    Consumer Protection: Federal and State Agencies Face Challenges
    in  Combating Predatory Lending (30-JAN-04, GAO-04-280).

    While there is no universally accepted definition, the term
    "predatory lending" is used to characterize a range of practices,
    including deception, fraud, or manipulation, that a mortgage
    broker or lender may use to make a loan with terms that are
    disadvantageous to the borrower. No comprehensive data are
    available on the extent of these practices, but they appear most
    likely to occur among subprime mortgages--those made to borrowers
    with impaired credit or limited incomes. GAO was asked to examine
    actions taken by federal agencies and states to combat predatory
    lending; the roles played by the secondary market and by consumer
    education, mortgage counseling, and loan disclosure requirements;
    and the impact of predatory lending on the elderly.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-04-280
        ACCNO:   A09188
      TITLE:     Consumer Protection: Federal and State Agencies Face
    Challenges in  Combating Predatory Lending
         DATE:   01/30/2004
      SUBJECT:   Consumer education
    	     Consumer protection
    	     Elderly persons
    	     Federal law
    	     Fraud
    	     Information disclosure
    	     Lending institutions
    	     Loan interest rates
    	     Mortgage loans
    	     State law
    	     Truth-in-lending law

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    GAO-04-280

    United States General Accounting Office

    GAO

    Report to the Chairman and Ranking

                Minority Member, Special Committee on Aging, U.S. Senate

    January 2004

    CONSUMER PROTECTION

    Federal and State Agencies Face Challenges in Combating Predatory Lending

                                           a

    GAO-04-280

    Highlights of GAO-04-280, a report to the Chairman and Ranking Minority
    Member, Special Committee on Aging, U.S. Senate

    While there is no universally accepted definition, the term "predatory
    lending" is used to characterize a range of practices, including
    deception, fraud, or manipulation, that a mortgage broker or lender may
    use to make a loan with terms that are disadvantageous to the borrower. No
    comprehensive data are available on the extent of these practices, but
    they appear most likely to occur among subprime mortgages-those made to
    borrowers with impaired credit or limited incomes. GAO was asked to
    examine actions taken by federal agencies and states to combat predatory
    lending; the roles played by the secondary market and by consumer
    education, mortgage counseling, and loan disclosure requirements; and the
    impact of predatory lending on the elderly.

    GAO suggests that Congress consider providing the Federal Reserve Board
    with the authority to routinely monitor and, as necessary, examine nonbank
    mortgage lending subsidiaries of financial and bank holding companies to
    ensure compliance with federal consumer protection laws applicable to
    predatory lending. Congress should also consider giving the Board specific
    authority to initiate enforcement actions under those laws against these
    nonbank mortgage lending subsidiaries.

    www.gao.gov/cgi-bin/getrpt?GAO-04-280.

    To view the full product, including the scope and methodology, click on
    the link above. For more information, contact David G. Wood at
    202-512-8678 or woodd@gao.gov.

    January 2004

    CONSUMER PROTECTION

    Federal and State Agencies Face Challenges in Combating Predatory Lending

    While only one federal law-the Home Ownership and Equity Protection Act-is
    specifically designed to combat predatory lending, federal agencies have
    taken actions, sometimes jointly, under various federal consumer
    protection laws. The Federal Trade Commission (FTC) has played the most
    prominent enforcement role, filing 19 complaints and reaching multimillion
    dollar settlements. The Departments of Justice and Housing and Urban
    Development have also entered into predatory lending-related settlements,
    using laws such as the Fair Housing Act and the Real Estate Settlement
    Procedures Act. Federal banking regulators, including the Federal Reserve
    Board, report little evidence of predatory lending by the institutions
    they supervise. However, the nonbank subsidiaries of financial and bank
    holding companies-financial institutions which account for a significant
    portion of subprime mortgages-are subject to less federal supervision.
    While FTC is the primary federal enforcer of consumer protection laws for
    these entities, it is a law enforcement agency that conducts targeted
    investigations. In contrast, the Board is well equipped to routinely
    monitor and examine these entities and, thus, potentially deter predatory
    lending activities, but has not done so because its authority in this
    regard is less clear.

    As of January 2004, 25 states, as well as several localities, had passed
    laws to address predatory lending, often by restricting the terms or
    provisions of certain high-cost loans; however, federal banking regulators
    have preempted some state laws for the institutions they supervise. Also,
    some states have strengthened their regulation and licensing of mortgage
    lenders and brokers.

    The secondary market-where mortgage loans and mortgage-backed securities
    are bought and sold-benefits borrowers by expanding credit, but may
    facilitate predatory lending by allowing unscrupulous lenders to quickly
    sell off loans with predatory terms. In part to avoid certain risks,
    secondary market participants perform varying degrees of "due diligence"
    to screen out loans with predatory terms, but may be unable to identify
    all such loans.

    GAO's review of literature and interviews with consumer and federal
    officials suggest that consumer education, mortgage counseling, and loan
    disclosure requirements are useful, but may be of limited effectiveness in
    reducing predatory lending. A variety of factors limit their
    effectiveness, including the complexity of mortgage transactions,
    difficulties in reaching target audiences, and counselors' inability to
    review loan documents.

    While there are no comprehensive data, federal, state, and consumer
    advocacy officials report that the elderly have disproportionately been
    victims of predatory lending. According to these officials and relevant
    studies, older consumers may be targeted by predatory lenders because,
    among other things, they are more likely to have substantial home equity
    and may have physical or cognitive impairments that make them more
    vulnerable to an unscrupulous mortgage lender or broker.

    Contents

    Transmittal Letter 1

      Executive Summary 3

    Purpose 3
    Background 3
    Results in Brief 4
    Principal Findings 7
    Matters for Congressional Consideration 15
    Agency Comments and Our Evaluation 16

    Chapter 1 18

    The Nature and Attributes of Predatory Lending 18

    Introduction	Emergence of Subprime Mortgage Market 21
    The Extent of Predatory Lending Is Unknown 23
    Emergence of Predatory Lending As Policy Issue 25
    Objectives, Scope, and Methodology 26

    Chapter 2
    Federal Agencies Have
    Taken Steps to Address
    Predatory Lending, but
    Face Challenges

    30 Federal Agencies Use a Variety of Laws to Address Predatory Lending
    Practices 30 Federal Agencies Have Taken Some Enforcement Actions, but

    Banking Regulators Have Focused on Guidance and Regulatory

    Changes 36
    Jurisdictional Issues Related to Nonbank Subsidiaries Challenge

    Efforts to Combat Predatory Lending 49
    Conclusions 54
    Matters for Congressional Consideration 55
    Agency Comments and Our Evaluation 55

    Chapter 3
    States Have Enacted
    and Enforced Laws to
    Address Predatory
    Lending, but Some
    Laws Have Been
    Preempted

    58
    States and Localities Have Addressed Predatory Lending through
    Legislation, Regulation, and Enforcement Actions 58
    Activities in North Carolina and Ohio Illustrate State Approaches to
    Predatory Lending 63
    Regulators Have Determined That Federal Law Preempts Some
    State Predatory Lending Laws, but Views on Preemption Differ
    68

                                        Contents

    Chapter 4
    The Secondary Market
    May Play a Role in
    Both Facilitating and
    Combating Predatory
    Lending

    72 The Development of a Secondary Market for Subprime Loans Can Benefit
    Consumers 72 The Secondary Market for Subprime Loans Can Facilitate
    Predatory Lending 76 Due Diligence Can Help Purchasers Avoid Predatory
    Loans, but Efforts Vary among Secondary Market Participants 77 Assignee
    Liability May Help Deter Predatory Lending but Can Also Have Negative
    Unintended Consequences 82

    Chapter 5
    The Usefulness of
    Consumer Education,
    Counseling, and
    Disclosures in
    Deterring Predatory
    Lending May Be
    Limited

    88

    Many Consumer Education and Mortgage Counseling Efforts Exist, but Several
    Factors Limit Their Potential to Deter Predatory Lending 88

    Disclosures, Even If Improved, May Be of Limited Use in Deterring
    Predatory Lending 96

    Chapter 6 99 Elderly Consumers A Number of Factors Make Elderly Consumers
    Targets of Predatory

    Lenders 99 May Be Targeted for Some Education and Enforcement Efforts
    Focus on Elderly

    Predatory Lending Consumers 102 Appendixes

    Appendix I: Appendix II:

    Appendix III: Appendix IV:

    Appendix V:

    FTC Enforcement Actions Related to Predatory Lending 106

    Comments from the Board of Governors of the Federal
    Reserve System 108

    Comments from the Department of Justice 111

    Comments from the Department of Housing and Urban
    Development 114

    Comments from the National Credit Union
    Administration 118

    Contents

               Appendix VI:      GAO Contacts and Staff Acknowledgments       120
                                              GAO Contacts                    120
                                          Staff Acknowledgments               120
                            Table 1: Preemption Determinations Issued by OCC,
        Table                                   OTS, and
                            NCUA Related to Predatory Mortgage Lending Laws
                               Figure 1: Federal Laws and Statutes Used to
    Figures              Address Lending Practices Generally Considered to
                                              be Predatory                     31
                              Figure 2: Structure and Federal Oversight of     50
                                            Mortgage Lenders
                            Figure 3: States and Localities That Have Enacted
                                                Predatory
                                              Lending Laws                     59
                                Figure 4: Steps in the Securitization of       74
                                          Residential Mortgages

    Abbreviations

    CRA Community Reinvestment Act
    DOJ Department of Justice
    ECOA Equal Credit Opportunity Act
    FDIC Federal Deposit Insurance Corporation
    FHA Federal Housing Administration
    FTC Federal Trade Commission
    GAO General Accounting Office
    GSE government-sponsored enterprise
    HMDA Home Mortgage Disclosure Act
    HOEPA Home Ownership and Equity Protection Act
    HUD Department of Housing and Urban Development
    NCUA National Credit Union Administration
    OCC Office of the Comptroller of the Currency
    OTS Office of Thrift Supervision
    RESPA Real Estate Settlement Procedures Act
    TILA Truth in Lending Act

    This is a work of the U.S. government and is not subject to copyright
    protection in the United States. It may be reproduced and distributed in
    its entirety without further permission from GAO. However, because this
    work may contain copyrighted images or other material, permission from the
    copyright holder may be necessary if you wish to reproduce this material
    separately.

    A

    United States General Accounting Office Washington, D.C. 20548

    January 30, 2004

    The Honorable Larry E. Craig
    Chairman
    The Honorable John Breaux
    Ranking Minority Member
    Special Committee on Aging
    United States Senate

    This report responds to your request that we evaluate issues related to
    predatory home mortgage lending. As you requested, this report reviews
    (1) federal laws related to predatory lending and federal agencies'
    efforts to
    enforce them, (2) actions taken by states to address predatory lending,
    (3)
    the secondary market's role in facilitating or inhibiting predatory
    lending,
    (4) how consumer education, mortgage counseling, and loan disclosures
    may deter predatory lending, and (5) the relationship between predatory
    lending activities and elderly consumers. This report includes a Matter
    for
    Congressional Consideration.

    As agreed with your office, we plan no further distribution of this report
    until 30 days from its issuance date unless you publicly release its
    contents
    sooner. We will then send copies of this report to the Chairman and
    Ranking Minority Member of the Senate Committee on Banking, Housing,
    and Urban Affairs; the Chairman and Ranking Minority Member of the
    House Committee on Financial Services; the Secretary of the Department
    of Housing and Urban Development; the Secretary of the Department of the
    Treasury; the Chairman of the Federal Trade Commission; the Chairman of
    the Board of Governors of the Federal Reserve System; the Chairman of the
    Federal Deposit Insurance Corporation; the Comptroller of the Currency;
    the Director of the Office of Thrift Supervision; the Chairman of the
    National Credit Union Administration; and other interested parties. Copies
    will also be made available to others upon request. In addition, this
    report
    will be available at no charge on the GAO Web site at http://www.gao.gov.

    This report was prepared under the direction of Harry Medina, Assistant
    Director. Please contact Mr. Medina at (415) 904-2000 or me at (202)
    5128678 if you or your staff have any questions about this report. Major
    contributors to this report are listed in appendix VI.

    David G. Wood Director, Financial Markets and Community Investment

    Executive Summary

    Purpose	Each year, millions of American consumers take out mortgage loans
    through mortgage brokers or lenders to purchase homes or refinance
    existing mortgage loans. While the majority of these transactions are
    legitimate and ultimately benefit borrowers, some have been found to be
    "predatory"-that is, to contain terms and conditions that ultimately harm
    borrowers. Loans with these features, often targeted at the elderly,
    minorities, and low-income homeowners, can strip borrowers of home equity
    built up over decades and cause them to lose their homes.

    The Chair and Ranking Minority Member of the Senate Special Committee on
    Aging asked GAO to examine the efforts under way to combat predatory
    lending. GAO reviewed (1) federal laws related to predatory lending and
    federal agencies' efforts to enforce them, (2) actions taken by states to
    address predatory lending, (3) the secondary market's role in facilitating
    or inhibiting predatory lending, (4) how consumer education, mortgage
    counseling, and loan disclosures may deter predatory lending, and (5) the
    relationship between predatory lending activities and elderly consumers.
    The scope of this work was limited to home mortgage lending and did not
    include other forms of consumer loans. To address these objectives, GAO
    reviewed data and interviewed officials from federal, state, and local
    agencies and from industry and consumer advocacy groups; examined federal,
    state, and local laws; and reviewed relevant literature. At GAO's request,
    federal agencies identified enforcement or other actions they have taken
    to address predatory lending. GAO also obtained data from publicly
    available databases; the data were analyzed and found to be sufficiently
    reliable for this report. Chapter 1 provides the details of the scope and
    methodology of this report. The work was conducted between January 2003
    and January 2004 in accordance with generally accepted government auditing
    standards.

    Background	While there is no uniformly accepted definition of predatory
    lending, a number of practices are widely acknowledged to be predatory.
    These include, among other things, charging excessive fees and interest
    rates, lending without regard to borrowers' ability to repay, refinancing
    borrowers' loans repeatedly over a short period of time without any
    economic gain for the borrower, and committing outright fraud or
    deception-for example, falsifying documents or intentionally

                                   Executive Summary

    misinforming borrowers about the terms of a loan.1 These types of
    practices offer lenders that originate predatory loans potentially high
    returns even if borrowers default, since many of these loans require
    excessive up-front fees. No comprehensive data are available on the
    incidence of these practices, but banking regulators, consumer advocates,
    and industry participants generally agree that predatory loans are most
    likely to occur in the market for "subprime" loans. The subprime market
    serves borrowers who have limited incomes or poor or no credit histories,
    in contrast with the prime market, which encompasses traditional lenders
    and borrowers with credit histories that put them at low risk of default.
    Originators of subprime loans most often are mortgage and consumer finance
    companies but can also be banks, thrifts, and other institutions.

    Serious data limitations make the extent of predatory lending difficult to
    determine. However, there have been a number of major settlements
    resulting from government enforcement actions or private party lawsuits in
    the last 5 years that have accused lenders of abusive practices affecting
    large numbers of borrowers. For example, in October 2002, Household
    International, a large home mortgage lender, agreed to pay up to $484
    million to homeowners to settle states' allegations that it used unfair
    and deceptive lending practices to make mortgage loans with excessive
    interest and fees. In addition, the rate of foreclosures of subprime loans
    has increased substantially since 1990, far exceeding the rate of increase
    for subprime originations. Some consumer groups and industry observers
    have attributed this development, at least in part, to an increase in
    abusive lending, particularly of loans made without regard to borrowers'
    ability to repay. Additionally, groups such as legal services agencies
    have reported seeing an ever-greater number of consumers, particularly the
    elderly and minorities, who are in danger of losing their homes as a
    result of predatory lending practices.

    Results in Brief	Federal agencies have addressed predatory lending under a
    variety of federal laws, including the Home Ownership and Equity
    Protection Act (HOEPA), which was an amendment to the Truth in Lending Act
    (TILA) designed specifically to combat predatory lending, and other
    consumer protection laws such as the Federal Trade Commission Act (FTC
    Act), TILA generally, and the Real Estate Settlement Procedures Act
    (RESPA). The

    1Throughout this report, the terms "predatory lending" and "abusive
    lending" are used to refer to such practices.

    Executive Summary

    Federal Trade Commission (FTC) has played a prominent role because it is
    responsible for implementing and enforcing certain federal laws among
    lending institutions that are not supervised by federal banking
    regulators. As of December 2003, FTC reported that it had taken 19
    enforcement actions against mortgage lenders and brokers for predatory
    practices, including some actions that have resulted in multimillion
    dollar settlements. The Department of Housing and Urban Development's
    (HUD) enforcement activities related to abusive lending have focused on
    criminal fraud in its Federal Housing Administration (FHA) loan insurance
    program. The federal banking regulators-the Federal Deposit Insurance
    Corporation (FDIC), Board of Governors of the Federal Reserve System (the
    Board), Office of the Comptroller of the Currency (OCC), Office of Thrift
    Supervision (OTS), and National Credit Union Administration (NCUA)-report
    little evidence of predatory lending by the depository institutions that
    they supervise. However, concerns exist about nonbank mortgage lending
    companies that are owned by financial or bank holding companies, which
    have been involved in several notable enforcement actions involving
    allegations of abusive lending practices. While FTC has clear authority to
    conduct investigations and enforce consumer protection laws among these
    nonbank mortgage lending companies, as a law enforcement agency its role
    is to investigate possible violations rather than to act as a supervisory
    agency with routine monitoring and examination responsibilities. The Board
    may be better equipped to monitor and examine these subsidiaries'
    compliance with federal consumer protection laws and thus to deter
    predatory lending, but it does not have clear authority to do so.

    According to a database that tracks state and local legislation, 25
    states, 11 localities, and the District of Columbia have passed their own
    laws addressing predatory lending.2 While these laws vary, most of them
    restrict the terms or provisions of mortgage loans originated within their
    jurisdictions. In addition, some states have strengthened the regulation
    and licensing of mortgage lenders and brokers, and state law enforcement
    agencies and banking regulators have taken a number of enforcement actions
    under state consumer protection and banking laws. Some federal regulators
    have asserted that federal law preempts some state predatory

    2Information relating to state and local laws and their provisions is from
    a database maintained by Butera & Andrews, a Washington, D.C., law firm
    that tracks predatory lending legislation, and is current as of January 9,
    2004. These laws only include state and local laws that placed actual
    restrictions on lending. For example, they do not include local ordinances
    that consisted solely of a resolution that condemned predatory lending.

    Executive Summary

    lending laws for the institutions they regulate, stating that federally
    chartered lending institutions should be required to comply with a single
    uniform set of national regulations. Many state officials and consumer
    advocates, however, maintain that federal preemption interferes with the
    states' ability to protect consumers.

    The secondary market for mortgage loans-which allows lenders and investors
    to sell and buy mortgages and mortgage-backed securities- provides lenders
    with an additional source of liquidity and may benefit borrowers by
    increasing access to credit and lowering interest rates. But the secondary
    market may also inadvertently serve to facilitate predatory lending, both
    by providing a source of funds for unscrupulous originators to quickly
    sell off loans with predatory terms and by reducing incentives for these
    originators to ensure that borrowers can repay their loans. Secondary
    market participants may use varying degrees of "due diligence"-a review
    and appraisal of legal and financial information-to avoid purchasing loans
    with abusive terms. Fannie Mae and Freddie Mac- which are relatively
    recent entrants in the subprime market-have due diligence processes that
    are designed, in part, to avoid purchasing loans that may have been
    harmful to consumers. Other firms may use due diligence not necessarily to
    avoid loans that may have harmed consumers but to avoid loans that are not
    in compliance with applicable law or that present undue financial or
    reputation risks. Some states have passed laws making secondary market
    buyers liable for violations by loan originators, although such laws may
    have the unintended consequence of reducing the availability of legitimate
    credit to consumers.

    A number of federal, state, nonprofit, and industry-sponsored
    organizations offer consumer education initiatives designed to deter
    predatory lending by, among other things, providing information about
    predatory practices and working to improve consumers' overall financial
    literacy. GAO's review of literature and interviews with consumer and
    federal officials suggest that while tools such as consumer education,
    mortgage counseling, and disclosures are useful, they may be of limited
    effectiveness in reducing predatory lending. For instance, consumer
    education is hampered by the complexity of mortgage transactions and the
    difficulty of reaching the target audience. Similarly, unreceptive
    consumers and counselors' lack of access to relevant loan documents can
    hamper the effectiveness of mortgage counseling efforts, while the sheer
    volume of mortgage originations each year makes providing universal
    counseling difficult. And while efforts are under way to improve the
    federally required disclosures associated with mortgage loans, the
    complexity of mortgage transactions

                                   Executive Summary

    also hinders these efforts, especially given the lack of financial
    sophistication among many borrowers who are targeted by predatory lenders.

    While there are no comprehensive data, government officials and consumer
    advocacy organizations have reported that elderly consumers have been
    disproportionately targeted and victimized by predatory lenders. According
    to these officials and organizations, elderly consumers appear to be
    favored targets for several reasons-for example, because they may have
    substantial equity in their homes or live on limited incomes that make
    them susceptible to offers for quick access to cash. Further, some seniors
    have cognitive or physical impairments such as poor eyesight, hearing, or
    mobility that may limit their ability to access competitive sources of
    credit. Most consumer financial education efforts seek to serve the
    general consumer population, but a few education initiatives have focused
    specifically on predatory lending and the elderly. Most legal assistance
    related to predatory lending aims at assisting the general population of
    consumers, although some is focused on elderly consumers in particular.

