Chairman Sarbanes, and thank you 
for inviting me.
    I am one of the plaintiff 's counsel in the Culpepper case, 
which you have heard so much about here today. That litigation 
and the U.S. Court of Appeals opinion in that case--and there 
are three of those opinions--are based on a very simple 
proposition. That simple proposition is that mortgage brokers 
should not charge borrowers more than the broker agrees to 
accept for his or her services. I do not believe that that is a 
controversial proposition.
    Yet, for some reason, when the Eleventh Circuit Court of 
Appeals issued an opinion that said, this yield spread premium 
was not a payment for services because nothing else was owed 
for those services, it caused the industry to go into an 
uproar. And that first decision was issued in 1998. That 
message was sent a long time ago.
    The mortgage industry, rather than amending and changing 
their practices, believed that they could continue violating 
the law simply by avoiding class certification decisions in 
that class action and in other class actions.
    I was interested to read when I read the prepared statement 
of Mr. Courson, he describes the operation of the yield spread 
premium in this way. He says, ``as the interest rate goes up, 
the borrower's upfront cash contribution goes down.'' He then 
goes on to say, ``I want to clarify, unequivocally, that the 
yield spread premium mechanism should be restricted to the 
function I just 
described.''
    I understood what he said, and if I am misunderstanding it, 
he is here today and he can correct me. But as I understood it, 
he is arguing the same thing I have been arguing for the last 5 
years to the mortgage industry, which has turned a deaf ear.
    Under the Culpepper rule that was established by the 
appellate court, the only thing that a lender has to do to 
avoid a class action lawsuit on yield spread premiums is to put 
language in the lender's contract--and they all have standard-
form contracts that they use with their brokers.
    If the lenders would simply put this same language in their 
contracts--that is, we will pay yield spread premiums on over-
par loans where they are used to lower borrower's upfront 
costs. And if they would actually enforce that, and it is easy 
to see whether a yield spread premium is used to lower upfront 
costs because there is a line for it on the HUD-1.
    If that were done, and I and other plaintiff 's lawyers 
have been advocating that now for 5 long years--if that had 
been done 5 years ago, the industry would not be facing the 
problems it is facing now. And if it were done tomorrow, it 
would not be facing yield spread premium litigation under 
Section 8 of RESPA the next day.
    The industry claims, and I wrote this quote down this 
morning, so I may not have gotten it verbatim, but it is 
close--tell us the rules so we can conduct business. That is 
what the industry says it wants. If that is what the industry 
wants, I cannot understand why it went to HUD and demanded HUD 
promulgate a rule that says a yield spread premium is legal, so 
long as it is reasonable.
    Mr. Falk claims that the RESPA statute says that yield 
spread premiums are legal, so long as the total compensation is 
reasonable. But the word reasonable is not contained, Chairman 
Sarbanes, in that statute. In preparation for coming to talk to 
you today, I went back and reread the Senate report issued by 
this Committee's report in connection with that 1974 piece of 
legislation.
    HUD asked the Congress for authority to determine what was 
a reasonable price for settlement charges and Congress refused 
to grant HUD that power. In this Committee's report, it stated 
several reasons why that was a bad idea. And one of the reasons 
stated was that it would require an army of bureaucrats to look 
at the transactions to determine what is reasonable.
    I also heard this morning Mr. Olson say that there are 16 
million transactions. The printed testimony from the Mortgage 
Brokers Association says that brokers are responsible for 
roughly two-thirds of those. So that would be something in 
excess of 10 million transactions. I would submit to you that 
it does not make any sense for HUD to attempt to examine 10 
million transactions to determine whether a payment is 
reasonable, whatever that is.
    Apparently, the truth of the matter is, the reasonableness 
standard, which is not the law and should not be the law, is 
simply a way to legalize any kind of illegal practice so long 
as it is widespread. As long as all of the brokers are getting 
the payments, it becomes reasonable and, under that standard, 
legal. Anything would be legal under that standard.
    Chairman Sarbanes. Virtually anything, yes. I guess the 
extreme, the very egregious might fall outside of the 
parameter. But otherwise, they just make reference to what the 
rest of the industry is doing and say, well, this constitutes a 
reasonable practice. Is that the point?
    Mr. Donaldson. Yes, sir.
    Chairman Sarbanes. Yes.
    Mr. Donaldson. Beatrice Hiers, who everyone heard from this 
morning, is one of the plaintiffs in the Culpepper case. And 
the defendant has argued long and hard that she received the 
benefit of that yield spread premium and that it was 
reasonable. That position was taken.
    The 2001 policy statement purports to treat yield spread 
premium payments to brokers in a totally different manner than 
it treats all other up charges. The example that is given in 
the policy statement is a situation where a lender obtains an 
appraisal for $175, charges the borrower $200, and pockets the 
$25.
    Now, the 2001 policy statement says that that is a 
violation of Section 8 of RESPA. While I do not disagree with 
that, I suspect that if I were to bring a lawsuit under that 
same fact situation, the response would be, look, from the 
defendants, $200 is a reasonable cost for an appraisal, and in 
fact, it may be a reasonable cost for an appraisal because a 
lender that purchases thousands of appraisals a year can 
probably force the appraiser to drive the price down.
    It may be a reasonable cost. But HUD is saying that is 
illegal. Yet, if a broker and borrower agree for a 1 percent 
loan origination fee, and if no other compensation is agreed 
upon, and at the closing table, the broker receives double that 
amount, in HUD's view, that apparently is perfectly legal.
    There is no legal distinction between those two situations 
based under the same statute and there is certainly no 
intellectual distinction that I can understand.
    In closing, I would like to respond very briefly to the 
statement about class actions that was just made by Mr. Olson. 
The man sitting at the end of the table is a Harvard Professor 
who prepared a study. It was not done at my request, but it was 
done at the request of other plaintiffs' class action lawyers 
in another RESPA case. We would not have that kind of 
information today if we had to rely--that was done because a 
class action lawyer has a lawsuit and it is a very expensive 
study because it took a lot of intelligent people a lot of 
hours to do it.
    Lawyers are not going to spend that kind of money to 
prepare those kinds of studies in order to get back $1,000 for 
somebody. It does not make economic sense.
    The idea that when litigation expenses are incurred, that 
it drives up the cost, defies what I understand to be simple 
economics, which is that retail prices are a function of supply 
and demand. I do not see how suing 150 out of the 2,800 lenders 
causes the price of mortgages to go up, and I do not think it 
does. I think that is a red herring.
    Last but not least, I have not conducted a study like 
Professor Jackson, but I have talked to a lot of borrowers. And 
it is my clear impression from those conversations that 
supports what he found about discrimination in yield spread 
premiums.
    The Wharton study that you referred to at the beginning of 
your comments here today, was not done for plaintiffs' lawyers. 
It was done by a professor who is featured prominently on the 
Mortgage Bankers Association's own web site. That study found 
that the two determining factors for how much mortgage brokers 
get paid are the size of the loan and the sophistication of the 
borrower.
    Thank you very much, Chairman Sarbanes.
    Chairman Sarbanes. Well, thank you.
    I want to thank all six panelists for their contribution. 
This was a panel that embraced a number of varying viewpoints 
and of course, it was our objective to get kind of a broad 
presentation. So, I want to thank all of you for coming today, 
for preparing what are obviously some very thoughtful 
statements, all of which will be included in the record in 
full.
    Now let me turn to a few of the issues that I think have 
emerged here. First of all, I want to address this question of 
the class action suits as opposed to individual suits because 
the new HUD directive is read to preclude the class action 
suit, as I understand it, or it is being so interpreted by some 
courts already across the country, if I am not mistaken, the 
2001 statement.
    Although it is then asserted, these individual suits can be 
brought. I think everyone has conceded that the individual 
suits can be brought. But it seems to me that what is going to 
happen is that any recourse to the courts to remedy the 
situation is going to be closed out because the amount of 
recovery in an individual case is so small, that you are not 
going to be able to mount the legal effort that is necessary to 
bring these practices under control.
    Now the counter to that is, well, if we allow the class 
action suits to go ahead, they will recover huge amounts and 
that will impose a very significant burden on the industry. Let 
me ask you, Mr. Donaldson, the individual's suit really does 
not provide much recourse to the courts, does it, to get at 
these practices?
    Mr. Donaldson. Well, it does not change the practices. When 
the Circuit Court of Appeals issued its first opinion in 
January 1998, the industry's response was, so long as the 
plaintiffs cannot get classes certified, we can go on our merry 
way and not change our practices. They said that publicly in 
the press.
    So, I think that answers that question. And you are 
certainly correct. It is difficult to undertake litigation and 
fight for long years, as we have in this case. It has been 
going on for 5 years, even a large yield spread premium is a 
small amount of money to fight over for years and years.
    Chairman Sarbanes. Now what is the requirement that you 
say, if the industry followed it, would in effect eliminate the 
abuse of these practices?
    Mr. Donaldson. I did not really say what I thought might 
eliminate the abuse of the practices, and I am not sure, as far 
as if you want my opinion on that question, certainly Secretary 
Martinez's suggestions in his mortgagee letter that has been 
discussed here today would be a good step in the right 
direction.
    Chairman Sarbanes. The Department is arguing that what they 
have done is protective of the consumer. And I am having great 
difficulty understanding why that is the case.
    The industry went to them to get protection from the class 
action suits. The class action suits would be a very heavy 
discipline on the industry if they carried forward, proceeding 
from Culpepper. So there was a discipline mechanism in place 
to, in effect, compel the industry presumably to clean up these 
practices. Otherwise, they were going to pay significant 
penalties, or recompense.
    It is not clear to me, if you take that out, what is left, 
or where you will turn, then, to protect the consumer from 
these practices. And so, despite the Department's assertion 
that this is to help the consumer, I have difficulty in 
following that, one of the reasons we are doing this hearing 
here today.
    Mr. Jackson, let me turn to you because you have done some 
very careful studies and I would be interested in your response 
to that question.
    Mr. Jackson. Well, I think that the policy statement can be 
interpreted as a significant impediment to litigation. As I 
mentioned in my testimony, I think the Department misunderstood 
the role of yield spread premiums at least for a large number 
of mortgage lenders. And so, it is possible that, on different 
facts, courts would proceed differently with the policy 
statement. So it is still possible to maintain litigation, I 
hope, against certain lenders.
    I would say that the management of class actions is a 
function for the courts to decide. I think the courts are 
responsible for determining how to structure their cases. And 
HUD does not have expertise in class action management, so the 
court should take a look at these cases and see what the 
sensible way to proceed is.
    That having been said, I think that the Department must go 
further on disclosure. The current disclosure techniques are 
simply inadequate. The main problem is the yield spread 
premiums, when they are disclosed, are disclosed as payments 
from the lender to the broker. A consumer would reasonably 
think it has nothing to do with them. And in fact, if you go on 
the HUD's web page today and look for an explanation, HUD says 
these payments have no cost to you. It is quite misleading for 
consumers and I am quite sympathetic to people----
    Chairman Sarbanes. Well, they have a cost to the consumer 
in that they are paying a higher interest rate, don't they?
    Mr. Jackson. I absolutely agree which is why I think the 
current HUD instructions and glossaries that are on their web 
page are just quite misleading.
    Chairman Sarbanes. Now, Mr. Courson, I understand, is it 
your position that if there is a yield spread premium, it 
should go to the credit of the borrower?
    Mr. Courson. Let me explain my statement in that regard. 
Once the broker establishes what their compensation is going to 
be in a transaction, as they enter into this transaction with 
the consumer, whether at that point that compensation is agreed 
upon is either paid in cash or paid through the use of the 
yield spread premium, should be the same dollar figure.
    In other words, you establish the compensation for which 
you are going to provide the services and then, giving the 
consumer some choices, which I talked about in my opening 
statement, as to whether to pay that compensation in cash, pay 
it through a higher interest rate in a yield spread, or through 
a combination of both. It could be both.
    Chairman Sarbanes. You think that the consumer should know 
up front what the broker's charges will be?
    Mr. Courson. Yes.
    Chairman Sarbanes. Do you agree with that, Mr. Falk?
    Mr. Falk. We believe that the compensation should be 
included on the Good Faith Estimate, together with the rest of 
the costs of the loan, so that consumers can adequately shop 
and compare between different financing options. Yes, they have 
to be disclosed, together with all of the other costs on the 
Good Faith Estimate.
    Chairman Sarbanes. So would you have the broker's 
recompense separately disclosed to the consumer up front?
    Mr. Falk. It is currently separately disclosed on the Good 
Faith Estimate. Yes, it should be itemized under the current 
system.
    Chairman Sarbanes. How would you handle the yield spread 
premium issue?
    Mr. Falk. As a separate disclosure on the Good Faith 
Estimate, which is current law.
    Chairman Sarbanes. Mr. Jackson.
    Mr. Jackson. I just disagree. I think that this is the kind 
of misleading statement.
    Chairman Sarbanes. Yes, let us talk about that.
    Mr. Jackson. It is currently disclosed as a POC--paid 
outside of closing--from lender to the broker.
    Chairman Sarbanes. Right.
    Mr. Jackson. It is absolutely unclear under current law 
that the borrower is paying that through higher interest rates.
    Chairman Sarbanes. Would you make it clear to the borrower, 
Mr. Falk, that the borrower is paying it?
    Mr. Falk. I would make it clear that all compensation is 
clear and concise.
    Chairman Sarbanes. Let me just deal with that very specific 
thing that Professor Jackson referred to.
    Mr. Falk. Yes.
    Chairman Sarbanes. Would you make that clear to the 
borrower, specifically?
    Mr. Falk. Broker fees are in part, fees paid by the lender 
for goods, services, and facilities provided to the lender by 
the broker, and partially fees for goods and services provided 
to the borrower. It is a combination of both. Therefore, that 
is why we believe that the initial disclosure form, the model 
loan origination agreement ``souped up,'' as we recommend to 
HUD, should be clearer on the definition of these various fees 
and charges.
    Chairman Sarbanes. Mr. Courson, would you make it clear, by 
responding to Professor Jackson?
    Mr. Courson. Mr. Chairman, yes. I submitted for the record 
and I have shared with the Committee a prototype, as I 
described it, of a disclosure agreement that we think 
incorporates what Mr. Donaldson discussed, and Mr. Jackson 
discussed, as part of the statement of policy in the mortgagee 
letter. And the thrust of this agreement, if you will, entered 
into at the start of the application process discloses the 
total broker compensation.
    So, in that regard, it would include whether it was 
compensation to be received through a yield spread, whether it 
was compensation to be received through an origination fee. It 
would be the total compensation from whatever source. And then 
I think as you look through that prototype agreement that our 
coalition put together, then it offers the consumer some 
choices.
    It says to the consumer that here is the compensation. The 
compensation will not exceed X and you have some choices. And 
then it goes through some choices as to paying in cash, paying 
through a higher interest rate, paying through a combination 
and so on. So that captures all elements of that compensation 
into a number on a not-too-exceed number, and then gives the 
consumer the opportunities I talked about in my statement of 
options on how to deal with those costs.
    Chairman Sarbanes. It seems to me that one of the 
difficulties here is the way the system is working now, and 
this goes to Mr. Rheingold's point about it is one thing to 
talk about it in theory. It is another thing to see how it 
works in practice, is that you have an option which you say, if 
properly used, enables the consumer to have an additional 
financing approach. Namely, a higher interest rate and then 
they get some money with which they can cover their closing 
costs. So, they do not need as much money up front. And that 
sounds like a worthy objective. But in practice, since it is 
not disclosed or disclosed in such a way that it is not 
apparent that this option is available, in effect, it becomes a 
rip-off of the consumer. It becomes an abuse.
    Now that raises the question, and this goes to how 
widespread the practice is, which goes back to Professor 
Jackson's study, but that raises the question, if there is 
substantial abuse, whether it is worth having this option 
available, if the consequence of having it available is to get 
the kind of instances that we heard from from the first panel 
this morning. Now that approach, in a sense, would close out an 
option that people say, if properly done, is desirable. On the 
other hand, if we cannot figure out a way to close out the 
abuses and sustain the option, and if the abuses are fairly 
prevalent, that may be the only recourse.
    Mr. Rheingold, you wanted to comment.
    Mr. Rheingold. Yes. Although I have not read Mr. Courson's 
disclosure of the model that he talks about, I can say that the 
concepts he expressed, we would fully endorse. We do not oppose 
yield spread premiums and we think, as you said, they actually 
can work in a manner that would benefit consumers.
    The point being here that if there is a total compensation 
disclosed up front, this is what I am going to get paid. I am 
your broker. This is what I am going to get paid. If the 
consumer is given a choice as to the method of payment, that is 
fine.
    The system that we have here today is market-distorting. 
One would think that if you have a broker, the broker will shop 
for you so that you get the best available loan. In essence, 
what we have here, in practice, as demonstrated by Mr. 
Jackson's study, is that the broker is not finding you the best 
available loan for your benefit, but they are looking for loans 
where they will get paid more money.
    In essence, the marketplace is not functioning right now. 
And if you, in fact, have a scheme where the total compensation 
is laid out upfront, and whether or not a yield spread premium 
is paid or not, I am going to pay that broker $2,000. I may pay 
it in cash. I may get it refinanced. I may have the lender pay 
that $2,000. I will choose it.
    But that money is set in stone and then there is no 
incentive for the broker to find a higher interest rate for 
that person because their compensation is not going to change 
based on what the interest rate is.
    Chairman Sarbanes. Because they will not get the yield 
spread premium.
    Mr. Rheingold. Well, they will get the yield spread 
premium.
    Chairman Sarbanes. But it will be credited to the borrower.
    Mr. Rheingold. Right. It will be a way they get paid, but 
there will not be an added incentive to find a higher interest 
rate because they will get paid more. That will eliminate it 
and the scheme that Mr. Courson describes, I believe will 
actually eliminate that market-distorting incentive that 
currently exists.
    Chairman Sarbanes. Mr. Falk, what do you say about that?
    Mr. Falk. Well, I think the marketplace is working for a 
vast number of Americans who have refinanced this year and 
saved billions of dollars of interest expenses.
    Mortgage companies act in multiple capacities, Mr. 
Chairman. Sometimes a mortgage company acts as a lender in a 
transaction and sometimes the company acts as a broker in a 
particular transaction. So, however you define the transaction, 
total compensation should be disclosed fully. It should be as 
transparent as possible. And it should meet with the wishes and 
the guidelines and the desires of the consumer.
    Therefore, I believe the market is working. We have 
increased competition, which is what we want in the 
marketplace. And I believe, by and large, mortgage brokers are 
bringing reduced costs to the marketplace and doing an 
excellent job.
    Chairman Sarbanes. How do I know which broker to go to on a 
competitive basis if they are not disclosing to me up front 
what their charges are?
    You say it is working on a competitive basis and I am then 
led to wonder, well, a lawyer will tell me what his fee is, a 
stockbroker tells me what his commission is, a real estate 
agent tells me what their fee is. If I cannot get that specific 
information from the broker, how do I shop amongst brokers as 
to who is going to give me the best value.
    Mr. Falk. We believe that consumers should always shop and 
compare, not only between brokers, but also with retail 
lenders, banks, credit unions and savings and loans. We are all 
part of that system.
    Chairman Sarbanes. Well, that is Professor Jackson's point, 
and we may get to that. I mean, we are dealing with a broker 
problem now and I can understand the brokers saying, well, if 
you are going to deal with the broker problem, we want you to 
deal with any comparable problem that may exist with the 
lenders. And that is broadening the universe of what we have to 
deal with. But let us for the moment operate with this limited 
universe we are addressing. How do we ensure that we will not 
get the kind of practices that we heard this morning from the 
people on the first panel?
    Let me ask this question first. Is there anyone on this 
panel who, having heard what we heard from the first panel, 
says, well, this is how the system operates and we get other 
benefits out of the workings of the system and therefore, we do 
not really think anything should be done to close out the 
practices that we heard this morning? Is there anyone at the 
table who takes that position?
    Mr. Olson.
    Mr. Olson. I think that those are exceptional 
circumstances.
    Chairman Sarbanes. Pardon.
    Mr. Olson. I think they were exceptional circumstances and 
not typical.
    Chairman Sarbanes. Let me not argue whether they are 
exceptional or not for the moment. Let me just get a response, 
whether there is anyone on this panel who thinks, having heard 
those practices, who says, well, it is regrettable, but we have 
this system that works, or we have this system in place and it 
moves a lot of transactions and people get credit and all the 
rest of it, and therefore, we really cannot close out those 
practices and we just have to, in a sense, accept them or 
tolerate them. And then, presumably, one would argue that there 
are not very many of them, and others would argue that there 
are quite a few of them. But is there anyone who thinks we just 
should accept those practices, at the table?
    Mr. Olson. I think we have been given some alternatives. If 
we make the compensation up front, then there would be less of 
this practice. I would agree with that.
    There is always imperfections in any market and I do not 
know if you can always eliminate every problem. We could go to 
shopping for a dress or going to the restaurant. There is 
always cases where someone paid more than they wish they had.
    Chairman Sarbanes. No, no, this is not a case where they 
pay more than they wish they had. This, it seems to me, what we 
heard this morning are cases in which they were clearly taken 
advantage of. They placed their confidence in someone. They, in 
effect, got representations that the person was really working 
on their interests, and it turned out they were not working in 
their interests and they put them into very difficult 
situations.
    Now, Professor Jackson says on the basis of his study, that 
he thinks that such practices are fairly widespread. Am I 
interpreting that correctly?
    Mr. Jackson. That is correct. It is much more widespread 
than several panelists this morning would suggest.
    Chairman Sarbanes. Yes.
    Mr. Jackson. It is a very generic practice and problem in 
the 
industry.
    Mr. Donaldson. Mr. Chairman, could I respond to the 
statement about the frequency of these occurrences?
    Chairman Sarbanes. Sure.
    Mr. Donaldson. With all due respect to Mr. Olson, Ms. Hiers 
got a mortgage from Irwin Mortgage Corporation, the defendant 
in the Culpepper case. I and other plaintiffs' lawyers who are 
representing that class have looked through approximately 5,000 
loan files. I did not find and, to the best of my knowledge, no 
other person found a single situation where any borrower was 
saved one thin dime in closing costs as a result of a yield 
spread premium being paid. And the idea that these are not 
commonplace problems simply cannot be--that allegation does not 
withstand the light of day of scrutiny if you actually look at 
the loan files.
    Situations like Beatrice Hiers' are not the least bit 
uncommon if you go look through these defendants' loan files. 
And although the mortgage bankers and the mortgage brokers are 
sitting before this Committee here today talking about how 
willing they are to disclose, my reading of the Federal 
Register of the negotiated rulemaking with HUD over the last 
several years, starting in 1995, tells me that they have 
vociferously fought against any disclosure whatsoever.
    And in preparing to come here today, I went to NAMB's web 
site and read their position paper, dated last month, talking 
about this very question. And there is an entire topic devoted 
to the proposition that, ``. . . originators should not be 
required to disclose their compensation.'' I do not understand.
    Chairman Sarbanes. Does anyone want to respond to that?
    Mr. Falk.
    Mr. Falk. Mr. Chairman----
    Chairman Sarbanes. We have you all at the table this 
morning for this purpose.
    Yes.
    Mr. Falk. Mr. Chairman, we as the mortgage brokers do 
believe in comprehensive mortgage reform. I believe over the 
last 5 or 6 years the National Association of Mortgage Brokers 
has been calling on Congress and HUD to work on the various 
problems that we have in our industry.
    There are just too many pieces of paper. It is confusing to 
the consumer. It can be faster and better, understandable to 
the consumer, to facilitate shopping and comparing. It can be 
better.
    We believe also an important part of this is RESPA 
enforcement that Secretary Martinez has called for and we 
applaud that effort. We look forward to his efforts in 
enforcing the rules that are currently on the books and 
clarifying others that need clarification.
    Last, we have called for more than what the HUD Secretary 
called for in our press release recently. We have called for 
Good Faith Estimate reform, which would have caused some of the 
problems that we heard about this morning not to exist.
    Right now, Mr. Chairman, when a Good Faith Estimate is 
required, there is no Federal requirement to redisclose the 
Good Faith Estimate of costs if the loan terms change 
significantly from the time of application to the time of 
funding.
    What we are saying is develop tolerances. When the Good 
Faith Estimate is initially constructed and delivered to the 
consumer, if tolerances are exceeded, then a redisclosure is 
necessary to avoid the surprises at the closing table, to avoid 
some of the things that we heard this morning on a purchase 
transaction, the story that we heard this morning from Ms. 
Hiers, who felt forced to close a transaction. That should not 
happen. And redisclosure on a Good Faith Estimate that exceeds 
certain tolerances could be a valuable tool for consumers so 
they are not taken advantage of.
    Chairman Sarbanes. Well, all three people we heard from 
before, I was struck by the fact that these are really hard-
working citizens. Every one of them.
    Their dream was to own a home, and that was obviously a 
very important part of providing security for their families. 
Ms. Hiers actually had her parents living with her until they 
passed away, along with her children. We have to get at these 
practices.
    Mr. Jackson, I know you have looked at the RESPA 
legislation in detail. My own reaction to the HUD 2001 policy 
statement was that, rather than clarifying the 1999 statement, 
it actually muddied the waters.
    My view of the RESPA law, in the 1999 statement was that 
each fee had to be tied to a legitimate service. In fact, the 
Senate report that accompanied the passage of RESPA indicates 
that RESPA, ``. . . prohibits the acceptance of any portion of 
any charge for the rendering of a real estate settlement 
service other than for services actually performed.'' So my 
understanding is that Congress wanted to prohibit referral fees 
from being tacked onto or hidden in with other fees that were 
for legitimate services or goods.
    And that is why, Mr. Falk, I kept pressing you specifically 
on the fee and the service because you can encompass the fee 
within a broader concept. And I have some concern now that this 
is what HUD is doing with this total compensation test, which 
would allow for referral fees, or may well allow for referral 
fees as long as HUD believes that the total payment to the 
broker is reasonable, even though the law specifically 
prohibits all referral fees.
    Now do you share that concern, Professor Jackson?
    Mr. Jackson. Senator Sarbanes, I do. This aspect of the 
policy statement is quite puzzling. If you go back to the 
legislative history of the Act that you are referring to, or 
even the press accounts that preceded the Act, what Congress 
was worried about were people in a trust relationship, like 
attorneys or real estate agents, who were steering their 
clients toward title insurance companies and other service 
providers and getting a kickback. And what Congress concluded 
was that these referral fees and kickbacks were increasing 
substantially homeownership costs, and they should prohibit 
them.
    Chairman Sarbanes. Mr. Donaldson, the Culpepper case in 
effect said, as I understand it, that these yield spread 
premiums were being paid without any relationship to providing 
any services.
    Mr. Donaldson. Yes, sir.
    Chairman Sarbanes. Is that correct?
    Mr. Donaldson. Yes, sir, that is correct.
    Chairman Sarbanes. In effect, you had the rate sheet and it 
was all geared to the rate sheet. As long as you brought them 
in at a higher interest rate, you got the yield spread premium 
and you, the broker, did not really have to do anything for 
that yield spread premium. Is that the essential thrust of that 
case?
    Mr. Donaldson. Yes, sir. And the form agreement between the 
lender and the broker simply provided that yield spread premium 
payments would be made when a borrower agrees to a higher than 
par interest rate. It had nothing to do with services. And in 
fact, at the outset of that litigation, the defendant did not 
even argue that it had to do with services. It argued that it 
was paying for a good which was the mortgage. This idea that 
this is a payment for services is something that was cooked up 
by industry lawyers after they lost their first argument.
    Chairman Sarbanes. My understanding is that there has been 
testimony in some of these class action suits--let me just 
quote a couple of them.
    A broker testified in a deposition that the only variable 
that determines the yield spread is the interest rate. A lender 
official was asked if there are any particular services that go 
into the pricing on a rate sheet. His answer, ``No, I am not 
aware of any services.''
    Mr. Donaldson. That is correct.
    Chairman Sarbanes. A lender offers to fund the same exact 
loan provided by the same broker for the same borrower with the 
same principle amount after the broker has done the work. The 
only variable is the yield spread premium, which is 
predetermined according to a rate sheet provided by the lender 
to the broker. Isn't that what happens?
    Mr. Donaldson. Yes, sir, that is exactly what happens.
    Chairman Sarbanes. Mr. Jackson, let me ask you one other 
question on this RESPA and the HUD statement. Apparently, now, 
the 2001 statement is that HUD is going to determine what is a 
reasonable fee. That is not the approach that the Congress took 
when they passed the legislation, at least as I understand it. 
In fact, we did not set up a structure to adjudge the 
reasonableness of the fees.
    Mr. Jackson. That is absolutely right.
    Chairman Sarbanes. Mr. Courson, Mr. Falk, do you think we 
should set up a structure to adjudge the reasonableness of 
fees, a Government structure to do that?
    Mr. Courson. Mr. Chairman, I think that is a very slippery 
slope. I think it is very difficult to judge what, when one 
loan may well be reasonable--we are talking about loans now in 
this particular context--and whether another loan may be 
unreasonable.
    You have geographical issues. You have different types of 
loans. I think that the Government setting standards, if you 
will, in terms of defining reasonableness will be very 
difficult over the hundreds of thousands of loans that are made 
each year.
    Chairman Sarbanes. Mr. Falk, I take it you would agree with 
that.
    Mr. Falk. I would add to the comment, yes, I do agree with 
Mr. Courson's testimony. Many loan programs and different 
products and services call for different types of services and 
goods and facilities rendered. Therefore, it is impossible to 
come up with a strict definition on a Federal level to deal 
with all of the complexity that goes into a particular loan 
transaction on a local level. It would just be very difficult.
    Chairman Sarbanes. Actually, I do not think anyone at the 
table is advocating establishing a governmental structure to 
adjudge the reasonableness of fees. Is that correct?
    Mr. Olson. That is correct.
    Chairman Sarbanes. I mean, as I read it, that is not the 
legislative scheme the Congress put in place.
    Now what the Department is doing is, conceivably--we are 
going to see now because they are working on a regulation--but, 
conceivably, undercutting the existing regulatory scheme, 
setting up this kind of reasonableness proposition.
    I do not know how that is going to be implemented or 
enforced. The industry, obviously, in its full-scale 
manifestation, would be opposed to it. The Congress made the 
judgment when we passed the legislation not to go down that 
path. But if we are not going to go down that path, it seems to 
me that HUD cannot abandon the two-stage testing process for 
these practices that in part were reflected by the court's 
decisions in the Culpepper case. So now if they are going to 
come in and vitiate the Culpepper case, it is hard for me to 
see what the remedy is going to be to preclude these practices 
from taking place.
    Mr. Rheingold. Senator.
    Chairman Sarbanes. So, I think that is, in effect, the 
challenge that HUD has presented to itself. They, in effect, 
now, it seems to me, have maneuvered themselves into a corner. 
And I am obviously very interested in how they are going to 
work out of this corner.
    Mr. Rheingold, you wanted to comment?
    Mr. Rheingold. I apologize.
    Chairman Sarbanes. That is all right. No, no.
    Mr. Rheingold. The industry, in fact, supported HUD's 
action and wanted them to apply a reasonableness test. HUD 
adopted what the industry was asking them to do, and there was 
one reason for it and one reason alone--everyone understands 
that if the only test is reasonableness, you cannot have a 
class action lawsuit.
    HUD's actions were simple. Call it cynical. The only 
purpose for their policy statement on October 15 was to 
undercut Culpepper. They may come out now with new regulations 
that are helpful. But the fact was that the October 15 
Statement of Policy was caused by industry's reaction to the 
Culpepper decision and their understanding that a 
reasonableness test would undercut the ability of any class 
action to go forward.
    Chairman Sarbanes. Do you think that there are mandates 
that could now be required of the industry that would preclude 
a repeat of the practices we saw on the first panel?
    Mr. Rheingold. I think there clearly are. Actually, I think 
some of the suggestions that Mr. Courson made are very viable. 
I think the notion that total compensation up front, that the 
total compensation does not depend upon the interest rate the 
person gets. The yield spread premium is simply a source of how 
that compensation gets paid. So, in essence, there is no 
incentive for a broker to get a higher rate mortgage because 
they are not going to get compensated any more.
    I think that would go a long way to solving the problems 
that exist. I hasten to add that in my experience in 
representing a lot of poor homeowners in this country, I never 
underestimate the cynicism of the industry and I never 
underestimate----
    Chairman Sarbanes. Or some elements of the industry.
    Mr. Rheingold. Some elements of the industry. I do not mean 
the entire, but some elements. I do not underestimate that. But 
I think that would go a long way forward in making things work.
    Chairman Sarbanes. I think the industry has to face this 
problem of the bad actors within their ranks. They just have to 
face it.
    Mr. Falk, do you want to comment?
    Mr. Falk. Yes. Thank you, Mr. Chairman. I would 
vociferously disagree with the other panelists who have tried 
to characterize the 2001-1 policy statement of HUD. We believe 
that the 1999-1 policy statement by Secretary Cuomo clearly 
outlined the requirements. We believe that the 2001-1 statement 
was merely a restatement of that existing policy that was 
originally stated in 1999.
    And so, to characterize it as some effort on the part of 
the HUD Secretary to undermine or to take away certain rights 
and privileges from consumers, we believe is a 
misinterpretation, with all due respect to the other panelists.
    Chairman Sarbanes. Yes. The difficulty I have with that 
statement, though, is that under the 1999 guidance, a class 
action suit was permitted in the Culpepper case. And since the 
new guidance has come out, I understand that there have been a 
couple of Federal courts across the country who have disallowed 
the class action suit. So if you see the class action suit as 
one effective remedy to eliminate these practices, then that 
remedy has been in effect wiped out.
    Also, HUD, by collapsing the two-step test, has markedly 
altered the situation. If it is left for reasonableness to be 
determined in a court case, that is not much remedy on an 
individual basis.
    They are not suggesting establishing a structure to 
determine reasonableness administratively, and of course, both 
of you would strongly disagree with going down that path, I 
presume, from what you have said earlier.
    So, we have a situation now in which the remedies are being 
eliminated on the basis of a so-called clarifying statement 
compared with where we were before. The rhetoric of the HUD 
press releases in terms of what they are trying to accomplish 
does not comport with the reality of their statement, in my 
perception. It will really be put to the test, obviously, as we 
look at the regulation that they are now seeking to formulate. 
And obviously, we intend to follow that process very closely.
    Well, I want to thank all the panelists. You have made a 
very significant contribution. It is our intention that your 
full statements and the transcript of this hearing will be 
forwarded to the Department, along with a letter of 
communication urging them to give the most careful 
consideration to what has been said here.
    This is a very important issue. As I said at the outset, 
people who render services are entitled to appropriate 
compensation for the services they render. But it ought not to 
extend to the point where they can engage in abusive practices 
and exploit people.
    Mr. Olson, I was a little concerned you were suggesting 
they are not making much money. That may or may not be the 
case. But, in any event, in order to make money, I do not think 
you are entitled to engage in abusive practices. I do not 
concede that in order to turn a profit, you can engage in any 
exploitative activity.
    Mr. Olson. I did not mean to suggest that.
    Chairman Sarbanes. Well, that was a possible implication. I 
just want to be very clear about that.
    I thank the panel very much.
    The hearing is adjourned.
    [Whereupon, at 12:10 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

    This morning the Committee will hold its third hearing on the 
subject of predatory lending. Our previous two hearings on this topic 
focused largely on the predatory loans and practices which resulted in 
stripping hard-earned equity away from many low-income homeowners. 
These include folding high points and fees, as well as products such as 
credit insurance, into the loan. We also looked at how unscrupulous 
lenders and mortgage brokers target the low-income, elderly, and 
uneducated borrowers as likely marks for predatory loans. Today's 
hearing will focus more on the role of the broker in the lending 
process, specifically the use and misuse of yield spread premiums.
    Let me start by addressing how yield spreads are used in the 
marketplace. Typically, a mortgage broker will offer to shop for a 
mortgage on behalf of a consumer. In many cases, that broker will 
promise to get the borrower a good deal, meaning low rates and fees. 
Borrowers pay the broker a fee for this service, either out of their 
savings or with the proceeds of the loan. Unbeknownst to them, however, 
that broker may also be paid a yield spread premium if he can get the 
borrower to sign up for a loan at a higher rate than the borrower 
qualifies for. The higher the mortgage rate, the higher the payment. We 
will hear about such cases this morning.
    Yield spread premiums can be a legitimate tool in helping a home 
buyer or homeowner offset all or some of the closing costs associated 
with buying or refinancing a home. When used properly, the broker 
discloses his total fee to the consumer. The consumer may then choose 
to pay that fee, and, perhaps other closing costs as well, by accepting 
a higher interest rate and having the lender pay the fee to the broker. 
In such cases where the borrower makes an informed choice the payment 
helps families overcome a barrier to homeownership--the lack of funds 
for closing costs.
    However, it appears that in practice, perhaps in widespread 
practice, yield spread premiums are not used to offset closing costs or 
the broker fees. Instead, these premiums are used to pad the profits of 
mortgage brokers, without regard to any services they may provide to 
borrowers. Let me quote from a report issued by the Financial 
Institutions Center at the Wharton School of Business at the University 
of Pennsylvania. Professor Emeritus Jack Guttentag, discussing the 
problem of ``rebate pricing'' that is, payments by lenders to brokers 
of yield spread premiums, writes:

          In most cases . . . rebates can be pocketed by the broker, 
        unless the broker commits to credit them to the borrower, which 
        very few do. Rebate pricing [that is YSP's] has been growing in 
        importance, and one of the reasons is that it helps mortgage 
        brokers conceal their profit on a transaction.

    Moreover, this does not just affect subprime borrowers, as do most 
of the other egregious practices we heard about in our previous 
hearings. This misuse of yield spread premiums affects prime borrowers, 
FHA borrowers, VA borrowers; however, because of the lack of openness 
and competition in the subprime market, it hits subprime borrowers 
hardest of all. Even for those with the best credit, the current use of 
yield spread premiums can cost thousands of dollars in increased 
financing costs.
    Yield spread premiums, when they are misused in this way, fall 
directly into the category of the kind of referral fees or kickbacks 
that were so prevalent in the settlement business prior to the passage 
of RESPA. After years of hearings and reports, the Congress passed the 
Real Estate Settlement Procedures Act (RESPA) in 1974 specifically to 
outlaw side payments of this kind because they increase the costs of 
homeownership for so many Americans. Indeed, the plain language of the 
law, regulations, 1998 Congressional instructions to HUD to formulate a 
policy on the issue, and the 1999 HUD policy statement--particulary 
when taking the legislative history into account--all make it clear 
that RESPA was intended to prohibit all payments that are not 
demonstrably and specifically for actual services provided. That is to 
say, each fee collected by the broker should be for a corresponding 
service actually provided.
    Because the majority of home loans are now originated through 
brokers, lenders have less and less direct access to borrowers. This 
means they must compete for the broker's attention to gain access to 
the ultimate consumer--the borrower. This competition means that, too 
often, lenders must pay yield spread premiums to the brokers simply for 
the referral of business. As all of us know, this is prohibited under 
the law precisely because it raises the costs of homeownership to the 
consumers.
    Regrettably, HUD's recent ``clarification'' of its 1999 policy 
statement on the issue of yield spread premiums will open the door to 
new and ongoing abuses of low- and moderate-income homebuyers and 
owners. Despite the Secretary's statement at his confirmation hearing 
that he finds predatory lending ``abhorrent,'' I fear that the new 
policy statement will facilitate the predatory and racially 
discriminatory practice of steering homeowners to higher interest rate 
loans without their knowledge, and, importantly, without any effective 
means of redress.
    Secretary Martinez has made increasing minority homeownership a 
primary goal of his Administration. However, a study done by Howell 
Jackson of Harvard Law School (who will testify on the second panel) 
shows that, while the current use of yield spread premiums imposes 
extra costs on all homebuyers, the burden falls especially hard on 
minorities. In other words, yield spread premiums, when they are used 
in this abusive fashion, put the dream of homeownership further out of 
reach for minority Americans. Those who still manage to achieve this 
dream are forced to pay thousands of dollars in increased interest 
costs over the life of their loans. Many find themselves in more 
precarious financial positions than they should or could be, thereby 
putting them more at greater risk of falling prey to the kind of 
repeated refinancings that we have seen lead to equity stripping or 
even the loss of the home.
    I recognize that it is unusual to have a hearing while the Congress 
is in recess. HUD has indicated, both in testimony before this 
Committee in December, and in the Federal Register, that it intends to 
publish a proposed regulation on this matter by the end of this month. 
These issues are so important that I wanted to make sure that there 
would be a public airing of the issues for the consideration of the 
Department while their deliberations were still ongoing.
                               ----------
                 PREPARED STATEMENT OF SUSAN M. JOHNSON
                        Cottage Grove, Minnesota

                            January 8, 2002

    My name is Susan Johnson and I am from Cottage Grove, Minnesota. I 
am pleased to have the opportunity to be able to address the Senate 
Banking Committee today about the $1,620 ``yield spread premium'' that 
was secretly paid by my lender, ABN AMRO Mortgage Group, to my mortgage 
broker, Allstate Mortgage, at my expense.
    In April 2000, my husband David and I had just moved back to the 
Twin Cities from Colorado Springs and were looking to buy a house. 
Through a real estate agent, we were introduced to David Schultz, owner 
of Allstate Mortgage, a mortgage broker in Plymouth, Minnesota. After 
meeting Mr. Schultz at a local restaurant, we hired him to find us a 
mortgage loan.
    From the outset, we were told by Mr. Schultz that he would find us 
a loan with the best possible interest rate. Mr. Schultz specifically 
told us that the fee for processing the loan would be 1 percent of the 
loan amount. We signed a written broker agreement with Mr. Schultz 
which allowed for a 1 percent broker fee. (Exhibit 1, Loan Origination 
Agreement) No other fees were ever demanded by Mr. Schultz, disclosed, 
or agreed to.
    When the closing occurred on May 23, 2000, to our surprise, the 
interest rate was higher than we understood it would be and the fees 
were far greater than the 1 percent fee we had agreed to. (Exhibit 2, 
HUD-1 Settlement Statement at lines 801-812) In fact, the total fees 
were nearly four times that amount! ($5,242.00) This included what we 
only later came to learn after the closing was a ``yield spread 
premium''--a $1,620 payment from the lender to our broker that was 
really paid by us since it was tied to an inflated interest rate on our 
loan.
    While we were upset about the fees, we had no choice but to go 
through with the closing or risk losing the house; being found in 
default of the Purchase Agreement; and forfeiting the $5,000 earnest 
money we had already given the sellers. While we objected to the fees 
and higher interest rate, there was no way for us to find another loan 
and still close on time. We were stuck and the broker knew it.
    As our HUD-1 Settlement Statement shows, we were charged the 
following fees at closing, none of which were disclosed, or agreed to 
beyond the initial 1 percent origination fee:

          $1,296 (1 percent) Loan Origination Fee
          $1,296 (1 percent) Loan Discount Fee
          $395 Processing Fee
          $200 Underwriting Fee
          $150 Doc Prep Fee
          $40 Funding Fee
          $350 Commitment Fee
          $285 Admin Fee

    Only after the closing did we discover the significance of the 
$1,620 ``yield spread premium'' (1.25 percent) which was assessed to us 
through an inflated above-par 
interest rate of 8.75 percent. At the time of the closing we had no 
idea what this ``premium'' was because it was only vaguely disclosed on 
our HUD-1 Settlement Statement as a ``Deferred Premium POC.'' \1\ In 
sum:
---------------------------------------------------------------------------
    \1\ Line 814 ``Deferred Premium $1,620 ($1,620 Pd by ABN AMRO 
Mortgage Group Inc., POC) to Allstate Home Mortgage.''

          The $1,620 yield spread premium was not disclosed, discussed, 
        or agreed to before the closing;
          My husband and I were never informed that our loan had an 
        above-par interest rate because of the premium payment from ABN 
        AMRO to the broker;
          The broker never explained how the yield spread premium 
        affected our interest rate or that our monthly mortgage 
        payments would be any higher because of the premium;
          No rate sheet or other document showing the direct 
        relationship between the inflated interest rate and the yield 
        spread premium payment from the lender to the broker was ever 
        shown to us;
          The yield spread premium did not offset or reduce any fee we 
        ever owed to the broker;
          The broker received all fees that we owed and agreed to (and 
        far more) directly in cash from us at the closing.\2\
---------------------------------------------------------------------------
    \2\ We never owed the broker any fees on top of the 1 percent fee 
Mr. Schultz told us he was charging before the closing. Mr. Schultz 
later admitted this when he gave a deposition. (Exhibit 3: Excerpts 
from Schultz deposition, March 15, 2001).

    After the closing, I wrote to the State of Minnesota Department of 
Commerce complaining about the transaction. After reviewing my letter, 
the Department of Commerce advised us to seek private legal counsel. 
The matter remains pending in Court in Minnesota. In that case, we have 
agreed to be representatives of other borrowers whose loans had yield 
spread premiums paid by the same lender in the same manner as ours.
    In conclusion, the $1,620 yield spread premium on our loan was 
nothing more than a bonus paid by the lender to the broker for securing 
a bad deal for my husband and me, and referring a better deal to the 
lender. This conduct should be illegal because:

          (1) the yield spread premium was not paid in exchange for any 
        ``service'' fee we owed the broker;
          (2) we received no benefit from the premium the lender paid 
        at our expense, such as an offsetting credit against any 
        closing fees or costs we actually owed, and;
          (3) the money was simply a kickback to the broker referring 
        our loan to the lender with a higher interest rate.

    The standard for evaluating the legality of this practice should 
not merely be whether the broker's ``total compensation,'' including 
the yield spread premium and other fees we never agreed to, is somehow 
``reasonable'' based on the broker's after-the-fact attempt to justify 
the higher fees he has already taken. Rather, the true nature of the 
disputed premium should be evaluated: that is, what was the premium 
actually paid in exchange for.
    To allow as lax a standard as ``reasonableness'' of total broker 
compensation to govern these transactions will only allow lenders and 
brokers like ABN AMRO and Mr. Schultz to continue ripping-off unknowing 
consumers like us, with a catch-us-if-you-can attitude. It will 
encourage brokers and lenders to continue to try to slip additional 
bonus fees into mortgage transactions regardless of what was agreed and 
without providing any actual credit to the consumer bearing the cost. 
If lenders are paying bonuses and incentives to brokers simply for 
referring high-rate loans to them, that should be illegal without 
concern for whether the broker or the lender thought the secret 
referral fee was ``reasonable.''
    Thank you.
Attachments
          Exhibit 1: Loan Origination Agreement with the broker for the 
        1 percent fee; HUD-1 Settlement Statements (Exhibit 1);
          Exhibit 2: HUD-1 Settlement Statement on ABN AMRO Mortgage 
        Group Inc. loan, May 23, 2000;
          Exhibit 3: Excerpts from Mr. Schultz's deposition testimony 
        admitting that the yield spread premium was never discussed 
        with us before the closing and offset no fee we owed.