      Principal Findings

        Federal Agencies Have Taken Enforcement and Other Actions to Address
        Predatory Lending, but Face Challenges

    Federal agencies and regulators have used a number of federal laws to
    combat predatory lending practices. Among the most frequently used
    laws-HOEPA, the FTC Act, TILA, and RESPA-only HOEPA was specifically
    designed to address predatory lending. Enacted in 1994, HOEPA places
    restrictions on certain high-cost loans, including limits on prepayment
    penalties and balloon payments and prohibitions against negative
    amortization. However, HOEPA covers only loans that exceed certain rate or
    fee triggers, and although comprehensive data are lacking, it appears that
    HOEPA covers only a limited portion of all subprime loans. The FTC Act,
    enacted in 1914 and amended on numerous occasions, authorizes FTC to
    prohibit and take action against unfair or deceptive acts or practices in
    or affecting commerce. TILA and RESPA are designed in part to provide
    consumers with accurate information about the cost of credit.

    Other federal laws that have been used to address predatory lending
    practices include criminal fraud statutes that prohibit certain types of
    fraud sometimes used in abusive lending schemes, such as forgery and false

    Executive Summary

    statements. Also, the Fair Housing Act and Equal Credit Opportunity Act-
    which prohibit discrimination in housing-related transactions and the
    extension of credit, respectively-have been used in cases against abusive
    lenders that have targeted certain protected groups.

    Using these or other authorities, federal agencies have taken a number of
    enforcement actions and other steps, such as issuing guidance and revising
    regulations.

    o 	Among federal agencies, FTC has a prominent role in combating predatory
    lending because of its responsibilities in implementing and enforcing
    certain federal laws among lending institutions that are not depository
    institutions supervised by federal banking regulators. FTC has reported
    that it has filed 19 complaints-17 since 1998-alleging deceptive or other
    illegal practices by mortgage lenders or brokers and that some actions
    have resulted in multimillion dollar settlements. For example, in 2002 FTC
    settled a complaint against a lender charged with engaging in systematic
    and widespread deceptive and abusive lending practices. According to FTC
    staff, close to 1 million borrowers will receive about $240 million in
    restitution under the settlement.

    o 	DOJ, which is responsible for enforcing certain federal civil rights
    laws, has filed an enforcement action on behalf of the FTC and identified
    two additional enforcement actions it has taken that are related to
    predatory mortgage lending practices. The statutes DOJ enforces only
    address predatory lending practices when they are alleged to be
    discriminatory.

    o 	HUD has undertaken enforcement activities related to abusive lending
    that primarily focus on reducing losses to the FHA insurance fund, most
    notably violations of criminal fraud statutes and FHA regulations through
    "property flipping" schemes, which in some cases can harm borrowers by
    leaving them with mortgage loans that may far exceed the value of their
    homes.3 HUD has also taken three enforcement actions in abusive mortgage
    lending cases for violations of RESPA's prohibitions on certain types of
    fees.

    3HUD's FHA mortgage insurance program makes loans more readily available
    for low-and moderate-income families by providing mortgage insurance to
    purchase or refinance a home. Lending institutions such as mortgage
    companies and banks fund the loans.

    Executive Summary

    o 	Federal banking regulators have stated that their monitoring and
    examination activities have uncovered little evidence of predatory lending
    in federally regulated depository institutions. Four of the five federal
    banking regulators reported taking no formal enforcement actions involving
    predatory mortgage lending against the institutions they regulate, while
    the fifth-OCC-reported that it has taken one formal enforcement action
    against a bank engaged in abusive mortgage lending. Regulators noted that
    they have taken informal enforcement actions to address questionable
    practices raised during the examination process and required their
    institutions to take corrective action.

    o 	The banking regulators have also issued guidance to the institutions
    they supervise on avoiding direct or indirect involvement in predatory
    lending. In addition, the Board has made changes to its regulations
    implementing HOEPA that, among other things, increase the number of loans
    HOEPA covers. The Board also made changes to its regulations implementing
    the Home Mortgage Disclosure Act that make it easier to analyze potential
    patterns of predatory lending.

    Federal agencies and banking regulators have coordinated their efforts to
    address predatory lending on certain occasions through participation in
    interagency working groups and through joint enforcement actions. For
    example, FTC, DOJ, and HUD coordinated to take an enforcement action
    against Delta Funding Corporation, with each agency investigating and
    bringing actions for violations of the laws within its jurisdiction.

    Issues related to federal oversight and regulation of certain nonbank
    mortgage lenders may challenge efforts to combat predatory lending.
    Nonbank mortgage lending companies owned by financial or bank holding
    companies (nonbank mortgage lending subsidiaries), such as finance and
    mortgage companies, account for an estimated 24 percent of subprime loan
    orginations, according to HUD, and some have been the target of notable
    federal and state enforcement actions involving allegations of abusive
    lending.4 FTC is the primary federal enforcer of consumer protection laws
    for these nonbank subsidiaries, but it is a law enforcement rather than
    supervisory agency. Thus, FTC's mission and resource allocations are
    focused on conducting investigations in response to consumer complaints
    and other information rather than on routine monitoring and examination

    4These nonbank subsidiaries are owned by the financial holding companies
    or bank holding companies and are not the direct operating subsidiaries of
    the bank itself.

                                   Executive Summary

    responsibilities. In contrast, the Board conducts periodic examinations of
    financial and bank holding companies and, under the Bank Holding Company
    Act, is authorized to monitor and examine the subsidiaries of a bank
    holding company under certain circumstances. However, this authority does
    not clearly extend to routine examinations of nonbank subsidiaries of
    these holding companies with regard to laws pertinent to predatory
    lending. In addition, the Board does not have specific authority under
    pertinent federal consumer protection laws to institute an enforcement
    action against a nonbank subsidiary of a financial or bank holding
    company. Granting the Board concurrent enforcement authority with the FTC
    for these nonbank subsidiaries of holding companies could help deter some
    predatory lending.

        Many States Have Passed Laws Addressing Predatory Lending, but Federal
        Agencies Have Preempted Some Statutes

    In response to concerns about the growth of predatory lending and the
    limitations of existing laws, 25 states, the District of Columbia, and 11
    localities have passed their own laws addressing predatory lending
    practices, according to a database that tracks such laws. Most of these
    laws regulate and restrict the terms and characteristics of high-cost
    loans- that is, loans that exceed certain rate or fee thresholds. While
    some state statutes follow the thresholds for covered loans established in
    HOEPA, many set lower thresholds in order to cover more loans than the
    federal statute. The statutes vary, but they generally cover a variety of
    predatory practices, such as balloon payments and prepayment penalties,
    and some include restrictions on such things as mandatory arbitration
    clauses that can restrict borrowers' ability to obtain legal redress
    through the courts.

    Some states have also increased the regulation of and licensing
    requirements for mortgage lenders and brokers, in part to address concerns
    that some unscrupulous lenders and brokers have been responsible for
    lending abuses and that these entities have not been adequately regulated.
    For example, some states have increased the educational requirements that
    lenders and brokers must meet in order to obtain a license. In recent
    years, state law enforcement agencies and banking regulators have also
    taken a number of actions against mortgage lenders involving predatory
    lending. For example, an official from Washington State's Department of
    Financial Institutions reported that the department had taken several
    enforcement actions to address predatory lending, including one that
    resulted in a lender being ordered to return more than $700,000 to 120
    Washington borrowers for allegedly deceiving them and charging prohibited
    fees.

                                   Executive Summary

    Three federal banking regulators-NCUA, OCC, and OTS-have issued opinions
    stating that federal laws preempt some state predatory lending laws for
    the institutions that they regulate. The regulators note that such
    preemption creates a more uniform regulatory framework, relieves lending
    institutions of the burden of complying with a hodgepodge of state and
    federal laws, and avoids state laws that may restrict legitimate lending
    activities. State officials and consumer advocates that oppose preemption
    argue that federal laws do not effectively protect consumers against
    predatory lending practices and that federal regulators do not devote
    sufficient resources toward enforcement of consumer protection laws for
    the institutions they oversee.

        The Secondary Market May Benefit Consumers but Can Also Facilitate Predatory
        Lending

    In 2002, an estimated 63 percent of subprime loans, worth $134 billion,
    were securitized and sold on the secondary market.5 The existence of a
    secondary market for subprime loans has benefited consumers by increasing
    the sources of funds available to subprime lenders, potentially lowering
    interest rates and origination costs for subprime loans. However, the
    secondary market may also inadvertently facilitate predatory lending by
    providing a source of funds for unscrupulous originators, allowing them to
    quickly sell off loans with predatory terms. Further, originators of
    subprime mortgage loans generally make their profits from high origination
    fees, and the existence of a secondary market may reduce the incentive for
    these lenders to ensure that borrowers can repay.

    Purchasers of mortgage loans undertake a process of due diligence designed
    to avoid legal, financial, and reputational risk. Prior to the sale,
    purchasers typically review electronic data containing information on the
    loans, such as the loan amount, interest rate, and credit score of the
    borrower. Purchasers also often physically review a sample of individual
    loans, including such items as the loan application and settlement forms.
    However, the degree of due diligence purchasers undertake varies. Fannie
    Mae and Freddie Mac-which are estimated to account for a relatively small
    portion of the secondary market for subprime loans-told us that they
    undertake a series of measures aimed at avoiding the purchase of

    5Originators of mortgage loans-which can include banks, other depository
    institutions, and mortgage lenders that are not depository
    institutions-may keep the loans or sell them on the secondary market.
    Secondary market purchasers may then hold the loans or pool together a
    group of loans and issue a security that is backed by a pool of mortgages
    (a "mortgage-backed security").

                                   Executive Summary

    loans with abusive characteristics that may have harmed borrowers. In
    contrast, according to some market participants, the due diligence of
    other secondary market purchasers of residential mortgages may be more
    narrowly focused on the creditworthiness of the loans and on their
    compliance with federal, state, and local laws. However, even the most
    stringent efforts cannot uncover some predatory loans. For example, due
    diligence by secondary market purchasers may be unable to uncover fraud
    that occurred during the loan underwriting or approval process, some
    excessive or unwarranted fees, or loan flipping.

    Under some state and local legislation, purchasers of mortgages or
    mortgage-backed securities on the secondary market may be liable for
    violations committed by the originating lenders-referred to as "assignee
    liability" provisions. HOEPA contains such a provision for loans above
    certain thresholds, as do the antipredatory lending laws in at least eight
    states and the District of Columbia, according to a database that tracks
    state predatory lending laws. Assignee liability is intended to discourage
    secondary market participants from purchasing loans that may have
    predatory features and to provide an additional source of redress for
    victims of abusive lenders. However, according to some secondary market
    participants, assignee liability can also discourage legitimate lending
    activity. Secondary market purchasers that are unwilling to assume the
    potential risks associated with assignee liability provisions have stopped
    purchasing, or announced their intention to stop purchasing, mortgages
    originated in areas covered by such provisions. Credit rating agencies-
    whose decisions influence securitizers' ability to sell the
    securities-have asserted that assignee liability provisions can make it
    difficult for them to measure the risk associated with pools of loans.
    Assignee liability provisions of the Georgia Fair Lending Act were blamed
    for causing several participants in the mortgage lending industry to
    withdraw from the market, and the provisions were subsequently repealed.

        The Usefulness of Consumer Education, Counseling, and Disclosures in
        Deterring Predatory Lending May Be Limited

    In response to widespread concern about low levels of financial literacy
    among consumers, federal agencies have conducted and funded financial
    education for consumers as a means of improving consumers' financial
    literacy and, in some cases, raising consumers' awareness of predatory
    lending practices. For example, FDIC sponsors a financial literacy
    program, MoneySmart, which is designed for low- and moderate-income
    individuals with little banking experience. Other federal agencies,
    including the Board, FTC, HUD, and OTS, engage in activities such as
    distributing educational literature, working with community groups, and

    Executive Summary

    providing institutions they regulate with guidance on encouraging
    financial literacy. Federal agencies have also taken some actions to
    coordinate their efforts to educate consumers about predatory lending. For
    example, in October 2003, the Interagency Task Force on Fair Lending,
    which consists of 10 federal agencies, published a brochure that alerts
    consumers to the potential pitfalls of home equity loans, particularly
    high-cost loans. A number of states, nonprofits, and trade organizations
    also conduct consumer financial education activities, which sometimes
    focus specifically on raising awareness about predatory lending.

    While representatives of the mortgage lending industry and consumer groups
    have noted that financial education may make some consumers less
    susceptible to abusive lending practices, GAO's review of literature and
    interviews with consumer and federal officials suggest that consumer
    education by itself has limits as a tool for deterring predatory lending.
    First, mortgage loans are complex financial transactions, and many
    different factors-including the interest rate, fees, provisions of the
    loan, and situation of the borrower-determine whether a loan is in a
    borrower's best interests. Even an excellent campaign of consumer
    education is unlikely to provide less sophisticated consumers with enough
    information to properly assess whether a loan contains abusive terms.
    Second, predatory lenders and brokers tend to use aggressive marketing
    tactics that are designed to confuse consumers. Broad-based campaigns to
    make consumers aware of predatory lending may not be sufficient to prevent
    many consumers-particularly those who may be uneducated or unsophisticated
    in financial matters-from succumbing to such tactics. Finally, the
    consumers who are often the targets of predatory lenders are also some of
    the hardest to reach with educational information.

    Prepurchase mortgage counseling-which can offer a "third party" review of
    a prospective mortgage loan-may help borrowers avoid predatory loans, in
    part by alerting consumers to predatory loan terms and practices. HUD
    supports a network of approximately 1,700 HUD-approved counseling agencies
    across the country and in some cases provides funding for their
    activities. While beneficial, the role of mortgage counseling in
    preventing predatory lending is likely to be limited. Borrowers do not
    always attend such counseling, and when they do, counselors may not have
    access to all of the loan documents needed to review the full final terms
    and provisions before closing. In addition, counseling may be ineffective
    against lenders and brokers engaging in fraudulent practices, such as
    falsifying applications or loan documents, that cannot be detected during
    a prepurchase review of mortgage loan documents.

                                   Executive Summary

    Finally, disclosures made during the mortgage loan process, while
    important, may be of limited usefulness in reducing the incidence of
    predatory lending practices. TILA and RESPA have requirements covering the
    content, form, and timing of the information that must be disclosed to
    borrowers. However, industry and consumer advocacy groups have publicly
    expressed dissatisfaction with the current disclosure system. HUD issued
    proposed rules in July 2002 intended to streamline the disclosure process
    and make disclosures more understandable and timely, and debate over the
    proposed rules has been contentious. Although improving loan disclosures
    would undoubtedly have benefits, once again the inherent complexity of
    loan transactions may limit any impact on the incidence of predatory
    lending practices. Moreover, even a relatively clear and transparent
    system of disclosures may be of limited use to borrowers who lack
    sophistication about financial matters, are not highly educated, or suffer
    physical or mental infirmities. Finally, as with mortgage counseling,
    revised disclosure requirements would not necessarily help protect
    consumers against lenders and brokers that engage in outright fraud or
    that mislead borrowers about the terms of loans in the disclosure
    documents themselves.

        Predatory Lenders May Target Elderly Consumers

    Consistent observational and anecdotal evidence, along with some limited
    data, indicates that, for a variety of reasons, elderly homeowners are
    disproportionately the targets of predatory lending. Abusive lenders tend
    to target homeowners who have substantial equity in their homes, as many
    older homeowners do. In addition, some brokers and lenders aggressively
    market home equity loans as a source of cash, particularly for older
    homeowners who may have limited incomes but require funds for major home
    repairs or medical expenses. Moreover, diseases and physical impairments
    associated with aging-such as declining vision, hearing, or mobility-can
    restrict elderly consumers' ability to access financial information and
    compare credit terms. Some older persons may also have diminished
    cognitive capacity, which can impair their ability to comprehend and make
    informed judgments on financial issues. Finally, several advocacy groups
    have noted that some elderly people lack social and family support
    systems, potentially increasing their susceptibility to unscrupulous
    lenders who may market loans by making home visits or offering other
    personal contact.

    Because the elderly may be more susceptible to predatory lending,
    government agencies and consumer advocacy organizations have focused some
    of their education efforts on this population. For example, the

                                   Executive Summary

    Justice Department offers on its Web site the guide "Financial Crimes
    Against the Elderly," which includes references to predatory lending. The
    Department of Health and Human Services' Administration on Aging provides
    grants to state and nonprofit agencies for programs aimed at preventing
    elder abuse, including predatory lending practices targeting older
    consumers. The AARP, which represents Americans age 50 and over, sponsors
    a number of financial education efforts, including a borrower's kit that
    contains tips for avoiding predatory lending.

    Consumer protection and fair lending laws that have been used to address
    predatory lending do not generally have provisions specific to elderly
    persons, although the Equal Credit Opportunity Act does prohibit unlawful
    discrimination on the basis of age in connection with any aspect of a
    credit transaction. Federal and state enforcement actions and private
    classaction lawsuits involving predatory lending generally seek to provide
    redress to large groups of consumers. Little comprehensive data exist on
    the age of consumers involved in these actions, but a few cases have
    involved allegations of predatory lending targeting elderly borrowers. For
    example, FTC, six states, AARP, and private plaintiffs settled a case with
    First Alliance Mortgage Company in March 2002 for more than $60 million.
    An estimated 28 percent of the 8,712 borrowers represented in the
    classaction suit were elderly. The company was accused of using
    misrepresentation and unfair and deceptive practices to lure senior
    citizens and those with poor credit histories into entering into abusive
    loans. In addition, some nonprofit groups-such as the AARP Foundation
    Litigation, the National Consumer Law Center, and South Brooklyn Legal
    Services' Foreclosure Prevention Project-provide legal services that
    focus, in part, on helping elderly victims of predatory lending.

      Matters for Congressional Consideration

    To enable greater oversight of and potentially deter predatory lending
    from occurring at certain nonbank lenders, Congress should consider making
    appropriate statutory changes to grant the Board of Governors of the
    Federal Reserve System the authority to routinely monitor and, as
    necessary, examine the nonbank mortgage lending subsidiaries of financial
    and bank holding companies for compliance with federal consumer protection
    laws applicable to predatory lending practices. Also, Congress should
    consider giving the Board specific authority to initiate enforcement
    actions under those laws against these nonbank mortgage lending
    subsidiaries.

                                   Executive Summary

      Agency Comments and Our Evaluation

    GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
    NCUA, OCC, OTS, and the Department of the Treasury for review and comment.
    The agencies provided technical comments that have been incorporated where
    appropriate. In addition, the Board, DOJ, FDIC, FTC, HUD, and NCUA
    provided general comments, which are discussed in greater detail at the
    end of chapter 2. The written comments of the Board, DOJ, HUD, and NCUA
    are printed in appendixes II through V.

    The Board commented that, while the existing structure has not been a
    barrier to Federal Reserve oversight, the approach recommended in our
    Matter for Congressional Consideration would likely be beneficial by
    catching some abusive practices that might not be caught otherwise. The
    Board also noted that the approach would pose tradeoffs, such as different
    supervisory schemes being applied to nonbank mortgage lenders based on
    whether or not they are part of a holding company, and additional costs.
    Because nonbank mortgage lenders that are part of a financial or bank
    holding company currently can be examined by the Board in some
    circumstances, they are already subject to a different supervisory scheme
    than other such lenders. We agree that the costs to the lenders and the
    Board would increase to the extent the Board exercised any additional
    authority to monitor and examine nonbank lenders, and believe that
    Congress should consider both the potential costs and benefits of
    clarifying the Board's authorities.

    The FTC expressed concern that our report could give the impression that
    we are suggesting that Congress consider giving the Board sole
    jurisdiction-rather than concurrent jurisdiction with FTC-over nonbank
    subsidiaries of holding companies. Our report did not intend to suggest
    that the Congress make any change that would necessarily affect FTC's
    existing authority for these entities, and we modified the report to
    clarify this point.

    DOJ commented that the report will be helpful in assessing the
    department's role in the federal government's efforts to develop
    strategies to combat predatory lending. DOJ disagreed with our inclusion
    in the report of "property or loan flips," which it said was a traditional
    fraud scheme but not a type of predatory lending. As we noted in our
    report, there is no precise definition of predatory lending. We
    incorporated a discussion of property flipping-quick resales of recently
    sold FHA properties-because HUD officials characterize some of these
    schemes as involving predatory practices that can harm borrowers. We
    included loan

    Executive Summary

    flipping-the rapid and repeated refinancing of a loan without benefit to
    the borrower-in our report because this is widely characterized in the
    literature and by federal, state, and nonprofit agency officials as a
    predatory lending practice.

    FDIC noted that our Matter for Congressional Consideration focuses on
    nonbank subsidiaries of holding companies even though these entities
    comprise, according to HUD, only about 20 percent of all subprime lenders.
    We recognize that our Matter does not address all subprime lenders or
    other institutions that may be engaging in predatory lending, but believe
    it represents a potential step in addressing predatory lending among a
    significant segment of mortgage lenders. NCUA said that the report
    provides a useful discussion of the issues and the agency concurs with our
    Matter for Congressional Consideration. HUD, in its comment letter,
    described a variety of actions it has taken that it characterized as
    combating predatory lending, particularly with regard to FHA-insured
    loans.

    Chapter 1

    Introduction

    In recent years, abuses in home mortgage lending-commonly referred to as
    "predatory lending"-have increasingly garnered the attention and concern
    of policymakers, consumer advocates, and participants in the mortgage
    lending industry.1 Once relatively rare, government enforcement actions
    and private party lawsuits against institutions accused of abusive home
    mortgage lending have increased dramatically in the last 10 years. In 2002
    alone, there were dozens of settlements resulting from accusations of
    abusive lending. In the largest of these, a major national mortgage lender
    agreed to pay up to $484 million to tens of thousands of affected
    consumers.