        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
                PREPARED STATEMENT OF HOWELL E. JACKSON

  Finn M.W. Caspersen and Household International Professor of Law and
            Associate Dean for Research and Special Programs
                    Harvard University School of Law

                            January 8, 2002

    Chairman Sarbanes and Members of the Committee, I am very pleased 
to be here today to discuss the problem of yield spread premiums and 
the Department of Housing and Urban Development's recent Statement of 
Policy 2001-1, 66 Fed. Reg. 53,052 (Oct. 18, 2001) (Statement of 
Policy). Yield spread premiums and related industry practices have 
become a major problem for American homeowners. Payments of this sort 
are inherently confusing and serve primarily to raise the cost of 
homeownership for many Americans, particularly the less educated and 
the financially unsophisticated, by billions of dollars a year. In my 
opinion, yield spread premiums 
represent the sharp practices that Congress should have prohibited when 
it enacted the Real Estate Settlement Procedures Act of 1974 (RESPA) 
more than 25 years ago. I urge both Congress and the Department of 
Housing and Urban Development to redouble their efforts to eliminate 
the substantial and widespread consumer abuses that yield spread 
premiums have visited upon American homeowners in recent years.
Introduction
    Over the past year, I have been investigating the economic impact 
of yield spread premiums.\1\ A major component of my investigation has 
been an empirical analysis of a nationwide sample of approximately 
3,000 mortgages originated by one group of affiliated lending 
institutions in the late 1990's. This study constitutes the most 
extensive empirical investigation of yield spread premiums to date. In 
my testimony before the Committee this morning, I would like first to 
discuss the implications of my study for the Department's policy 
statement and then to propose a number of specific actions I believe 
the Department should take to prevent abusive uses of yield spread 
premiums in the future.
---------------------------------------------------------------------------
    \1\ I initially undertook this project as an expert for the 
plaintiff class in Glover v. Standard Federal Bank, Civil No. 97-2068 
(DWF/SRN) (U.S. District Court, District Court of Minnesota) (pending) 
and am currently expanding the study into an academic article, the 
current draft of which is attached to this testimony: Howell E. Jackson 
& Jeremy Berry, Kickbacks or Compensation: The Case of Yield Spread 
Premiums (January 8, 2002) (hereinafter ``Jackson & Berry'') [a 
abridged draft of this paper is available at http://
www.law.harvard.edu/faculty/hjackson/pdfs/january__draft.pdf.
---------------------------------------------------------------------------
The Policy Statement
    Let me begin by commending the Department for its willingness to 
take on an issue as complex as the payment of yield spread premiums. 
While my analysis of these practices differs from the Department's 
views in many important respects, I wholeheartedly agree with the 
Department's initial premise and the premise of the RESPA itself: That 
real estate settlement practices are an area in which governmental 
intervention is necessary both to protect consumers and to ensure the 
efficient operation of market forces.
    My comments about the policy statement are divided into two parts. 
First, I will discuss the statement's factual assumptions about the 
role of yield spread premiums in today's mortgage market. Second, I 
will comment on several aspects of the Department's legal analysis of 
how Section 8 of RESPA, which prohibits certain kickbacks and unearned 
referral fees, should be applied to the payment of yield spread 
premiums.

Factual Assumptions about the Role of Yield Spread Premiums
    As explained in the policy statement, the Department conceives of 
yield spread premiums as a valuable ``option'' that ``permits 
homebuyers to pay some or all of the upfront settlement costs over the 
life of the mortgage through a higher interest rate.'' \2\ This method 
of financing upfront settlement costs, according to the Department, is 
particularly suited to borrowers who are low on cash and ``whose loan-
to-value ratio has already reached the maximum permitted by the 
lender.'' \3\ Based on these factual assumptions, the Department 
concludes that the yield spread premium is a ``legitimate tool to 
assist the borrower'' and a financing option that ``fosters 
homeownership.'' \4\
---------------------------------------------------------------------------
    \2\ 66 Fed. Reg. at 53,054.
    \3\ Id.
    \4\ Id.
---------------------------------------------------------------------------
    As a purely theoretical matter, the Department's assumptions about 
the role of yield spread premiums are plausible. Homeowners who are 
short on cash could, theoretically, use yield spread premiums to 
finance settlement costs. My study, however, offers compelling evidence 
that yield spread premiums are not being used in this way.\5\ Rather, 
the manner in which yield spread premiums are levied combined with the 
complex structure of real estate settlement procedures serves 
principally to allow mortgage brokers to impose higher prices on 
borrowers who bear the cost of these charges--particularly on 
individuals who are less educated and less sophisticated about 
financial matters. This abusive form of price discrimination 
substantially increases the overall costs to borrowers, thereby 
imposing a hidden tax on homeownership for many Americans.
---------------------------------------------------------------------------
    \5\ As indicated above, the sample upon which my empirical study is 
based was limited to loans originated by an affiliated group of lending 
institutions and thus does not include loans from all lending 
institutions in the industry. It is possible that the abusive practices 
uncovered in my study are peculiar to the lending institutions included 
in my sample. However, I doubt that this is the case. Industry experts 
have opined that the practices of the lenders in my study ``are typical 
of other wholesale lenders.'' See Report of David Olson, Glover v. 
Standard Federal Bank, Civil No. 97-2068 (DWR/SRN) (U.S. District 
Court, District Court of Minnesota) (filed June 24, 2001) (expert for 
defendants). At a minimum, the evidence uncovered in my study should 
put the burden on the Department to demonstrate with comparable 
evidence that the factual assumptions underlying the policy statement 
are accurate for the industry generally.
---------------------------------------------------------------------------
Yield Spread Premiums Are Not Currently Presented to Consumers as an
Optional Way to Finance Settlement Costs
    An initial problem with the Department's understanding of yield 
spread premiums is its notion that these payments represent an option 
consumers voluntarily choose. Consumers are given no such choice. 
Mortgage brokers, in my experience, never describe yield spread 
premiums as an optional method for financing settlement costs, nor do 
the Department's own consumer publications or the most popular consumer 
guides for buying a home. What is more, consumers are never given the 
advice they would need to make a meaningful comparison between the cost 
of higher interest rates over the life of a loan and direct cash 
payments for closing costs.\6\ Rather, borrowers are simply told that 
their loans will have a certain interest rate, and they never 
understand that the interest rate is higher than it needs to be or that 
the higher interest rate is used to finance a payment to the mortgage 
broker.
---------------------------------------------------------------------------
    \6\ What HUD regulations do require is ``disclosure'' of yield 
spread premiums. However, this disclosure is inadequate in many 
respects. Yield spread premiums are not reported in a consistent manner 
in HUD-1 forms; oftentimes they appear on back pages of the form and 
sometimes in a smaller font. Most important, these payments are almost 
always denominated ``p.o.c. by lender,'' meaning that they are ``paid 
outside of closing by the lender.'' It is inconceivable that more than 
a tiny fraction of consumers can correctly evaluate this information. 
For a more complete discussion of the problems consumers face in 
deciphering this information, see Jackson & Berry, supra note 1, at 2-
5, 51-65.
    One measure of inadequacy of current disclosure practices is the 
difficulty my assistants had even finding the amount of yield spread 
premiums on HUD-1 forms. Even after receiving explicit training on the 
subject, a team of paralegals and certified public accountants was only 
able to find yield spread premiums on about two-thirds of the forms on 
which the payments were supposedly disclosed. See Jackson & Berry, 
supra note 1, at 71-74 & n.112.
---------------------------------------------------------------------------
Incidence and Magnitude of Yield Spread Premiums Are Extremely High
    Another erroneous factual assumption implicit in the policy 
statement is the notion that yield spread premiums are paid by a 
relatively small number of borrowers who lack adequate resources to pay 
closing costs directly. To the contrary, my study indicates that the 
vast majority of borrowers pay yield spread premiums--on the order of 
85 to 90 percent of all transactions.\7\ Moreover, the average amount 
of yield spread premiums is quite substantial, on the order of $1,850 
per transaction, making these payments the most important single source 
of revenue for mortgage brokers.\8\ In other words, contrary to the 
Department's assumptions, yield spread premiums are not an ``optional'' 
form of financing made available to a limited number of borrowers with 
special needs. Rather these payments constitute by far the largest 
source of compensation for mortgage brokers and are imposed on almost 
all borrowers who obtain mortgages or refinancings through this segment 
of the industry.
---------------------------------------------------------------------------
    \7\ See Jackson & Berry, supra note 1, at 73 (Table 2).
    \8\ Id. at 78-81.
---------------------------------------------------------------------------
Most Borrowers with Yield Spread Do Not Need Extra Financing
    Another fallacy in the Department's factual assumption is its 
suggestion that borrowers who pay yield spread premiums have no other 
means of paying closing costs. This assumption is clearly wrong. 
According to my analysis, more than three-quarters of the borrowers who 
were charged yield spread premiums had loans that were less than the 
defendant lending institutions' maximum loan-to-value ratios and 
therefore could easily have financed closing costs by increasing the 
amount of their loans.\9\ In other words, most borrowers who are 
charged yield spread premiums do not need an extra (and exorbitantly 
costly) form of financing for their closing costs.
---------------------------------------------------------------------------
    \9\ Id. at 147 & n. 180. My study did not consider other sources of 
funding, such as cash reserves or credit cards or loans from family 
members. Were these and other alternative sources considered, even more 
borrowers would have had viable financing options other than paying 
yield spread premiums. As explained below, the true costs of yield 
spread premiums are so high that a borrower would be well advised to 
employ almost any other form of financing.
---------------------------------------------------------------------------
Mortgage Brokers Earn on Average $1,046 More on Loans With
Yield Spread Premiums
    Another erroneous premise of the policy statement is that industry 
offers yield spread premiums as a service to their customers and is 
indifferent to whether consumers pay closing costs directly or through 
the imposition of yield spread 
premiums. Mortgage brokers clearly much prefer making loans with yield 
spread premiums. According to my study, mortgage brokers made an 
average of $1,046 more on loans with yield spread premiums than they 
did on comparable loans unaffected by these practices.\10\ Thus, on 
average, borrowers who get loans with yield spread premiums pay their 
mortgage brokers over a thousand dollars more than other borrowers. 
This substantial difference, in my view, goes a long way to explain why 
the industry has so zealously resisted efforts to police the payment of 
yield spread premiums, and it clearly refutes the Department's premise 
that yield spread premiums are just another form of payment.\11\
---------------------------------------------------------------------------
    \10\ Id. at 91-97 (Figure 14).
    \11\ Why mortgage brokers can earn more money on loans with yield 
spread premiums is an interesting and important academic question. I 
explore this issue in considerable detail in my academic writings on 
the subject. In brief, I believe a number of factors are at work. In 
this context, consumers are primarily concerned with buying homes and 
being approved for financings; thus, they spend less time monitoring 
the comparatively smaller costs associated with real estate settlement. 
In addition, they trust their mortgage brokers to recommend appropriate 
financing terms and cannot easily police these recommendations. In 
addition, consumers have difficulty calculating costs of higher monthly 
payments as compared with direct cash 
payments and are not protected by market forces because these side 
payments allow brokers to discriminate among sophisticated an 
unsophisticated consumers and avoid creation of a single market price 
for settlement services. See Id. at 51-65.
---------------------------------------------------------------------------
On Average, Seventy-Five Percent of Yield Spread Premiums Goes to
Mortgage Brokers
    The most critical error in the policy statement is its assumption 
that mortgage brokers use yield spread premiums to ``recoup the upfront 
costs incurred on the borrower's behalf.'' \12\ In my study, I employed 
a variety of statistical techniques to explore the relationship between 
yield spread premiums and direct cash payments to mortgage brokers. 
With the highest degree of statistical confidence, my studies refute 
the proposition that borrowers receive a dollar for dollar offset for 
yield spread premiums.\13\ My best estimate is that borrowers, on 
average, enjoy 25 cents of benefit for each dollar paid in yield spread 
premiums.\14\ In other words, the vast majority of yield spread 
premiums--on the order of seventy-five percent--serve only to increase 
the compensation of mortgage brokers. Contrary to the Department's 
assumptions, consumers do not, by a long stretch, recoup the costs of 
yield spread premiums.
---------------------------------------------------------------------------
    \12\ 66 Fed. Reg. at 53,054.
    \13\ Jackson & Berry, supra note 1, at 102-16.
    \14\ Id.
---------------------------------------------------------------------------
Characterized as a Form of Financing, Yield Spread Premiums Are 
        Usurious
    As explained above, I do not believe that yield spread premiums are 
actually being offered to borrowers as a form of financing upfront 
costs.\15\ However, if one were to accept this characterization and 
then attempt to estimate the cost of this financing, the implicit 
interest rates are absolutely outrageous. For an average borrower in my 
study, the implicit interest rate on a ``yield spread premium loan'' to 
finance closing costs would be in excess of 114 percent per year--on 
the order of ten times higher than a typical credit card interest 
rate.\16\ Had the Department been aware of the true costs of this 
financing when it prepared its policy statement, I expect it would have 
approached the problem in a very different manner.
---------------------------------------------------------------------------
    \15\ See supra text accompanying note 6.
    \16\ Jackson & Berry, supra note 1, at 144-47.
---------------------------------------------------------------------------
African-Americans and Hispanics Pay Much More for Mortgage Broker 
        Services
    While my study suggests that yield spread premiums are a very bad 
deal for the average consumers, I believe these practices are 
particularly injurious to the least sophisticated members of society--
groups of which the Department has historically been most protective. 
To test this hypothesis, I also examined the relationship between 
mortgage broker compensation and the racial identity of borrowers. The 
results indicated that mortgage brokers charged two racial groups--
African-Americans and Hispanics--substantially more for settlement 
services than they did other borrowers. For African-Americans, the 
average additional charge was $474 per loan, and for Hispanics, the 
average additional charge was $580 per loan.\17\ While I expect to do 
more work on this aspect of my analysis, these preliminary results are 
consistent with my hypothesis that current industry practices allow 
mortgage 
brokers to exploit less sophisticated borrowers by imposing higher 
charges.
---------------------------------------------------------------------------
    \17\ Id. at 120-26. This analysis controls for a variety of 
factors, including principal loan characteristics, credit quality of 
borrower, loan-to-value ratios, and certain geographic variables.
---------------------------------------------------------------------------
Legal Analysis Proposed in the Policy Statement
    The Department's misapprehension of the true economic impact of 
yield spread premiums has substantial implications for the policy 
statement's legal analysis. Had the Department understood how 
disadvantageous yield spread premiums are for most consumers, the 
Agency would, I believe, have proposed that the payments be treated 
very differently under the two-step test used to determine whether 
particular payments are prohibited under Section 8 of RESPA.\18\
---------------------------------------------------------------------------
    \18\ In an earlier statement of policy, the Department proposed 
this two-step test. Under the first step, courts are to consider 
whether a particular payment is made for ``goods and services actually 
furnished or services actually performed.'' If the answer to this 
question is no, then liability is attached; if the answer is no, then 
the court must proceed to the second step of the test, under which it 
must determine whether the amount of the payment was reasonably related 
to the goods and services provided. See HUD Statement of Policy 1999-1, 
64 Fed. Reg. 10,080 (March 1, 1999).
---------------------------------------------------------------------------
Payment of Yield Spread Premiums Could Run Afoul of the First Step of 
        HUD's Test
    In its policy statement, the Department summarily concludes that 
yield spread premiums are paid for ``goods or services'' and thus 
reasons that the payments passed the first step of the Department's 
test. If one accepts the Department's factual assumptions--that yield 
spread premiums are a bona fide option for financing closing costs and 
that the payments are in fact recouped through offsetting reductions in 
closing costs--this conclusion would be understandable. However, if 
instead one credits the findings of my study--that the yield spread 
premiums serve primarily to increase payments to mortgage brokers and 
not to lower the upfront costs of borrowers--the legality of the 
payments under step one of the HUD test is far from clear. As explained 
above, my study suggests that only a fraction of each dollar of yield 
spread premiums goes to financing goods and services. Under these 
circumstances, I believe that it is more accurate to characterize the 
payment of yield spread premiums as not being a bona fide payment for 
goods and services. Under this view, the practice runs afoul the first 
step of the Department's test for legality.

Allowing Payments of This Sort To Escape Liability Under Step One Does 
        Not
Square With the Congressional Policies Underlying Section 8 of RESPA
    The alternative approach--that is, allowing settlement service 
providers to escape liability under step one as long as the providers 
could show they contributed some value to the transaction--flies in the 
face of the legislative history that preceded the passage of RESPA. In 
the early 1970's, real estate settlements were plagued by kickbacks and 
referral fees. Typically, a firm with substantial influence over the 
settlement--for example an attorney or a real estate agent--would 
demand sidepayments from other service providers, such as title 
insurance companies, as a quid pro quo for recommending the service 
provider to preform the transaction. It was these referral fees that 
Congress should outlaw with Section 8 of the RESPA, principally because 
Congress believed these transactions increased the overall cost of 
homeownership.\19\ Were the Department to adopt the position that 
recipients of kickbacks have a defense from Section 8 liability if they 
can demonstrate that they provided some other goods or service for the 
transaction, it would seem to have created a major loophole for just 
the kinds of sharp practices that the provision was 
designed to eliminate. After all, almost all of the recipients of 
kickbacks that motivated the passage of the Act also performed some 
level of service for the settlement transactions in questions. 
Certainly, where statistical evidence demonstrates that the payments in 
question (here yield spread premiums) serve substantially--indeed 
primarily--to increase the cost of homeownership, the activity should 
be proscribed under Section 8.
---------------------------------------------------------------------------
    \19\ Id. at 9-23.
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Inappropriateness of Individualized Adjudication of Reasonableness
    A further difficulty with the Department's legal analysis is its 
apparent willingness to have the courts determine the reasonableness of 
yield spread premiums on a case-by-case basis. As this aspect of the 
policy statement concerns a matter of judicial management, it is a 
matter that the courts themselves will have to resolve. But, on 
multiple dimensions, individualized determinations of reasonableness of 
the sort the Department appears to favor would be problematic. To begin 
with, in order to measure the impact of yield spread premiums for a 
particular borrower, a court must consider the impact of the payments 
in a large number of cases, as I did in my study. As is well-developed 
in other areas of the law--ranging from disparate impact cases to 
securities litigation--it is impossible to assess the reasonableness of 
one borrower's payments in a vacuum. For both litigants and courts, it 
would be an inefficient use of resources to repeat this analysis on a 
transaction by transaction basis. In addition, the Department's 
approach invites the judicial rate regulation that Congress expressly 
rejected when it enacted RESPA more than 25 years ago. In the early 
1970's, many recommended ratemaking procedures for real estate 
settlement services, but Congress chose instead to police the industry 
through a combination of disclosure rules and the liability provisions 
of Section 8. The policy statement threatens to resurrect judicial rate 
regulation as the principal mechanism for controlling kickbacks in the 
real estate settlement field. Arguably, under the Department's 
approach, a Section 8 plaintiff would be forced to sustain the costs of 
a hearing on reasonableness whenever a defendant demonstrates that it 
provided any goods or services in connection with a settlement. In my 
view, this approach subverts the intentions of Congress and leaves 
consumers inadequately protected from predatory practices, such as the 
payment of yield spread premiums. Moreover, the approach seems to 
relieve from liability many of the abusive practices that Congress 
intended to outlaw with the enactment of Section 8.

Proposals for Prospective Relief
    One of the most heartening aspects of the policy statement is the 
Department's willingness to propose changes in the disclosure rules 
regarding yield spread premiums and related practices. In my view, 
reforms in this vein could go a long way toward protecting consumers 
and improving the efficiency of the market in this area. In particular, 
I would recommend the following specific changes.

Requiring Disclosure of Par Rate Loan Option
    One of the principal sources of confusion underlying yield spread 
premiums is that most consumers are not aware that when they are 
offered an above-par loan (on which a yield spread premium is paid), 
they almost always have the option of receiving a par rate loan with a 
lower interest rate and lower monthly payments. Whenever a mortgage 
broker proposes an above-par loan, the Department should therefore 
require the broker to offer the borrower a comparable loan with a par 
interest rate. By offering consumers both types of loans, mortgage 
brokers would make clear that above-par loans (and yield spread 
premiums) are simply one option for home financing.\20\ Requiring such 
offerings would also encourage both the Department and independent 
consumer groups to educate consumers about the pros and cons of the two 
options.
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    \20\ Brokers might also be required to disclose the rate sheet 
associated with the pricing of their loans. This would provide more 
information than most consumers would need but could be useful to 
consumer groups and the financial press.
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Direct Payment of Yield Spread Premiums to Consumers (on Line 200)
    Whenever a mortgage broker presents a Good Faith Estimate or a HUD-
1 form for an above-par loan, the full amount of the yield spread 
premium should be paid directly to the borrower in the form of a credit 
on line 200. If yield spread premiums are to become a legitimate form 
of financing, the proceeds of the financing must always be given to the 
borrower. Then, the borrower can decide how to use those funds--whether 
to pay for closing costs or some other purpose. A further advantage of 
this reform is that it will force mortgage brokers to provide borrowers 
with a full accounting of their costs elsewhere on the form. Under the 
current rules, brokers use yield spread premiums to disguise their true 
levels of compensation. Not only is the current practice inherently 
deceptive; it also makes it all but impossible for consumers to compare 
the true costs of loans from different brokers and lenders.

Prohibition on Discount Points Paid to Brokers
    A further practice that should be eliminated is the payment of 
discount points to mortgage brokers. Traditionally, consumers pay 
discounts points to lenders in order to obtain a below-par loan--that 
is, a loan with an interest rate below the rate on a comparable par 
loan. Under current HUD regulations, however, mortgage brokers are also 
permitted to charge discount points ``to lower'' the interest rate of a 
loan. In my study, I discovered that mortgage brokers were routinely 
charging discount points, even on par and above-par loans.\21\ This 
practice is inherently deceptive. The only way a mortgage broker can 
``lower'' the interest rate on such loans is to start by offering the 
borrower an above-par rate. In this context, the payment of discount 
fees to mortgage brokers simply serves to convert a yield spread 
premium into a direct upfront cost for the borrower.\22\ In my view, 
the term ``discount fees'' should be limited to payments made to the 
lending institution that are actually used to lower a par rate loan 
into a below-par loan.
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    \21\ The incidence of discount fees to mortgage brokers ranged from 
10 percent to 47 percent, depending on the sample, and averaged between 
$744 and $1,335. See Id. at 77 (Table 4).
    \22\ Not only does this practice needlessly complicate the true 
compensation of mortgage brokers; but it also belies claims that above-
par loans are being used to lower upfront costs for consumers. How 
could a consumer rationally request an above par loan for this reason 
and then pay an upfront discount fee to turn the loan back into a par 
loan?
---------------------------------------------------------------------------
Comparable Reforms for Direct Lenders
    A final area of regulatory reform concerns the development of 
comparable disclosure requirements for direct lenders. Representatives 
of mortgage brokers occasionally defend current disclosure practices on 
the grounds that reforms of the sort outlined above would put mortgage 
brokers at a disadvantage to direct lenders. The Department, I believe, 
should reject claims of this sort. To begin with, mortgage brokers have 
become the leading source of home mortgages in the United States. It is 
imperative that the Department correct disclosure practices for this 
dominant segment of the industry. To allow issues associated with other 
sectors of the industry to stand in the way of such reforms would be 
letting the tail wag the dog. Still, I agree with those who say that 
disclosure reforms for direct lenders are also appropriate. After all, 
when direct lenders charge above-par rates and then resell their loans 
in the secondary market, they receive implicit yield spread premiums. 
The solution to this problem, I believe, is to require direct lenders 
to credit borrowers with an implicit yield spread premiums similar to 
the ones to be required for mortgage brokers. For direct lenders who 
actively participate in the wholesale purchase of loans, the 
appropriate par rates could be derived from the institution's 
contemporaneous rate sheets. For other direct lenders, the Department 
might maintain and keep current a national listing of averages of par 
rates for various categories of loans, derived from the contemporaneous 
rates sheets of leading wholesalers. The Department would have to work 
out the details of such a proposal, but the concept is well within the 
Agency's expertise.
    Let me conclude by again commending the Department for taking on 
this issue. I would be delighted to work with the Department as it 
moves forward in this area, and would welcome any questions that 
Members of the Committee have.


                               ----------
                   PREPARED STATEMENT OF JOHN COURSON

            Chairman-elect, Mortgage Bankers Association and
President and Chief Executive Officer, Central Pacific Mortgage Company
                           Folsom, California

                            January 8, 2002

    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 Chairman-elect 
of the Mortgage Bankers Association of America (MBA),\1\ and it is in 
that capacity that I appear before you today.
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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 2,800 
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.
---------------------------------------------------------------------------
    This morning I have been asked to testify before your Committee to 
present MBA's views regarding the issue of lender payments to mortgage 
brokers, generally referred to as ``yield spread premiums,'' and how 
they are to be judged under the antikickback provisions of the Real 
Estate Settlement Procedures Act (RESPA). To ensure a clear 
understanding of our position on this issue, it is important to lay the 
groundwork by defining the term ``yield spread premium,'' and 
highlighting the 
important role that this financing tool plays in mortgage transactions.
Definitions
    As a general rule, the term ``yield spread premium'' is used in the 
mortgage lending industry to refer to a type of payment from a lender 
to a mortgage broker, which is paid in the context of ``brokered'' loan 
transactions. In such transactions, mortgage brokers generally operate 
as intermediaries between consumers and lenders. In effect, they 
function as the interface with prospective borrowers, serving as the 
``storefront'' for mortgage loan products offered by lenders. In this 
role, mortgage brokers are much more than ``retailers'' of loans; they 
perform real and valuable services in the origination phase of the 
mortgage transaction process. Among other things, mortgage brokers 
bring borrowers and lenders together and match consumer needs with 
lender products, they collect pertinent financial information, render 
advice to consumers, and generate all documentation and verification 
required for the loan transaction to occur.
    It is important to clarify that, for the various goods, services, 
and facilities they provide in the origination of loans, mortgage 
brokers are entitled to be compensated. Generally, such compensation 
will occur in either of two ways. Brokers may collect their full 
compensation from the consumer directly, in the form of a cash payment. 
Alternatively, they can be paid, in part or in whole, indirectly by the 
lender, through the mechanism of a yield spread premium.
    The yield spread premium mechanism works by allowing a consumer to 
choose a higher interest rate in exchange for lower upfront costs. 
Under this financing tool, the higher interest rate allows lenders to 
tender an amount reflecting the value of that increased yield to 
mortgage brokers as compensation for the goods, services, or facilities 
that they render. In technical parlance, a ``yield spread premium'' is 
thus defined as a payment that a lender makes to a mortgage broker that 
reflects the increased yield over ``par'' on a particular loan. In 
practical terms, a yield spread premium is a mechanism that provides 
borrowers with a vital tool to allow for the financing of some or all 
of their home loan closing costs.
    The yield spread premium mechanism allows mortgage brokers the 
flexibility to offer consumers numerous options and choices as to the 
combination of upfront payments and interest rates that best suits the 
borrower's individual needs. In short, as the interest rate goes up, 
the borrower's upfront cash contribution goes down. The added financial 
flexibility afforded by the yield spread premium is extremely important 
because a vast number of borrowers--especially those who have limited 
funds for downpayments, or who have reached borrowing limits--need the 
flexibility to finance the required closing costs to achieve 
homeownership. Those consumers who lack sufficient independent funds 
literally depend on the YSP option to purchase and/or refinance a home.
    I want to clarify, unequivocally, that the yield spread premium 
mechanism should be restricted to the function I just described, which 
is to compensate the broker for goods, services, or facilities provided 
or to allow for the financing of other closing-related costs. If, on 
the other hand, the yield spread payment does not fit this definition, 
and the payment is used for purposes other than to compensate brokers 
for the bona fide goods, services, or facilities they provide, or to 
finance other required closing costs, then the payment may be 
considered suspect, and should be dealt with appropriately. I want to 
make clear that we do not consider it appropriate to use the yield 
spread premium mechanism as a means to inflate interest rates in a way 
that defrauds the consumer into higher loan prices. Nor do we consider 
it appropriate to use the yield spread premium as a means of concealing 
referral payments to brokers. To the extent that such abuses do occur, 
they should be labeled for what they are--violations of the law.
HUD's Policy Statements
    We are in agreement with HUD's formulation of the test for 
determining the 
legality of lender payments to mortgage brokers under RESPA. As you 
know, the rules for determining the legality of payments to mortgage 
brokers under RESPA's antireferral fee prohibitions are set forth in a 
1999 HUD policy statement,\2\ and recently clarified through an 
additional statement published on October 18, 2001.\3\ In those policy 
statements, HUD has explicitly acknowledged that yield spread premiums 
are very useful tools to assist consumers in financing homeownership. 
The policy statement clarifies that yield spread premiums, so long as 
they compensate the broker for goods, services, or facilities provided 
in the origination of a mortgage loan, are not in themselves illegal 
under RESPA. Under HUD's jurisdiction over RESPA's referral fee 
prohibitions, the policy statement and the subsequent clarification 
state unequivocally that yield spread premium payments are to be 
considered illegal if they constitute referral payments or if they 
incorporate referral fees in the payment. We agree.
---------------------------------------------------------------------------
    \2\ Real Estate Settlement Procedures Act Statement of Policy 1999-
1 Regarding Lender Payments to Mortgage Brokers; Final Rule, 64 Fed. 
Reg. 10080-10087 (March 1, 1999).
    \3\ Real Estate Settlement Procedures Act Statement of Policy 2001-
1: Clarification of Statement of Policy 1999-1 Regarding Lender 
Payments to Mortgage Brokers, and Guidance Concerning Unearned Fees 
Under Section 8(b), 66 Fed. Reg. 53052-53059 (October 18, 2001).
---------------------------------------------------------------------------
    HUD's formulation under Section 8 of RESPA correctly recognizes 
that the legal test for analyzing yield spread premiums (or other 
lender payments to mortgage brokers) must distinguish between those 
payments that are legitimate compensation to brokers, and those that 
are merely referral fees. In setting forth its formulation, HUD tracks 
the RESPA statute quite closely. As mentioned above, RESPA sets a 
strict prohibition against kickbacks and referral fees. The statute 
also states that payments for real goods or services are not 
prohibited. It is a simple and straightforward test. If you pay a 
referral fee, you are breaking the law. If, however, the fee is 
tendered as compensation for real goods, services, or facilities, then 
the payment cannot, by definition, constitute a referral fee or a 
kickback, and is therefore not prohibited under RESPA strictures.
    This is precisely what HUD sets forth in the policy statement 
formulation. When a lender pays a fee to a mortgage broker, first, one 
has to lay the foundation and ensure that services, goods, or 
facilities were actually furnished by the mortgage broker. If services, 
goods, or facilities were actually furnished, then one has to make sure 
that the payment to the broker does not incorporate a referral fee 
portion that could be deemed illegal under RESPA. According to HUD, 
this is done by scrutinizing the total of broker payments to ensure 
that they are ``reasonably related'' to the value of the services, 
goods, or facilities furnished. Any amount over the ``reasonable'' 
level could be deemed to constitute a ``referral fee.'' The 
``reasonableness'' test is the test that HUD has consistently used to 
judge Section 8 liability in all circumstances since RESPA was enacted.
    Note that this ``two-prong test'' strikes the best possible balance 
between RESPA's affirmation for fees paid as compensation for goods or 
services actually provided, and the statute's proscription of referral 
fees. Note also the internal logic of the HUD two-prong test--the first 
prong focuses on what the broker provides in the transaction, and the 
second prong analyzes the fees that were paid for those services. Each 
step is grounded on statutory language and each step is necessary to 
the legal analysis under Section 8 of RESPA.
HUD Clarifications
    In large part, the controversy prompting today's hearing appears to 
be the recent clarification to the 1999 policy statement issued by the 
Department on October 18, 2001. In that clarificatory statement, the 
Department declared that it should eliminate certain ambiguities with 
respect to yield spread premiums.
    The specific ``ambiguity'' that HUD should remedy stemmed from an 
appellate decision entitled Culpepper v. Irwin Mortgage Corp., 253 F.3d 
1324 (11th Cir. 2001) (Culpepper III). In that decision, the Eleventh 
Circuit Court of Appeals reached a decision that was in direct conflict 
with the ``two-prong'' formulation established by HUD under the 1999 
policy statement. In that decision, the 11th Circuit described HUD's 
1999 policy statement as ``ambiguous'' and created a new test that 
resulted in per se liability for the payment of yield spread 
premiums.\4\
---------------------------------------------------------------------------
    \4\ According to HUD, the Culpepper III decision results in per se 
liability through its conclusion that a jury could find that yield 
spread premiums are illegal kickbacks or referral fees where the 
lender's payments are based exclusively on the interest rate 
differentials reflected on the rate sheets and the lender has no 
knowledge of what services, if any, the broker performs.
---------------------------------------------------------------------------
    In issuing the clarification, HUD was abiding by previous 
Congressional directives to articulate clear legal standards. In 
1998,\5\ Congress expressed concern about the ``legal uncertainty'' 
surrounding the test for liability in these cases, particularly in 
light of the fact that ``Congress never intended payments by lenders to 
mortgage brokers for goods or facilities actually furnished or for 
services actually performed to be violations of [Section 8 of RESPA].'' 
\6\ Congress then specifically ``direct[ed]'' HUD to issue a ``policy 
statement'' in order ``to clarify its position'' and provide ``guidance 
to . . . the courts.'' \7\
---------------------------------------------------------------------------
    \5\ See Reform of the Real Estate Settlement Procedures Act (RESPA) 
and the Truth in Lending Act (TILA): Hearing Before the House Committee 
on Banking and Financial Services, 105th Congress at 22-28, 50, 275 
(July 22 and September 16, 1998).
    \6\ Conf. Rep. No. 105-769, reprinted in 1998 U.S.C.C.A.N. at 539, 
568.
    \7\ Id.
---------------------------------------------------------------------------
    The 1999 policy statement thus represented HUD's Congressionally 
mandated effort to promote uniformity on the legality of yield spread 
premiums under Federal law. After the issuance of the 1999 policy 
statement, lenders and mortgage brokers, especially those who had faced 
years of costly litigation in these cases, justifiably relied on HUD's 
legal formulations as having finally eliminated litigable issues 
relating to the governing standard for liability. Indeed, district 
courts overwhelmingly agreed, and interpreted the 1999 policy statement 
to articulate the ``two-prong test'' that I described above.
    The Eleventh Circuit's Culpepper III decision, however, shattered 
this legal clarity and returned the lending industry to the confusing 
legal environment that existed before 1999. By finding the 1999 policy 
statement ``ambiguous,'' and articulating a legal test resulting in per 
se liability that was entirely separate from the one advanced by HUD, 
Culpepper III plunged lenders, brokers, consumers, and courts into the 
same chaotic state that led Congress to direct HUD to act in the first 
place. A new wave of over 40 yield spread premium RESPA nationwide 
class actions were filed in the immediate aftermath of Culpepper III. 
Over 80 class actions were still pending in district courts around the 
country, with a particularly heavy concentration in the Eleventh 
Circuit. The risk of inconsistent determinations based on the solitary 
Federal statute at issue in these cases was very real. In the meantime, 
several district courts outside the Eleventh Circuit were refusing to 
follow Culpepper III's RESPA liability analysis, and instead continued 
to accord deference to HUD's policy statements.\8\
---------------------------------------------------------------------------
    \8\ See Bjustrom v. Trust One Mortgage Corp., No. C-001166P, 2001 
U.S. Dist. LEXIS 17890 (W.D. Wash. October 26, 2001); Vargas v. 
Universal Mortgage Corp., No. 01 C 0087, 2001 U.S. Dist. LEXIS 19635 
(N.D. Ill. November 29, 2001).
---------------------------------------------------------------------------
    I note that inconsistencies in the governing legal standard are 
extremely problematic for lenders. Most wholesale lenders make loans in 
a variety of geographic regions, and a large number of lenders have 
truly nationwide operations. There were many lenders who had already 
successfully defended prior RESPA challenges to their payment of yield 
spread premium, typically at costs ranging in the hundreds of thousands 
of dollars. Many of these same mortgage bankers began facing renewed 
litigation in the Eleventh Circuit where they were exposed to very 
different standards under the unique rules established by Culpepper 
III. This renewed legal con-
fusion forced many national lenders to give serious consideration to 
halting or geographically limiting the practice of offering yield 
spread premiums, despite its admitted consumer benefits.
    It is in the midst of this environment of legal turmoil that the 
Department decided to clarify RESPA through the 2001-1 policy 
statement. To reestablish clarity, HUD declared that it expressly 
``disagree[d] with the judicial interpretation regarding Section 8 of 
RESPA and the 1999 Statement of Policy'' found in Culpepper III. 66 
Fed. Reg. 53054-55. In the clarification, HUD sets forth its definitive 
reading of the law that neither Section 8(a) of RESPA nor the 1999 
Statement of Policy supports the conclusion that a yield spread premium 
can be presumed to be a referral fee based upon the use of a rate 
sheet, or because the lender does not have specific knowledge of what 
services the broker has performed.
    We believe that HUD acted properly and very responsibly as the 
regulatory 
agency that holds jurisdiction and bears the ultimate duty for the 
proper administration of RESPA. Absent HUD's clarification, the 
confused legal landscape would have been intolerable in terms of risk 
and legal exposure. Not only was the Eleventh Circuit's decision 
irreconcilable with HUD's reading of the law, but it threatened 
catastrophic industry liability, and also threatened to eliminate from 
the marketplace yield spread premiums and the critically important role 
they play in promoting homeownership.
Class Action
    An additional criticism has been that the legal articulation in the 
2001 policy statement cuts off the possibility of consumer redress 
under RESPA. The clarifications set forth in the 2001-1 Statement of 
Policy do not eliminate a single consumer's legal rights. In the 2001 
policy statement, HUD asserts that, in order to determine whether yield 
spread premiums violate Section 8 restrictions, it is necessary to look 
at each transaction individually. Far from immunizing the industry, 
however, this ruling stems from HUD's longstanding recognition that the 
origination of mortgage loans, the specific services provided by 
mortgage brokers, and the difficulty of providing those services, all 
differ with each loan, each applicant, and each marketplace or 
geographical location.
    In short, HUD's assertion that RESPA demands individualized loan-
by-loan analysis of the level of services performed in relation to the 
fees paid does not reflect an attempt to relieve industry from 
liability. It reflects the reality, as recognized by every 
Administration since RESPA was enacted, that each transaction is 
different and contains unique features that requires varying levels of 
time, effort, and expertise.\9\ Just as the consumer disclosures 
mandated by RESPA demand individualized disclosures reflecting the 
specific costs that relate to the specific loan transaction at hand, 
the analysis of legality under Section 8 of RESPA also demands a 
tailored examination of the goods and facilities provided or services 
performed by the broker in the transaction.
---------------------------------------------------------------------------
    \9\ For instance, HUD's official position on the test for liability 
of yield spread premiums before the issuance of the 1999-1 Statement of 
Policy confirms that this principle is longstanding policy at HUD. 
Specifically, HUD's General Counsel from the Clinton Administration, 
Gail Laster, gave testimony at a Joint Hearing on RESPA Reform, 
convened on July 22, and September 16, 1998, before the House 
Subcommittee on Financial Institutions and Consumer Credit and the 
Subcommittee on Housing and Community Opportunity. In relevant part, 
Ms. Laster testified as follows:
      Ms. Velazquez. Thank you very much, Madam Chairwoman. . . . Could 
you answer one simple question for me? Are yield spread premiums legal 
or illegal?
      Ms. Laster. It depends on whether or not the fee is reasonably 
related to the goods or services provided. That is not a legalism, but 
I think in terms of understanding the RESPA statute, it is not a 
ratemaking statute. We cannot promulgate a rate that says this is 
legal. By statute, Congress has prescribed that we examine on a case-
by-case basis whether or not a fee is reasonably related to the 
services provided. (emphasis added).
---------------------------------------------------------------------------
Additional Consumer Protections
    As I mentioned above, we all recognize that there are instances 
where yield spread premiums are used in ways that could be harmful to 
consumers. We hear reports of consumers who pay egregious interest 
rates due in whole or in part to wildly inflated yield spread premium 
fees, or mortgage brokers that conceal yield spread payments in a way 
that leads to the consumer's detriment.
    In this regard, we commend the Chairman in his leadership in 
holding these hearings, as such problems do require our full attention. 
We also commend the Department for its initiative to ensure that 
consumers receive full and meaningful disclosures in the mortgage 
process. In the 2001 policy statement, HUD has articulated the need to 
strengthen the information provided to consumers by brokers by adding 
such disclosures as the types of services that the broker will perform, 
the amount of the brokers total compensation for performing those 
services (including yield spread premiums), and whether or not the 
broker has an agency or fiduciary relationship with the borrower. 
Additionally, the 2001 policy statement clarifies that borrowers should 
be made aware of the trade-off between upfront costs and rates, and 
that such information should be provided to the applicant early in the 
loan transaction.
    The Secretary has announced that he will push forth with rulemaking 
in this area. MBA agrees with the Secretary's initiatives and will 
strive to work with HUD to achieve the best possible regulatory outcome 
to rid the market of abusive lending practices. We think it is 
important to point out, that current Federal rules and regulations 
already provide for a great deal of consumer disclosures. We note, for 
example, that yield spread premium payments are today included as part 
of the finance charge calculations, and thus, are fully disclosed to 
consumers through the APR 
disclosure under the Truth in Lending Act. We note also that these 
yield spread premium payments must be specifically broken out and 
separately itemized and disclosed on the Good Faith Estimate and HUD-1 
forms under RESPA. That statute also requires that lenders and/or 
mortgage brokers deliver to consumers a Special Information Booklet 
that sets forth an explanation of mortgage broker compensation, points, 
fees, and their interrelationship.
    As an industry, we welcome additional disclosure requirements if 
they truly serve to protect consumers from unscrupulous practices. We 
note, for instance, that MBA took a leadership role in creating model, 
voluntary and supplemental disclosures for its members to use. These 
disclosures provide further explanations of the choices borrowers have 
to compensate their mortgage brokers--through direct payments, yield 
spread premiums financed through higher interest rates, or some 
combination of the two. This additional disclosure was commended and 
encouraged by HUD,\10\ and is now an accepted and routine part of the 
disclosure process for our membership.
---------------------------------------------------------------------------
    \10\ 66 Fed. Reg. at 10087.
---------------------------------------------------------------------------
    MBA believes, however, that ultimately, we can do much better. We 
can, and should, construct systems of consumer protection that go 
beyond mere disclosures. In the end, consumers run the risk of being 
tricked and deceived as long as consumers are subjected to the arcane 
and outdated disclosure system that is now mandated by Federal law. As 
with predatory lending, we believe that it is absolutely essential to 
enact comprehensive reform of the current mortgage lending laws. So 
long as the mortgage process remains confusing and perplexing, 
consumers will run the risk of being gouged and defrauded, whether 
through trickery involving yield spread premiums, or through other 
schemes that unscrupulous actors will continue to develop to exploit 
the unwary and unsophisticated. We look forward to working with HUD and 
the Congress to enact the necessary legislative and regulatory changes 
necessary to achieve the goals of lasting protections for all 
consumers.

Conclusion
    To summarize, Mr. Chairman, we reiterate that as we develop more 
protections and disclosures in this area, we must keep in mind that 
yield spread premiums are extremely valuable consumer financing 
mechanisms, and that they are a crucial element in today's housing and 
mortgage markets. As lenders, Government, and consumer advocates, we 
all share in the responsibility of ensuring that this important 
financing tool is not abused by unscrupulous actors or damaged by 
frivolous class action claims. Going forward, we fully support HUD's 
calls for improved consumer disclosures and we look forward to working 
with the Department as we advance on this very important endeavor.
    Thank you for the opportunity to share our views with the 
Committee.
                               ----------
                  PREPARED STATEMENT OF JOSEPH L. FALK

           President, National Assocation of Mortgage Brokers

                            January 8, 2002

    Mr. Chairman and Members of the Committee, I am 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 the 
Committee today on behalf of the Nation's mortgage brokers on the 
subject of yield spread premiums.
    NAMB currently has more than 13,000 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.
    The Committee has asked for NAMB's views on the recent Statement of 
Policy 2001-1 issued by the Department of Housing and Urban Development 
concerning yield spread premiums, and our views concerning what HUD 
should do going forward to prevent the ``abusive use'' of yield spread 
premiums. Before discussing these two issues in detail, we would first 
like to review the important role mortgage brokers play in our mortgage 
market and our Nation's economy, and why yield spread premiums are so 
important to the effective functioning of the market. We will then 
discuss why NAMB believes the Statement of Policy issued by HUD was 
both necessary and correct, and offer NAMB's views regarding HUD's 
actions going forward.
The Importance of Mortgage Brokers in Today's Economy
    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 approximately 65 percent of all residential mortgages in 
America. In Florida alone, there are over 23,000 licensed mortgage 
brokers. The rise of the mortgage broker has also significantly 
increased competition in the mortgage industry, resulting in a decline 
in mortgage interest rates and closing costs 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 play an extremely important role in our economy. 
Following the collapse of the savings and loan industry in the 1980's, 
and then the rapid consolidation of mortgage banking firms in the 
1990's, we now find that in many communities, particularly in central 
cities and small towns, people may have a difficult time finding a 
retail bank branch or retail mortgage lending branch. If they do find a 
retail lender, their mortgage choices are limited to the products and 
services offered by that lender, which often are very few. But almost 
any consumer can find a mortgage broker right in their community that 
can provide access to many loan programs, assist in clearing up credit 
problems, help clear title defects, and provide other assistance to 
help the consumer obtain a loan that suits his or her financial needs 
and objectives.
    Mortgage brokers are generally small business owners. The average 
mortgage broker employs fewer than 10 people. Mortgage brokers know 
their neighbors, build their businesses primarily through referrals 
from satisfied customers, and succeed by becoming active members of 
their communities. The fact that small mortgage brokerages originate 
over half of all mortgages, indicates that mortgage brokers are 
effectively meeting consumers' desires for convenience, service, and 
competitive prices.
    Since the middle of 2000, the Nation's economy has been 
experiencing a slowdown, with increasing unemployment and business 
failures, declining consumer spending, and other negative economic 
indicators. The one bright spot in this cloudy picture has been the 
housing and mortgage finance sector. Mortgage originations increased in 
2000 from 1999, and again in 2001. Many mortgage lenders and mortgage 
brokers experienced record volumes of business in 2001. Mortgage 
lending has been a vital counterweight as the rest of the economy 
entered a recession.
    Even in today's weakened and uncertain economy, home sales and new 
home construction continue to increase. This creates and sustains 
hundreds of thousands of jobs in real estate, construction, and 
ancillary industries. Mortgage refinances have benefited many 
homeowners, allowing them to reduce their monthly payments, convert to 
shorter term loans to save thousands of dollars in total interest, or 
access their home equity to improve their financial situation. Today, 
total home equity held by American households once again exceeds the 
total value of other investments. When properly used, access to home 
equity has become a lifeline for many seniors whose retirement funds 
have been dramatically reduced by the decline in the stock market, and 
for families who face layoffs or uncertain employment prospects in the 
next several months.
    Mortgage brokers provide the flexibility and capacity for the 
market to absorb a huge volume of new originations, as has occurred in 
the last few months. This capacity allows consumers to immediately take 
advantage of interest rate declines and to access their home equity if 
needed. If mortgage brokers did not exist, lenders with brick-and-
mortar offices would not have been able to handle the surge of purchase 
and refinance business that has been so helpful to consumers and to our 
economy in the last year.
    It is thus vitally important to America's homeowners and to the 
economy as a whole that we avoid any new regulations, legislation, or 
legal decisions that could impede the efficient and effective 
functioning of the wholesale mortgage market.
Yield Spread Premiums and Their Importance
    One of the barriers to homeownership is insufficient cash for a 
downpayment or to pay closing costs. Mortgage brokers have originated 
hundreds of thousands of loans for people who were able to buy a home, 
refinance an existing mortgage at a lower interest rate, or obtain a 
home equity loan with little or no cash required for upfront closing 
costs or broker fees. These costs are financed through a slightly 
higher interest rate than the borrower would pay if he or she paid the 
closing costs in cash. Most retail lenders (for example commercial 
banks, thrifts, credit unions, and retail mortgage companies) also 
offer ``no- or low-cost'' loans at slightly higher rates.
    The ability of consumers to obtain loans with little or no upfront 
costs is critical in today's economy. In uncertain times such as these, 
people want to conserve and to build up their cash reserves and reduce 
monthly payments. Interest rates have 
fallen in the last year to the extent that homeowners can still often 
reduce the rate on their existing mortgage through a refinance and save 
thousands of dollars in interest payments, lower the payments, and 
conserve cash, by paying some or all closing costs through a higher 
interest rate. When a mortgage broker arranges such a loan, the broker 
receives most or all of its compensation indirectly from the lender--a 
yield spread premium.
    Such indirect compensation paid by lenders to mortgage brokers is 
legal under the applicable Federal law, the Real Estate Settlement 
Procedures Act or RESPA, so long as the total compensation to the 
broker is reasonably related to services actually performed, goods 
actually provided, or facilities actually furnished. In all loans 
originated by mortgage brokers, the broker is providing a facility to 
the wholesale lender, in effect serving as the lender's branch office. 
The broker also does most, if not all of the work in assembling the 
loan package, which is creating a good, and which can often require a 
great deal of time and expense. Brokers typically take the application, 
order the appraisal and credit report, verify the borrower's income and 
employment, and perform many other aspects of loan origination that 
benefit the lender and enable it to underwrite and approve the loan.
    Mortgage brokers also perform services directly for borrowers that 
are legally compensable. These may include advising the borrower about 
various loan programs and options to assist the borrower in selecting a 
loan program that meets his or her financial situation and objectives; 
helping the borrower improve his or her credit rating in order to 
qualify for a lower interest rate or better loan terms, and other 
assistance. Many brokers work late into the evenings and on weekends 
taking applications, gathering documents, and meeting borrowers at 
their homes and offices. Such personal and convenient service is one 
reason mortgage brokers are preferred by many consumers.
    Mortgage brokers clearly provide legally compensable services, 
goods, and facilities to both wholesale lenders and to borrowers. These 
services, goods, and facilities all ultimately benefit the borrower, by 
enabling the borrower to qualify for and receive the loan the borrower 
wants. Retail lenders perform similar origination functions and earn 
similar fees when they sell mortgages into the secondary market, as 
they do with the vast majority of loans they originate. However, retail 
lenders do not disclose to borrowers their income on loans that are 
subsequently sold in the secondary market. Mortgage brokers do.
    We want to emphasize this. There is nothing fundamentally different 
about the way retail lenders and mortgage brokers earn income. The only 
difference is that consumers know how much the originator is being paid 
only when the originator is a mortgage broker. This is because HUD 
requires the disclosure and itemization of all such ``indirect 
compensation'' by lenders to mortgage brokers, on both the Good Faith 
Estimate and the HUD-1 settlement statement. Loan sales by retail 
lenders are considered secondary market transactions, which are not 
subject to RESPA.
    Mortgage interest rates are highly competitive. Consumers today are 
more sophisticated than ever in researching and shopping rates. A 
mortgage broker determines the fee on a particular loan based on a 
number of factors, including the work required to arrange the loan, 
such as assisting the borrower in improving his or her credit rating. 
Fees may also be determined based on the loan program, market 
competition, and many other factors. The flexibility of indirect 
compensation allows mortgage brokers to stay competitive with, and 
often beat, retail lenders on price while still earning a reasonable 
profit.
    It is also important to note that in most cases involving payments 
of yield spread premiums, the mortgage broker receives nothing until 
the loan closes. Mortgage brokers often do a great deal of work to 
arrange loans that never get to closing, for a variety of reasons. They 
receive no compensation for this work.