      The Nature and Attributes of Predatory Lending

    Predatory lending is an umbrella term that is generally used to describe
    cases in which a broker or originating lender takes unfair advantage of a
    borrower, often through deception, fraud, or manipulation, to make a loan
    that contains terms that are disadvantageous to the borrower. While there
    is no universally accepted definition, predatory lending is associated
    with the following loan characteristics and lending practices:

    o 	Excessive fees. Abusive loans may include fees that greatly exceed the
    amounts justified by the costs of the services provided and the credit and
    interest rate risks involved. Lenders may add these fees to the loan
    amounts rather than requiring payment up front, so the borrowers may not
    know the exact amount of the fees they are paying.

    o 	Excessive interest rates. Mortgage interest rates can legitimately vary
    based on the characteristics of borrowers (such as creditworthiness) and
    of the loans themselves. However, in some cases, lenders may charge
    interest rates that far exceed what would be justified by any riskbased
    pricing calculation, or lenders may "steer" a borrower with an excellent
    credit record to a higher-rate loan intended for borrowers with poor
    credit histories.

    o 	Single-premium credit insurance. Credit insurance is a loan product
    that repays the lender should the borrower die or become disabled. In the
    case of single- premium credit insurance, the full premium is paid all at
    once-by being added to the amount financed in the loan-rather than on a
    monthly basis. Because adding the full premium to the

    1Throughout this report, the terms predatory lending and abusive lending
    are used interchangeably.

    Chapter 1 Introduction

    amount of the loan unnecessarily raises the amount of interest borrowers
    pay, single-premium credit insurance is generally considered inherently
    abusive.

    o 	Lending without regard to ability to repay. Loans may be made without
    regard to a borrower's ability to repay the loan. In these cases, the loan
    is approved based on the value of the asset (the home) that is used as
    collateral. In particularly egregious cases, monthly loan payments have
    equaled or exceeded the borrower's total monthly income. Such lending can
    quickly lead to foreclosure of the property.

    o 	Loan flipping. Mortgage originators may refinance borrowers' loans
    repeatedly in a short period of time without any economic gain for the
    borrower. With each successive refinancing, these originators charge high
    fees that "strip" borrowers' equity in their homes.

    o 	Fraud and deception. Predatory lenders may perpetrate outright fraud
    through actions such as inflating property appraisals and doctoring loan
    applications and settlement documents. Lenders may also deceive borrowers
    by using "bait and switch" tactics that mislead borrowers about the terms
    of their loan. Unscrupulous lenders may fail to disclose items as required
    by law or in other ways may take advantage of borrowers' lack of financial
    sophistication.

    o 	Prepayment penalties. Penalties for prepaying a loan are not
    necessarily abusive, but predatory lenders may use them to trap borrowers
    in high-cost loans.

    o 	Balloon payments. Loans with balloon payments are structured so that
    monthly payments are lower but one large payment (the balloon payment) is
    due when the loan matures. Predatory loans may contain a balloon payment
    that the borrower is unlikely to be able to afford, resulting in
    foreclosure or refinancing with additional high costs and fees. Sometimes,
    lenders market a low monthly payment without adequate disclosure of the
    balloon payment.

    Predatory lending is difficult to define partly because certain loan
    attributes may or may not be abusive, depending on the overall context of
    the loan and the borrower. For example, although prepayment penalties can
    be abusive in the context of some loans, in the context of other loans
    they can benefit borrowers by reducing the overall cost of loans by
    reducing the lender's prepayment risk.

    Chapter 1 Introduction

    According to federal and industry officials, most predatory mortgage
    lending involves home equity loans or loan refinancings rather than loans
    for home purchases. Homeowners may be lured into entering refinance loans
    through aggressive solicitations by mortgage brokers or lenders that
    promise "savings" from debt consolidation or the ability to "cash out" a
    portion of a borrower's home equity. Predatory lending schemes may also
    involve home improvement contractors that work in conjunction with a
    lender. The contractor may offer to arrange financing for necessary
    repairs or improvements, and then perform shoddy work or fail to complete
    the job, while leaving the borrower holding a high-cost loan. Abuses in
    loan servicing have also increasingly become a concern. Abusive mortgage
    lenders or servicing agents may charge improper late fees, require
    unjustified homeowner's insurance, or not properly credit payments. In
    November 2003, the Federal Trade Commission (FTC) and the Department of
    Housing and Urban Development (HUD) reached a settlement with a large
    national mortgage servicer, Fairbanks Capital, after the company was
    accused of unfair, deceptive, and illegal practices in the servicing of
    mortgage loans. The settlement will provide $40 million to reimburse
    consumers.

    Originating lenders or brokers that engage in abusive practices can make
    high profits through the excessive points and fees that they charge,
    particularly when borrowers make their payments regularly. Even when a
    loan enters foreclosure, the originator of a predatory loan may still make
    a profit due to the high up-front fees it has already collected. Moreover,
    a lender that sells a loan in the secondary market shortly after
    origination no longer necessarily faces financial risk from foreclosure.2
    Similarly, a mortgage broker that collects fees up front is not affected
    by foreclosure of the loan.

    According to HUD and community groups, predatory lending not only harms
    individual borrowers but also can weaken communities and neighborhoods by
    causing widespread foreclosures, which reduce property values. Predatory
    lending also serves to harm the reputation of honest and legitimate
    lenders, casting them in the same suspicious light as those making unfair
    loans and thus increasing their reluctance to extend credit to the
    traditionally underserved communities that are often targeted by abusive
    lenders.

    2As discussed in chapter 4, the secondary market is where existing
    mortgage loans and mortgage-backed securities are sold and purchased.

                                 Chapter 1 Introduction

      Emergence of Subprime Mortgage Market

    The market for mortgage loans has evolved considerably over the past 20
    years. Among the changes has been the emergence of a market for subprime
    mortgage loans. Most mortgage lending takes place in what is known as the
    prime market, which encompasses traditional lenders and borrowers with
    credit histories that put them at low risk of default. In contrast, the
    subprime market serves borrowers who have poor or no credit histories or
    limited incomes, and thus cannot meet the credit standards for obtaining
    loans in the prime market.3 It is widely accepted that the overwhelming
    majority of predatory lending occurs in the subprime market, which has
    grown dramatically in recent years. Subprime mortgage originations grew
    from $34 billion in 1994 to more than $213 billion in 2002 and in 2002
    represented 8.6 percent of all mortgage originations, according to data
    reported by the trade publication Inside B&C Lending. Several factors
    account for the growth of the subprime market, including changes in tax
    law that increased the tax advantages of home equity loans, rapidly
    increasing home prices that have provided many consumers with substantial
    home equity, entry into the subprime market by companies that had
    previously made only prime loans, and the expansion of credit scoring and
    automated underwriting, which has made it easier for lenders to price the
    risks associated with making loans to credit-impaired borrowers.

    Originating lenders charge higher interest rates and fees for subprime
    loans than they do for prime loans to compensate for increased risks and
    for higher servicing and origination costs. In many cases, increased risks
    and costs justify the additional cost of the loan to the borrower, but in
    some cases they may not. Because subprime loans involve a greater variety
    and complexity of risks, they are not the uniformly priced commodities
    that prime loans generally are. This lack of uniformity makes comparing
    the costs of subprime loans difficult, which can increase borrowers'
    vulnerability to abuse.

    However, subprime lending is not inherently abusive, and certainly all
    subprime loans are not predatory. Although some advocacy groups claim that
    subprime lending involves abusive practices in a majority of cases, most
    analysts believe that only a relatively small portion of subprime loans

    3There is no uniform definition across the lending industry for what
    characterizes a loan as subprime. Subprime loans are generally given to
    borrowers with credit scores that are below a certain threshold, but that
    threshold can vary according to the policies of the individual lender.

    Chapter 1 Introduction

    contain features that may be considered abusive. In addition, according to
    officials at HUD and the Department of the Treasury, the emergence of a
    subprime mortgage market has enabled a whole class of credit-impaired
    borrowers to buy homes or access the equity in their homes. At the same
    time, however, federal officials and consumer advocates have expressed
    concerns that the overall growth in subprime lending and home equity
    lending in general has been accompanied by a corresponding increase in
    predatory lending. For example, lenders and brokers may use aggressive
    sales and marketing tactics to convince consumers who need cash to enter
    into a home equity loan with highly disadvantageous terms.

    Originators of subprime loans are most often mortgage and consumer finance
    companies, but can also be banks, thrifts, and other institutions. Some
    originators focus primarily on making subprime loans, while others offer a
    variety of prime and subprime loans. According to HUD, 178 lenders
    concentrated primarily on subprime mortgage lending in 2001. Fifty-nine
    percent of these lenders were independent mortgage companies (mortgage
    bankers and finance companies), 20 percent were nonbank subsidiaries of
    financial or bank holding companies, and the remainder were other types of
    financial institutions. Only 10 percent were federally regulated banks and
    thrifts.4

    About half of all mortgage loans are made through mortgage brokers that
    serve as intermediaries between the borrower and the originating lender.
    According to government and industry officials, while the great majority
    of mortgage brokers are honest, some play a significant role in
    perpetrating predatory lending. A broker can be paid for his services from
    up-front fees directly charged to the borrower and/or through fees paid
    indirectly by the borrower through the lender in what is referred to as a
    "yield spread premium."5 Some consumer advocates argue that compensating
    brokers this way gives brokers an incentive to push loans with higher
    interest rates and fees. Brokers respond that yield spread premiums in
    fact allow them to reduce the direct up-front fees they charge consumers.

    4HUD annually identifies a list of lenders that specialize in either
    subprime or manufactured home lending. HUD occasionally updates data
    related to past years. The information provided here was based on data
    available as of November 7, 2003.

    5A "yield spread premium" is a payment a mortgage broker receives from a
    lender based on the difference between the actual interest rate on the
    loan and the rate the lender would have accepted on the loan given the
    risks and costs involved. The higher the actual loan rate compared with
    the acceptable loan rate, the higher the yield spread premium.

                                 Chapter 1 Introduction

      The Extent of Predatory Lending Is Unknown

    Currently no comprehensive and reliable data are available on the extent
    of predatory lending nationwide, for several reasons. First, the lack of a
    standard definition of what constitutes predatory lending makes it
    inherently difficult to measure. Second, any comprehensive data collection
    on predatory lending would require access to a representative sample of
    loans and to information that can only be extracted manually from the
    physical loan files. Given that such records are not only widely dispersed
    but also generally proprietary, to date comprehensive data have not been
    collected.6 Nevertheless, policymakers, advocates, and some lending
    industry representatives have expressed concerns in recent years that
    predatory lending is a significant problem. Although the extent of
    predatory lending cannot be easily quantified, several indicators suggest
    that it may be prevalent. Primary among these indicators are legal
    settlements, foreclosure patterns, and anecdotal evidence.

    In the past 5 years, there have been a number of major settlements
    resulting from government enforcement actions and private party lawsuits
    accusing lenders of abusive lending practices affecting large numbers of
    borrowers. Among the largest of these settlements have been the following:

    o 	In October 2002, the lender Household International agreed to pay up to
    $484 million to homeowners across the nation to settle allegations by
    states that it used unfair and deceptive lending practices to make
    mortgage loans with excessive interest and charges.

    o 	In September 2002, Citigroup agreed to pay up to $240 million to
    resolve charges by FTC and private parties that Associates First Capital
    Corporation and Associates Corporation of North America (The

    6One of the few studies that sought to quantify the extent of predatory
    lending was "Quantifying the Economic Cost of Predatory Lending," E.
    Stein, Coalition for Responsible Lending, July 25, 2001 (revised Oct. 30,
    2001). We were not able to verify the reliability of the study's data,
    which were based on several sources. Other empirical data appears in a
    study by Freddie Mac on its automated underwriting system, "Automated
    Underwriting: Making Mortgage Lending Simpler and Fairer for America's
    Families," September 1996. The company evaluated a sample of 15,000
    subprime mortgage loans originated by four financial institutions and
    provided preliminary estimates that between 10 and 35 percent of the
    borrowers who received these loans could have qualified for a loan in the
    prime market. Some consumer advocates have said these data suggest that
    some borrowers may be "steered" to high-cost loans even though they
    qualify for conventional loans with better terms. A Freddie Mac official
    told us that the data are insufficient to necessarily draw that
    conclusion.

    Chapter 1 Introduction

    Associates) engaged in systematic and widespread deceptive and abusive
    lending practices.7 According to FTC staff, under the settlement close to
    1 million borrowers will receive compensation for loans that
    misrepresented insurance products and that contained other abusive terms.

    o 	In response to allegations of deceptive marketing and abusive lending,
    First Alliance Mortgage Company entered into a settlement in March 2002
    with FTC, six states, and private parties to compensate nearly 18,000
    borrowers more than $60 million dollars.

    Further, between January 1998 and September 1999, the foreclosure rate for
    subprime loans was more than 10 times the foreclosure rate for prime
    loans.8 While it would be expected that loans made to less creditworthy
    borrowers would result in some increased rate of foreclosure, the
    magnitude of this difference has led many analysts to suggest that it is
    at least partly the result of abusive lending, particularly of loans made
    without regard to the borrower's ability to repay. Moreover, the rate of
    foreclosures of subprime mortgage loans has increased substantially since
    1990, far exceeding the rate of increase for subprime originations. A
    study conducted for HUD noted that while the increased rate in subprime
    foreclosures could be the result of abusive lending, it could also be the
    result of other factors, such as an increase in subprime loans that are
    made to the least creditworthy borrowers.9

    In the early 1990s, anecdotal evidence began to emerge suggesting that
    predatory lending was on the rise. Legal services agencies throughout the
    country reported an increase in clients who were facing foreclosure as a
    result of mortgage loans that included abusive terms and conditions. These
    agencies noted that for the first time they were seeing large numbers of

    7Citigroup acquired Associates First Capital Corporation and Associates
    Corporation of North America in November 2000 and merged The Associates'
    consumer finance operations into its subsidiary, CitiFinancial Credit
    Company.

    8See HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home
    Mortgage Lending: A Joint Report (June 2000), 34-35. The report noted that
    from January 1998 through September 1999, foreclosure rates averaged 0.2
    percent for prime mortgage loans and 2.6 percent for subprime mortgage
    loans.

    9Harold L. Bunce, Debbie Gruenstein, Christopher E. Herbert, and Randall
    M. Scheessele, "Subprime Foreclosures: The Smoking Gun of Predatory
    Lending?" Paper presented at the U.S. Department of Housing and Urban
    Development conference "Housing Policy in the New Millennium," Crystal
    City, VA, October 2000.

                                 Chapter 1 Introduction

    consumers, particularly elderly and minority borrowers, who were facing
    the loss of homes they had lived in for many years because of a high-cost
    refinancing. Similar observations were also reported extensively at forums
    on predatory lending sponsored by HUD and the Department of the Treasury
    in five cities during 2000, at hearings held in four cities during 2000 by
    the Board of Governors of the Federal Reserve System (the Board), and at
    congressional hearings on the issue in 1998, 2001, 2002, and 2003.10

    Federal officials and consumer advocates maintain that predatory lenders
    often target certain populations, including the elderly and some lowincome
    and minority communities. Some advocates say that in many cases, predatory
    lenders target communities that are underserved by legitimate
    institutions, such as banks and thrifts, leaving borrowers with limited
    credit options. According to government officials and legal aid
    organizations, predatory lending appears to be more prevalent in urban
    areas than in rural areas, possibly because of the concentration of
    certain target groups in urban areas and because the aggressive marketing
    tactics of many predatory lenders may be more efficient in denser
    neighborhoods.11

    Emergence of The federal government began addressing predatory home
    mortgage

    lending as a significant policy issue in the early 1990s. In 1994, the
    CongressPredatory Lending As passed the Home Ownership and Equity
    Protection Act (HOEPA), anPolicy Issue amendment to the Truth in Lending
    Act that set certain restrictions on

    "high-cost" loans in order to protect consumers.12 In 1998, as part of an

    10Hearing on "Equity Predators: Stripping, Flipping and Packing Their Way
    to Profits," Special Committee on Aging, U.S. Senate, March 16, 1998.
    Hearing on "Predatory Mortgage Lending: The Problem, Impact and
    Responses," Committee on Banking, Housing, and Urban Affairs, U.S. Senate,
    July 26 and 27, 2001. Hearing on "Predatory Mortgage Lending Practices:
    Abusive Uses of Yield Spread Premiums," Committee on Banking, Housing, and
    Urban Affairs, U.S. Senate, January 8, 2002. Hearing on "Protecting
    Homeowners: Preventing Abusive Lending While Preserving Access to Credit,"
    Subcommittees on Financial Institutions and Consumer Credit and Housing
    and Community Opportunity, Committee on Financial Services, House of
    Representatives, November 5, 2003.

    11A Rural Housing Institute report found that predatory lending did not
    appear to have infiltrated rural counties in Iowa as much as urban
    counties. However, the institute also noted there have been reports of
    many cases of predatory lending in rural areas of the country overall,
    with comparably severe effects on rural victims. See Rural Voices, Vol. 7,
    No. 2, Spring 2002, 4-5.

    12See Pub. L. 103-325 S:S: 151-158, 108 Stat. 2190-2198.

                                 Chapter 1 Introduction

    overall review of the statutory requirements for mortgage loans, HUD and
    the Board released a report recommending that additional actions be taken
    to protect consumers from abusive lending practices.13 HUD and the
    Department of the Treasury formed a task force in 2000 that produced the
    report Curbing Predatory Home Mortgage Lending, which made several dozen
    recommendations for addressing predatory lending.14, 15

    As discussed in chapters 2 and 3, a variety of federal, state, and local
    laws have been used to take civil and criminal enforcement actions against
    institutions and individuals accused of abusive lending practices. Various
    federal agencies have responsibilities for enforcing laws related to
    predatory lending. In addition, some state or local enforcement
    authorities-including attorneys general, banking regulators, and district
    attorneys-have used state and local laws related to consumer protection
    and banking to address predatory lending practices. In addition, many
    private attorneys and advocacy groups have pursued private legal actions,
    including class actions, on behalf of borrowers who claim to have been
    victimized by abusive lending.

      Objectives, Scope, and Methodology

    Our objectives were to describe (1) federal laws related to predatory
    lending and federal agencies' efforts to enforce them; (2) the actions
    taken by the states in addressing predatory lending; (3) the secondary
    market's role in facilitating or inhibiting predatory lending; (4) how
    consumer education, mortgage counseling, and loan disclosures may deter
    predatory lending; and (5) the relationship between predatory lending
    activities and elderly consumers. The scope of this work was limited to
    home mortgage lending and did not include other forms of consumer loans.

    To identify federal laws and enforcement activities related to predatory
    lending, we interviewed officials and reviewed documents from HUD, the

    13Board of Governors of the Federal Reserve System and 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.

    14HUD-Treasury Task Force on Predatory Lending, Curbing Predatory Home
    Mortgage Lending: A Joint Report, June 2000.

    15During 2003, there were at least two bills introduced in Congress that
    addressed predatory or abusive lending practices-the Responsible Lending
    Act (H.R. 833, Feb. 13, 2003) and the Predatory Lending Consumer
    Protection Act of 2003 (S. 1928, Nov. 21, 2003).

    Chapter 1 Introduction

    Department of Justice (DOJ), the Department of the Treasury, the Federal
    Deposit Insurance Corporation (FDIC), FTC, the Board, the National Credit
    Union Administration (NCUA), the Office of the Comptroller of the Currency
    (OCC), and the Office of Thrift Supervision (OTS). We asked each agency to
    provide us with the enforcement actions they have taken that-in their
    assessment-were related to predatory home mortgage lending. We compiled
    and reviewed data on these enforcement actions and other steps these
    agencies have taken to address abusive lending practices. We also reviewed
    and analyzed federal laws that have been used to combat these practices.

    To identify actions taken by states and localities, we reviewed and
    analyzed a publicly available database maintained by the law firm of
    Butera & Andrews that tracks state and municipal antipredatory lending
    legislation. We reviewed information related to this database and
    conducted interviews with the person who maintains it. In order to
    identify gaps in the completeness or accuracy of data, we compared data
    elements from this database and from three similar databases maintained by
    Lotstein Buckman, the National Conference of State Legislatures, and the
    Mortgage Bankers Association of America. We determined that the data were
    sufficiently reliable for use in this report. We also interviewed
    officials representing a wide range of state and local government
    agencies, lending institutions, and advocacy groups in a number of states
    and municipalities. In order to illustrate approaches taken in certain
    states with regard to predatory lending, we collected and analyzed
    additional information from two states, North Carolina and Ohio. We chose
    these states to illustrate the differing characteristics of two states'
    approaches to addressing predatory lending-particularly with regard to
    legislation restricting high-cost loans and tightening regulation of
    mortgage lenders and brokers. We also conducted meetings with the
    Conference of State Bank Supervisors and the National Association of
    Attorneys General that included representatives from several states.
    Additionally, we conducted interviews with OCC, OTS, and NCUA to
    understand their policies and processes on federal preemption of state
    antipredatory lending laws.

    To describe the secondary market's role, we interviewed officials and
    reviewed documents from the Bond Market Association, the Securities
    Industry Association, Fannie Mae, Freddie Mac, a due diligence contractor,
    and two credit rating agencies. We also spoke with officials representing
    federal and state agencies, and with representatives of the lending
    industry and consumer groups. In addition, we reviewed and analyzed
    several local and state laws containing assignee liability provisions.