HUD Statements of Policy 1999-1 and 2001-1
    Despite the clear advantages of mortgages involving yield spread 
premiums, the clear legality of such payments, and the clear choices 
being made every day by consumers to obtain their mortgages through 
mortgage brokers, the wholesale mortgage market is under assault in the 
courts. Trial lawyers across America have continued to file and pursue 
class action lawsuits claiming that all yield spread premiums are 
illegal under Section 8 of RESPA. Over 150 such class action lawsuits 
are active in courts across the country against virtually every major 
wholesale mortgage lender. Some of these suits were first filed in 
1996.
    Many courts have dismissed such suits, rightfully in our view. 
Others have been withdrawn after courts refused class certification. 
However, some courts have allowed these suits to continue, and trial 
lawyers continue to venue-shop and file new suits, in search of one 
court that will agree with their inaccurate portrayal of the wholesale 
mortgage market. This flood of litigation, and differing opinions of 
various courts, has caused a great deal of uncertainty and anxiety in 
the mortgage industry. The cost of defending these class actions is 
staggering, already running into millions of dollars each for the 
largest lenders involved. These costs are, of course, passed on to 
consumers. The potential liability for the industry is tens of billions 
of dollars. Lenders could be forced to cease all wholesale lending if a 
judgment goes against even one lender, or if a major settlement occurs.
    The only real winners here are the class action attorneys who stand 
to win millions of dollars in contingency fees. Their clients stand to 
receive only small refunds, or a few dollars off the cost of their next 
loan. The real impact will be the exit from wholesale lending of most, 
if not all, major mortgage lenders. The potential liability for them 
will simply be too great to justify staying in the business. The real 
losers will then be tomorrow's first-time homebuyers, tomorrow's 
working families, and 
tomorrow's entrepreneurs who will not be able to get a mortgage without 
paying hundreds of dollars upfront--which, for low-income people 
without cash, will mean no mortgages at all.
    Many small businessmen and women may not be able to stay in 
business as mortgage brokers without being able to offer consumers low- 
or no-cost loans. As competition decreases, all potential mortgage 
borrowers will experience higher costs and fewer choices--and in some 
cases, no choices at all. The ripple effect on the overall economy, as 
mortgage borrowing declines and employment in the housing and mortgage 
finance sector falls, could be substantial.
    In 1998, Congress made its views clear on this issue. In the 
Conference Report accompanying the VA-HUD and Independent Agencies 
Appropriations Act of 1999 [H.R. Conf. Rep. No. 105-769, 105th 
Congress, 2d sess. 260] Congress explicitly stated that it was 
``concerned about the legal uncertainty [regarding indirect 
compensation] that continues absent such a policy statement.'' Congress 
further stated that it ``never intended payments by lenders to mortgage 
brokers for goods or facilities actually furnished or for services 
actually performed to be violations of Sections 8(a) or (b) of the Real 
Estate Settlement Procedures Act (12 U.S.C. 2601 et. seq.) Congress 
directed the Department of Housing and Urban Development (HUD) to issue 
a statement of policy clarifying the legality of mortgage broker 
compensation paid by lenders. Congress further directed HUD to consult 
with all interested parties in developing this policy statement.
    HUD followed the directive of Congress with the release of 
Statement of Policy 1999-1 [FR Vol. 64, No. 39, pp. 10080-10087] on 
March 1, 1999. The policy statement says that:

          In determining whether a payment from a lender to a mortgage 
        broker is permissible under Section 8 of RESPA, the first 
        question is whether goods or facilities were actually furnished 
        or services were actually performed for the compensation paid. 
        The fact that goods or facilities have been actually furnished 
        or that services have been actually performed by the mortgage 
        broker does not by itself make the payment legal. The second 
        question is whether the payments are reasonably related to the 
        value of the goods or facilities that were actually furnished 
        or services that were actually performed.

    NAMB participated in the development of this Statement of Policy, 
along with many other industry groups, as well as major consumer 
advocacy organizations. HUD, to its credit, insisted that a consensus 
of all the participating groups be reached. All who participated agreed 
that Statement of Policy 1999-1 correctly interpreted RESPA as it 
relates to mortgage broker compensation. The policy statement enjoyed 
bipartisan approval from the Clinton Administration and Congress.
    When Statement of Policy 1999-1 was released, most of us in the 
mortgage industry believed the litigation crisis had been resolved. 
Using the ``two-part test'' set forth in the statement meant that the 
legality of any mortgage broker compensation would have to be judged on 
a case-by-case basis, not as a class action. It is important to note 
here that this test allows individual cases of abuse to be addressed 
and remedied in court, while limiting inappropriate class actions. 
Following the publication of the statement, the number of new class 
action lawsuits dwindled. Several existing lawsuits were dismissed, and 
class certification was denied, by courts that agreed with HUD's 
interpretation of RESPA and agreed that broker compensation must be 
judged on a case-by-case basis. However, other lawsuits continued to 
proceed with the hope by the trial lawyers that a court might interpret 
Statement of Policy 1999-1 in such a way that a class action could 
still go forward.
    Unfortunately, this occurred in June 2001, when the Eleventh 
Circuit Court of Appeals affirmed certification of a class by the U.S. 
District Court of Alabama in Culpepper v. Irwin Mortgage Corp. The 
Eleventh Circuit found an ambiguity in Statement of Policy 1999-1, and 
failed to complete its analysis of yield spread premiums by only 
applying the first test. The Court also implied that a lower court 
could, in fact, find that all yield spread premiums are illegal, 
thereby justifying certification of the class. Not surprisingly, NAMB 
believes this was a misinterpretation of both RESPA and Statement of 
Policy 1999-1. It left the industry once again facing billions of 
dollars in liability. It also left HUD in contravention of the 1998 
Congressional directive to provide definitive guidance to the industry 
and clarify any legal ambiguities surrounding mortgage broker 
compensation. Dozens of new lawsuits have been filed since the Eleventh 
Circuit decision. Clearly this is not because of a sudden rampant wave 
of abuse in the mortgage market, but because class action attorneys see 
an opportunity for multimillion dollar fees.
    HUD immediately recognized the potential disaster created by this 
decision, and recognized its responsibility to remove the ambiguity 
found by the Eleventh Circuit by clarifying its existing policy. In the 
process of developing its response, HUD once again met with a wide 
range of interested parties, including NAMB, and including consumer 
advocacy groups. On October 15, 2001, HUD issued Statement of Policy 
2001-1 [Fed. Reg. 66, No. 202, pp. 53052-53059]. HUD states in the 
preamble to this policy statement that:

          This Statement of Policy is being issued to eliminate any 
        ambiguity concerning the Department's position with respect to 
        those lender payments to mortgage brokers charactenized as 
        yield spread premiums. . . . In issuing this Statement of 
        Policy, the Department clarifies its interpretation of Section 
        8 of the Real Estate Settlement Procedures Act (RESPA) in 
        Statement of Policy 1999-1 Regarding Lender Payments to 
        Mortgage Brokers (the 1999 Statement of Policy). . . . Today's 
        Statement of Policy reiterates the Department's position that 
        yield spread premiums are not per se legal or illegal, and 
        clarifies the test for the legality of such payments set forth 
        in HUD's 1999 Statement of Policy. As stated there, HUD's 
        position that lender payments to mortgage brokers are not 
        illegal per se does not imply, however, that yield spread 
        premiums are legal in individual cases or classes of 
        transactions. The legality of yield spread premiums turns on 
        the application of HUD's test in the 1999 Statement of Policy 
        as clarified today.

    HUD is to be congratulated for Statement of Policy 2001-1. The 
statement is simply a clarification of existing policy and the existing 
views of HUD concerning yield spread premiums. As the regulator of 
RESPA, HUD has a responsibility to provide all parties affected by 
RESPA with clear rules and guidance so that the law can be effectively 
understood and implemented nationwide, and so that nationwide lenders 
can comply with the law. Continued ambiguity, whether created by court 
decisions, market changes, or other factors, creates unnecessary and 
costly uncertainty for both business and consumers. The only parties 
that benefit from ambiguity are trial lawyers.
    Statement of Policy 2001-1 has also been accepted by the courts in 
two important court rulings in class action lawsuits, Vargas v. 
Universal Mortgage Corp. and Bjustrom v. Trust One Mortgage Corp. In 
Bjustrom, U.S. District Judge Marsha J. Pechman of the Western District 
Court of Washington granted summary judgment to the defendant, Trust 
One Mortgage Corp. Judge Pechman applied the new policy statement to 
find that yield spread premiums are not illegal per se even though 
there may be no ``tie'' between the premium and particular services 
performed by the broker. The Court found that the Statement of Policy 
is a permissible interpretation of RESPA and therefore must be given 
deference.
    In Vargas, Judge James B. Zagel of the U.S. District Court, 
Northern District of Illinois, denied certification of a class. Judge 
Zagel agreed with HUD that the fact that yield spread premiums are 
calculated based on a rate sheet does not make them per se illegal 
referral fees. He also found that there are legitimate reasons why a 
borrower would choose to pay a higher interest rate on a loan that 
included a yield spread premium. Importantly, Judge Zagel also found 
that HUD's two-part test to determine legality of a yield spread 
premium is faithful to the RESPA statute, and that:

          . . . the Act [RESPA] compels a case-by-case analysis of 
        individual plaintiffs' claims every bit as much as the HUD 
        Statement. HUD's ``reasonableness requirement'' was not made 
        out of whole cloth; it is implicit in Sec. 2607(c) which 
        authorizes compensation for ``services actually performed.''

    We expect other courts to agree with these two decisions. Yield 
spread premiums that are properly disclosed and meet the HUD test 
should be considered legal and not abusive. Any yield spread premium 
that does not meet this test may be illegal, and HUD's policy statement 
clearly allows consumers who believe their loan has included an illegal 
yield spread premium to seek legal remedy. With the legal uncertainty 
removed, our industry can now move forward and HUD can move forward to 
address the real problems in the mortgage market.

HUD's Actions Going Forward
    The other issue on which the Committee has asked us to comment is 
what HUD should do going forward to address ``abusive use'' of yield 
spread premiums. We fully agree that illegal uses of yield spread 
premiums should be prosecuted to the full extent of the law. Any 
compensation that does not meet the HUD test is illegal, and those 
paying or receiving illegal payments should be punished. The NAMB 
believes such abuses are rare, and we believe that HUD is moving 
forward appropriately in two ways.
    First, HUD is moving to more aggressively enforce RESPA and punish 
violators. It is devoting more resources, reorganizing, and refocusing 
to dramatically improve its historically poor record in enforcing 
RESPA. Our industry has long been frustrated with the lack of RESPA 
enforcement by HUD. Even a little enforcement can go a long way in 
serving notice to all settlement service providers that there will be a 
high price for violating the law. This includes the payment or receipt 
of illegal yield spread premiums or any other fees that are paid to any 
industry participant in violation of RESPA. NAMB applauds HUD's new 
enforcement effort and hopes Congress will support it with increased 
funding and personnel allocations.
    The other way HUD is moving to address abuses is with a new RESPA 
regulation. In Statement of Policy 2001-1, HUD announced:

          This Statement of Policy also reiterates the importance of 
        disclosure so that borrowers can choose the best loan for 
        themselves, and it describes disclosures HUD considers best 
        practices. The Secretary is also announcing that he intends to 
        make full use of his regulatory authority to establish clear 
        requirements for disclosure of mortgage broker fees and to 
        improve the settlement process for lenders, mortgage brokers, 
        and consumers.

    Secretary Martinez, in remarks before this Committee on December 
13, 2001, further stated his commitment to RESPA reform:

          To ensure that homebuyers have the information they need in 
        order to make an informed purchase, I have undertaken 
        comprehensive reform of the Real Estate Settlement Procedures 
        Act (RESPA). In addition to preserving yield spread premiums as 
        a valuable tool for opening the doors of homeownership, reform 
        will: (1) ensure better protections for new homebuyers and 
        those who refinance; (2) offer clarity for the mortgage lending 
        industry about their disclosure responsibilities, and; (3) 
        provide an additional tool to fight predatory lending.
          The need for RESPA reform is even more urgent during times of 
        economic uncertainty. Homeownership helps create financial 
        stability for families, and in return brings economic stability 
        to our communities.

    NAMB fully agrees with Secretary Martinez and we support a new 
rulemaking to improve the disclosures provided to consumers. Mortgage 
brokers are confronted every day with the frustrations of our customers 
about the many confusing, and largely useless, disclosures and 
paperwork we thrust at them. Consumers who may be desperate for cash or 
credit may not always fully investigate their loan options or closely 
examine the many disclosures they receive.
    Consumers are entitled to better, simpler disclosures provided 
earlier in the process, so they can more effectively compare loans. 
Consumers should have simple disclosures without a lot of fine print. 
They should easily be able to question and change terms and fees with 
which they do not agree, well before closing. These improvements could 
reduce compliance burdens and costs for originators, and the savings 
would be passed on to consumers. Consumers would be in a stronger 
position with more information, thereby decreasing the incidence of 
abusive lending practices of all kinds--including, but not limited to, 
any illegal yield spread premiums.
    NAMB has developed detailed proposals for this rulemaking, and we 
have shared these with HUD and with this Committee. NAMB supports a 
new, mandatory disclosure to be required of all originators at or 
before application, that clearly defines what the originator will do in 
the transaction, how its compensation will be earned, and the choices 
available that could affect both the way the originator is compensated 
and whether the consumer will have to pay any fees upfront at closing. 
NAMB also supports establishing tolerances for the Good Faith Estimate 
and requiring redisclosure if the tolerances are exceeded, in order to 
prevent surprise additional costs to consumers at closing, including 
inappropriate increases in yield spread premiums.
    This new disclosure would build upon the successful Model Loan 
Origination Agreement that NAMB and MBA jointly developed in 1998, and 
which both associations encourage our members to use. We believe this 
new agreement will help consumers better understand the process, while 
not adding significantly to the complexity of that process.

Conclusion
    Wholesale mortgage lending through mortgage brokers, and 
particularly the wide availability of loans requiring the borrower to 
pay little or no cash at closing, is a key element in sustaining 
America's economy through this period of great uncertainty and 
difficulty. Used properly, yield spread premiums are an important part 
of this market, and it is therefore important to consumers that the use 
of legal yield spread premiums continue, without the threat of class 
action litigation that could seriously impede the efficient functioning 
of the market and damage the economy. When yield spread premiums are 
properly disclosed and properly used, they are not illegal.
    NAMB believes that HUD has acted responsibly as the regulator under 
RESPA: First, by issuing Statement of Policy 2001-1 to clarify existing 
policy concerning yield spread premiums, provide certainty to the 
mortgage industry, and reduce the threat of class action litigation; 
second, by significantly increasing and improving its investigation and 
enforcement of RESPA violations; and third, by developing new and 
improved disclosures that will help consumers avoid illegal and abusive 
fees. NAMB supports a new, mandatory disclosure to be provided at the 
earliest possible time by all originators that fully informs consumers 
about the loan origination 
process. NAMB also supports improving the Good Faith Estimate by 
establishing tolerances and requiring redisclosure.
    Thank you again for this opportunity to share NAMB's views with the 
Committee.
                               ----------
                  PREPARED STATEMENT OF IRA RHEINGOLD
     Executive Director, National Association of Consumer Advocates

                            January 8, 2002

    Mr. Chairman and Members of the Committee, the National Association 
of Consumer Advocates \1\ thanks you for inviting us to testify today 
regarding HUD's recent policy ``clarification'' on yield spread 
premiums. We offer our testimony here today on behalf of our members, 
as well as the National Consumer Law Center.\2\
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    \1\ The National Association of Consumer Advocates is a nonprofit 
organization designed to promote justice for all consumers by 
maintaining a forum for information sharing among consumer advocates 
across the country. Our mission is to serve as a voice for consumers in 
the ongoing struggle to curb unfair and abusive business practices, 
especially in the areas of finance and credit.
    \2\ The National Consumer Law Center, Inc. (NCLC) is a nonprofit 
Massachusetts corporation founded in 1969 at Boston College School of 
Law and dedicated to the interests of low-income consumers. NCLC 
provides legal and technical consulting and assistance on consumer law 
issues to legal services, Government and private attorneys across the 
country. Cost of Credit (NCLC 1995), Truth in Lending (NCLC 1996) and 
Unfair and Deceptive Acts and Practices (NCLC 1991), three of twelve 
practice treatises published and annually supplemented by NCLC, and our 
newsletter, NCLC Reports Consumer Credit & Usury Ed., describe the law 
currently applicable to all types of consumer loan transactions.
---------------------------------------------------------------------------
    At the outset, let me make it perfectly clear that while we believe 
that the use of yield spread premiums can be a source of benefit for 
American consumers, this practice as it is currently being used by the 
mortgage lending industry, is both abusive and deceptive. Furthermore, 
instead of carrying out its mandate to promote homeownership by 
encouraging a fair, open, and honest marketplace, HUD has attempted to 
use its policymaking authority to legitimatize the otherwise illegal, 
anticompetitive nature of yield spread premium abuse. This testimony 
will discuss how yield spread premiums currently operate in the real 
world, explore previous efforts to regulate this practice, explain how 
HUD's purported clarification in the 2001 policy statement ignores the 
law and perpetuates and encourages bad lending behavior and finally, 
offer proposals to make the use of yield spread premiums provide 
American homeowners with real benefit.

Yield Spread Premiums in the Current Marketplace
    Section 8(a) of RESPA prohibits any person from giving or receiving 
any fee, kickback or thing of value pursuant to any agreement incident 
to a real estate settlement involving a Federally related mortgage.\3\ 
This rather simple provision was the product of much debate in Congress 
and was created in 1972 because of the widespread recognition that 
referral fees and kickbacks were making the marketplace anticompetitive 
(homebuyers were not being directed to a service provider who would 
provide them with the best deal, but instead to the provider who would 
pay the largest sum of money to the referring agent).\4\ The rationale 
for this legislation was simple. Eliminate market-distorting incentives 
and homeowners would have real opportunity to obtain the most 
beneficial and cost efficient loan products available. While Section 
8(a) of RESPA seems rational, fair, and explicit, current participants 
in the home lending marketplace have gone to great effort to obfuscate 
the law and preserve their ability to receive and provide kickbacks at 
the great expense of American homeowners. This is where the practice of 
yield-spread premiums (YSP's) enters our story.
---------------------------------------------------------------------------
    \3\ Reg. X Sec. 3500.14(b).
    \4\ For a detailed discussion of RESPA's legislative history see 
the Report of Howell Jackson in Glover v. Standard Federal Bank, pp. 3-
19.
---------------------------------------------------------------------------
    In a nutshell, the YSP's are payments made by a lender to a 
mortgage broker in return for a referral of an ``above-par'' loan. An 
above-par loan is a loan with a YSP paid to the broker and a higher 
interest rate than the loan the borrower qualified for. A par loan is a 
loan with an interest rate that an individual homeowner would qualify 
for if she/he paid no discount points and was charged no YSP. For a 
``below-par'' loan, the homeowner would pay discount points in exchange 
for the lower interest rate.
    In theory YSP's could offer homeowners using a mortgage broker a 
valuable choice. Borrowers could choose the amount of points they would 
want to pay (or not pay) and thus choose an interest rate. For 
instance, a homeowner who did not want to pay an upfront broker fee, 
could choose an above-par interest rate and have the lender pay the 
broker in the form of a YSP. While this could all be so very neat and 
clean (and legal), this scenario does not remotely reflect what is 
happening in today's consumer marketplace.
    Consumers who do business with mortgage brokers generally have the 
understanding that the brokers will provide them the loan at the lowest 
rate that the broker finds for them. Consumers have generally 
understood and agreed to a specific broker's fee to be paid directly by 
them--either in cash or by borrowing more--to the mortgage broker to 
compensate the broker for obtaining the loan. What consumers do not 
understand, and have not agreed to, is the mortgage broker receiving an 
additional fee from the lender.
    As an attorney for the last 5 years running a foreclosure 
prevention project in Chicago, I have had the opportunity to review 
hundreds and hundreds of loan documents. I have probably interviewed 
thousands of homeowners, given countless seminars and trained and spoke 
with scores of attorneys representing consumers. In all that time, I 
have seen countless loans that contained both yield spread premiums and 
borrower paid broker fees, yet not once, have I spoken to a homeowner 
who knew that a YSP had been paid on their loan, or that because of the 
YSP, the interest rate they received was greater than they were 
otherwise qualified. To some, this evidence is anecdotal, but both 
industry commentary \5\ and objective study \6\ bear this observation 
out. This reality begs two questions. First, if YSP's are not being 
paid for the benefit of consumers, why are they being paid? Second, if 
these are referral fees why aren't these payments illegal?
---------------------------------------------------------------------------
    \5\ Professor Jack Guttentag, Professor of Finance Emeritus at the 
Wharton School (whose nationally syndicated ``Ask the Mortgage 
Professor'' columns are featured on the Mortgage Bankers Association of 
America's own website) recently conducted a study of mortgage broker 
fees. That study, Bankers Association of America's own website) 
recently conducted a study of mortgage broker fees. That report, 
entitled ``Another View of Predatory Lending'' (published by the 
Wharton Financial Institutions Center and available as a free download 
from its website), found that there is no correlation between the fees 
paid to a mortgage broker on a given loan and the amount of work 
performed by the mortgage brokers on that loan. The Guttentag Study 
concluded that the only two ``major determinants'' of mortgage broker 
profit are ``loan size'' and ``the sophistication of the borrower 
relative to the sales skills of the loan officer.
    \6\ Report of Howell Jackson.
---------------------------------------------------------------------------
    The answer to the first question is very simple. YSP's are 
generally paid by the lender to the broker solely in compensation for 
the higher rate loan. In other words, because the broker brings to the 
lender a loan at a higher rate than the consumer would otherwise 
qualify, the broker is paid a fee, or kickback. These fees are solely 
an extra fee that the broker is able to extract from the deal. In 
practice, the borrower is not only paying an upfront broker fee, but is 
also paying a higher interest rate as a result of this kickback. As 
this practice clearly provides an incentive for brokers to obtain 
above-par loans for consumers, the dynamics of the marketplace closely 
resemble the marketplace that Congress attempted to control with its 
passage of RESPA.