    Chapter 1 Introduction

    To describe the role of consumer education, mortgage counseling, and
    disclosures in deterring predatory lending, we interviewed officials from
    entities that engage in consumer financial education, including several
    federal and state agencies, industry trade groups, and local nonprofit
    organizations such as the Long Island Housing Partnership, the Greater
    Cincinnati Mortgage Counseling Service, and the Foreclosure Prevention
    Project of South Brooklyn Legal Services. We also reviewed and analyzed
    the materials these entities produce. Additionally, we conducted a
    literature review of studies that have evaluated the effectiveness of
    consumer education and homeownership counseling.

    To describe the impact on older consumers, we conducted a literature
    review on predatory lending and the elderly and examined studies on
    financial exploitation of the elderly. We also examined certain
    enforcement activities and private party lawsuits in which elderly
    consumers may have been targeted by abusive lenders. We interviewed
    federal and state agencies that have addressed issues of financial abuse
    of the elderly, including the Department of Health and Human Services'
    Administration on Aging and the National Institute on Aging, as well as
    nonprofit groups that have addressed this issue, including AARP (formerly
    known as the American Association of Retired Persons).

    In addressing all of the objectives, we met with a wide range of
    organizations that represent consumers, among them the National Community
    Reinvestment Coalition, the Coalition for Responsible Lending, the
    National Consumer Law Center, the Association of Community Organizations
    for Reform Now, and AARP. We also met with organizations representing
    various aspects of the mortgage lending industry, among them the American
    Financial Services Association, the Consumer Mortgage Coalition, the
    Coalition for Fair and Affordable Lending, America's Community Bankers,
    the National Association of Mortgage Brokers, the Mortgage Bankers
    Association of America, and the National Home Equity Mortgage Association.

    We provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
    NCUA, OCC, OTS, and the Department of the Treasury for review and comment.
    The agencies provided technical comments that have been incorporated, as
    appropriate, as well as general comments that are discussed at the end of
    chapter 2. The written comments of the Board, DOJ, HUD, and NCUA are
    printed in appendixes II through V. We conducted our work between January
    2003 and January 2004 in accordance

    Chapter 1 Introduction

    with generally accepted government auditing standards in Atlanta, Boston,
    New York, San Francisco, and Washington, D.C.

    Chapter 2

    Federal Agencies Have Taken Steps to Address Predatory Lending, but Face
    Challenges

    While HOEPA is the only federal law specifically designed to combat
    predatory mortgage lending, federal agencies, including federal banking
    regulators, have used a number of federal consumer protection and
    disclosure statutes to take actions against lenders that have allegedly
    engaged in abusive or predatory lending.1 These statutes have enabled
    agencies to file complaints on behalf of consumers over issues such as
    excessive interest rates and fees, deceptive lending practices, and fraud.
    FTC, DOJ, HUD, and federal banking regulators have taken steps to address
    predatory lending practices through enforcement and civil actions,
    guidance, and regulatory changes. In some cases, agencies have coordinated
    their efforts through joint enforcement actions and participation in
    interagency working groups or task forces. However, questions of
    jurisdiction regarding certain nonbank mortgage lenders may challenge
    efforts to combat predatory lending. While the Board has authority to
    examine many such nonbank mortgage lenders under certain circumstances, it
    lacks clear authority to enforce federal consumer protection laws against
    them.

      Federal Agencies Use a Variety of Laws to Address Predatory Lending Practices

    As shown in figure 1, Congress has passed numerous laws that can be used
    to protect consumers against abusive lending practices. Federal agencies
    have applied provisions of these laws to seek redress for consumers who
    have been victims of predatory lending. Among the most frequently used
    laws are TILA, HOEPA, the Real Estate Settlement Procedures Act (RESPA),
    and the FTC Act. 2 Congress has also given certain federal agencies
    responsibility for writing regulations that implement these laws. For
    example, the Board writes Regulation Z, which implements TILA and HOEPA,
    and HUD writes Regulation X, which implements RESPA. Also, in some cases,
    DOJ has brought actions under criminal fraud statutes based on conduct
    that can constitute predatory lending.

    1HOEPA amended various provisions of the Truth In Lending Act. In the
    context of this report, the term "federal banking regulators" refers to
    the Board, the federal supervisory agency for state-chartered banks that
    are members of the Federal Reserve System; OCC, which supervises national
    banks and their subsidiaries; FDIC, the federal regulator responsible for
    insured state-chartered banks that are not members of the Federal Reserve
    System; OTS, the primary federal supervisory agency for federally insured
    thrifts and their subsidiaries; and NCUA, which supervises federally
    insured credit unions.

    2TILA, as amended, is codified at 15 U.S.C. S:S: 1601 - 1667f (2000 & Supp
    2003). The pertinent consumer protection provisions of the FTC Act are
    contained in 15 U.S.C. S:S: 41 - 58 (2000). RESPA is codified at 12 U.S.C.
    S:S: 2601 - 2617 (2000 & Supp 2003).

                                       Chapter 2
                          Federal Agencies Have Taken Steps to
                          Address Predatory Lending, but Face
                                       Challenges

    Figure 1: Federal Laws and Statutes Used to Address Lending Practices Generally
                               Considered to be Predatory

    Source: GAO.

    aHOEPA covers only a limited portion of all subprime loans.

    TILA, which became law in 1968, was designed to provide consumers with
    accurate information about the cost of credit. Among other things, the act
    requires lenders to disclose information about the terms of loans-
    including the amount being financed, the total finance charge, and
    information on the annual percentage rate-that can help borrowers
    understand the overall costs of their loans. TILA also provides borrowers
    with the right to cancel certain loans secured by a principal residence
    within 3 days of closing or 3 days of the time at which the final
    disclosure is made, whichever is later.3

    3See 15 U.S.C. S: 1635.

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    In 1994, Congress enacted the HOEPA amendments to TILA in response to
    concerns about predatory lending. HOEPA covers certain types of loans made
    to refinance existing mortgages, as well as home equity loans, that
    satisfy specific criteria.4 HOEPA covers only a limited portion of all
    subprime loans, although there is no comprehensive data on precisely what
    that portion is.5 The law is designed to limit predatory practices for
    these so-called "high-cost" HOEPA loans in several ways. First, it places
    restrictions on loans that exceed certain rate or fee thresholds, which
    the Board can adjust within certain limits prescribed in the law. For
    these loans, the law restricts prepayment penalties, prohibits balloon
    payments for loans with terms of less than 5 years, prohibits negative
    amortization, and contains certain other restrictions on loan terms or
    payments.6 Second, HOEPA prohibits lenders from routinely making loans
    without regard to the borrower's ability to repay. Third, the law requires
    lenders to include disclosures in addition to those required by TILA for
    consumer credit transactions to help borrowers understand the terms of the
    high-cost loan and the implications of failing to make required payments.
    Each federal banking regulator is charged with enforcing TILA and HOEPA
    with respect to the depository institutions it regulates, and FTC is
    primarily responsible for enforcing the statutes for most other financial
    institutions, including independent mortgage lenders and nonbank
    subsidiaries of holding companies. In enforcing TILA and HOEPA, FTC has
    required violators to compensate borrowers for statutory violations. Under
    certain

    4HOEPA covers closed-end refinancing loans and home equity loans with
    either (i) an annual percentage rate that exceeds the rate for Treasury
    securities with comparable maturities by more than a specified amount, or
    (ii) points and fees that exceed the greater of 8 percent of the loan
    amount or $400, which is adjusted annually for inflation. 15 U.S.C. S:
    1602(aa)(1), (3); see 12 C.F.R. S: 226.32 (2003). HOEPA does not apply to
    purchase money mortgages (i.e., loans to purchase or construct a
    residence), open-end credit (i.e., a line of credit), and reverse
    mortgages. See, e.g., 15 U.S.C. S: 1639.

    5The Board has cited a study conducted for the American Financial Services
    Association that estimated that-using current triggers-HOEPA would have
    covered nearly 38 percent of subprime first mortgage loans originated by
    nine major national lenders from 1995-2000. See M. Staten and G.
    Elliehausen, "The Impact of The Federal Reserve Board's Proposed Revisions
    to HOEPA on the Number and Characteristics of HOEPA Loans" (July 24,
    2001). In the past, the Board has also cited estimates from data from OTS
    that, using the current triggers, HOEPA would cover roughly 5 percent of
    all subprime loans, but the Board noted to us that this estimate may be
    conservative. See 65 Fed. Reg. at 81441.

    6Negative amortization occurs when loan payment amounts do not cover the
    interest accruing on a loan, resulting in an increasing outstanding
    principal balance over time. See 15 U.S.C. S: 1639(f).

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    circumstances, HOEPA provides for damages in addition to the actual
    damages a person sustains as a result of a creditor's violation of the
    act.7

    RESPA, passed in 1974, seeks to protect consumers from unnecessarily high
    charges in the settlement of residential mortgages by requiring lenders to
    disclose details of the costs of settling a loan and by prohibiting
    certain other costs.8 Among its provisions is a prohibition against
    kickbacks- payments made in exchange for referring a settlement service,
    such as lender payments to real estate agents for the referral of
    business. RESPA also prohibits unearned fees such as adding an additional
    charge to a third party fee when no or nominal services are performed.
    These practices can unjustly increase the costs of loans and the
    settlement process. HUD enforces RESPA, working closely with federal
    banking regulators and other federal agencies such as the FTC and the
    Department of Justice. HUD often brings joint enforcement actions with
    these agencies, using RESPA and the statutes enforced by the other federal
    agencies. In addition, the banking regulators may prohibit violations of
    RESPA in their own regulations.

    The FTC Act, enacted in 1914 and amended on numerous occasions, provides
    the FTC with the authority to prohibit and take action against unfair or
    deceptive acts or practices in or affecting commerce. FTC has used the act
    to address predatory lending abuses when borrowers have been misled or
    deceived about their loan terms.9

    Various criminal fraud statutes prohibit certain types of fraud sometimes
    used in abusive lending schemes, including forgery and false statements.
    DOJ and HUD have used these statutes to fight fraudulent schemes that have
    resulted in borrowers purchasing homes worth substantially less than their
    mortgage amounts or borrowers being unfairly stripped of the equity in
    their homes. HUD officials have described some of these fraudulent
    activities as constituting predatory lending.

    7See Pub. L. No. 103-325 S: 153(a), 15 U.S.C. S: 1640(a).

    8Among other things, RESPA requires the good faith disclosure of estimated
    settlement costs within 3 days after an application for a mortgage loan
    and, at or before settlement, a uniform settlement statement (HUD-1) that
    enumerates the final cost of the loan.

    9Banking regulators are also authorized to enforce standards imposed
    pursuant to the FTC Act with respect to unfair or deceptive acts or
    practices by the institutions they supervise. See 12 U.S.C. S: 57a(f).

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    The following other federal laws have been used to a lesser extent to
    address abusive lending:

    o 	The Fair Housing Act prohibits discrimination based on race, sex, and
    other factors in housing-related transactions, and the Equal Credit
    Opportunity Act (ECOA) prohibits discrimination against borrowers in the
    extension of credit. Federal agencies have used both laws in cases against
    lenders that have allegedly targeted certain protected groups with abusive
    loans.

    o 	The Home Mortgage Disclosure Act (HMDA) requires lenders to make
    publicly available certain data about mortgage loans. Federal agencies
    have used the data provided by HMDA to help identify possible
    discriminatory lending patterns, including those that involve abusive
    lending practices.

    o 	The Community Reinvestment Act (CRA) requires that banking regulators
    consider a depository institution's efforts to meet the credit needs of
    its community-including low- and moderate-income neighborhoods-in
    examinations and when it applies for permission to take certain actions
    such as a merger or acquisition. An institution's fair lending record is
    taken into account in assessing CRA performance. CRA regulations state
    that abusive lending practices that violate certain federal laws will
    adversely affect an institution's CRA performance.10

    o 	Also, federal banking regulators may rely on their supervisory and
    enforcement authorities under the laws they administer, as well as on the
    Federal Deposit Insurance Act, to enforce these consumer protections laws
    and ensure that an institution's conduct with respect to compliance with
    consumer protection laws does not affect its safety and soundness or that
    of an affiliated institution.

    o 	Finally, FTC and the banking regulators can also use the Fair Debt
    Collection Practices Act and Fair Credit Reporting Act in enforcement

    10On January 20, 2004, FDIC announced approval of a joint interagency
    notice of proposed rulemaking regarding the Community Reinvestment Act.
    The proposed rule would amend the act's regulations to expand and clarify
    the provision that an institution's Community Reinvestment Act evaluation
    is adversely affected when the institution has engaged in specified
    discriminatory, illegal, or abusive credit practices in connection with
    certain loans. FDIC said that the Board, OCC, and OTS were expected to
    announce their approval of the proposed rulemaking shortly.

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    actions related to predatory lending that involve violations of credit
    reporting and loan servicing provisions.

    Although a number of federal laws have been used to protect borrowers from
    abusive lending or to provide them redress, not all potentially abusive
    practices are illegal under federal law. Enforcement officials and
    consumer advocates have stated that some lenders make loans that include
    abusive features but are designed to remain below the thresholds that
    would subject them to the restrictions of HOEPA. For loans not covered
    under HOEPA, certain lending practices many consider to be abusive are
    not, depending on the circumstances, necessarily a violation of any
    federal law. For example, it is not necessarily illegal to charge a
    borrower interest rates or fees that exceed what is justified by the
    actual risk of the mortgage loan. Nor is it per se illegal under federal
    law to "steer" a borrower with good credit who qualifies for a prime loan
    into a higher cost subprime loan.11 Finally, with the exception of loans
    covered under HOEPA, there are no federal statutes that expressly prohibit
    making a loan that a borrower will likely be unable to repay.12

    11Even in instances where charging high interest rates or fees or steering
    borrowers to subprime loans do not violate federal consumer protection
    statutes, imposing such rates and fees on a discriminatory basis against
    groups protected under the Fair Housing Act and ECOA could constitute
    violations of those laws.

    12A pattern of making loans without regard to the ability of borrowers to
    repay can be considered a violation of the safety and soundness
    requirements imposed on federally insured depository institutions and
    could also reflect poorly on an institution's compliance with the
    Community Reinvestment Act. See OCC Advisory Letter 2003-2 (Guidance for
    National Banks to Guard Against Predatory and Abusive Lending Practices),
    February 21, 2003. For loans that are covered under HOEPA, making a loan
    without regard to a borrower's ability to repay is not prohibited unless
    it can be demonstrated that an institution has engaged in a "pattern or
    practice" of doing so. OCC in its recent rulemaking prohibited national
    banks or their operating subsidiaries from making consumer loans based
    predominantly on the foreclosure or liquidation value of a borrower's
    collateral. See 69 Fed. Reg. 1904 (Jan. 13, 2004).

                                       Chapter 2
                          Federal Agencies Have Taken Steps to
                          Address Predatory Lending, but Face
                                       Challenges

      Federal Agencies Have Taken Some Enforcement Actions, but Banking Regulators
      Have Focused on Guidance and Regulatory Changes

    FTC, DOJ, and HUD have taken enforcement actions to address violations
    related to abusive lending.13 As of December 2003, FTC reported that the
    agency had taken 19 actions against mortgage lenders and brokers for
    predatory practices. DOJ has addressed predatory lending that is alleged
    to be discriminatory by enforcing fair lending laws in a limited number of
    cases. HUD's efforts have generally focused on reducing losses to the
    Federal Housing Administration (FHA) insurance fund, including
    implementing a number of initiatives to monitor lenders for violations of
    FHA guidelines.14 HUD reported having taken a small number of actions to
    enforce RESPA and the Fair Housing Act in cases involving predatory
    lending.

    Federal banking regulators stated that their monitoring and examination
    activities have revealed little evidence of predatory lending practices by
    federally regulated depository institutions. Accordingly, most banking
    regulators reported that they have taken no formal enforcement actions
    related to predatory mortgage lending abuses by the institutions they
    supervise. Regulators have addressed predatory lending primarily by
    issuing guidance to their institutions on guarding against direct or
    indirect involvement in predatory lending practices and by making certain
    changes to HOEPA and HMDA regulations. In addition, several federal
    agencies have coordinated certain efforts to pursue enforcement actions
    related to predatory lending and have shared information on their efforts
    to address fair lending and predatory lending.

    13Most enforcement actions discussed in this chapter were civil judicial
    actions brought and settled by FTC, DOJ, and HUD.

    14HUD's FHA mortgage insurance program makes loans more readily available
    for low-and moderate-income families by providing mortgage insurance to
    purchase or refinance a home. Lending institutions such as mortgage
    companies and banks fund the loans.

                                       Chapter 2
                          Federal Agencies Have Taken Steps to
                          Address Predatory Lending, but Face
                                       Challenges

        FTC Has Played the Predominant Federal Role in Enforcement Actions Related
        to Predatory Lending

    FTC is responsible for implementing and enforcing certain federal laws
    among lending institutions that are not supervised by federal banking
    regulators. FTC reported that between 1983 and 2003, it filed 19
    complaints alleging deceptive or other illegal practices by mortgage
    lenders and brokers, 17 of them filed since 1998.15 For a list of these
    FTC enforcement actions, see appendix I. As of December 2003, FTC had
    reached settlements in all but one of the cases. In most of these
    settlements, companies have agreed to provide monetary redress to
    consumers and to halt certain practices in the future. In some cases, the
    settlements also imposed monetary penalties that the companies have paid
    to the government. Among the recent enforcement actions related to
    predatory lending that the FTC identified are the following:

    o 	The Associates. In 2002, FTC settled a complaint against Associates
    First Capital Corporation and Associates Corporation of North America
    (collectively, The Associates), as well as their successor, Citigroup. The
    complaint alleged that the lender violated the FTC Act and other laws by,
    among other things, deceiving customers into refinancing debts into home
    loans with high interest rates and fees and purchasing high-cost credit
    insurance. The settlement, along with a related settlement with private
    parties, provides for up to $240 million in restitution to borrowers.16

    o 	First Alliance. In 2002, FTC, along with several states and private
    plaintiffs, settled a complaint against First Alliance Mortgage Company
    alleging that it violated federal and state laws by misleading consumers
    about loan origination and other fees, interest rate increases, and
    monthly payment amounts on adjustable rate mortgage loans. The company
    agreed to compensate nearly 18,000 borrowers more than $60

    15FTC has also recently addressed abuses in the mortgage loan servicing
    industry. In November 2003, it announced settlements with Fairbanks
    Capital Holding Corp., its wholly owned subsidiary Fairbanks Capital
    Corp., and their founder and former CEO (collectively, Fairbanks) on
    charges that Fairbanks violated the FTC Act, RESPA, and other laws by
    failing to post consumers' mortgage payments in a timely manner and
    charging consumers illegal late fees and other unauthorized fees. The
    settlement will provide $40 million in redress to consumers. The case was
    jointly filed with HUD. United States of America v. Fairbanks Capital
    Corp. et al., Civ. Action No. 03-12219-DPW (D. Mass.)(filed 11/12/03).

    16Citigroup, Inc., acquired The Associates in a merger that was completed
    in November 2000. The FTC complaint named Citigroup and CitiFinancial
    Credit Company as successor defendants.

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    Challenges

    million in consumer redress and to refrain from making misrepresentations
    about future offers of credit.

    o 	Fleet Finance and Home Equity U.S.A. In 1999, Fleet Finance, Inc., and
    Home Equity U.S.A., Inc., settled an FTC complaint alleging violations of
    the FTC Act, TILA, and related regulations. These violations included
    failing to provide required disclosures about home equity loan costs and
    terms and failing to alert borrowers to their right to cancel their credit
    transactions. To settle, the company agreed to pay up to $1.3 million in
    redress and administrative costs and to refrain from violating TILA in the
    future.

    o 	Operation Home Inequity. In 1999, FTC conducted "Operation Home
    Inequity," a law enforcement and consumer education campaign that sought
    to curb abusive practices in the subprime mortgage lending market. FTC
    reached settlements with seven subprime mortgage lenders that had been
    accused of violating a number of consumer protections laws, including the
    FTC Act, TILA, and HOEPA. Six companies were required to pay $572,000 in
    consumer redress, and all lenders were required to adhere to future
    lending restrictions. FTC staff told us that the operation was intended in
    large part to increase consumers' awareness of predatory lending and to
    provide a deterrent effect by warning lenders that FTC is able and willing
    to take action against them.

    FTC staff expressed their belief that the agency's enforcement actions
    over the years have been successful in deterring other lenders from
    engaging in abusive practices. However, in a congressional hearing in 2000
    FTC had requested statutory changes that would improve its ability to
    enforce HOEPA. For example, FTC recommended that Congress expand HOEPA to
    prohibit the financing of lump-sum credit insurance premiums in loans
    covered by HOEPA and to give FTC the power to impose civil penalties for
    HOEPA violations.17

    17Prepared statement of the Federal Trade Commission before the House
    Committee on Banking and Financial Services on "Predatory Lending
    Practices in the Subprime Industry," May 24, 2000. Since then, many
    mortgage lenders have said they are abandoning lump-sum credit insurance.