Prior Attempts To Curb Yield Spread Premium Abuse
    Because this problem has existed for over a decade (and because the 
lending industry has attempted various justifications for this 
seemingly obvious illegal practice), there has been extensive 
litigation. The industry had sought assistance from Congress in the 
past. Finally, in 1998, Congress issued a directive to HUD to write a 
Statement of Policy. Consumer representatives worked diligently with 
the mortgage industry and HUD to develop the language.\7\ The Statement 
of Policy that was issued by HUD in 1999 met with both consumer 
advocate and industry approval. Consumer advocates approved of the 
policy statement in large part because of the explicit direction 
provided to the lending industry on how a lender can properly pay a 
broker fee:
---------------------------------------------------------------------------
    \7\ ``The conferees expect HUD to work with representatives of 
industry, Federal agencies, consumer groups, and other interested 
parties on this policy statement.'' See the Conference Report on the 
Departments of Veterans Affairs and Housing and Urban Development, and 
Independent Agencies Appropriations Act, 1999, H.R. Conf. Rep. No. 
1050769 at 260 (1998).

          Mortgage brokers and lenders can improve their ability to 
        demonstrate the reasonableness of their fees if the broker 
        discloses the nature of the broker's services and the various 
        methods of compensation at the time the consumer first 
        discusses the possibility of a loan with the broker.
          [T]he most effective approach to disclosure would allow a 
        prospective borrower to properly evaluate the nature of the 
        services and all costs for a broker transaction, and to agree 
        to such services and costs before applying for a loan. Under 
        such an approach, the broker would make the borrower aware of . 
        . . the total compensation to be paid to the mortgage broker, 
        including the amounts of each of the fees making up that 
        compensation. If indirect fees are paid, the consumer would be 
        made aware of the amount of these fees and their relationship 
        to direct fees and an increased interest rate. If the consumer 
        may reduce the interest rate through increased fees or points, 
        this option also would be explained. [Emphasis added.] \8\
---------------------------------------------------------------------------
    \8\ Real Estate Settlement Procedures Act Statement of Policy 1999-
1 Regarding Lender Payments to Mortgage Brokers. 64 FR 10080 (March 1, 
1999) at 10087.

    With this clear direction on how to avoid liability for paying 
broker fees, consumer advocates reasonably believed that the mortgage 
industry would immediately adopt these recommendations and employ them 
in all future loans. This belief was wrong. Instead the industry 
continued as before--lenders continued to pay broker fees without 
evaluating either the services provided by the broker or whether the 
payment of the lender fee reduced the fees otherwise owed by the 
borrower. Because the benefit to the brokers and lenders was so great 
(higher fees for brokers, higher interest rates for lenders), the 
mortgage industry's strategy was to continue its illegal practice, pay 
off the few individual actions brought against it and mount a massive 
effort to fight class action cases challenging the payment of these 
fees, which might actually cost the industry real money and cause the 
industry to change its behavior.
    Initially after the 1999 Statement of Policy this strategy appeared 
to be working. Most Federal courts generally denied class 
certification, requiring an intensely factual analysis to determine 
legality,\9\ while a few Federal district courts did permit the class 
actions to proceed. \10\ This scene changed significantly however, when 
the Eleventh Circuit Court of Appeals issued a comprehensive analysis 
of RESPA's requirements regarding referral fees, the 1999 Statement of 
Policy, and upheld class certification, on June 15, 2001.\11\
---------------------------------------------------------------------------
    \9\ See for example Golan v. Ohio Savings Bank, 1999 U.S. Dist. 
LEXIS 16452 (N.D. Ill. October 15, 1999); Brancheau v. Residential 
Mortgage, 187 F.R.D. 591 (D. Minn. 1999); Levine North Am. Mortgage, 
188 F.R.D. 320 (D. Minn. 1999); Smitz v. Aegis Mortgage Corporation, 48 
F. Supp. 2d 877 (D. Minn. 1999).
    \10\ Heimmermann v. First Union Mortgage, 188 F.R.D. 403 (N.D. Ala. 
1999); Briggs v. Countrywide Funding Corporation, 188 F.R.D. 645 (M.D. 
Ala. 1999).
    \11\ Culpepper v. Irwin Mortgage Corporation, 253 F. 3d 1324 (11th 
Cir. 2001).
---------------------------------------------------------------------------
    The crux of the analysis in the Culpepper case is that for HUD's 
Statement of Policy to be consistent with RESPA, a two-part test is 
necessary to determine the legality of the lender paid broker fees. 
First, whether the lender paid fee was for goods, services, or 
facilities provided. Second, whether the total fee paid was 
reasonable.\12\ The court found class certification appropriate 
because--
---------------------------------------------------------------------------
    \12\ A significant basis for this rationale is not only HUD's 1999 
Statement of Policy, but also the language of RESPA's provision 
distinguishing between legal fees and referral fees. Section 8(c) of 
RESPA permits ``the payment of a fee . . . by a lender . . . for 
services actually performed.'' 12 U.S.C. Sec. 2607(c)(1)(C). 253 F.3d 
at 1328. (Emphasis added.)

          The terms and conditions under which a lender pays the broker 
        a yield spread premium can determine whether the yield spread 
        premium is compensation for referring loans rather than a bona 
        fide fee for services. There is no suggestion from the evidence 
        or the argument here that Irwin negotiates yield spread 
        premiums loan-by-loan, rather than paying them according to 
        terms and conditions common to all the loans.\13\
---------------------------------------------------------------------------
    \13\ 253 F. 3d at 1329.

    In essence, the Culpepper court was saying, if the lender paid a 
broker a yield spread premium without looking at whether services were 
provided, the lenders practice violated RESPA. Therefore, the first 
step of the two-part test--whether the lender paid fee was for 
services--could be answered without performing a factual analysis of 
each individual loan. Therefore, the court concluded that there was no 
reason that the case could not proceed as a class action. The court 
noted that the formula by which a lender paid broker fee is paid ``does 
not take into account the amount of work the broker actually performed 
in originating the loan or how much the borrower paid in fees for the 
broker services.'' \14\
---------------------------------------------------------------------------
    \14\ The factual basis for the court's conclusion was stated in 
this way:
      The ``yield spread premiums'' at issue in this case . . . are 
payments from [the lender] to its mortgage brokers that the written 
agreement between them contemplates, but does not define. Each business 
day, Irwin distributes a rate sheet to its brokers, listing the terms 
of the loans Irwin is offering that day. The loans' interest rates are 
set with reference to a ``par rate.'' If the broker originates a loan 
at a below-par rate, it gets no compensation from Irwin. On the other 
hand, originating a loan at an above-par rate garners the broker a 
yield spread premium, whose amount is determined by a formula that 
includes the amount of the loan and the difference between the loan 
rate and the par rate. The formula does not take into account the 
amount of work the broker actually performed in originating the loan or 
how much the borrower paid in fees for the broker's services. 253 F. 3d 
at 1325.
---------------------------------------------------------------------------
    The mortgage industry responded to the Culpepper case by 
immediately turning to HUD and seeking a ``clarification'' of the 1999 
Statement of Policy removing all references to language, which would 
support the Eleventh Circuit Court's analysis. The stated rationale was 
simply to ``clarify'' the ``ambiguity'' in the policy statement.\15\ 
Despite the fact that the 1999 Statement of Policy was unambiguous 
regarding how the industry could legally pay yield spread broker fees, 
the industry coyly requested:
---------------------------------------------------------------------------
    \15\ See letter from Anne Canfield, Executive Director of the 
Consumer Mortgage Coalition, to Secretary Mel Martinez, dated September 
25, 2001. http://www.houselaw.net/alerts/092801a.pdf.

          HUD must issue decisive and clear rules that benefit both 
        borrowers and lenders by creating a regulatory environment in 
        which consumers can make 
        informed choices and lenders can operate their businesses, 
        without the constant prospect of having industry practices that 
        benefit consumers challenged in litigation.\16\
---------------------------------------------------------------------------
    \16\ Id.

    The industry portrayed a ``clear rule'' for the future as an 
appropriate trade-off for the requested ``clarification of the 1999 
Statement of Policy.'' \17\ This completely ignored the obvious--that 
HUD had already provided a clear rule, just as the industry is now 
requesting, in the 1999 Statement of Policy, which the industry had 
simply ignored.
---------------------------------------------------------------------------
    \17\ See memorandum from Howard Glaser, Mortgage Bankers 
Association, entitled ``What We Are Asking For.''
---------------------------------------------------------------------------
HUD's Actions
    In the weeks preceding the issuance of the 1999 Statement of 
Policy, HUD officials met with consumer representatives on dozens of 
occasions to work through many of the complex issues involved in this 
problem. Many of these meetings were also attended by representatives 
of the mortgage industry. In contrast, prior to the 2001 Statement, HUD 
officials met with consumer representatives three times, despite 
numerous requests and offers by these representatives to engage in a 
more substantial dialogue.\18\
---------------------------------------------------------------------------
    \18\ On July 11, 2001 consumer representatives met with General 
Counsel Richard Hauser and other HUD representatives. On September 11, 
2001 consumer representatives met for a few minutes with Secretary 
Martinez, FHA Commissioner Weicher, Mr. Hauser, and others. Given the 
tragic occurrences of the day, this meeting was aborted and resumed on 
September 19. On October 11, after numerous requests, consumer 
representatives again met with Mr. Hauser, Commissioner Weicher, and 
others.
---------------------------------------------------------------------------
    The consumer representatives tried to make clear to HUD officials 
these essential points:

 Providing the ``clarification'' of the 1999 Statement as 
    sought by the mortgage industry would have the effect of completely 
    eliminating class actions as a form of redress for illegal lender 
    paid broker fees.\19\
---------------------------------------------------------------------------
    \19\ This assumes that a court agrees that the 2001 HUD Statement 
of Policy should be provided deference. There is substantial legal 
question regarding the extent of reliance that a court may place on an 
agency's interpretative statement which has not been subject to notice 
and comment. The Supreme Court has distinguished between the deference 
due regulations promulgated by formal notice-and-comment rulemaking or 
formal adjudications and those made informally. See Christensen v. 
Harris County, 529 U.S. 576, 120 S. Ct. 1655, 1662, 146 L. Ed. 2d 621 
(1999).
---------------------------------------------------------------------------
 Without class actions as a means to litigate the legality of 
    these fees, the industry has no incentive to change their practices 
    or even to comply with a new regulation--because there are 
    insufficient legal resources in this Nation to represent consumers 
    in individual actions involving claims of only a few thousand 
    dollars.
 The ``new'' disclosures offered by the industry--and proposed 
    by HUD--provide fewer actual protections for consumers than those 
    recommended by HUD in the 1999 policy statement. Unlike the 1999 
    recommendations which include the consumer's agreement to the 
    lender paid broker fee, the 2001 proposal only mentions 
    ``disclosure.'' \20\
---------------------------------------------------------------------------
    \20\ Consumer representatives maintain that requiring the consumer 
to agree to the payment of a lender paid broker fee is an essential 
element in a regulatory structure that would truly protect consumers 
from illegal yield spread premiums.
---------------------------------------------------------------------------
 Limiting illegal lender paid broker fees is an essential step 
    in redressing predatory mortgage lending.

    The mortgage industry provided specific language to HUD to 
``clarify'' the 1999 policy statement. HUD adopted every recommendation 
made by the industry. The crux of HUD's ``clarification'' comes on page 
11, with the statement:

          HUD's position is that in order to discern whether a yield 
        spread premium was for goods, facilities, or services under the 
        first part of the HUD test, it is necessary to look at each 
        transaction individually . . .\21\
---------------------------------------------------------------------------
    \21\ Department of Housing and Urban Development, RESPA Statement 
of Policy 2001-1: Clarification of Statement of Policy 1999-1 Regarding 
Lender Payments to Mortgage Brokers, and Guidance Concerning Unearned 
Fees Under Section 8(b) at 11.

    Such a position, if deferred to by the courts, would almost 
certainly preclude class action suits, thus removing the only effective 
legal recourse to challenge and change this practice. In fact, the 2001 
Statement of Policy collapses the two-part test articulated in the 1999 
Statement into a single analysis; which represents a serious departure 
from not only the 1999 Statement, but also the Congressional directive 
in RESPA.\22\
---------------------------------------------------------------------------
    \22\ The new test ``requires that total compensation to the 
mortgage broker be reasonably related to the total set of goods or 
facilities actually furnished or services performed.'' Id. at 13. 
Although HUD says there is still a two-part test, the two tests appear 
identical.
---------------------------------------------------------------------------
    HUD's action is absolutely crippling to consumer rights, as it 
removes any incentive the industry has to cooperate with any future 
action that HUD might take to address the egregious practice of 
upselling mortgage loans. In his press release, 
Secretary Martinez claims to be pursuing a reform to require full 
upfront disclosure of all total compensation to be paid to the broker. 
However, even if HUD initiates a proposed rulemaking to do this (which 
was not proposed in the October 15 Statement), and even if the 
regulation goes beyond the meaningless recommendations in the 2001 
Statement, it will be a regulation without any effective enforcement 
mechanism.

Making Yield Spread Premiums Work for Consumers
    Several years ago, Congress requested that the two Federal agencies 
most familiar with the implementation of the laws involved in the 
mortgage process--HUD and the Federal Reserve Board--evaluate the 
complex issues of improving and streamlining the mortgage process, 
while addressing predatory lending. In 1998, these two agencies issued 
a comprehensive report.\23\ This Joint Report, in addition to proposing 
comprehensive reform to address predatory lending, also proposed two 
alternatives to address the fact that the current system does not 
ensure a truly competitive marketplace for mortgage loans.
---------------------------------------------------------------------------
    \23\ Board of Governors of the Federal Reserve System, Department 
of Housing and Urban Development, 
Joint Report to the Congress Concerning Reform to the Truth in Lending 
Act and the Real Estate Settlement Procedures Act, July 1998 
(hereinafter ``Joint Report''). These two Government agencies listened 
to the multitude of industry representatives, as well as consumer 
representatives, and issued a complex and comprehensive report.
---------------------------------------------------------------------------
    One alternative would be a dramatic change in the system governing 
the disclosures consumers receive both when they apply for the loan and 
when they close the loan. The other alternative is to beef up the 
current system and require information to be provided which is 
meaningful.

Alternative One
    In the Joint Report, HUD indicated its commitment to actually 
improving the system of shopping for mortgages, rather than continue 
the confusion. The primary mechanism for accomplishing a more open 
system would be to require mortgage lenders (and brokers) to provide a 
guaranteed interest rate and closing costs before collecting any 
application fees from consumers.
    As the charges for mortgage loans are often based on the borrower's 
creditworthiness and the value of the collateral, some underwriting 
would have to be performed by the creditors before the guaranteed rate 
could be provided. To its credit, HUD agreed with consumer advocates 
and proposed that ``consumers be provided guaranteed information about 
closing costs, interest rate, and points early enough so that they can 
shop and make informed choices.'' \24\
---------------------------------------------------------------------------
    \24\ Joint Report at XVII.
---------------------------------------------------------------------------
    On the other hand, the large mortgage lenders have been pushing 
hard for a change in the law which would mandate a guaranteed closing 
costs ``package,'' without a guarantee for rates and points. In this 
way, the lenders could market their loans based on the closing cost 
package. Consumer advocates have opposed the closing cost package by 
itself because it would be like marketing tires to car buyers before 
they purchase the car: A borrower would likely apply for a loan based 
on the guaranteed closing cost package, without receiving any guarantee 
of the interest rate or points. Encouraging borrowers to apply for 
loans based only the closing cost package would end up costing 
borrowers in at least two ways: (1) if the actual closing costs 
incurred by the lender for the loan exceeds the anticipated amount, 
there would be nothing to prevent the lender from increasing the 
interest rate or the points charged on the loan to make up for the 
difference; (2) in fact, there is nothing to prevent the lender from 
increasing the price of the loan to borrowers who have already paid so 
much money to apply for the loan, that they cannot afford to go 
elsewhere for their home loan.

Alternative Two
    HUD also proposed a change in the rules governing early 
disclosures. These early disclosures need to be transformed into 
commitments to deal with the issue of deceptive yield spread premiums.
    The mortgage industry has consistently stated that it wants to 
ensure that yield spread premiums remain legal so that borrowers can 
benefit from their use--such as by reducing the upfront closing costs 
required to be paid from cash or equity. We as consumer advocates 
agree. We think the following principles,\25\ if followed, would 
guarantee that yield spread premiums would be legal and beneficial for 
consumers.
---------------------------------------------------------------------------
    \25\ See Appendix A for a full proposal that amends Reg. X and 
adopts these principles.

          1. Before any payment is made to the broker, the borrower and 
        the mortgage broker must enter into a binding fee agreement 
        regarding the total compensation, however denominated, to be 
        paid to the broker.
          2. The borrower must be offered a choice of how to pay the 
        broker fee, whether in cash, by borrowing more, by increasing 
        the interest rate or points, or having the lender pay the 
        broker fee. This choice is offered after loan approval but 
        before the settlement.
          3. The amount the broker is paid is the same whether paid by 
        the borrower or the lender. The amount paid the broker by the 
        lender reduces, by the exact amount, the amount owed by the 
        borrower to the mortgage broker.
          4. The total amount paid by borrower and lender must be 
        reasonable and be compensation for goods, services, and 
        facilities actually provided.

    These principles accomplish several things. First, the consumer 
knows upfront how much the mortgage broker will charge. Second, the 
consumer is given the opportunity to choose how this payment will be 
paid. Third, and most importantly, the broker compensation remains the 
same regardless of method of payment. This point is crucial, because it 
eliminates any anticompetitive incentive the broker has to place the 
borrower in a loan with an interest rate greater than they otherwise 
would qualify. In other words, whether the borrower chooses a below-par 
loan, a par loan or an above-par loan with a yield spread premium, the 
broker compensation will remain the same. This is not how the system 
works today and it must be changed.
    In summary, yield spread premiums have been a source of mortgage 
lending abuse for a number of years. Finally, when the Federal courts 
began to seriously hold the mortgage lending industry liable, the 
industry, instead of reforming its ways turned to HUD for salvation. 
HUD, instead of protecting consumers, cast its lot with mortgage 
lenders and attempted to protect the anticompetitive marketplace that 
currently exists, HUD's ultimately cynical policy clarification was not 
only disappointing but also an abdication of their mandate to protect 
and promote homeownership. We can only hope that in the future, HUD 
will rethink its decision and issue regulations that adopt principles 
that not only claim to protect consumers, but also in practice actually 
do.
                               Appendix A

                    Proposed Changes to Regulation X

1. Add Following Definitions to Sec. 3500.2(b)
    Total compensation received by a mortgage broker for bringing 
together a borrower and a lender to obtain a Federally related mortgage 
loan for the borrower includes all payments made by the borrower 
directly to the mortgage broker in cash or in the form of any thing of 
value, all payments received from the proceeds of the loan, and all 
payments received from the lender or any other settlement service 
provider that are directly related to the brokering of the loan.
    Par rate means the interest rate offered to a mortgage broker 
(through lender's price sheets) at which the lender will fund 100 
percent of the loan with no premiums or discounts to the mortgage 
broker.\26\
---------------------------------------------------------------------------
    \26\ Source: HUD Statement of Policy 1999-1, 64 Fed. Reg. 10080, 
10081 n.1 (March 1, 1999).
---------------------------------------------------------------------------
2. Add the Following Addition to Sec. 3500.14(g)
    Sec. 3500.14(g)(4): The payment of a fee by a lender to a mortgage 
broker related to the making of a Federally related mortgage loan shall 
not violate Section 8 of RESPA (12 U.S.C. Sec. 2607) or Sec. 3500.14 if 
all of the conditions set forth in this subsection are satisfied.\27\
---------------------------------------------------------------------------
    \27\ Source: Language mirrors affiliated business arrangement 
exemption in 24 C.F.R. Sec. 3500.15(b).

          (i) The mortgage broker agrees to represent the borrower, to 
        act as the borrower's agent, and to get the most favorable 
        mortgage loan that meets borrower's stated objectives.\28\
---------------------------------------------------------------------------
    \28\ Source: HUD Proposed Rule, 62 Fed. Reg. 53912, 53927 (October 
16, 1997) (proposed Mortgage Broker Contract, Appendix F). See also, 
Federal Reserve/HUD Joint Statement to Congress on RESPA/TILA Reform 
(1998).
---------------------------------------------------------------------------
          (ii) Prior to the preparation of the mortgage loan 
        application or receipt of any payment, whichever is first, the 
        mortgage broker and the borrower complete and execute a 
        Mortgage Broker Contract, in substantial conformity with the 
        form in Appendix F to this part, that states clearly and 
        conspicuously: \29\
---------------------------------------------------------------------------
    \29\ Source: HUD Proposed Rule, 62 Fed. Reg. at 53925 (proposed 
Sec. 3500.14(g)(2)(I)(A).

            (A) the mortgage broker's total compensation, expressed 
        both as a dollar amount and as a percent of the loan amount 
        requested by the borrower;
            (B) the borrower owes any compensation to the mortgage 
        broker only if the borrower enters into a Federally related 
        mortgage loan with a lender to whom the mortgage broker 
        referred the borrower; and
            (C) the available methods by which the borrower can choose 
        to pay the mortgage broker the total compensation in the 
        Mortgage Broker Contract.

          (iii) Following loan approval, but no later than five (5) 
        business days before settlement, the lender and borrower enter 
        into a Broker Funding Contract, in substantial conformity with 
        the form in Appendix G to this part, that states clearly and 
        conspicuously:

            (A) the available methods by which the borrower can pay the 
        mortgage broker the total compensation disclosed in the 
        Mortgage Broker Contract;
            (B) the par rate, the proposed interest rate, and the 
        monthly payment (excluding escrow) of any method described in 
        Sec. 3500.14(g)(4)(ii)(A) when the lender offers to pay all or 
        part of the total compensation to the mortgage broker through 
        funds resulting from an interest rate higher than the par rate 
        for a mortgage loan with otherwise equivalent terms and fees;
            (C) that the borrower may select one of the methods 
        described in Sec. 3500.14(g)(4)(ii)(A).

          (iv) The total compensation paid to the mortgage broker 
        compensates the broker for goods, services, and facilities and 
        is reasonably related to the value of such good, services, and 
        facilities.
          (v) Any fee paid by the lender to the mortgage broker for the 
        Federally related mortgage loan reduces, dollar for dollar, the 
        amount owed to the mortgage broker by the borrower pursuant to 
        the Mortgage Broker Contract described in 
        Sec. 3500.14(g)(4)(ii) and must be paid at or before the 
        settlement.
          (vi) The borrower receives a copy of the Mortgage Broker 
        Contract described in Sec. 3500.14(g)(4)(ii), and the Broker 
        Funding Contract described in Sec. 3500.14(g)(4)(iii).
          (vii) The mortgage loan, the Mortgage Broker Contract, and 
        Broker Funding Contract do not contain provisions that waive or 
        restrict the borrower's right to enforce the provisions of 
        RESPA and these regulations or other rights related to the 
        mortgage through judicial process.
3. Add Supplementary Information Regarding Applicable Date
    These amendments apply to mortgage loans entered into on or after 
January 1, 2002 [or other date in the future].
4. Add Appendix F, Mortgage Broker Contract
    [TO BE DRAFTED]
5. Add Appendix G, Broker Compensation Contract
    [TO BE DRAFTED]

                   PREPARED STATEMENT OF DAVID OLSON

              Managing Director, Wholesale Access Mortgage
                     Research and Consulting, Inc.