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                          Federal Agencies Have Taken Steps to
                          Address Predatory Lending, but Face
                                       Challenges

        DOJ Has Enforced Fair Lending Laws in Connection with Predatory Lending

    DOJ's Housing and Civil Enforcement Section is responsible for enforcing
    certain federal civil rights laws, including the Fair Housing Act and
    ECOA. DOJ identified two enforcement actions it has taken related to
    predatory mortgage lending practices that it alleged were discriminatory.
    18

    o 	Delta Funding. In 2000, DOJ, in cooperation with FTC and HUD, brought
    charges against Delta Funding Corporation, accusing the consumer finance
    company of violations of the Fair Housing Act, HOEPA, ECOA, RESPA, and
    related federal regulations. 19 Delta allegedly approved and funded loans
    that carried substantially higher broker fees for African American females
    than for similarly situated white males. Delta was also accused of
    violating certain consumer protection laws by paying kickbacks and
    unearned fees to brokers to induce them to refer loan applicants to Delta
    and by systematically making HOEPA loans without regard to borrowers'
    ability to repay. The settlement placed restrictions on the company's
    future lending operations and victims were compensated from previously
    established monetary relief funds.20

    o 	Long Beach Mortgage. In 1996 DOJ settled a complaint alleging
    violations of the Fair Housing Act and ECOA against Long Beach Mortgage
    Company.21 According to the complaint, the company's loan officers and
    brokers charged African American, Hispanic, female, and

    18In addition to these cases, DOJ filed an amicus curiae brief in a
    private case, Hargraves v. Capital City Mortgage Corp., Civ. Action No.
    98-1021 (JHG/AK) (D DC), in which the department contended that certain
    alleged predatory lending practices violated the Fair Housing Act and
    ECOA. The case involved a mortgage lender that allegedly engaged in a
    pattern or practice of deceiving African American borrowers about the
    terms of their loans and other information, such as the total amount due.
    In addition, DOJ filed a complaint in United States v. Action Loan, Civ.
    Action No. 3:00CV-511-H (W.D. KY), which resulted from enforcement efforts
    by the FTC and HUD and involved allegations of predatory mortgage lending.

    19United States v. Delta Funding Corp., Civ. Action No. CV 00 1872 (E.D.
    N.Y. 2000).

    20Two monetary relief funds totaling over $12 million were set up under a
    previous remediation agreement involving Delta and the New York State
    Banking Department.

    21United States v. Long Beach Mortgage Company, Case No. 96-6159 (1996).
    Prior to December 1990, Long Beach Bank was a savings and loan
    association, chartered by the state of California. Between December 1990
    and October 1994, Long Beach Mortgage Company operated under the name of
    Long Beach Bank as a federally chartered thrift institution. In 1999,
    Washington Mutual, a federally chartered thrift, acquired Long Beach
    Mortgage Company and owns it at the holding company level.

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                          Federal Agencies Have Taken Steps to
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                                       Challenges

    older borrowers higher loan rates than it charged other similarly situated
    borrowers. The company agreed to set up a $3 million fund to reimburse
    1,200 consumers who had received Long Beach loans.22

    Representatives from both FTC and DOJ have stated that their enforcement
    actions can be very resource intensive and can involve years of discovery
    and litigation. For example, FTC filed a complaint against Capitol City
    Mortgage Corporation in 1998 that is still in litigation more than 5 years
    later. FTC staff told us that because cases involving predatory lending
    can be so resource intensive, the agencies try to focus their limited
    resources on the cases that will have the most impact, such as those that
    may result in large settlements to consumers or that will have some
    deterrent value by gaining national exposure. Similarly, DOJ officials
    select certain discrimination cases, including those mentioned above, in
    part because of their broad impact.

        HUD's Enforcement Activities Focus on FHA Loans

    HUD's enforcement and regulatory activity with regard to abusive mortgage
    lending comes primarily through its management of the FHA single-family
    mortgage insurance programs, its rule-making and enforcement authority
    under RESPA, and its enforcement of the Fair Housing Act.

    Most of HUD's enforcement activities related to abusive lending have
    focused on reducing losses to the FHA insurance fund. Investigators from
    HUD's Office of the Inspector General have worked with investigators from
    U.S. Attorneys' Offices and the FBI in a joint law enforcement effort to
    target fraud in the FHA mortgage insurance program, which can result in
    defaults and thus in losses to the insurance fund.23 The fraudulent
    activities sometimes involve property flipping schemes, which can harm
    borrowers by leaving them with mortgage loans that may far exceed the

    22DOJ has also taken enforcement actions to address other practices, such
    as credit repair schemes, that do not involve abusive lending but that
    nonetheless serve to illegally strip homeowners of their equity.

    23GAO has issued a number of reports on the FHA single-family insurance
    program, a highrisk program area. For example, see U.S. General Accounting
    Office, Major Management Challenges and Program Risks: Department of
    Housing and Urban Development,

    GAO-03-103 (Washington, D.C.: January 2003).

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    Challenges

    value of their homes.24 Under certain circumstances, such activity can
    involve predatory lending practices. To address these crimes,
    investigators have presented evidence of false statements and other
    criminal fraud and deception. In addition, representatives from HUD told
    us that they have processes in place to ensure that lenders adhere to
    agency guidelines and make loans that satisfy FHA requirements. The Office
    of Lender Activities and Program Compliance approves, recertifies, and
    monitors FHA lenders and works with them to ensure compliance. If
    necessary, the office refers violating lenders to HUD's Mortgagee Review
    Board, which has the authority to take administrative actions such as
    withdrawing approval for a lender to make FHA-insured loans. HUD officials
    told us that the board has taken many administrative actions to address
    violations that could be indicative of predatory lending, such as charging
    excessive and unallowable fees, inflating appraisals, and falsifying
    documents showing income or employment. In an effort to address abusive
    property flipping schemes involving homes secured by FHA-insured loans,
    HUD issued a final rule in May 2003 that prohibits FHA insurance on
    properties resold less than 90 days after their previous sale.

    HUD officials say that programs they have in place to improve the
    monitoring of FHA lenders also serve to deter predatory lending. For
    example, HUD's Credit Watch Program routinely identifies those lenders
    with the highest early default and insurance claim rates and temporarily
    suspends the FHA loan origination approval agreements of the riskiest
    lenders, helping to ensure that lenders are not making loans that
    borrowers cannot repay. Also, the Neighborhood Watch program provides
    information to FHA participants about lenders and appraisers whose loans
    have high default and FHA insurance claim rates. HUD told us that it has
    also taken a series of actions to better ensure the integrity of
    appraisals used to finance FHA insured loans. As of December 2003, HUD was
    in the final stages of issuing a rule that would hold lenders accountable
    for appraisals associated with loans they make.

    24In property flipping schemes, properties are purchased and quickly
    resold at grossly inflated values. In some cases the inflated value is
    established by an interim sale to a "straw buyer" and then flipped to an
    unsuspecting purchaser. In other cases, first-time buyers who have been
    turned down for home loans because of poor credit or low income are
    targeted by flippers who arrange loans well in excess of the real value of
    the property using fabricated employment and deposit records. These
    schemes often involve many players, including mortgage lenders, mortgage
    brokers, underwriters, and home-improvement workers. Almost all flipping
    schemes involve false appraisals. While HUD categorizes property flipping
    as a predatory lending practice, not all federal agencies concur with this
    categorization.

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    HUD's Office of RESPA and Interstate Land Sales is responsible for
    handling complaints, conducting investigations, and taking enforcement
    actions related to RESPA. HUD has taken several enforcement actions
    related to RESPA's prohibition of kickbacks and referral fees, three of
    which related directly to abusive mortgage lending, as of December 2003.25
    Also, as discussed above, in November 2003 HUD and FTC jointly filed a
    case against and reached settlement with a mortgage loan servicing company
    charged with violations of the FTC Act, RESPA, and other laws.26 HUD has
    also recently hired additional staff to enhance its RESPA enforcement
    efforts. Finally, in 2002, HUD issued a proposed rule designed to change
    the regulatory requirements of RESPA to simplify and potentially lower the
    costs of the home mortgage settlement process. According to HUD, as of
    December 2003, the final rule had been submitted to the Office of
    Management and Budget and was being reviewed.

    HUD's Office of Fair Housing and Equal Opportunity is responsible for
    enforcing the Fair Housing Act. HUD identified one action-a letter of
    reprimand to a financial institution-related to enforcement of this act in
    a case involving predatory lending.

        Federal Banking Regulators Have Issued Guidance and Made Regulatory Changes

    According to federal banking regulators and state enforcement authorities,
    federally regulated depository institutions-banks, thrifts, and credit
    unions-have not typically engaged in predatory lending practices. Federal
    banking regulators have systems in place to track customer complaints and
    reported that they have received few complaints related to predatory
    lending by the institutions they supervise. The regulators conduct routine
    examinations of these institutions and have the authority, in cases of
    suspected predatory lending, to enforce a variety of fair lending and
    consumer protection laws. Banking regulators noted that the examination
    process, which involves routine on-site reviews of lenders' activities,
    serves as a powerful deterrent to predatory lending by the institutions
    they examine.

    25For example, a complaint filed jointly by HUD, FTC, and Illinois
    authorities against Mercantile Mortgage Company in 2002 alleged that for
    almost 3 years, a broker referred virtually every one of his loan
    customers to Mercantile in exchange for a fee as high as 10 percent. The
    other two cases involving RESPA include Delta Funding (2000) and Action
    Loan Company (2000).

    26United States of America v. Fairbanks Capital Corp., 03-12219-DPW (D.
    MA, filed Nov. 12, 2003).

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    Officials of OTS, FDIC, the Board, and NCUA said that they had taken no
    formal enforcement actions related to predatory mortgage lending against
    the institutions they regulate. 27 Officials at OCC said they have taken
    one formal enforcement action related to predatory mortgage lending to
    address fee packing, equity stripping, and making loans without regard to
    a borrower's ability to pay. In November 2003, the agency announced an
    enforcement action against Loan Star Capital Bank seeking to reimburse 30
    or more borrowers for more than $100,000 in abusive fees and closing costs
    that violated the FTC Act, HOEPA, TILA, and RESPA.28 The bank also was
    required to conduct a comprehensive review of its entire mortgage
    portfolio and to provide restitution to any additional borrowers who may
    have been harmed.

    While most federal banking regulators stated that they have taken no
    formal enforcement actions, representatives from some said they had taken
    informal enforcement actions to address some questionable practices among
    their institutions. For example, OTS has examined institutions that may
    have charged inappropriate fees or violated HOEPA and resolved the
    problems by requiring corrective action as part of the examination
    process. In addition, most of the banking regulators have taken formal
    enforcement actions, including issuing cease-and-desist orders, in
    response to activities that violated fair lending and consumer protection
    laws but were not necessarily deemed to constitute "predatory lending."

    Guidance	Federal banking regulators have issued guidance to their
    institutions about both predatory lending and subprime lending in general.
    In February 2003, OCC issued two advisory letters related to predatory
    lending to the national banks and the operating subsidiaries it
    supervises. One letter provided specific guidelines for guarding against
    predatory lending practices during loan originations, and the other
    alerted institutions to the risk of indirectly

    27Banking regulators have broad enforcement powers and can take formal
    actions (cease and desist orders, civil money penalties, removal orders,
    and suspension orders, among others) or informal enforcement actions (such
    as memoranda of understanding and board resolutions). Not all informal
    actions are publicly disclosed.

    28Matter of Clear Lake National Bank, AA-EC03-25 (OCC Nov. 7, 2003). The
    lender that made the loans, Clear Lake National Bank of San Antonio,
    Texas, merged with another bank in April 2003 to become Lone Star Capital
    Bank, N.A. OCC brought the action under the enforcement authority provided
    by Section 8 of the Federal Deposit Insurance Act, 12 U.S.C. 1818.

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    Address Predatory Lending, but Face
    Challenges

    engaging in predatory lending through brokered or purchased loans.29 The
    advisory letters described loan attributes that are often considered
    predatory and established standards for policies and procedures for
    monitoring loan transactions to avoid making, brokering, or purchasing
    loans with such attributes. For example, the first letter stated that
    banks should establish underwriting policies and procedures to determine
    that borrowers have the capacity to repay their loans. The advisory letter
    also stated OCC's position that predatory lending will also affect a
    national bank's CRA rating. The advisories have also clarified ways in
    which predatory practices can create legal, safety and soundness, and
    reputation risks for national banks. For example, they laid out ways in
    which the origination or purchase of predatory loans may constitute
    violations of TILA, RESPA, HOEPA, the FTC Act, and fair lending laws. In
    addition, in January 2004, OCC issued a rule adopting antipredatory
    lending standards that expressly prohibit national banks from making loans
    without regard to the borrower's ability to repay and from engaging in
    unfair and deceptive practices under the FTC Act.30

    In 1999 and 2001, the Board, FDIC, OCC, and OTS issued joint guidance to
    their institutions on subprime lending in general.31 The guidance
    highlighted the additional risks inherent in subprime lending and noted
    that institutions engaging in such lending need to be aware of the
    potential for predatory practices and be particularly careful to avoid
    violating fair lending and consumer protection laws and regulations. The
    NCUA issued similar guidance to insured credit unions in 1999.32 Federal
    banking

    29OCC Advisory Letter 2003-2 (Guidance for National Banks to Guard Against
    Predatory and Abusive Lending Practices), February 21, 2003; and OCC
    Advisory Letter 2003-3 (Avoiding Predatory and Abusive Lending Practices
    in Brokered and Purchased Loans), February 21, 2003.

    3069 Fed. Reg. 1904 (Jan. 13, 2004).

    31The Board, FDIC, OCC and OTS, Interagency Guidance on Subprime Lending,
    March 1, 1999; and Expanded Guidance for Subprime Lending Programs,
    January 31, 2001. The 2001 guidance applies to institutions with subprime
    lending programs with an aggregate credit exposure greater than or equal
    to 25 percent of Tier 1 capital.

    32NCUA Letter to Credit Unions No. 99-CU-05, Risk Based Lending, June
    1999.

                                       Chapter 2
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    regulators have also previously issued guidance about abusive lending
    practices, unfair or deceptive acts or practices, and other issues related
    to predatory lending.33

    Regulatory Changes	The Board is responsible for issuing regulations that
    implement HOEPA and HMDA, two laws that play a role in addressing
    predatory lending. In December 2001, in response to concerns that HOEPA
    may not be adequately protecting consumers from abusive lending practices,
    the Board amended Regulation Z, which implements HOEPA, to

    o 	lower the interest rate "trigger" that determines whether loans are
    covered under HOEPA in order to bring more loans under the protection of
    the law,34

    o 	require that fees paid for credit insurance and similar debt protection
    products be included when determining whether loans are subject to HOEPA,

    o 	prohibit creditors that make HOEPA loans from refinancing the loan
    within one year of origination with another HOEPA loan, unless the
    refinancing is in the borrower's interest, and

    o 	clarify the prohibition against engaging in a "pattern or practice" of
    lending without regard to borrowers' ability to repay.35

    In February 2002, the Board also made changes to Regulation C, which
    implements HMDA. The changes, which went into effect in January 2004,
    require lenders to provide additional data that may facilitate analyses of
    lending patterns that may be predatory. For example

    33See OCC Advisory Letter 2000-7 (abusive lending practices); OCC Advisory
    Letter 2000-10, OCC Advisory Letter 2000-11, OTS Chief Executive Officers
    Letter 131, OTS Chief Executive Officers Letter 132, and NCUA Letter
    01-FCU-03 (title loans and payday lending); OCC Bulletin 2001-47
    (third-party relationships); and OCC Advisory Letter 2002-3 and FDIC
    Financial Institution Letter 57-2002 (unfair or deceptive acts or
    practices).

    34The Board adjusted the annual percentage rate (APR) trigger from 10 to 8
    percentage points above the rate for Treasury securities with comparable
    maturities. The change applies only to first lien mortgages; the
    subordinate lien mortgage APR trigger remained at 10 percent.

    3566 Fed. Reg. 65604 (Dec. 20, 2001).

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    o 	if the costs to the borrower of financing a loan exceed a certain
    threshold determined by the Board, the lender must report the cost of the
    loan;36

    o 	if an application or loan involves a manufactured home, the lender is
    required to identify that fact, in part to help identify predatory
    practices involving these types of homes; and

    o 	if a loan is subject to HOEPA, the lender is required to identify that
    fact in order to give policymakers more specific information about the
    number and characteristics of HOEPA loans.37

    Because HOEPA expressly grants the Board broad authority to issue rules to
    regulate unfair or deceptive acts and practices, some consumer advocacy
    organizations have argued that the Board should use its authority to do
    more to curb predatory lending.38 For example, some consumer groups have
    called on the Board to use its rule-making authority to prohibit the
    financing of single-premium credit insurance-a product that is believed by
    many to be inherently predatory.39 Under the McCarran Ferguson Act,40
    unless a federal statute is specifically related to the business of
    insurance, the federal law may not be construed to invalidate, impair, or
    supercede any state law enacted to regulate the business of insurance.
    Board officials say it is not clear the extent to which rules issued by
    the Board under HOEPA seeking to regulate the sale of singlepremium credit
    insurance would be consistent with that standard. The Board has previously
    recommended that it would be more appropriate for Congress to address this
    issue through changes in law. Some consumer groups also have argued that
    the Board should increase the loan data reporting requirements of HMDA to
    help detect abusive lending. The

    36More specifically, lenders are required to report the difference or
    spread between a loan's annual percentage rate (a value reflecting both
    the interest rate and certain fees associated with a loan) and the yield
    on a Treasury security of comparable maturity, for loans where this spread
    exceeds certain thresholds set by the Board. See, generally, 67 Fed. Reg.
    7222 (Feb. 15, 2002) and 67 Fed. Reg. 43218 (June 27, 2002).

    37Id.

    38See 15 U.S.C. S: 1639(l)(2).

    39In its 2001 amendments to the HOEPA rules, the Board added
    single-premium credit insurance to HOEPA's fee trigger.

    40See 15 U.S.C. S: 1012.

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    Board has added certain loan pricing and other items to the HMDA reporting
    requirements, effective in January 2004, but did not add other data
    reporting requirements, such as the credit score of the applicant. Board
    officials said this is based on the belief that the need for additional
    loan data to ensure fair lending must be weighed against the costs and
    burdens to the lender of gathering and reporting the additional
    information.

        Agencies Have Coordinated on Enforcement Actions and Participated in
        Interagency Groups

    Federal agencies have worked together to investigate and pursue some cases
    involving predatory lending. For example, FTC, DOJ, and HUD coordinated to
    take enforcement action against Delta Funding Corporation, with each
    agency investigating and bringing actions for violations of the laws under
    its jurisdiction. DOJ conducted its enforcement action against Long Beach
    Mortgage Company in coordination with OTS, which investigated the initial
    complaint in 1993 when the company was a thrift. Federal agencies have
    also coordinated with state authorities and private entities in
    enforcement actions. For example, in 2002, FTC joined six states, AARP,
    and private attorneys to settle a complaint against First Alliance
    Mortgage Company alleging that the company used deception and manipulation
    in its lending practices.

    Federal regulators have also coordinated their efforts to address fair
    lending and predatory lending through working groups. For example

    o 	In the fall of 1999 the Interagency Fair Lending Task Force, which
    coordinates federal efforts to address discriminatory lending, established
    a working group to examine the laws related to predatory lending and
    determine how enforcement and consumer education could be strengthened.41
    Because of differing views on how to define and combat predatory lending,
    the group was unable to agree on a federal interagency policy statement
    related to predatory lending in 2001. The Task Force then continued its
    efforts related to consumer education and published a brochure in 2003 to
    educate consumers about predatory lending practices.

    o 	The five banking regulators have conducted additional coordination
    activities through the Federal Financial Institutions Examination

    41The agencies that participated in the working group were OCC, OTS, FDIC,
    the Board, NCUA, DOJ, FTC, HUD, the Federal Housing Finance Board, and the
    Office of Federal Housing Enterprise Oversight.

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    Challenges

    Council's Task Force on Consumer Compliance.42 The task force coordinates
    policies and procedures for ensuring compliance with fair lending laws and
    the Community Reinvestment Act, both of which have been identified as
    tools that can be used to address predatory lending. The council publishes
    a document that responds to frequently asked questions about community
    reinvestment, including how examiners should consider illegal credit
    practices, which may be abusive, in determining an institution's Community
    Reinvestment Act rating.

    o 	In 2000, HUD and the Department of the Treasury created the National
    Task Force on Predatory Lending, which convened forums around the country
    to examine the issue and released a report later in the year.43 The report
    made specific recommendations to Congress, federal agencies, and other
    stakeholders that were aimed at (1) improving consumer literacy and
    disclosure, (2) reducing harmful sales practices, (3) reducing abusive or
    deceptive loan terms and conditions, and (4) changing structural aspects
    of the lending market.

    Some of the recommendations made in the HUD-Treasury task force report
    have been implemented. For example, as recommended in the report, the
    Board has adopted changes to HOEPA regulations that have increased the
    number of loans covered and added additional restrictions. In addition, as
    the report recommended, FTC and some states have devoted more resources in
    the past few years to actively pursuing high-profile enforcement cases. As
    discussed in chapter 5, federal and state agencies have also worked to
    improve one of the areas highlighted in the report: public awareness about
    predatory lending issues. Other recommendations made in the report have
    not been implemented, however. For example, Congress has not enacted
    legislation to expand penalties for violations of TILA, HOEPA, and RESPA
    or to increase the damages available to borrowers harmed by such
    violations. HUD and the Department of the Treasury told us that they have
    not formally tracked the status of the recommendations made in the report,
    although HUD officials said they are

    42The Federal Financial Institutions Examination Council is a formal
    interagency body composed of representatives of each of the five federal
    banking regulators. The council was established in 1979 and is empowered
    to (1) prescribe uniform principles, standards, and report forms for the
    federal examination of financial institutions and (2) make recommendations
    to promote uniformity in the supervision of financial institutions.

    43U.S. Department of the Treasury and U.S. Department of Housing and Urban
    Development, Curbing Predatory Home Mortgage Lending: A Joint Report, June
    2000.

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    informally monitoring the recommendations in the report that relate to
    their agency. Officials at both agencies also noted that the report and
    its recommendations were the product of a previous administration and may
    or may not reflect the views of the current administration.

    In addition to participating in interagency groups, agencies share
    information related to fair lending violations under statutory
    requirements and formal agreements. For example, since 1992 HUD and the
    banking regulators have had a memorandum of understanding stating that HUD
    will refer allegations of fair lending violations to banking regulators
    and a 1994 executive order requires that executive branch agencies notify
    HUD of complaints and violations of the Fair Housing Act. In addition,
    whenever the banking regulatory agencies or HUD have reason to believe
    that an institution has engaged in a "pattern or practice" of illegal
    discrimination, they are required to refer these cases to DOJ for possible
    civil action.

      Jurisdictional Issues Related to Nonbank Subsidiaries Challenge Efforts to
      Combat Predatory Lending

    Jurisdictional issues related to the regulation of certain nonbank
    mortgage lenders may challenge efforts to combat predatory lending. Many
    federally and state-chartered banks and thrifts, as well as their
    subsidiaries, are part of larger financial holding companies or bank
    holding companies.44 These holding companies may also include nonbank
    financial companies, such as finance and mortgage companies, that are
    subsidiaries of the holding companies themselves. These holding company
    subsidiaries are frequently referred to as affiliates of the banks and
    thrifts because of their common ownership by the holding company. As shown
    in figure 2, the federal regulators of federally and state-chartered banks
    and thrifts also regulate the subsidiaries of those institutions. For
    example, as the primary regulator for national banks, OCC also examines
    operating subsidiaries of those banks. On the other hand, federal
    regulators generally do not perform routine examinations of independent
    mortgage lenders and affiliated nonbank subsidiaries of financial and bank
    holding companies engaged in mortgage lending.

    44A subsidiary of a bank, thrift, or credit union is controlled through
    partial or complete ownership by the institution. Federal laws and
    regulations set more specific requirements that dictate whether an
    institution is a subsidiary. For the purposes of this report, the term
    holding company refers to both (traditional) bank holding companies and
    bank holding companies that qualify as financial holding companies as
    defined by the Board.

                                       Chapter 2
                          Federal Agencies Have Taken Steps to
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                                       Challenges

             Figure 2: Structure and Federal Oversight of Mortgage Lenders

    Source: GAO.

    Note: The primary federal agency for enforcement of the various federal
    laws used to combat abusive or predatory lending activities is shown in
    parentheses.

    aFTC is responsible for enforcing federal laws for lenders that are not
    depository institutions but it is not a supervisory agency and does not
    conduct routine examinations.

    Some disagreement exists between states and some federal banking
    regulators over states' authority to regulate and supervise the operating
    subsidiaries of federally chartered depository institutions. For example,
    OCC issued an advisory letter in 2002 noting that federal law provides the
    agency with exclusive authority to supervise and examine operating
    subsidiaries of national banks and that the states have no authority to
    regulate or supervise these subsidiaries.45 Some representatives of state
    banking regulators expressed concerns to us about this because of the
    subsidiaries' potential involvement in predatory lending practices. OCC

    45OCC Advisory Letter 2002-9 (Questions Concerning Applicability and
    Enforcement of State
    Laws: Contacts From State Officials, November 25, 2002.); see also 69 Fed.
    Reg. 1904
    (Jan. 13, 2004).

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    has stated that the subsidiaries of the institutions it regulates do not
    play a large role in subprime lending and that little evidence exists to
    show that these subsidiaries are involved in predatory lending. But some
    state enforcement authorities and consumer advocates argue otherwise,
    citing some allegations of abuses at national bank subsidiaries. However,
    several state attorneys general have written that predatory lending abuses
    are "largely confined" to the subprime lending market and to
    non-depository institutions, not banks or direct bank subsidiaries.46 OCC
    officials stated that the agency has strong monitoring and enforcement
    systems in place and can and will respond vigorously to any abuses among
    institutions it supervises.47 For example, OCC officials pointed to an
    enforcement action taken in November 2003 that required restitution of
    more than $100,000 to be paid to 30 or more borrowers for fees and
    interest charged in a series of abusive loans involving small "tax-lien
    loans."

    A second issue relates to the monitoring and supervision of certain
    nonbank subsidiaries of holding companies. As noted previously, many
    federally and state-chartered banks and thrifts, as well as their
    subsidiaries, are part of larger financial or bank holding companies.48
    These holding companies may also include nonbank subsidiaries, such as
    finance and mortgage companies, that are affiliates but not subsidiaries
    of the federally regulated bank or thrift. Although these affiliates
    engage in financial activities that may be subject to federal consumer
    protection and fair lending laws, unlike depository institutions they are
    not subject to routine supervisory examinations for compliance with those
    laws. While the Board has jurisdiction over these entities for purposes of
    the Bank Holding Company Act, it lacks authority to ensure and enforce
    their compliance

    46See Brief of Amicus Curiae State Attorneys General, National Home Equity
    Mortgage Ass'n v. OTS, Civil Action No. 02-2506 (GK) (D D.C.) (March 21,
    2003) at 10-11.

    47Another jurisdictional issue is uncertainty as to whether the FTC shares
    jurisdiction with federal banking regulators over bank subsidiaries that
    are not themselves banks (operating subsidiaries). While OCC maintains it
    has exclusive regulatory jurisdiction over the operating subsidiaries of
    national banks, FTC argues that a provision of the Gramm-Leach-Bliley Act
    provides for the two agencies to share jurisdiction. See Pub. L. No.
    106-102 S: 133(a). A federal district court has upheld FTC's
    interpretation. (See Minnesota v. Fleet Mortg. Corp., 181 F. Supp. 2d 995
    (D MN 2001)). We are not aware of any instance in which this matter has
    interfered with an FTC enforcement action.

    48In addition to financial and bank holding companies, there are thrift
    holding companies, which can include thrifts and other financial
    institutions. Each thrift holding company is regulated and subject to
    examination by OTS. See 12 USC S:1467a (b)(4).

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    with federal consumer protection and fair lending laws in the same way
    that the federal regulators monitor their depository institutions.

    One reason for the concern about these entities is that nonbank
    subsidiaries of holding companies conduct a significant amount of subprime
    mortgage lending. Of the total subprime loan originations made by the top
    25 subprime lenders in the first 6 months of 2003, 24 percent were
    originated by nonbank subsidiaries of holding companies. In addition, of
    the 178 lenders on HUD's 2001 subprime lender list, 20 percent were
    nonbank subsidiaries of holding companies. These types of subsidiaries
    have also been targets of some of the most notable federal and state
    enforcement actions involving abusive lending. For example, The Associates
    and Fleet Finance, which were both nonbank subsidiaries of bank holding
    companies, were defendants in two of the three largest cases involving
    subprime lending that FTC has brought.49

    The Associates case illustrates an important aspect of the current federal
    regulatory oversight structure pertinent to predatory lending. The Board
    has authority under the Bank Holding Company Act to condition its approval
    of holding company acquisitions. The Board used this authority in
    connection with Citigroup's acquisition of European American Bank because
    of concerns about the subprime lending activities of The Associates, which
    Citigroup had acquired and merged into its CitiFinancial subsidiary. As a
    condition of approving the acquisition of European American Bank, the
    Board directed that an examination of certain subprime lending
    subsidiaries of Citigroup be carried out to determine whether Citigroup
    was effectively implementing policies and procedures designed to ensure
    compliance with fair lending laws and prevent abusive lending practices.
    However, the Board does not have clear authority to conduct the same type
    of monitoring outside of the Bank Holding Company Act approval process.
    Although the Board has the authority to monitor and

    49Citigroup acquired The Associates in November 2000 and merged The
    Associates' consumer finance operations into its subsidiary, CitiFinancial
    Credit Company, a nonbank subsidiary of the holding company. In 1999,
    Fleet Finance, Inc., and its successor company, Home Equity U.S.A., Inc.,
    agreed to pay $1.3 million to settle an FTC complaint alleging deceptive
    disclosures and TILA violations in conjunction with Fleet Finance, Inc.,
    loans. At the time of the settlement, Fleet Finance had become Home Equity
    U.S.A., Inc. Both Fleet Finance, Inc., and Home Equity U.S.A., Inc., were
    nonbank subsidiaries of bank holding companies. At the time of the
    settlement, the bank holding company was Fleet Financial Group, Inc.,
    which has been renamed FleetBoston Financial Corporation. Home Equity
    U.S.A., Inc., continues to operate as a nonbank subsidiary of FleetBoston
    Financial Corporation, a bank holding company.

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    perform routine inspections or examinations of a bank holding company,
    this authority apparently does not extend to routine examinations of
    nonbank subsidiaries of bank holding companies with regard to compliance
    with consumer protection laws. The Bank Holding Company Act, as amended by
    the Gramm-Leach-Bliley Act, authorizes the Board to examine a nonbank
    subsidiary for specific purposes, including "to monitor compliance with
    the provisions of (the Bank Holding Company Act) or any other Federal law
    that the Board has specific jurisdiction to enforce against such company
    or subsidiary." Federal consumer protection laws do not give the Board
    specific enforcement jurisdiction over nonbank subsidiaries.

    For this reason, FTC is the primary federal agency monitoring nonbank
    subsidiaries' compliance with consumer protection laws. FTC is the primary
    federal enforcer of consumer protection laws for these nonbank
    subsidiaries, but it is a law enforcement rather than supervisory agency.
    Thus, FTC's mission and resource allocations are focused on conducting
    investigations in response to consumer complaints and other information
    rather than on routine monitoring and examination responsibilities.
    Moreover, as discussed elsewhere in this report, states vary widely in the
    extent to which they regulate practices that can constitute predatory
    lending.

    The HUD-Treasury report on predatory lending argued that the Board should
    take more responsibility for monitoring nonbank subsidiaries of bank
    holding companies, in part to ensure that consumer protection laws are
    adequately enforced for these institutions. Similarly, in 1999, GAO
    recommended that the Board monitor the lending activities of nonbank
    mortgage lending subsidiaries of bank holding companies and consider
    examining these entities if patterns in lending performance, growth, or
    operating relationships with other holding company entities indicated the
    need to do so.50 In its written response to GAO's recommendation, the
    Board said that while it has the general legal authority to examine these
    entities, it has neither the clear enforcement jurisdiction nor the legal
    responsibility for engaging in such activities, as Congress has directly
    charged FTC with primary responsibility over enforcement with regard to
    these entities.

    50See U.S. General Accounting Office, Large Bank Mergers: Fair Lending
    Review Could be Enhanced With Better Coordination, GAO/GGD-00-16
    (Washington, D.C.: Nov. 3, 1999), 20 and 47.

                                       Chapter 2
                          Federal Agencies Have Taken Steps to
                          Address Predatory Lending, but Face
                                       Challenges

    Among federal agencies, the Board is uniquely situated to monitor the
    activities of the nonbank mortgage lending subsidiaries of financial and
    bank holding companies by virtue of its role as the regulator of holding
    companies and its corresponding access to data (such as internal operating
    procedures, loan level data, and current involvement in subprime lending)
    that are not readily available to the public. In addition, the Board has
    extensive experience monitoring and analyzing HMDA data. The recent
    changes in HMDA reporting requirements will increase the Board's ability
    to effectively monitor nonbank mortgage lending subsidiaries of holding
    companies for lending abuses.

    In contrast to the specific limits on the Board's examination authority,
    its authority to enforce the federal consumer protection laws against
    nonbank subsidiaries is somewhat less clear. The laws themselves specify
    the institutions subject to enforcement by the Board, but those
    institutions generally do not include nonbank subsidiaries. The Board has
    concluded that it must defer enforcement action at least where, as here, a
    statute specifically prescribes its enforcement jurisdiction to cover only
    certain entities and specifically grants enforcement authority for other
    entities to another agency.

    Conclusions	Under a number of laws, federal agencies have taken action to
    protect consumers from abusive lending practices. While FTC has taken a
    number of significant enforcement actions to battle abuses in the
    industry, its resources are finite and, as a law enforcement agency, it
    does not routinely monitor or examine lenders, including the mortgage
    lending subsidiaries of financial and bank holding companies.

    Congress provided banking regulators with the authority to ensure
    compliance with consumer protection laws by the institutions they
    regulate, in part because it recognized the efficiencies of having banking
    regulators monitor for compliance with these laws while examining their
    institutions for safety and soundness. The Board is in a position to help
    ensure compliance with federal consumer protection laws by certain
    subsidiaries of financial and bank holding companies if it were clearly
    authorized to do so. While concerns about predatory lending extend well
    beyond the activities of the nonbank subsidiaries of holding companies,
    these entities represent a significant portion of the subprime mortgage
    market. Monitoring the mortgage lending activities of the nonbank
    subsidiaries would help the Board determine when it would be beneficial to
    conduct examinations of specific nonbank subsidiaries. The Board could

                                       Chapter 2
                          Federal Agencies Have Taken Steps to
                          Address Predatory Lending, but Face
                                       Challenges

    then refer its findings to DOJ, HUD, or FTC or take its own enforcement
    action if a problem exists. Granting the Board concurrent enforcement
    authority-with the FTC-for these nonbank subsidiaries of holding companies
    would not diminish FTC's authority under federal laws used to combat
    predatory lending.

    The significant amount of subprime lending among holding company
    subsidiaries, combined with recent large settlements in cases involving
    allegations against such subsidiaries, suggests a need for additional
    scrutiny and monitoring of these entities. The Board is in an optimal
    position to play a larger role in such monitoring but does not have clear
    legal authority and responsibility to do so for these entities with regard
    to monitoring compliance of consumer protection laws.

      Matters for Congressional Consideration

    To enable greater oversight of and potentially deter predatory lending
    from occurring at certain nonbank lenders, Congress should consider making
    appropriate statutory changes to grant the Board of Governors of the
    Federal Reserve System the authority to routinely monitor and, as
    necessary, examine the nonbank mortgage lending subsidiaries of financial
    and bank holding companies for compliance with federal consumer protection
    laws applicable to predatory lending practices. Also, Congress should
    consider giving the Board specific authority to initiate enforcement
    actions under those laws against these nonbank mortgage lending
    subsidiaries.

      Agency Comments and Our Evaluation

    GAO provided a draft of this report to the Board, DOJ, FDIC, FTC, HUD,
    NCUA, OCC, OTS, and the Department of the Treasury for review and comment.
    The agencies provided technical comments that have been incorporated, as
    appropriate. In addition, the Board, DOJ, FDIC, FTC, HUD, and NCUA
    provided general comments, which are discussed below. The written comments
    of the Board, DOJ, HUD, and NCUA are printed in appendixes II through V.

    The Board commented that, while the existing structure has not been a
    barrier to Federal Reserve oversight, the approach recommended in our
    Matter for Congressional Consideration would likely be beneficial by
    catching some abusive practices that might not be caught otherwise. The
    Board also noted that the approach would pose tradeoffs, such as different
    supervisory schemes being applied to nonbank mortgage lenders based on

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    whether or not they are part of a holding company. Because nonbank
    mortgage lenders that are part of a financial or bank holding company are
    already subject to being examined by the Board in some circumstances, they
    are already subject to a different supervisory scheme than other such
    lenders. For example, in its comments the Board noted that it may on
    occasion direct an examination of a nonbank lending subsidiary of a
    holding company when necessary in the context of applications that raise
    serious fair lending or compliance issues. Accordingly, we do not believe
    that clarifying jurisdiction as contemplated in the Matter would result in
    a significant departure from the current supervisory scheme for nonbank
    mortgage lenders. The Board also noted that that there could be some
    additional cost to the nonbank mortgage lending subsidiaries of financial
    or bank holding companies, as well as to the Board, if the Board were to
    exercise additional authority. We agree and believe that Congress should
    consider both the potential costs as well as the benefits of clarifying
    the Board's authorities.

    The FTC expressed concern that our report could give the impression that
    we are suggesting that Congress consider giving the Board sole
    jurisdiction-rather than concurrent jurisdiction with FTC-over nonbank
    subsidiaries of holding companies. Our report did not intend to suggest
    that the Congress make any change that would necessarily affect FTC's
    existing authority for these entities and we modified our report to
    clarify this point. To illustrate the difference in regulatory and
    enforcement approaches, our draft report contrasted the Board's routine
    examination authority with the FTC's role as a law enforcement agency. In
    its comments, FTC noted that it uses a number of tools to monitor nonbank
    mortgage lenders, of which consumer complaints is only one. The agency
    also commented that a key difference between the FTC and the Board is that
    the Board has access to routine information to aid in its oversight as
    part of the supervisory process. Our report did not intend to suggest that
    the FTC's actions are based solely on consumer complaints, and we revised
    the report to avoid this impression.

    DOJ commented that the report will be helpful in assessing the
    department's role in the federal government's efforts to develop
    strategies to combat predatory lending. DOJ disagreed with our inclusion
    in the report of "property or loan flips," which it characterized as a
    traditional fraud scheme rather than an example of predatory lending. As
    our report states, there is no precise definition of predatory lending. We
    included a discussion of efforts to combat "property flipping" because HUD
    officials told us that these schemes sometimes involve predatory practices
    that can

    Chapter 2
    Federal Agencies Have Taken Steps to
    Address Predatory Lending, but Face
    Challenges

    harm borrowers. As we note in the report, while HUD categorizes property
    flipping as a predatory lending practice, not all federal agencies concur
    with this categorization. Distinct from property flipping is "loan
    flipping"- the rapid and repeated refinancing of a loan without benefit to
    the borrower. This practice is widely noted in literature and by federal,
    state, industry, and nonprofit officials as constituting predatory
    lending.

    FDIC noted that our Matter for Congressional Consideration focuses on
    nonbank subsidiaries of financial and bank holding companies even though
    these entities comprise, according to HUD, only about 20 percent of all
    subprime lenders. We acknowledge that our Matter does not address all
    subprime lenders or institutions that may be engaging in predatory
    lending, but believe it represents a step in addressing predatory lending
    among a significant category of mortgage lenders. NCUA said that the
    report provides a useful discussion of the issues and that the agency
    concurs with our Matter for Congressional Consideration. HUD, in its
    comment letter, described a variety of actions it has taken that it
    characterized as combating predatory lending, particularly with regard to
    FHA-insured loans.

    Chapter 3

    States Have Enacted and Enforced Laws to Address Predatory Lending, but Some
    Laws Have Been Preempted

    In part because of concerns about the growth of predatory lending and the
    limitations of existing state and federal laws, 25 states, the District of
    Columbia, and 11 localities had passed their own laws addressing predatory
    lending practices as of January 9, 2004.1 Most of the state laws restrict
    the terms or provisions of certain high-cost loans, while others apply to
    a broader range of loans. In addition, some states have taken measures to
    strengthen the regulation and licensing of mortgage lenders and brokers,
    and some have used existing state consumer protection and banking laws to
    take enforcement actions related to abusive lending. However, regulators
    of federally chartered financial institutions have issued opinions stating
    that federal laws may preempt some state predatory lending laws and that
    nationally chartered lending institutions should have to comply only with
    a single uniform set of national standards. Many state officials and
    consumer advocates have opposed federal preemption of state predatory
    lending laws on the grounds that it interferes with the states' ability to
    protect consumers.

      States and Localities Have Addressed Predatory Lending through Legislation,
      Regulation, and Enforcement Actions

    Since 1999, many states and localities have passed laws designed to
    address abusive mortgage lending by restricting the terms or provisions of
    certain loans. In addition, states have increased the registration or
    licensing requirements of mortgage brokers and mortgage lenders and have
    undertaken enforcement activities under existing consumer protection laws
    and regulations to combat abusive lending.

    1Except where citations to provisions of state laws are provided, all
    information relating to state and local laws and their provisions is from
    a database maintained by Butera & Andrews, a Washington, D.C., law firm
    that tracks predatory lending legislation. These laws include only state
    and local laws that place actual restrictions on lending and do not
    include, for example, local ordinances that consist solely of a resolution
    that condemned predatory lending. As noted in chapter 1, we took measures
    to verify the reliability of these data.

     Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
                           but Some Laws Have Been Preempted

    A Growing Number of According to the database of state laws, as of January
    9, 2004, 25 states and States and Localities Have the District of Columbia
    had passed laws that were specifically designed to Passed Laws to Address
    address abusive lending practices.2 (See fig. 3.) These laws were
    motivated,

    at least in part, by growing evidence of abusive lending and by
    concernsAbusive Lending that existing laws were not sufficient to protect
    consumers against abusive lending practices.

    Figure 3: States and Localities That Have Enacted Predatory Lending Laws

                               Source: Butera & Andrews.

    2North Carolina enacted the first state law (N.C. Gen. Stat.
    24-1-.1E[1999]) in 1999; it took effect on July 1, 2000. Nearly all the
    other state laws were enacted between 2001 and 2003.

    Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
    Lending, but Some Laws Have Been Preempted

    Based on our review of the database of state laws, the predatory lending
    statutes in 20 of the 25 states regulate and restrict the terms and
    characteristics of certain kinds of "high-cost" or "covered" mortgage
    loans that exceed certain interest rate or fee triggers.3 Some state laws,
    such as those in Florida, Ohio, and Pennsylvania, use triggers that are
    identical to those in the federal HOEPA statute but add provisions or
    requirements, such as restrictions on refinancing a loan under certain
    conditions.4 Other state laws, such as those of Georgia, New Jersey and
    North Carolina, use triggers that are lower than those in HOEPA and
    therefore cover more loans than the federal legislation.5 Some states
    design their triggers to vary depending on the amount of the loan. For
    example, in New Mexico and North Carolina, covered loans greater than
    $20,000 are considered high cost if the points and fees on the loan exceed
    5 percent of the total loan amount (North Carolina) or equal or exceed it
    (New Mexico). In these states, loans for less than $20,000 are considered
    high cost if the points and fees exceed either 8 percent of the total or
    $1,000.6 In the remaining 5 states, the predatory lending laws apply to
    most mortgage loans; there is no designation of loans as high cost. For
    example, West Virginia's law in effect generally prohibits lenders from
    charging prepayment penalties on any loans and restricts points and fees
    to either 5 or 6 percent, depending on whether the loan includes a yield
    spread premium.7 Michigan's law prohibits the financing of single-premium
    credit insurance into loans.8

    According to the database, common provisions in state laws are designed to
    address the following:

    o 	Lending without regard to the ability to repay. Restrictions on the
    making of loans without regard to the borrower's ability to repay the
    loan, sometimes referred to as asset-based lending.

    3Massachusetts has imposed similar restrictions on high-cost loans, but it
    was done through regulatory changes rather than legislation.

    4See, e.g., Fla. Stat. Ann. S:S: 494.0079, 494.00791 (2003); Ohio Rev.
    Code Ann. S:S: 1394; Ohio Rev. Code Ann. S: 1349.25 (2003); 63 PA Stat. S:
    456.503 (2003).

    5See GA Code Ann. S: 7-6A-2(2003); N.J. Stat. Ann. S: 46:10B-24 (West
    2003); N.C. Gen. Stat. S: 24-1.1E (2003).

    6N.C. Gen. Stat. S: 24-1-1E; N.M. Stat. Ann S: 58-21A-3 (2003).

    7W. VA. Code S:S: 46A-3-110, 31-17-8 (2003).

    8See Mich. Comp. Laws S: 445.1634 (2003).

    Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
    Lending, but Some Laws Have Been Preempted

    o 	Prepayment penalties. Limitations on the amount of a prepayment
    penalty, terms under which a penalty can be assessed, or both.

    o 	Balloon payments. Prohibitions on loans with balloon payments or
    restrictions on their timing.

    o 	Negative amortization. Prohibitions on loans where regularly scheduled
    payments do not cover the interest due.

    o 	Loan flipping. Restrictions or prohibitions on the repeated refinancing
    of certain loans within a short period of time if the refinancing will not
    benefit the borrower.

    o 	Credit counseling. Requirements that borrowers either receive or are
    notified of the availability of loan counseling.

    o 	Arbitration clauses. Restrictions on mandatory arbitration clauses,
    which limit a borrower's right to seek redress in court. Some laws
    prohibit mandatory arbitration clauses altogether, while others require
    compliance with certain standards, such as those set by a nationally
    recognized arbitration organization.

    o 	Assignee liability. Provisions that expressly hold purchasers or
    securitizers of loans liable for violations of the law committed by the
    originator, under certain conditions. (See ch. 4 for more information on
    assignee liability.)

    In addition, according to the database we reviewed, 11 cities and counties
    have passed laws of their own designed to address predatory lending since
    2000.9 Some local laws are similar to state laws in that they define
    highcost loans and restrict their provisions, such as in Los Angeles,
    California. Other localities, such as Oakland, California, have passed
    resolutions prohibiting lenders that engage in predatory lending practices
    from doing business with the locality.

    9In some cases, these laws were enacted but pending litigation stayed
    enforcement.

     Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
                           but Some Laws Have Been Preempted

        Some States Have Increased the Regulation of Lenders and Brokers and
        Undertaken Enforcement Activities to Combat Predatory Lending

    In general, states have regulated mortgage lenders and brokers, although
    to varying degrees. Some state officials told us that because of concerns
    that unscrupulous mortgage lenders and brokers were not adequately
    regulated and were responsible for lending abuses, some states have
    increased their regulation or licensing requirements of lenders and
    brokers. As part of their licensing requirements, states sometimes require
    that these companies establish a bond to help compensate victims of
    predatory lenders or brokers that go out of business, and some states also
    require that individuals working for or as mortgage lenders and brokers
    meet certain educational requirements.

    Some states have also reorganized their agencies' operations to better
    address abuses by lenders and brokers. For example, an official with the
    Kansas Office of the State Banking Commissioner told us that in 1999 the
    Kansas legislature created the Division of Consumer and Mortgage Lending,
    which provides additional staff for examination and enforcement
    activities. Similarly, an official from the Idaho Department of Finance
    told us that the state created the Consumer Finance Bureau in 2000 to
    oversee and conduct routine examinations of mortgage brokers and mortgage
    lenders.

    State law enforcement agencies and banking regulators have also taken a
    number of actions in recent years to enforce existing state consumer
    protection and banking laws in cases involving predatory lending. For
    example, an official from the Washington Department of Financial
    Institutions reported that it has taken several enforcement actions in
    recent years to address predatory lending. In one such action, a
    California mortgage company that allegedly deceived borrowers and made
    prohibited charges was ordered to return more than $700,000 to 120
    Washington State borrowers. According to officials of the Conference of
    State Bank Supervisors, states reported that in addressing predatory
    lending they have usually relied on general state consumer protection laws
    in areas such as fair lending, licensing, and unfair and deceptive
    practices. In some states, consumer protection statutes do not apply to
    financial institutions, so state banking regulators, rather than the
    attorneys general, typically initiate enforcement activities. Because
    allegations of predatory practices often involve lending activities in
    multiple states, states have sometimes cooperated in investigating alleged
    abuses and negotiating settlements. For example, in 2002 a settlement of
    up to $484 million with Household Finance Corporation resulted from a
    joint investigation begun by the attorneys general and financial
    regulatory agencies of 19 states and the

     Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
                           but Some Laws Have Been Preempted

    District of Columbia. State agencies have also conducted investigations in
    conjunction with the federal government.

    Activities in North States have varied in their approaches to addressing
    predatory lending

    issues. We reviewed legislative and enforcement activities related
    toCarolina and Ohio predatory lending in two states, North Carolina and
    Ohio, to illustrate two Illustrate State different approaches.

    Approaches to

      Predatory Lending

        Impact of North Carolina's Laws on High-Cost Loans and Licensing of Brokers
        and Originators Remains Uncertain

    North Carolina has enacted two separate laws to address concerns about
    predatory lending. In 1999, the legislature passed a law that attempted to
    curb predatory lending by prohibiting specific lending practices and
    restricting the terms of high-cost loans.10 In 2001, North Carolina
    supplemented its predatory lending law by adopting legislation that
    required the licensing of mortgage professionals (mortgage lenders,
    brokers, and loan officers), defined a number of prohibited activities
    related to the making of residential mortgages, and enhanced the
    enforcement powers of the banking commissioner.11

    According to the North Carolina Commissioner of Banks, the North Carolina
    laws applicable to predatory lending were the product of a consensus of
    banks, mortgage bankers and brokers, nonprofit organizations, and other
    stakeholders and were intended to address lending abuses that were not
    prohibited by federal statutes and regulations. Among other things, the
    1999 legislation, known as the North Carolina Anti-Predatory Lending Law,
    imposes limitations specific to both "high-cost"

    10N.C. Session Law 1999-332. 11N.C. Sessions Laws 2001-393 and 2001-399.

    Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
    Lending, but Some Laws Have Been Preempted

    loans and other "consumer home loans."12 North Carolina's predatory
    lending law did not restrict initial interest rates but instead focused on
    prohibiting specific lending practices and restricting the terms of
    high-cost loans. In conjunction with other North Carolina laws, the 1999
    legislation contains four key features. First, it bans prepayment
    penalties for all home loans with a principal amount of $150,000 or less.
    Second, it prohibits loan flipping-refinancings of consumer home loans
    that do not provide a reasonable, net tangible benefit to the borrower.
    Third, it prohibits the financing of single-premium credit life insurance.
    Finally, it sets a number of restrictions on high-cost loans, including
    making loans without regard to borrowers' ability to repay; financing
    points, fees, and any other charges payable to third parties; or setting
    up loans with balloon payments. Further, the law prohibits home
    improvement contract loans under which the proceeds go directly to the
    contractor, and requires that borrowers receive financial counseling prior
    to closing.

    Although the North Carolina predatory lending law governs the practices of
    lenders and mortgage brokers, some groups questioned whether it provided
    for effective enforcement. Specifically, concerns were focused on the lack
    of state licensing and oversight of all segments of the mortgage lending
    profession, including mortgage brokers and bankers. Additionally, some
    critics asserted that the statute provided the state banking commissioner
    with limited and uncertain authority to enforce the predatory lending
    provisions. As a result, even before the predatory lending legislation
    passed, stakeholders worked on a measure to fill the gaps left by the
    state's predatory lending law.

    12The North Carolina predatory lending law defines a high-cost loan as a
    home loan of $300,000 or less that has one or more of the following
    characteristics: (1) points, fees (excluding certain amounts specified in
    the law), and other charges totaling more than 5 percent of the borrowed
    amount if the loan is $20,000 or more, or the lesser of 8 percent of the
    amount borrowed or $1,000 if the loan is less than $20,000; (2) an
    interest rate that exceeds by more than 10 percent per annum the yield on
    comparable Treasury bills; or (3) a prepayment penalty that could be
    collected more than 30 months after closing or that is greater than 2
    percent of the amount prepaid. According to the North Carolina
    Commissioner of Banks, the $300,000 cap is based on the presumption that
    those able to borrow $300,000 or more are able to adequately protect
    themselves. "Consumer home loans" are loans in which (i) the borrower is a
    natural person, (ii) the debt is incurred by the borrower primarily for
    personal, family, or household purposes, and (iii) the loan is secured by
    a mortgage or deed of trust upon real estate upon which there is located
    or there is to be located a structure or structures designed principally
    for occupancy of from one to four families which is or will be occupied by
    the borrower as the borrower's principal dwelling.

    Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
    Lending, but Some Laws Have Been Preempted

    North Carolina's second statute, the Mortgage Lending Act, was signed into
    law on August 29, 2001. Prior to the act, some mortgage banking firms and
    all mortgage brokerages domiciled in the state had been required to
    register with the state's banking regulator, but individual loan
    originators were not. The Mortgage Lending Act imposed licensing
    requirements on all mortgage bankers and brokers, including individuals
    who originate loans, and added continuing education and testing
    requirements for mortgage loan officers. The provisions of the act mean
    that individuals as well as firms are now subject to regulatory
    discipline. According to the North Carolina Commissioner of Banks, the act
    has been effective in reducing the number of abusive brokers and
    individual loan originators. The commissioner noted that a large number of
    applications for licenses have been denied because the applicants did not
    meet basic requirements or did not pass the required background check.

    Studies on the impact of North Carolina's Anti-Predatory Lending Law have
    offered conflicting conclusions. For example, one study found an overall
    decline in subprime mortgages and concluded that any reductions in
    predatory lending had been attained at the expense of many legitimate
    loans.13 Some have pointed to this evidence as suggesting that the law has
    reduced legitimate credit to those who most need it. Another study found a
    reduction in subprime originations but attributed the decline to a
    reduction in loans with abusive or predatory terms.14 Consumer advocates
    and state officials have cited this study as evidence that the law has
    worked as intended.

    Our review of the five studies available on the impact of the North
    Carolina predatory lending law suggested that data limitations and the
    lack of an accepted definition of predatory lending make determining the
    law's impact difficult. For example, information about borrowers' risk
    profiles, the pricing and production costs of the loans, and the lenders'
    and borrowers' behaviors was not available to the study researchers. In
    addition, the extent to which any potential reductions in predatory loans

    13Elliehausen and Staten, Regulation of Subprime Mortgage Products: An
    Analysis of North Carolina's Predatory Lending Law, Georgetown University
    School of Business (November 2002).

    14Quercia, Stegman, and Davis, The Impact of North Carolina's
    Anti-Predatory Lending Law: A Descriptive Assessment, Center for Community
    Capitalism, The Frank Hawkins Kenan Institute of Private Enterprise,
    University of North Carolina at Chapel Hill (June 25, 2003).

     Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
                           but Some Laws Have Been Preempted

    can be attributed to the Mortgage Lending Act as opposed to the
    Anti-Predatory Lending Law is unclear. Additional experience with the
    North Carolina laws may be needed in order to properly assess them.

        Ohio Has Preempted Local Laws and Taken Action to Regulate Mortgage Brokers

    In February 2002, the Ohio legislature enacted a law with the purpose of
    bringing Ohio law into conformance with HOEPA.15 Among other things, the
    legislation preempted certain local predatory lending ordinances. The law
    was passed in response to an ordinance enacted in the city of Dayton,
    which was designed to fight predatory lending by regulating mortgage loans
    originated in that city. Proponents of the state law argued that
    regulating lenders is a state rather than municipal function and that
    lending rules should be uniform throughout the state. Some advocates
    argued that the state law prevents cities from protecting their citizens
    from abusive lending practices.

    The Ohio law imposes certain restrictions on high-cost loans as defined by
    HOEPA. These include additional restrictions on credit life or disability
    insurance beyond those imposed by HOEPA. The law also prohibits the
    replacement or consolidation of a zero-interest rate or other low-rate
    loan made by a governmental or nonprofit lender with a high-cost loan
    within the first 10 years of the low-rate loan unless the current holder
    of the loan consents in writing to the refinancing.16 Because the purpose
    of this law was to bring Ohio's law into conformance with HOEPA, the law
    applies only to loans that qualify as mortgage loans subject to HOEPA.
    Thus, like predatory lending laws in some other states, the Ohio law
    applies to relatively few loans.

    In May 2002, the Ohio legislature passed another piece of legislation,
    designed in part to address abusive lending-the Ohio Mortgage Broker
    Act-that imposed requirements on the state's mortgage brokers and loan
    officers.17 Among other things, this law required state examination,
    education, and licensing of loan officers, and prohibited brokers from
    engaging in certain deceptive or fraudulent practices. It also required
    that

    15See Ohio Rev. Code. Ann. S: 1349.32 (2003).
    16Ohio Rev. Code Ann. S: 1349.27 (2002).
    17See Ohio. Rev. Code Ann. S:S: 1322.01 - 1322.12 (2003).

    Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
    Lending, but Some Laws Have Been Preempted

    mortgage brokers and loan officers receive continuing education and take
    prelicensing competency tests.

    In the act adopting HOEPA standards, the Ohio legislature also established
    a Predatory Lending Study Committee, which was charged with investigating
    the impact of predatory lending practices on the citizens and communities
    of Ohio.18 The study committee consisted of 15 members, including
    representatives from state agencies, consumer groups, and the lending
    industry. The act required the committee to submit a report to the
    governor and legislators by the end of June 2003. The committee reached
    consensus on two major issues. First, it recommended that all appraisers
    in the state be licensed and subject to criminal background checks, and
    second, it recommended increased enforcement of the Ohio Mortgage Broker
    Act. The Division of Financial Institutions, which is responsible for
    enforcing the Ohio Mortgage Broker Act, has hired additional staff to
    ensure compliance with the law. The report and recommendations have been
    forwarded to the governor and the committee suggested that the Ohio
    General Assembly consider all recommendations.

    Other local ordinances have been passed in Ohio to address predatory
    lending. One of these ordinances, passed in November 2002 by the Toledo
    City Council to regulate mortgage lending practices, was challenged, and
    its enforcement stayed, because of the state HOEPA law passed in February
    2002.19 One provision of that ordinance prohibited making an abusive loan
    by "taking advantage of a borrower's physical or mental infirmities,
    ignorance or inability to understand the terms of the loan." This
    provision drew criticism from the mortgage industry, which said the
    language was vague and difficult to comply with. For example, one
    secondary market participant noted that it would be nearly impossible to
    assess borrowers' mental capabilities for loans they did not originate in
    the first place. Violating the law was made a criminal offense, and
    convicted offenders could not receive city contracts or conduct other
    business with the city.

    182002 Ohio Laws HB 386 S: 5.

    19Ordinance No. 271-03. As of November 17, 2003, the City of Toledo was
    temporarily enjoined from enforcing application, enforcement, or other
    effectuation of this ordinance as a result of a lawsuit asserting that the
    ordinance is preempted by the Home Ownership and Equity Protection Act of
    Ohio. AFSA v. City of Toledo, Ohio, No. C10200301547 (Lucas County).

     Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
                           but Some Laws Have Been Preempted

      Regulators Have Determined That Federal Law Preempts Some State Predatory
      Lending Laws, but Views on Preemption Differ

    Significant debate has taken place as to the advantages and disadvantages
    of state and local predatory lending laws. In several cases, regulators of
    federally supervised financial institutions have determined that federal
    laws preempt state predatory lending laws for the institutions they
    regulate. In making these determinations, two regulators-OCC and OTS-have
    cited federal law that provides for uniform regulation of federally
    chartered institutions and have noted the potential harm that state
    predatory lending laws can have on legitimate lending. Representatives of
    the lending industry and some researchers agree with the federal banking
    regulators, arguing that restrictive state predatory lending laws may
    ultimately hurt many borrowers by reducing the supply of lenders willing
    to make subprime loans, creating undue legal risks for legitimate lenders,
    and increasing the costs of underwriting mortgage loans. Moreover,
    industry representatives have said that most predatory lending practices
    are already illegal under federal and state civil and criminal laws and
    that these laws should simply be more stringently enforced. In contrast,
    many state officials and consumer advocates are opposed to federal
    preemption of state predatory lending laws. They maintain that federal
    laws related to predatory lending are insufficient, and thus preemption
    interferes with their ability to protect consumers in their states,
    particularly from any potential abuses by the subsidiaries of federally
    chartered institutions.

        OCC, OTS, and NCUA Have Determined That Federal Law Preempts Some State
        Predatory Lending Laws

    Because both the federal and state governments have roles in chartering
    and regulating financial institutions, questions can arise as to whether a
    federal statute preempts particular state laws.20 Affected parties may
    seek guidance from federal agencies requesting their views on whether a
    particular federal statute preempts a particular state law; in these
    instances, the agency may issue an advisory opinion or order on the issue.
    Because the courts are ultimately responsible for resolving conflicts
    between federal and state laws, these advisory opinions and orders are
    subject to court challenge and review. As of November 2003, one or more
    federal regulators had determined that federal laws preempted the
    predatory mortgage lending laws of the District of Columbia and five

    20See U.S. General Accounting Office, Role of the Office of Thrift
    Supervision and Office of the Comptroller of the Currency in the
    Preemption of State Law, GAO/GGD/OGC-00-51R (Washington, D.C.: Feb. 7,
    2000) for additional information on federal preemption of state banking
    laws.

    Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
    Lending, but Some Laws Have Been Preempted

    states-Georgia, New Jersey, New Mexico, New York, and North Carolina. (See
    table 1.)

    Table 1: Preemption Determinations Issued by OCC, OTS, and NCUA Related to
    Predatory Mortgage Lending Laws

                               OCC                OTS                        NCUA
                    Georgia (2003)   Georgia (2003)                Georgia (2002)
                                    New York (2003)               New York (2000)
                                   New Mexico (2003)     North Carolina (2002)
                                   New Jersey (2003)  District of Columbia (2003)

    Source: GAO.

    Preemption of state law is rooted in the U.S. Constitution's Supremacy
    Clause, which provides for the supremacy of federal law. Over the years,
    the courts have developed a substantial body of precedent that has guided
    the analysis of whether any particular federal law or regulation overrides
    or preempts state law. The courts' analysis of whether federal law
    preempts state law has fundamentally centered on whether Congress intended
    for the federal law or regulation to override state law, either from the
    face of the statute itself (express preemption) or from the structure and
    purpose of the statute (implied preemption.) In their preemption opinions,
    OCC, OTS, and NCUA have cited a variety of legislation and legal
    precedents. Since 1996, OTS has had regulations in place that describe its
    preemption of state lending laws.21 In January 2004, OCC issued a rule
    amending its regulations in a similar manner, clarifying what types of
    state laws federal law preempts in the context of national bank lending.22
    OCC stated that it issued the rule in response to the number and
    significance of the questions that have arisen with respect to the
    preemption of state laws and to reduce uncertainty for national banks that
    operate in multiple states. In its rulemaking, OCC stated that it was
    seeking to provide more comprehensive standards regarding the
    applicability of state laws to lending, deposit taking, and other
    authorized activities of national banks. The regulations

    212 C.F.R S: 560.2(a).
    2269 Fed. Reg. 1904 (Jan. 13, 2004).

     Chapter 3 States Have Enacted and Enforced Laws to Address Predatory Lending,
                           but Some Laws Have Been Preempted

    list examples of the types of state statutes that are preempted (such as
    laws regulating credit terms, interest rates, and disclosure requirements)
    and examples of the types of state laws that would not be preempted (such
    as laws pertaining to zoning, debt collection, and taxation). When OCC
    first proposed these rules, one news article stated that it "triggered a
    flood of letters and strong reactions from all corners of the predatory
    lending debate." States and consumer groups were critical of the proposal.
    In contrast, the Mortgage Bankers Association of America and some large
    national banking companies wrote comment letters in support of OCC's
    proposed rules.