                            January 8, 2002

Qualifications
    I am the Managing Director of an economic research firm. I have 
been studying the mortgage industry for over 30 years. Since 1991 our 
firm has conducted much of the primary research on mortgage brokers in 
the United States. Although I am a member of the MBA and NAMB, I do not 
represent either association at these hearings. I merely represent 
myself as an independent economist. I have been asked to comment on the 
recent Statement of Policy 2001-1 by HUD concerning yield spread 
premiums (YSP's), and what HUD should do to prevent their abusive use. 
I also have some thoughts to share about markets, economics, and 
predatory lending.
    In the early days of my professional career, I was a student of 
socialist systems and spent time in Russia and Eastern Europe. I saw 
first-hand how miserably socialism operated. It led to slow growth, few 
benefits to the consumer, and loss of political freedom. The first 10 
years of my career made me passionate about market systems as the best 
way to meet the economic needs of the population and preserve the most 
freedom. From my experience, the best solution to most economic needs 
is to let the market operate more freely. This will produce the most 
goods at the lowest cost.

Mortgage Broker Market
    The mortgage market in the United States is highly competitive--at 
least that part concerning the origination of mortgage loans. Only 
those firms that have low costs can compete today. No firm is earning 
monopoly profits at the expense of the consumer.
    Mortgage brokers have evolved fairly recently to meet the needs of 
consumers. There were only a few operating before 1980. By 1987, they 
had 20 percent of the market. In 2001, we estimate they had around 65 
percent of the market. That is, of the $2 trillion of residential 
mortgage loans originated, $1.3 trillion were made by mortgage brokers.
    Mortgage brokers are the leading channel for the production of 
mortgages. We 
estimate there are 33,000 of these small, independent firms today. The 
median firm has 5 workers, including the owner. The average firm has 9 
workers, for a total employment of nearly 300,000 persons. They operate 
throughout the United States. The median firm is only 5 years old. So, 
they are quintessentially an industry of small firms competing 
vigorously with one another. If they do not give the consumer good 
service, they go out of business. In this sense, they are similar to 
barber shops. No firm has any special factors with which to exact 
extra-normal profits from the consumer other than personal service.
    Market information is widespread. Any shopper can log onto a 
computer and get instant market information from thousands of competing 
firms. Prices also are available in newspapers and television. 
Mortgages have become a commodity, with very little variation in price 
among lenders. There are firms out there, especially internet firms, 
that compete solely on price and offer little human interaction. Up 
until now, consumers have not flocked to these firms, but have stayed 
mainly with local brokers who can walk them through the complex process 
of originating a mortgage. The paperwork to complete a mortgage is 
highly regulated and complex and must be done correctly. If the loan is 
not done correctly, the consumer does not get the loan and the loan 
originator does not get paid.
    Fifteen years ago, this industry was dominated by savings and loan 
associations. Since then, a vigorous secondary market has evolved that 
allows mortgages to be converted into securities and traded around the 
world. The tasks to make a mortgage have become specialized. We now 
have about 100 wholesale mortgage firms buying loans from 33,000 
mortgage brokers. Mortgage servicing has become more centralized within 
the hands of a few larger wholesale firms. But brokers are the low cost 
producer of the origination process.
    The mortgage industry is highly volatile, with periods of high 
refinancing. Such peak volume years occurred in 1993, 1998, and 2001, 
when volume nearly doubled from the prior year. It is especially in 
such years that brokers are needed. The existing retail firms are not 
equipped to grow their work forces that fast. But brokers are very 
agile and can grow and contract more quickly to meet the needs of the 
market. Without brokers, the market would have virtually collapsed last 
year and many consumers who wanted the opportunity to refinance their 
mortgage to a lower rate would have been frustrated. There would have 
not been enough trained workers available to meet their need.

Yield Spread Premiums
    The mortgage industry serves the housing industry. It has become 
national policy to permit as many households as possible to own their 
own home. The goal is get the share of homeowning households up to 70 
percent. The main factor holding back more consumers from buying a 
house is the downpayment. So the market has evolved several ways to 
solve that problem--no downpayment or very low downpayment mortgages. 
It costs about 2 percent of the mortgage amount or $2,800, which is 
needed to compensate the broker for his cost, time, and profit in 
originating a mortgage loan. Most buyers today either do not have that 
amount to pay the origination fee or prefer to finance that fee. The 
mortgage originator cannot perform his origination function without 
being paid. From this has evolved the ``yield spread premium,'' which 
is a way for the homebuyer to retain more of his cash and yet pay the 
mortgage broker for his service--predominately saving the consumer 
dollars by refinancing at a lower rate and thereby lowering the 
consumer's cashflow. Mortgagors are saving on average about $100 per 
month (assuming a 1 percent reduction in the interest rate from 7.5 
percent to 6.5 percent on a $160,000 loan) by enlisting the mortgage 
broker's services. In today's market, the consumer has the choice of 
paying all of the fee upfront, part of the fee upfront, or financing 
the entire fee. The typical homebuyer opts to pay part of the fee 
upfront. So the income of the mortgage broker in today's market is 55 
percent in fees from the consumer and 45 percent in the form of a 
payment from the wholesaler.
    Yield spread premiums are really a financing tool. They became 
available around 1990 due to securitization. Their availability has 
spurred mortgage finance and had various spillover effects, including 
expanding the ranks of homebuyers; increasing refinance activity; 
growing the ranks of originators, especially brokers; and aiding the 
economic expansion of the 1990's. In particular, it has helped moderate 
the current recession by promoting the financing of homes and keeping 
the housing market vigorous.
    If Congress outlawed yield spread premiums, the results would be: 
(1) fewer mortgage originations, especially among middle- and low-
income consumers; (2) higher out-of-pocket expenses for homebuyers and 
homeowners; (3) fewer mortgage originators; (4) reduced national income 
and GDP.
    Exactly how many fewer mortgage transactions would result with a 
ban on yield spread premiums is conjecture. We believe the reduction 
could be 33 percent. A ban would adversely affect mortgagors, and 
broker mortgagees. There would absolutely be fewer of each group. The 
declines in each would be proportional. These declines would ripple 
through the mortgage sector, affecting realtors, builders, appraisers, 
mortgage insurers, credit bureaus, escrow companies, etc. Mortgage 
costs would rise due to less competition.
    More disclosures would add complexity and cost to a mortgage 
process which is already extremely confusing to the consumer. Predatory 
mortgage legislation is probably superfluous. The existing laws protect 
consumers from being bilked by swindlers and gougers. The number of 
predatory victims is quite small compared with the size of the mortgage 
industry. We estimate the number of mortgagors served with a new or 
refinanced loan at 60 million in the past 5 years. Very few have been 
harmed. There is no evidence to the contrary. Is it worth harming that 
huge market with even more laws? Enforcement of existing laws is the 
answer.

Reaction to HUD Clarification on YSP's
    I was present in Toronto, Canada at the MBA annual meeting when Mel 
Martinez announced his clarification of HUD's policy on yield spread 
premiums. I support his clarification because it explained the earlier 
statement HUD made in 1999 to the judiciary and thus should stop class 
action law suits over the mere payment of yield spreads to brokers. The 
mortgage industry has been plagued by class action law suits for 
several years that have cost the industry tens of millions of dollars. 
Ultimately, these costs are paid by consumers.

Impact on Brokers of Limiting YSP's
    I have been a long time supporter of mortgage brokers, who in 2001 
handled about 65 percent of all mortgage originations in the United 
States. They did so because they are the low cost providers. Our firm 
has studied this issue since 1991 and has been unwavering in its 
conclusions that brokers provide consumers with better service at a 
lower cost than their competitors. To restrict brokers is to hurt 
consumers.
    Brokers get half their income in the form of yield spread premiums. 
I estimate that if yield spread premiums were made illegal, about one-
third of all brokers would drop out of the business; and the other two-
thirds could survive by charging higher upfront origination fees, but 
it would dramatically change their customer profile. They would no 
longer be able to serve as many consumers with credit problems or FHA 
buyers. That means the market share of mortgage brokers would diminish. 
This would be very anticonsumer because brokers do a majority of the 
refinances in years such as 2001. Banks, thrifts, credit unions, and 
mortgage lenders use the concept of yield spread premium but do not 
have to report it. Any restriction on YSP's would only adversely affect 
brokers and have no impact on these other mortgage lenders. In 
addition, the retail channel (made up by banks, thrifts, etc.) just 
could not handle the volume. That means in the next refinance wave, 
many consumers would not get the refinances they desire, certainly not 
compared to those who refinanced them in the past waves. You would in 
effect frustrate about one-third of the 7 million households that did 
refinances, or 2.3 million households. Do you really wish to frustrate 
that many people? We estimate there are 33,000 independent mortgage 
brokers processing and originating loans currently within the United 
States. The average firm has 9 people working for them for a total of 
297,000 employees across the brokerage industry. Do you wish to put 
99,000 people out of work? In Maryland, there are 550 independent 
mortgage brokers with total employment of about 5,000 people. Do you 
wish to put 1,700 Maryland workers out on the street?
    Maryland has lost many financial services firms over the past 30 
years, including my former firm, Commercial Credit. There was MBNA, 
Maryland National Bank, Equitable Banks, and Baltimore Federal Savings 
Bank. In part, the 550 mortgage broker firms in Maryland have replaced 
the mortgage departments of those once venerable firms. But if Congress 
bans YSP's, you would put one-third of these 
brokers out of business also and force further consolidation in the 
industry. Nor would the consumer be benefited. You would force 
consumers into the hands of larger firms, mostly based elsewhere, that 
might charge higher rates and fees. Shrinking the supply given fixed 
demand would shift supply to the left and the price would, of course, 
rise. Consumers would pay a higher price consequently.

Impact on Consumers of Limiting YSP's
    If yield spreads are eliminated and all consumers have to pay out-
of-pocket fees, a large number of lower-income people would be pushed 
out of the market. This would fall most heavily on minorities. It would 
lower the portion of households that can become homeowners. Past 
Administrations have aimed toward 70 percent of all households becoming 
homeowners. That percentage would have to fall greatly, perhaps back 
down to 60 percent. As all these transactions are taken out of the 
market, there are thousands of secondary market impacts--a reduction in 
credit agents, appraisers, escrow agents, etc. Call them unintended 
consequences.
    What happens when Government protects consumers from borrowing 
mortgage money? Some loans are not made or the consumer resorts to 
credit cards and to personal loans at 18-21 percent interest or to hard 
money lenders at even higher rates of interest. Right now the prime 
mortgage industry is barely profitable and subprime mortgage lending is 
unprofitable. There has been an exodus of capital for the past several 
years. Consumers will not be benefited by causing more lenders to exit.

Disclosures to Curb Abuses
    If we mandate even more disclosures, make it the same for all 
lenders. The problem with asking brokers to estimate their YSP's at 
time of application is that they do not know what it will be. Until the 
loan application is complete, they do not know who they will be selling 
the loan to or what their YSP will be. They can only say that typically 
they earn half the cost of doing the transaction in that form. This is 
also true of all other retail lenders, not just brokers but loan 
originators at banks, thrifts, credit unions, and finance companies 
too. If you mandate even more disclosure, make it the same for all 
lenders. I would support uniform disclosures of all mortgage originator 
payments as a way to curb abusive uses of yield spread premiums to the 
extent they exist. But I do not think abuses are widespread, as 
consumers are increasingly sophisticated about financial matters. Doing 
away with yield spread premiums would not eliminate predatory lenders 
who thrive on cheating uneducated customers.
    Rather than trying to eliminate every vestige of overpricing, 
Congress should foster more education about loans. Over the past 3 
years, over half the firms in subprime lending have shut down. The 
remaining firms are not very profitable and are trembling not to be 
sued by the many new laws now on the books. I dare say, very few 
predatory acts (however these are defined) are taking place. Flipping 
has hurt Baltimore, but that has little to do with YSP's. Therefore, 
any new legislation beyond uniform disclosures across the entire 
industry would be redundant, counter-productive, and against the 
consumer's best interest. The normal use of a YSP is not predatory 
lending. It is part of doing business.
                               ----------

                PREPARED STATEMENT OF DAVID R. DONALDSON
                     Counsel, Donaldson & Guin, LLC

                            January 8, 2002

    Chairman Sarbanes, distinguished Members of the Committee, thank 
you for inviting me to testify on the abusive uses of yield spread 
premiums. By way of introduction, I am a lawyer in private practice in 
Birmingham, Alabama. I represent the plaintiff class in Culpepper v. 
Irwin Mortgage Corporation, a damages suit brought under the Real 
Estate Settlement and Procedures Act (RESPA). A 1998 Federal court of 
appeals decision in Culpepper \1\ led to HUD's 1999 Statement of Policy 
(SOP).\2\ Another decision by that same court in June 2001 resulted in 
HUD's 2001 SOP \3\ that this Committee has asked me to discuss here 
today.
---------------------------------------------------------------------------
    \1\ Culpepper v. Inland Mortgage Co., 132 F.3d 692, rehearing 
denied, 144 F.3d 717 (11th Cir. 1998).
    \2\ 64 Fed. Reg. 10080.
    \3\ 66 Fed. Reg. 53052.
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    I would like to begin by expressing my deep appreciation to this 
Committee for its efforts to examine and curb abusive and deceptive 
lending practices. The mortgage industry's current yield spread premium 
practices that are reflected in HUD's 2001 SOP are an integral part of 
the well-documented predatory problem that is crying out for 
examination and remedy.
    Irwin and many other lenders currently offer brokers yield spread 
premium payments whenever brokers are able to convince borrowers to 
accept higher interest rate loans. Consumers are, in effect, being 
encouraged to borrow money that lenders use to bribe brokers to do 
business with them. Consequently, brokers who have been fully 
compensated by loan origination fees and other ``direct'' payments also 
receive unearned additional ``compensation'' that costs homeowners 
thousands of additional dollars in mortgage payments over the duration 
of their loans.
    RESPA outlaws all kickbacks and referral fees.\4\ Under Culpepper, 
a yield spread premium can be legal if the evidence demonstrates that 
the yield spread premium was paid in exchange for the broker's 
services.\5\ HUD's 2001 SOP seeks to delete the ``for services'' 
requirement and thereby legalize ``reasonable'' referral fees even when 
no additional compensation is owed to the broker. I believe HUD's 
recent 
actions to be misguided, irrational, and in direct conflict with 
Congress's express intent in passing RESPA.
---------------------------------------------------------------------------
    \4\ This Committee's 1974 Report issued in connection with the 
original RESPA litigation, states that RESPA is intended to ``prohibit 
all kickback or referral fee arrangements whereby any payment is made . 
. . for the referral of real estate settlement business.'' S. Rep. No. 
93-866, 1974 U.S.C.C.A.N. 6546, 6551.
    \5\ See Culpepper v. Inland Mortgage Co., 132 F.3d 692, rehearing 
denied, 144 F.3d 717 (11th Cir. 1998). The 1999 SOP states: ``In the 
determination of whether payments from lenders to mortgage brokers are 
permissible under Section 8 of RESPA, the threshold question is whether 
there were goods or facilities actually furnished or services actually 
performed for the total compensation paid to the mortgage broker.'' 64 
Fed. Reg. at 10085.
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Yield Spread Premiums Are Not Being Used To Lower Closing Costs
    HUD's ostensible reason for the 2001 SOP was its claim that 
Culpepper might prevent borrowers from using yield spread premiums to 
lower their upfront closing costs.\6\ The court's Culpepper decisions, 
however, expressly allow borrowers to finance closing costs through 
yield spread premiums.\7\ A yield spread premium could be legal under 
Culpepper III if the lender's form contract with the mortgage broker 
required the broker to use the yield spread premium payment to reduce 
borrowers' upfront closing costs.\8\
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    \6\ The text of the 2001 SOP, as well as the Secretary's news 
release announcing that pronouncement justified the SOP on the grounds 
that ``[y]ield spread premiums serve to allow the borrower a lower 
upfront cash payment in return for a higher interest rate. . . .'' See 
66 Fed. Reg. at 53055; see also HUD News Release No. 01-105.
    \7\ Culpepper I, 144 F.3d at 718.
    \8\ A yield spread premium is legal under Culpepper III ``if the 
agreement to pay it bore the hallmarks of a fee-for-service exchange.'' 
Culpepper III, 253 F.3d at 1331.
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    HUD's and the industry's ``consumer benefit'' arguments are clearly 
``red herrings.'' Under HUD's ``reasonableness test,'' YSP's are legal 
regardless of whether they are used to lower closing costs. Moreover, 
lenders and brokers do not, in fact, use yield spread premiums to lower 
borrowers' closing costs. At the outset of the Culpepper litigation, 
Irwin claimed that ``the yield spread premium was simply the market-
driven payment to [the broker] for an asset--the loan itself.'' \9\ It 
was only after the courts rejected that argument that industry lawyers 
concocted the idea that yield spread premiums were used to lower 
borrowers' closing costs. My colleagues and I have examined thousands 
of Irwin's borrowers' loan documents, and I have yet to find a single 
class member whose closing costs were reduced as a result of yield 
spread premiums. Among class members in other cases, I am only aware of 
a tiny handful of settlement statements reflecting credits against the 
borrowers' obligations resulting from yield spread premiums.\10\
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    \9\ Culpepper v. Inland Mortgage Corp., 953 F.Supp. 367, 371 (N.D. 
Ala. 1997).
    \10\ The HUD-1 Settlement Statements required by RESPA and HUD to 
be delivered at closing is required to reflect credits against closing 
costs for payments made by the lender on the borrower's behalf if any 
were given.
---------------------------------------------------------------------------
    If yield spread premiums were actually being used to lower 
borrowers' closing costs, the lenders could expect to prevail in the 
litigation. Indeed, if they are not violating the law, they will 
prevail in court. But it is highly improper for HUD to attempt to 
overrule the courts, alter the plain meaning of Congress' statute, and, 
indeed, interfere with both procedural and evidentiary issues in the 
judicial system. HUD has no such power, nor should it.

HUD's 2001 SOP Does Nothing To Curb Abusive YSP Payments
    HUD and mortgage industry representatives have publicly admitted 
that mortgage brokers frequently tack on unexpected charges at closing 
when it is too late for borrowers to obtain other financing.\11\ This 
should come as no surprise since the National Association of Mortgage 
Brokers (NAMB) takes the position that brokers should be allowed to 
hide yield spread premiums from borrowers.\12\ While the Culpepper 
court's ``fee for services'' approach would help curb these nefarious 
``bait and switch'' tactics, HUD's ``reasonableness'' test encourages 
brokers to tack on additional charges at closing. Since the 
``reasonableness'' of a charge is measured by what other brokers 
charge, no referral fee or kickback can be illegal under HUD's test as 
long as the practices are widespread.
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    \11\ In HUD's Press Release No. 01-105 announcing the 2001 SOP, 
Secretary Martinez stated: ``At closing, too many American families sit 
down at the settlement table and discover unexpected fees that can add 
thousands of dollars to the cost of their loans.'' In the December 23, 
2001 edition of The Los Angeles Times, Mr. Falk, who is testifying here 
today on behalf of the National Association of Mortgage Brokers, was 
quoted as stating that ``horror stories abound of borrowers arriving at 
closing to find that [the] actual cost of various services are hundreds 
of dollars above what was disclosed on the Good Faith Estimate.''
    \12\ During HUD's negotiated rulemaking on yield spread premiums 
that led up to its 1997 proposed rule for providing for binding 
contracts between brokers and borrowers, the NAMB argued 
``strenuously'' that yield spread premiums should not be disclosed to 
borrowers. See 62 FR at 53917. In the NAMB's December 4, 2001 Position 
Paper entitled ``Mortgage Originator Disclosures--Position on 
Prospective HUD Rulemaking Concerning Mortgage Originator Disclosures'' 
(available on the NAMB's website www.namb.org) has an entire section 
(at para. 4) devoted to its contention that ``Originators should not be 
required to disclose their compensation.''
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HUD's ``Reasonableness'' Test Amounts to Illegal Rate Regulation
    When Congress passed RESPA, it expressly rejected HUD's proposals 
for authority to impose caps on settlement charges. Congress chose to 
allow the market to set prices and rejected HUD's request for a ``large 
bureaucracy'' within HUD to set rates for various types of loans in 
various locales.\13\ Since HUD lacks the legal authority and the staff 
to set caps on settlement charges for various loans, it surely cannot 
examine millions of individual loan transactions to determine if 
individual broker payments are ``reasonable.'' HUD's ``reasonableness'' 
rule ignores the fact that allowing the ``market'' to set prices is a 
two-way street. If brokers are free to set their own charges, they must 
also be prohibited from collecting more than borrowers agree to pay.
---------------------------------------------------------------------------
    \13\ See 1974 U.S.C.C.A.N. at 6550.
---------------------------------------------------------------------------
The 2001 SOP Test For Yield Spread Premium Payments To Brokers Is
Inconsistent With The Test For Other Types of Markups by Other

Settlement Service Providers
    The 2001 SOP is also internally inconsistent in the way it treats 
yield spread premium payments to mortgage brokers as opposed to other 
types of mark-ups charged by other service providers. While imposing a 
``reasonableness'' test for YSP pay-
ments to brokers, the 2001 SOP states that other settlement service 
providers violate RESPA whenever they mark up the cost of a third 
party's services without providing additional settlement services over 
and above the services for which the provider has already been 
paid.\14\ For example, the 2001 SOP states that a RESPA violation 
occurs when a lender collects $200 from the borrower for an appraisal 
fee, pays an independent appraiser $175 and pockets the $25 mark-
up.\15\ The ``reasonableness'' of the $200 charge is presumably 
irrelevant. HUD has recently (and with great fanfare) \16\ brought 
several RESPA enforcement actions arising from a variety of contexts 
unrelated to yield spread premiums. None of these recent enforcement 
actions would have been possible under HUD's ``reasonableness'' test 
for yield spread premiums. Conversely, under the test applied to 
appraisals and other settlement charges, if a broker charges a loan 
origination fee and then marks up a borrower's interest rate a RESPA 
violation would occur. There is no legal or logical basis for this 
inconsistent treatment.
---------------------------------------------------------------------------
    \14\ See 66 Fed. Reg. at 53059.
    \15\ See 66 Fed. Reg. at 53058.
    \16\ See HUD Press Release No. 01-118.
---------------------------------------------------------------------------
HUD Has Tacitly Admitted That Its 2001 SOP Is Inadequate To Protect
Consumers
    HUD recognizes that its ``reasonableness'' test is inadequate to 
protect borrowers. On the same day that HUD released its 2001 SOP, it 
also sent a letter \17\ to all FHA approved lenders setting out HUD's 
views on ``best practices'' regarding yield spread premiums. HUD urges 
lenders to disclose the total amount of the broker's compensation, 
including the yield spread premium and to obtain a written 
acknowledgment by the borrower. HUD also suggested that lenders reflect 
yield spread premiums as credits on borrower's HUD-1's.
---------------------------------------------------------------------------
    \17\ Mortgagee Letter 2001-26 (available on HUD's website).
---------------------------------------------------------------------------
HUD's Claim That The 2001 SOP Is A ``Clarification'' Is Unsupportable
    HUD's claim that the 2001 SOP reflects its earlier intent is 
disingenuous. In the 1999 SOP and in correspondence between HUD's 
former General Counsel and Members of Congress, including a Member of 
this Committee, HUD expressly stated that the 1999 SOP was not intended 
to change existing law, which was expressed in the appellate court's 
previous Culpepper decisions.\18\
---------------------------------------------------------------------------
    \18\ See attached letter from Gail Laster to Senator Richard Shelby 
dated March 21, 2000.
---------------------------------------------------------------------------
    Five years ago when the Culpepper case was filed, Irwin did not 
even require brokers to disclose yield spread premium amounts on 
borrowers' Good Faith Estimates. It was not until after the 1998 
Culpepper decision that Irwin began requiring brokers to disclose yield 
spread premium amounts on GFE's. Although the industry has been forced 
by the ongoing yield spread premium class action litigation to make at 
least minimal yield spread premium disclosures to consumers, much more 
is needed if consumers are to be able to have any hope of protecting 
themselves in mortgage loan originations.
    Obviously, HUD is correct in the view expressed in its recent 
mortgagee letter that brokers should disclose their total compensation 
and that borrowers should be given credit against whatever is owed to 
the broker when the broker receives a yield spread premium. Even with 
that disclosure, however, it is doubtful that any but even the most 
sophisticated borrower could make an informed decision about yield 
spread premiums without additional disclosures being required. To make 
an informed decision about yield spread premiums, borrowers would also 
have to know how much their rates are being increased to generate the 
yield spread premium and have to know how much additional monthly 
interest payments they would incur as a result of the markup. Moreover, 
in order to prevent unscrupulous brokers from overcharging and to 
prevent borrowers from ``bait and switch'' tactics where yield spread 
premiums are disclosed for the first time at closing on the HUD-1, HUD 
must require the mortgage industry to use yield spread premiums to 
lower closing costs as it now claims to be doing.
    Finally, I would be remiss if I failed to point out my personal 
opinion that current yield spread premium practices encourage 
discrimination. After spending 5 years of looking at numerous 
borrowers' closing documents it is clear to me that borrowers who are 
black, female, or Hispanic pay higher total broker ``compensation'' 
than white males. That opinion is also supported by a recent Urban 
Institute Study financed by HUD which found that ``[t]here is no 
question that minorities are less likely than whites to obtain mortgage 
financing and that, if successful, they receive less generous loan 
amounts and terms.'' HUD News Release, No 99-191, New 
Reports Document Discrimination Against Minorities by Mortgage Lending 
Institutions, at 1 (September 15, 1999). The Urban Institute Study also 
found that African-Americans and Hispanics tend to pay higher YSP's 
than whites and that women pay more than men. Urban Institute Study at 
95 n. 11. One of the Culpepper plaintiffs, Beatrice Hiers, is an 
African-American female from Baltimore whose broker received over 
$10,000 for assisting in her origination of a $160,000 FHA mortgage. 
The $4,500 YSP would never have been paid under the Culpepper rule. 
According to Irwin, that payment was legal because it was 
``reasonable.''
    Federal regulators require banks and other depository institutions 
to implement safeguards to prevent racial and other types of 
discrimination by their employees. Mortgage brokers, however, are often 
nothing more than an individual or small group of individuals acting as 
independent contractor loan officers. They are not subjected to any 
oversight by institutional lenders or by regulators. Current yield 
spread premium practices that base ``compensation'' on the broker's 
ability to convince borrowers to accept higher interest rates encourage 
discrimination.
    Thank you again for inviting me and for your attention to these 
important issues.

 RESPONSE TO WRITTEN QUESTIONS OF SENATOR SARBANES FROM HOWELL 
                           E. JACKSON

Q.1. During the hearing, Mr. Olson said that the mortgage 
brokerage business ``is not very profitable.'' Do you have any 
information on the profitability of the mortgage broker 
industry?

A.1. While I have not undertaken an independent investigation 
of the profitability of the mortgage brokerage business, I 
reviewed several reports on the subject that Mr. Olson himself 
prepared. Contrary to Mr. Olson's testimony at the hearing, 
these reports indicate that mortgage brokers have been 
extremely profitable in the past decade and, in particular, 
during the 1996-2000 period during which the sample loans in my 
study were originated.
    To begin with, consider the growth of mortgage brokers. 
According to Mr. Olson's Wholesale Access Report: Mortgage 
Brokers 1998 (published in 1999), the industry grew 
dramatically during the 1990's:

    There were about 36,000 mortgage brokers in the United 
States in 1998, up from 14,000 in 1991 and 31,000 in 1997. 
There was a 14.5 percent average annual rate of growth in the 
number of brokers from 1991 to 1998, which is parallel to the 
15 percent average annual growth in originations over the same 
period. (Page 1)

    Without any further information, I would be skeptical of 
any claims that an industry experiencing such a sustained rate 
of growth ``is not very profitable.'' If the industry were not 
profitable, why would so many new firms have been established 
during the last decade? However, one does not have to rely on 
inferences to assess the profitability of mortgage brokers in 
the 1990's. Mr. Olson's report directly addresses the issue:

    The median broker produced $20 million, had 5 employees, 
produced 200 loans, earned $2,000 gross per loan, for a total 
revenue of $400,000 per firm. In 1991, the median broker 
produced $15 million with 5 employees. (Page 1)

    So while the number of mortgage brokers more than doubled 
between 1991 and 1998, the level of originations of the median 
firm also increased by a third.
    Finally, Mr. Olson's report offers the following evaluation 
of the profitability of the mortgage brokerage business in 
1998:

    The median broker earned $2,000 gross income/loan for 200 
loans, which means gross revenue of $400,000 (Table 94). The 
mean broker earned $2,443 gross income/loan for 325 loans, 
which means gross revenue of $794,000. Median expenses were 
$240,000, for a net profit of $160,000 (40 percent). The mean 
broker earned a profit of $203,000 on $794,000 (26 percent). 
Our study covering 1992 shows a median 
profit of $100,000 on revenue of $400,000. This suggests a 
higher rate of profit in 1998 than earlier. Since brokers are 
rarely C Corporations, they do not pay a corporate profits tax. 
They do however pay taxes at their lower personal rate. This 
suggests a total profit by brokers of $7.3 billion (36,000 
 $203,000) before taxes. This exceeds the amount 
earned by the two Federal agencies combined and much of the 
rest of the mortgage industry. (Page 14) (Emphasis added).

    As the median firm operates as a sole proprietorship, Mr. 
Olson's report suggests that a typical mortgage broker earned 
$160,000 in 1998--an extraordinary median level of income for 
an industry that does not require substantial training or 
advanced degrees.
    Last year, Mr. Olson issued an updated Whole Access Report: 
Mortgage Brokers 2000 (published in 2001). In connection with 
litigation for which I am serving as an expert witness for the 
plaintiff class, I have reviewed a copy of this more recent 
report. However, the 2000 report was supplied to me under 
conditions of confidentiality and I am not free to reveal to 
the Committee the detail of Mr. Olson's more recent work. I 
can, however, provide the Committee my overall assessment of 
the 2000 report. While there have been some changes in the 
structure and the earnings of mortgage brokers since 1998, I am 
highly confident that Mr. Olson would concur in my opinion that 
there is little in this more recent report to suggest that 
mortgage brokering does not remain a profitable enterprise.

Q.2. In your view, is the 2001 HUD ``clarification'' consistent 
with the law, and should the courts give it deference?

A.2. In the 2001 policy statement, 66 Fed. Reg. 53,052 (October 
18, 2001), the Department proposes a legal standard to 
determine when the payment of yield spread premiums violates 
Section 8 of RESPA. Under the Department's approach, a yield 
spread premium constitutes a per se violation of Section 8 only 
if the mortgage broker receiving the payment provides no goods 
or services in connection with the transaction. If the mortgage 
broker does provide either such goods or services, then the 
payment is legal unless the borrower can demonstrate that the 
broker's total compensation was unreasonable. Reasonableness, 
under the Department's policy statement, is to be determined on 
a case-by-case basis and not (by implication) in a class action 
lawsuit.
    In my testimony before the Committee I questioned the 
factual assumptions underlying the Department's 2001 policy 
statement.\1\ I also have serious questions about the policy 
statement's fidelity to the statutory language of Section 8 of 
RESPA. In my view, there are three principal difficulties in 
the Department's legal analysis.
---------------------------------------------------------------------------
    \1\ As I explained in my testimony, an initial problem with the 
policy statement is the Department's factual assumptions that yield 
spread premiums are simply an alternative source of financing for 
closing costs used by a discrete group of borrowers who cannot afford 
to pay those costs directly. My own study of yield spread premiums 
suggests that these payments are being imposed much more broadly and 
that borrowers who incur these hidden charges end up paying their 
mortgage brokers much more--on the order of $1,000 more--than do 
borrowers with comparable loans unaffected by yield spread premiums. 
The Department's misunderstanding of the true role of yield spread 
premiums further weakens the legal basis of the policy statement.
---------------------------------------------------------------------------
The Policy Statement Appears to Create a Loophole for the
Market Abuses That Congress Clearly Intended for
Section 8 To Eradicate
    In the legislative process leading up to the original 
passage of RESPA in 1974, Congress was confronted with 
substantial evidence that real estate professionals, such as 
lawyers and real estate agents, were using their influence over 
real estate transactions to extract kickbacks from title 
insurance companies and other settlement service providers. 
Concluding that such payments were inherently unfair and 
needlessly increased the cost of homeownership, Congress 
adopted Section 8 to outlaw these practices. A major difficulty 
with the Department's 2001 policy statement is that it appears 
to create a substantial defense for precisely the practices 
that Congress intended to prohibit with Section 8. All of the 
recipients of these pre-RESPA kickbacks provided some good or 
service for the transaction in question and also received other 
sources of compensation for their services. The Department's 
new policy statement would, as best as I can tell, permit the 
payments of kickbacks in real estate settlements unless the 
recipient of the kickback could show that its total 
compensation (including the kickback) was not unreasonable. 
Such solicitude for the payment of kickbacks is wholly 
inconsistent with Congress's purpose in enacting Section 8 of 
RESPA.

The Department's 2001 Policy Statement Establishes a
Regime of De Facto Rate Regulation for Mortgage Services
in Direct Contradiction of Congressional Intent
    When adopting RESPA in 1974, Congress expressly rejected 
the proposals to establish a national system of rate regulation 
for real estate settlement services and chose instead a 
combination of prohibitions, such as Section 8, and disclosure 
requirements. With its 2001 policy statement, the Department 
effectively repeals this Congressional choice. As I read the 
policy statement, courts would be called upon to evaluate the 
legality of most kickbacks and referral fees based on the 
reasonableness of the total compensation of the recipient. 
While the Department does not delineate the precise contours of 
this reasonableness standard, the courts would presumably have 
to consider a kickback recipient's total costs, figure in 
reasonable rates of return on investment, and come up with an 
overall reasonable price for the recipient's goods and services 
in light of contemporaneous market prices for other comparable 
goods and services. Congress clearly did not want a Federal 
administrative agency to engage in this rate regulation, and I 
am highly doubtful that it would have intended for the courts 
to play such a role.

The Policy Statement Gratuitously Intrudes Upon Judicial
Functions
    A further problem with the 2001 policy statement is its 
gratuitous intrusion into the management of judicial cases. In 
an apparent effort to influence the certification of plaintiff 
classes in pending cases, the 2001 policy statement includes 
language suggesting that ``it is necessary to look at each 
transaction individually'' and that reasonableness depends on 
an evaluation of factors that can only be considered on a case-
by-case basis. This analysis strikes me as misguided and 
inconsistent with prevailing judicial practices. First of all, 
reasonableness in a particular case can only be determined in 
comparison to a broader category. Of necessity, therefore, 
litigation over yield spread premiums will involve 
consideration of a large number of transactions. And the best 
way to determine whether loans with yield spread premiums 
entail unreasonable compensation to mortgage brokers is to 
compare samples of loans with yield spread premiums to samples 
without yield spread premiums.\2\ To require repeated analysis 
of this sort in a host of individual cases strikes me as a 
highly wasteful use of judicial resources. Moreover, the 
Department's approach seems to confuse the question of how much 
individual borrowers were injured through the payment of 
illegal kickbacks--something that might well vary from 
transaction to transaction and thus potentially influence the 
amount of damages--with the question of underlying liability. 
In many areas of the law, courts determine liability on a 
class-wide basis and then base damage awards on individualized 
determinations. Whether class certification would also be 
appropriate for civil suits challenging yield spread premiums 
under Section 8 of RESPA strikes me as a matter for the court, 
not an administrative agency, to resolve.
---------------------------------------------------------------------------
    \2\ In the litigation in which I am serving as an expert witness, 
experts for both sides defendants as well as plaintiffs--used this 
statistical--analysis to evaluate the impact of yield spread premiums 
on mortgage broker compensation.
---------------------------------------------------------------------------
    How much deference the Federal courts should accord the 
Department's 2001 policy statement is an important question 
that I did not address in my testimony before the Committee and 
that I will only briefly touch upon in this supplemental 
statement. As described above, I believe there are serious 
inconsistencies between the 2001 policy statement and the 
Congressional purposes in enacting Section 8 of RESPA. To the 
extent that the courts agree with my analysis of these issues, 
the policy statement would be subject to diminished deference 
even under the high standards that the Supreme Court set forth 
in Chevron U.S.A. Inc. v. Natural Resources Defense Council, 
467 U.S. 837 (1984). Just last year, however, the Supreme Court 
narrowed the scope of the Chevron doctrine by holding that when 
an agency interpretation is not the product of either formal 
adjudication or notice-and-comment rulemaking, the Chevron 
deference standards may not even apply. See United States v. 
Mead Corporation, 533 U.S. 218 (2001). While the implications 
of the Court's recent ruling remain to be determined, I think 
it is fair to say the decision reduces the degree of deference 
that Federal courts are likely to show interpretative rulings 
such as the Department's 2001 policy statement. Particularly to 
the extent that the policy statement purports to dictate the 
manner in which the judiciary should manage class certification 
procedures, judicial deference to the agency's view should be 
modest. See Adams Fruit Co. v. Barrett, 494 U.S. 638 (1990) 
(inappropriate for courts to consult executive interpretations 
to resolve ambiguities in the scope of a judicially enforceable 
remedy).

Q.3. Currently, when individuals apply for loan assistance or a 
home mortgage, they are unaware of their credit scoring, and 
are therefore, under the Fair Credit Reporting Act (FCRA), 
vulnerable to acts of predatory lending including taking on a 
mortgage with a high-interest rate even though their credit 
score may qualify them for a low-interest loan. I think this is 
a serious issue, and Senator Allard and I have introduced the 
Consumer Credit Score Disclosure Act of 2001, which amends the 
FCRA to provide the consumer with a copy of: (1) the 
information obtained from a consumer reporting agency or that 
was developed and used by that user of the credit score 
information; or (2) a copy of the information provided to the 
user by a third party that developed the credit score, plus a 
general description of credit scores, their use, and the 
sources and kinds of data used to generate credit scores. As an 
expert testifying before the Committee, would you agree, that 
individuals should have access to their credit score in order 
to protect themselves from acts of predatory lending?

A.3. Yes. I agree that it would be useful for consumers to be 
given access to their credit scores. In addition, as I 
indicated in my testimony, I think consumers should also be 
provided information regarding the range of loans--including 
par value loans--available to borrowers with their credit 
scores. In addition to improving the fairness of loan 
transactions, disclosures of this sort would allow consumer 
groups and the financial press to provide better guidance to 
borrowers and thereby enhance the overall operations of credit 
markets.

                             *  *  *  *  *

      Response to the Statement of ABN AMRO Mortgage Group

    Following the Committee's hearing of January 8, 2002, ABN 
AMRO Mortgage Group filed a statement disagreeing with certain 
aspects of my testimony and appending statements by two expert 
witnesses retained by defendants in the Glover v. Standard 
Federal Bank litigation in which I am serving as an expert for 
the plaintiffs. Having reviewed these materials, I remain 
confident that my testimony before the Committee presents an 
accurate picture of the abusive nature of yield spread 
premiums, that these payments 
impose substantial additional costs on consumers, and that the 
reforms I advocated for HUD-1 disclosures are fully warranted.

RESPONSE TO WRITTEN QUESTION OF SENATOR SCHUMER FROM JOSEPH L. 
                              FALK

Q.1. As an expert testifying before the Committee, would you 
agree, that an individual should have access to their credit 
score in order to protect themselves from acts of predatory 
lending?

A.1. NAMB strongly believes that all consumers should have 
access to their credit score in order to know where they stand 
in the eyes of the lender, and to better understand how one's 
credit history can affect his/her ability to purchase and own a 
home. We do not believe accessibility should be a function of 
whether the individual is a candidate for a prime or subprime 
loan, but instead, available to any and all consumers seeking 
to obtain a mortgage. More than just words, NAMB has taken 
tangible steps to help educate consumers about the importance 
of one's credit score. On November 19, 2001, NAMB released an 
educational piece entitled, ``Buying A Home . . . How Will Your 
Credit History Affect You?'' This is part of NAMB's efforts to 
encourage consumers to ``Know the Score.'' The article 
identifies the five key criteria used in determining a credit 
score and lets consumers know that they can receive a copy of 
``A Consumer's Guide to the Facts & Fiction About Credit 
Scoring and Its Role in Lending'' from any NAMB mortgage broker 
member.





RESPONSE TO WRITTEN QUESTION OF SENATOR SARBANES FROM DAVID R. 
                           DONALDSON

Q.1. In your view, is the 2001 HUD ``clarification'' consistent 
with the law, and should the courts give it deference?

A.1. No. HUD's 2001 ``clarification'' regarding yield spread 
premium payments is inconsistent with RESPA's plain language 
and its legislative intent. The courts should not afford HUD's 
SOP 2001-1 any deference.
    Section 8(a) of RESPA expressly outlaws all referral fees, 
not just ``unreasonably'' high referrals fees.\1\ HUD and the 
courts have recognized that yield spread premiums violate 
Section 8 of RESPA unless they fall within the ``goods or 
services'' language of Section 8(c), which states that RESPA 
does not prohibit ``payment for goods or facilities actually 
furnished or for services actually performed . . .'' 12 U.S.C. 
Sec. 2607(c) (Emphasis added.) Thus, for a yield spread premium 
to be legal under RESPA, the lender must demonstrate that the 
yield spread premium was paid for legitimate ``services'' other 
than the referral of the loan.
---------------------------------------------------------------------------
    \1\ Section 8(a) of RESPA states:
    No person shall give and no person shall accept any fee, kickback, 
or thing of value pursuant to any agreement or understanding, oral or 
otherwise, that business incident to or a part of a real estate 
settlement service involving a Federally related mortgage loan shall be 
referred to any person.
---------------------------------------------------------------------------
    HUD's 1999 SOP on yield spread premiums contained the same 
``for services'' requirement that is set out in the statute. 
HUD's 2001 SOP, however, deleted the statute's ``for services'' 
language. According to the 2001 SOP, yield spread premium 
payments are legal so long as the amount of money received by 
the broker is ``reasonable.'' 66 Fed. Reg. at 53055. There is 
nothing in the statute to support HUD's conclusion that 
``reasonable'' referral few are legal. As this Committee 
pointed out in its 1974 Report issued when Congress first 
enacted the statute, RESPA was intended to ``prohibit all 
kickback or referral fee arrangements whereby any payment is 
made . . . for the referral of real estate settlement 
business.'' S. Rep. No. 93-866, 1974 U.S.C.C.A.N. 6546, 6551 
(Emphasis added.)
    When Congress passed RESPA, it rejected proposals to allow 
HUD to determine when rates are too high. Congress chose to 
allow an open and honest market to set prices and rejected 
HUD's request for a ``large bureaucracy'' within HUD to set 
rates for various types of settlement services in various 
locales. See 1974 U.S.C.C.A.N. at 6550. Nonetheless, HUD has 
now unilaterally attempted to grant itself the power it was 
denied by Congress to regulate the ``reasonableness'' of broker 
payments. HUD's 2001 SOP is clearly illegal and inconsistent 
with RESPA. HUD lacks the authority to set ``reasonableness'' 
caps that allow brokers to charge borrowers more than the 
borrowers agreed to pay.
    RESPA carries criminal as well as civil penalties. Yet 
HUD's 2001 ``reasonableness'' test is so vague and ambiguous 
that it could never withstand a constitutional challenge. As 
the Court of Appeals pointed out, by focusing entirely on the 
agreement between the broker and borrower and ignoring the 
lender's purpose in making the yield spread premium payment, 
the ``reasonableness'' test would place the lender in the 
``bizarre position of not knowing whether its conduct was 
illegal when it committed it.'' Culpepper v. Irwin Mortgage 
Corp., 253 F.3d 1324, 1331 (11th Cir. 2001).
    I also believe that the 2001 SOP is invalid due to HUD's 
failure to comply with the requirements of Section 8(c)(5) of 
RESPA, which allows HUD to make RESPA interpretations by 
regulation after consulting with the Attorney General, the 
Secretary of Veterans Affairs, the Federal Home Loan Bank 
Board, the Federal Deposit Insurance Corporation, the Board of 
Governors of the Federal Reserve System, and the Secretary of 
Agriculture. The 2001 SOP was not adopted by regulation. Nor 
did HUD consult with other agencies before issuing the SOP.
    HUD's 2001 SOP is based on the misconception that the 
purpose of yield spread premiums is to allow borrowers to lower 
their ``direct'' closing costs, such as loan origination fees. 
That idea is pure fantasy. It is an argument dreamed up in the 
course of this litigation after the Court of Appeals rejected 
Irwin's claim that YSP's are compensation for above-par 
mortgages. Not one shred of evidence has been submitted in any 
of the yield spread premium cases to support this fallacious 
premise. Indeed, it is my understanding that mortgage industry 
representatives were unable to locate a single borrower who was 
helped by the use of yield spread premiums to testify at the 
hearing on January 8 conducted by this Committee from among the 
millions of borrowers whose brokers have received YSP's.
    Lenders offer YSP's for one reason only, to encourage 
brokers to send them business. Mr. Olson who testified as a 
mortgage industry expert at this Committee's January 8 hearing, 
has admitted under oath that he has conducted studies to 
determine the amount of yield spread premium that lenders must 
offer to obtain broker referrals. Likewise, Standard Federal's 
Jeff Conner candidly admitted that Standard Federal offers 
yield spread premiums ``to get business.'' Numerous witnesses 
in the Standard Federal case have now admitted that the YSP's 
are nothing but a program of inducements to brokers to refer 
loans to Standard Federal or its subsidiaries rather than to 
some competing lender. Others admit that the lender is merely 
buying high-yield loans by offering the broker a financial 
inducement to lock borrowers into high mortgage rates. 
Similarly, in the Culpepper case, Irwin admitted that the 
broker was owed no ``additional compensation'' for its services 
and that ``the yield spread premium was paid to [the mortgage 
broker in part] for the slightly above-par yield on the 
mortgage note and [in part] for the right to service the 
loan.'' Culpepper v. Inland Mortgage Corp., 132 F.3d 692, 697-
98 (11th Cir. 1998). Copies of some of the Standard Federal 
testimony is enclosed. I can readily furnish additional 
testimony if you desire it.
    HUD's 2001 SOP is also based on the misconception that the 
Eleventh Circuit Court of Appeals' Culpepper decisions made all 
yield spread premiums illegal. Nothing could be further from 
the truth. The Culpepper decisions made it crystal clear that 
borrowers may legally use YSP's to finance closing costs and 
that lenders may pay YSP's if their contracts with the brokers 
provide for additional compensation for the broker's legitimate 
services.\2\ The difference between HUD's approach and the 
statute as interpreted by the Eleventh Circuit is that the 
Culpepper court's decision limits YSP payments to situations 
where brokers are owed additional compensation. HUD, on the 
other hand, now advocates allowing brokers to charge more than 
borrowers agree to pay.
---------------------------------------------------------------------------
    \2\ However, as Professor Jackson pointed out in his testimony 
before the Committee, using YSP's to finance closing costs often 
results in a shockingly high interest rate on the small increment of 
additional money that is credited to the borrowers.
---------------------------------------------------------------------------
    HUD's 2001 policy statement is fundamentally inconsistent 
with RESPA's referral fee prohibition. HUD has no power to 
interpret RESPA in a manner that frustrates the statute or the 
policy underlying the statute. HUD's 2001 policy statement 
violates this fundamental rule and is accordingly not entitled 
to any deference by the courts.

 RESPONSE TO WRITTEN QUESTION OF SENATOR SCHUMER FROM DAVID R. 
                           DONALDSON

Q.1. As an expert testifying before the Committee, would you 
agree that individuals should have access to their credit 
scores in order to protect themselves from acts of predatory 
lending?

A.1. I agree that borrowers should be provided with a copy of 
all information provided by the consumer reporting agencies to 
third parties along with information explaining how credit 
scores are calculated and used. If lenders are forced to stop 
offering illegal incentives for brokers to jack up people's 
interest rates and if brokers are forced to provide credit 
scoring information to borrowers, borrowers will have a 
``fighting chance'' to avoid being tricked into originating 
``above-par'' mortgages that cost them millions of dollars in 
unnecessary interest payments.



















































































































































































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