        Views Differ on the Implications of Federal Preemption of State Predatory
        Lending Laws

    Federal banking regulators point out that preemption of states'
    antipredatory lending laws applies only to institutions chartered by the
    agency issuing the preemption order. For example, OTS's preemption opinion
    served to preempt New Jersey's predatory lending statute for federally
    chartered thrifts but did not affect the statute's applicability to
    independent mortgage companies, national banks, and state-chartered banks
    and thrifts. In preempting the New Jersey Home Ownership Security Act of
    2002, OTS's Chief Counsel noted that requiring federally chartered thrifts
    to comply with a hodgepodge of conflicting and overlapping state lending
    requirements would undermine Congress's intent that federal savings
    institutions operate under a single set of uniform laws and regulations
    that would facilitate efficiency and effectiveness.23 Federal banking
    regulators have said that they have found little to no evidence of
    predatory lending by the institutions they regulate, pointing out that
    federally supervised institutions are highly regulated and subject to
    comprehensive supervision.24 They have also noted that they have issued
    guidance and taken numerous other steps to ensure that their institutions
    do not engage in predatory lending. Further, OCC has stated that state
    predatory lending laws, rather than reducing predatory lending among
    federally supervised institutions, can actually restrict and inhibit
    legitimate lending activity. The lending industry has generally supported
    preemption. For example, the Mortgage Bankers Association of America has
    argued

    23Office of Thrift Supervision, P-2003-5, Preemption of New Jersey
    Predatory Lending Act (July 22, 2003).

    24Several state law enforcement authorities have also said that predatory
    lending generally occurs outside of banks and direct bank subsidiaries.
    See Brief of Amicus Curiae State Attorneys General, National Home Equity
    Mortgage Ass'n v. OTS, Civil Action No. 02-2506 (GK) (D D.C.) (March 21,
    2003) at 10-11.

    Chapter 3 States Have Enacted and Enforced Laws to Address Predatory
    Lending, but Some Laws Have Been Preempted

    that uniformity in lending regulations is central to an efficient and
    effective credit market.

    In contrast, many state officials and consumer advocates have opposed
    federal preemption of state predatory lending laws, for several reasons.
    First, they contend that state predatory lending laws are necessary to
    address gaps in relevant federal consumer protection laws. For example,
    one state official said that the predatory lending legislation adopted by
    his state was more focused and effective than the provisions of the
    Federal Trade Commission Act. In addition, opponents of preemption claim
    that federal regulators may not devote the necessary resources or have the
    willingness to enforce federal consumer protection laws relevant to
    predatory lending by federally chartered institutions and their
    subsidiaries. In response to OCC's and OTS's statements that there is no
    evidence of predatory lending among subsidiaries of federally regulated
    depository institutions, opponents of preemption noted that there are
    several cases in which allegations of abusive lending practices involving
    some of these subsidiaries have been raised.25

    25 For example, see Comments on OCC Working Paper, Center for Responsible
    Lending, 7-10, October 6, 2003,
    http://www.predatorylending.org/pdfs/CRLCommentsonOCCWorkingPaper.pdf.

    Chapter 4

    The Secondary Market May Play a Role in Both Facilitating and Combating
    Predatory Lending

    By providing lenders with an additional source of liquidity, the secondary
    market can benefit borrowers by increasing the availability of credit and,
    in general, lowering interest rates. While a secondary market for prime
    mortgage loans has existed for decades, a relatively recent secondary
    market for subprime loans now offers these potential benefits to subprime
    borrowers as well. However, the secondary market may also serve to
    facilitate predatory lending, as it can provide a source of funds for
    unscrupulous originators that quickly sell off loans with predatory terms.
    Secondary market participants may use varying degrees of due diligence to
    avoid purchasing loans with abusive terms. In addition, some states have
    enacted legislation with assignee liability-potentially holding purchasers
    liable for violations of abusive lending laws that occurred in the loan
    origination. However, extending liability to secondary market purchasers
    may cause lenders and other secondary market participants, such as credit
    rating agencies, to withdraw from the market, as occurred in Georgia.

      The Development of a Secondary Market for Subprime Loans Can Benefit Consumers

    Originators of mortgage loans-which can include banks, other depository
    institutions, and mortgage lenders that are not depository institutions-
    may keep the loans or sell them in the secondary market. Secondary market
    purchasers may then hold the loans in their own portfolio or may pool
    together a group of loans and issue a mortgage-backed security that is
    backed by a pool of such loans. The securitization of mortgage loans
    became common during the 1980s and, by the 1990s, had become a major
    source of funding in the prime mortgage market. According to the Office of
    Federal Housing Enterprise Oversight, by the end of 2002 more than 58
    percent of outstanding U.S. single-family residential mortgage debt was
    financed through securitization. Two government-sponsored enterprises-
    Fannie Mae and Freddie Mac-represented nearly 40 percent of the amount
    securitized.1

    The securitization of subprime mortgage loans did not become common until
    the mid-1990s. The development of a secondary market for these loans has
    been an important factor in the growth of subprime lending, expanding
    subprime lenders' access to funds and thus increasing the availability of
    subprime credit. The trade journal Inside B&C Lending estimated that in
    2002 approximately 63 percent of new subprime

    1A government-sponsored enterprise (GSE) is a congressionally chartered,
    publicly owned corporation established and accorded favored regulatory
    treatment to increase access to the capital market for specific economic
    sectors, including housing.

    Chapter 4
    The Secondary Market May Play a Role in
    Both Facilitating and Combating Predatory
    Lending

    mortgages, representing $134 billion, were securitized. The originators of
    subprime loans are often nonbank mortgage and finance companies. As
    secondary market participants-such as the Wall Street investment firms
    that have been the major underwriters for subprime securities-have grown
    more willing to purchase these instruments, subprime originators have
    gained access to an important source of liquidity that has allowed them to
    make more subprime loans.

    As shown in figure 4, the process of securitization starts with borrowers
    obtaining mortgages either directly from a lender or through a broker. The
    lender then creates a pool-a separate legal entity that purchases the
    mortgages and issues securities based on them. The lender hires a credit
    rating agency, which has no direct financial interest in the deal, to
    confirm the value of the securities based on the expected return and risks
    of the underlying mortgages. At the same time, the lender hires an
    underwriter to sell the securities to investors. The value of the
    securities is based exclusively on the mortgages themselves and is
    separate from the financial condition of the original lender. Finally, a
    servicer is hired to collect mortgage payments from the borrowers and
    disburse interest and principal payments to the investors. The process
    described above is for securitizations performed via private conduits-that
    is, without the participation of government-sponsored enterprises.

    Chapter 4
    The Secondary Market May Play a Role in
    Both Facilitating and Combating Predatory
    Lending

    Figure 4: Steps in the Securitization of Residential Mortgages

    Source: GAO.

    Note: This chart represents the process for fully private securitizations
    and not for governmentsponsored enterprises.

    Freddie Mac and Fannie Mae are relatively recent entrants into the
    subprime market; Freddie Mac began purchasing subprime loans in 1997 and
    Fannie Mae in 1999. Both companies have moved slowly and have limited
    their purchases to the segment of the subprime market with the most
    creditworthy of subprime loans. At present, the companies are believed to
    represent a relatively small portion of the overall secondary market for
    subprime loans. The exact portion they represent is not clear, but a study
    conducted for HUD estimated that the companies purchased

    Chapter 4
    The Secondary Market May Play a Role in
    Both Facilitating and Combating Predatory
    Lending

    about 14 percent of the subprime loans originated in 2002.2 Both Fannie
    Mae and Freddie Mac have stated publicly that they plan on expanding their
    role in the subprime market in the future. In part, this may be a result
    of the affordable housing goals that HUD set for the GSEs in October 2000,
    which increased the goals for loans made to low- and moderate-income
    borrowers.3 HUD recommended that the GSEs consider enhancing their roles
    in the subprime market-which often serves low- and moderateincome
    borrowers-to help standardize mortgage terms in that market and
    potentially reduce interest rates for subprime borrowers. While the GSEs
    are currently believed to represent a small portion of the secondary
    market for subprime lending, some market observers believe their share
    will grow.

    The growth of the secondary market for subprime loans has potentially
    benefited some consumers. By providing subprime lenders with a new source
    of liquidity, these lenders face lower funding costs and reduced interest
    rate risk, in part because the supply of lenders willing to make loans to
    borrowers with impaired credit has increased. Many analysts say that, as a
    result, mortgage loans are now available to a whole new population of
    consumers and interest rates on subprime loans made by reputable lenders
    have fallen. In addition, increased securitization of subprime lending may
    lead to more uniform underwriting of subprime loans, which could further
    reduce origination costs and interest rates to consumers.

    2K. Temkin, J. Johnson, D. Levy, "Subprime Markets, the Role of GSEs, and
    Risk-Based Pricing," prepared by The Urban Institute for the U.S.
    Department of Housing and Urban Development, March 2002. Other estimates
    of the GSEs' share of securitization of the subprime market have varied,
    in part because-as noted earlier-there is no consistent industry
    definition of what constitutes subprime.

    3The Federal Housing Enterprises Financial Safety and Soundness Act of
    1992 requires Fannie Mae and Freddie Mac to meet annual
    percent-of-business housing goals established by HUD for three categories:
    low-and moderate-income, underserved, and special affordable. HUD set the
    following goals for 2001 through 2003: low- and moderate-income- 50
    percent of the total number of units financed; underserved-31 percent of
    the total number of units financed; and special affordable-20 percent of
    the total number of units financed.

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

      The Secondary Market for Subprime Loans Can Facilitate Predatory Lending

    While the development of a secondary market for subprime loans may have
    benefits for borrowers, it can also provide a source of funds for
    unscrupulous originators that quickly sell off loans with predatory terms.
    The secondary market can complicate efforts to eliminate predatory lending
    by separating ownership of a loan from its originator. This separation can
    undermine incentives to reduce risk in lending and create incentives that
    may increase the attractiveness of making loans with predatory terms. As
    noted earlier, some originators of subprime mortgage loans make their
    profits from high origination fees. The existence of a market that allows
    originating lenders to quickly resell subprime loans may reduce the
    incentive these lenders have to ensure that borrowers can repay. Further,
    lenders often market their products through brokers that do not bear the
    risks associated with default, as brokers are compensated in upfront fees
    for the loans they help originate. Some lenders and state officials told
    us that unscrupulous brokers sometimes deceive originating lenders
    regarding borrowers' ability to repay. Even if deceived, lenders who
    originate the loans and then sell them in the secondary market ultimately
    may not bear the risk of a loan default. Taken together, these
    circumstances can undermine efforts to combat predatory lending practices.

    Market forces provide some incentives to deter secondary market purchasers
    from purchasing predatory loans because these loans create both credit and
    reputation risk.4 However, predatory loans do not in all cases create
    unusual financial risks or losses for secondary market purchasers. For
    example, in most states loan purchasers are generally not liable for
    damages that may have resulted from the origination of abusive loans that
    they purchased, mitigating much of the legal risk of buying loans that may
    have violated laws addressing predatory lending. Moreover, loans with
    predatory features may carry very high interest rates and have barriers to
    prepayment, which may more than compensate for the increased credit risks
    associated with subprime loans.

    However, investors' insistence on the use of credit enhancements in the
    securitization process may offset or mitigate the incentives to engage in
    predatory lending of originators who sell loans to the secondary market.

    4Reputation risk is the current and prospective impact on a company's
    earnings and capital arising from negative public opinion from other
    market participants. This risk may expose a misbehaving originator or
    lender to litigation, financial loss, and a decline in its customer base
    if its behavior injures its customers or clients.

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

    Credit enhancements, which refer to a variety of approaches used to reduce
    the credit risk of an obligation, are common in securitization
    transactions, in part because of concerns that originators may try to pass
    on lower-quality loans. Because the price investors will pay for
    securities is based on risk as well as return, sellers use the
    enhancements to lower the risk and thus raise the price of securities. For
    example, the securities may be overcollateralized by ensuring that the
    value of the collateral backing the securities-in the case of mortgage
    backed securities, the face value of the loans-exceeds the value of the
    securities being offered for sale. The difference provides a "cushion" or
    reserve against possible credit losses and permits a higher loss rate on
    the total mortgage pool without endangering payments to the owners of the
    securities. Securitizers can also include recourse provisions in their
    loan purchases that require sellers to take back loans in the event of
    borrower default. As a result of these factors, the degree to which
    originators of loans sold in the secondary market-including loans with
    abusive terms-are insulated from credit risks associated with those loans
    varies, and the profits from selling the loans may vary with the costs of
    credit enhancement.

      Due Diligence Can Help Purchasers Avoid Predatory Loans, but Efforts Vary
      among Secondary Market Participants

    Secondary market purchasers of residential mortgage loans undertake a
    process of due diligence designed to minimize legal, financial, and
    reputation risk associated with the purchase of those loans. Due diligence
    can play an important role in avoiding the purchase of abusive loans, but
    cannot necessarily identify all potentially abusive loans. Officials of
    Fannie Mae and Freddie Mac-which, as noted previously, are relatively
    recent entrants in the subprime market-are also concerned about risks but
    say that their due diligence processes are also designed to avoid
    purchasing loans that may have been harmful to consumers. Other firms' due
    diligence is not necessarily specifically intended to avoid loans that may
    have harmed consumers but rather to avoid purchasing loans that are not in
    compliance with applicable law or that present undue financial or
    reputation risks.5

    5OCC has issued guidelines stating that national banks are expected to
    undertake appropriate due diligence to avoid purchasing predatory loans.
    See OCC Advisory Letter 2003-3 (Avoiding Predatory and Abusive Lending
    Practices in Brokered and Purchased Loans), February 21, 2003.

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

        Due Diligence May Deter the Purchase of Some Predatory Loans but Has
        Limitations

    Loans purchased in the secondary market are usually not purchased
    individually but rather as a pool of many loans. Purchasers or
    securitizers of residential mortgage loans try to ensure that the loans in
    a particular pool are creditworthy and in compliance with law. Purchasers
    perform a general background and financial review of the institutions from
    which they purchase loans. In addition, secondary market purchasers of
    loans nearly always conduct due diligence, or a review and appraisal of
    confidential legal and financial information related to the loans
    themselves. Before or after the sale, purchasers may review electronic
    data containing information on the loans, such as the loan amount,
    interest rate, and borrower's credit score. Purchasers also may physically
    review a sample of individual loans, including items such as the loan
    applications and settlement forms.

    Some industry representatives and federal agencies say that appropriate
    due diligence can play an important role in deterring predatory lending.
    Participants in the secondary market have an interest in not purchasing
    loans that may be considered predatory because such loans can create
    unwarranted legal, financial, and reputation risk. For example, if such
    loans violate relevant municipal, state, or federal laws, purchasing them
    could, in some cases, expose the buyers to legal risks such as lawsuits,
    fines, and penalties. Moreover, predatory loans may be more likely to go
    into default, increasing financial risk without a commensurate increase in
    expected returns. In addition, many industry officials told us that
    reputation risk is a major reason why they want to avoid purchasing
    predatory loans. Firms involved in the securitization process do not want
    to be associated with predatory lending activity that could affect their
    relationships with other firms, community groups, and government agencies.

    Due diligence reviews for residential mortgage loans are designed to
    determine the financial characteristics of the loans and to ensure
    compliance with applicable federal, state, and municipal laws, including
    those designed to prohibit predatory lending. The reviews also can be
    designed to detect loans that have potentially abusive terms but are not
    necessarily violating any law. For example, an electronic review of loan
    data can flag characteristics such as interest rates that appear excessive
    but are nonetheless legal. A loan-level file review, in which a purchaser
    reviews the physical loan origination documents, offers access to more
    information and can highlight items such as points and fees and the
    borrower's capacity to repay. While nearly all purchasers of loans use due

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

    diligence to check for legal compliance, purchasers set their own
    guidelines for what other loan characteristics meet their standards.

    While due diligence in the secondary market is important, the role that it
    can play in deterring predatory lending by performing due diligence is
    limited. For one thing, more than one-third of all new subprime loans are
    not securitized in the first place but are held in the portfolio of the
    originating lender and thus do not face securitizers' due diligence
    reviews. In addition, even the most thorough due diligence will not
    necessarily catch all abusive loans or abusive lending practices. For
    example:

    o 	Due diligence may not detect fraud in the underwriting or approving of
    a mortgage. For instance, if a mortgage broker includes false information
    in a loan application to ensure that a borrower meets an originator's
    income requirements, the process of due diligence may not detect it.6

    o 	The data tapes used for loan reviews do not include point and fee
    information.7 Thus, securitizers typically cannot detect excessive or
    unwarranted fees prior to purchasing a loan without a loan-level review.

    o 	Loan flipping (repeated refinancings) can be difficult to detect
    because loan files do not necessarily include information on previous
    refinancings.

        Fannie Mae and Freddie Mac Appear to Perform Extensive Due Diligence to
        Avoid Buying Loans with Abusive Terms

    Fannie Mae and Freddie Mac have relatively strict criteria for the loans
    they purchase, particularly subprime loans. As noted, both companies limit
    their purchases to the most creditworthy subprime loans. In April 2000,
    Fannie Mae issued guidelines to sellers of subprime loans that set
    criteria designed to help the GSE avoid purchasing loans with abusive
    features. For example, the guidelines state that Fannie Mae's approved
    lenders may not "steer" a borrower who qualifies for a standard loan to a
    higher cost

    6Some securitizers have begun to use fraud detection software as part of
    their due diligence of residential mortgage loans. Such software analyzes
    specific data fields within a loan file and looks for characteristics and
    inconsistencies that may signal fraud in the appraisal, loan application,
    or loan itself. In some cases, a fraud review can also be incorporated as
    part of the regular due diligence process.

    7A prepurchase financial due diligence review may not look at point and
    fee data because the risks and returns to the loan purchaser depend not on
    payments that were made at origination but rather on future payments by
    the homeowner. However, a review of points and fees is often done during a
    subsequent loan-level file review.

    Chapter 4
    The Secondary Market May Play a Role in
    Both Facilitating and Combating Predatory
    Lending

    product, may not make loans without regard to the borrower's ability to
    repay, and may not in most instances charge more than 5 percent of the
    loan amount in points and fees. Freddie Mac issued similar guidelines to
    its sellers and servicers in December 2000. Further, both companies, like
    other secondary market purchasers, rely on a system of representations and
    warranties, under which sellers contractually agree to buy back loans they
    sell that turn out not to meet the terms of the contract.

    Fannie Mae and Freddie Mac officials told us that they undertake a series
    of measures aimed at avoiding the purchase of loans with predatory
    characteristics. Approved sellers and servicers undergo a background check
    and operational review and assessment that seeks, in part, to determine
    whether lenders are able to comply with their guidelines. Fannie Mae and
    Freddie Mac also require that special steps, such as additional due
    diligence measures, be taken in purchasing subprime loans. For example,
    Fannie Mae requires that subprime loans be originated using the company's
    automated desktop underwriting system, which helps ensure that borrowers
    are not being steered to a more expensive loan than they qualify for.8
    Fannie Mae officials say that the automated desktop underwriting system
    also facilitates traditional lenders that serve subprime borrowers.

    In addition, both companies said that they undertake extensive and costly
    due diligence that goes well beyond simple legal compliance and is aimed
    at avoiding loans that may potentially be considered abusive or
    detrimental to the borrower. Both companies use an outside contractor to
    conduct their loan-level due diligence reviews on subprime loans. The
    contractor has a standard "script" that reviews a large number of data
    elements related to legal compliance and creditworthiness. However, the
    contractor told us that Fannie Mae and Freddie Mac add elements to the
    script to make the review more stringent with regard to identifying
    potentially abusive practices. For example, Freddie Mac requires the
    contractor to check whether the lender has gathered evidence of a
    borrower's income information directly or relied on self-verification,
    which can raise uncertainty about a borrower's capacity to repay. In
    addition, the

    8Fannie Mae and Freddie Mac officials note that their antipredatory
    lending policies and compliance measures are only one element in their
    efforts to fight predatory lending. For example, both companies also have
    special programs that provide appropriately priced loans to
    credit-impaired borrowers and other consumers who tend to be targeted by
    predatory lenders; support homebuyer education and counseling for at-risk
    individuals; and have special loan programs designed for borrowers who
    have been targeted or victimized by predatory lenders.

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

    contractor told us that Fannie Mae and Freddie Mac are more likely than
    other firms to reject or require a repurchase if evidence exists that the
    loan may involve a predatory practice-even if the loan is otherwise
    legally compliant.

        Other Purchasers Vary in the Extent of Their Due Diligence

    According to industry representatives, all purchasers of mortgage loans
    undertake a process of due diligence, but the process can vary in its
    degree of stringency and comprehensiveness. For example, while most firms
    typically pull a sample of loans for a loan-level file review, companies
    may review anywhere between a few percent and 100 percent of the loans. In
    addition, companies vary in terms of the data elements they choose to
    review. Some firms review prior loans made to the borrower in an effort to
    detect loan flipping, while others do not. Further, some companies may be
    more willing than others to purchase loans that are considered
    questionable in terms of legal compliance, creditworthiness, or other
    factors.

    As noted earlier, loans that have harmed consumers and that may be deemed
    "predatory" by some observers are not necessarily against the law, nor do
    they necessarily increase the risk of the loan.9 Industry officials told
    us that while securities firms are concerned with the reputation risk that
    may come with purchasing abusive loans, the primary function of their due
    diligence is to ensure compliance with the law and to protect investors by
    ensuring that loans are creditworthy.10

    9One example would be steering borrowers to higher-cost loans than is
    justified by their credit histories. This practice is often considered
    abusive but is not per se a violation of federal law, nor does it
    necessarily increase credit risk to the lender.

    10Reputation risk can also be an issue for sellers of loans to the
    secondary market. Regularly selling loans that later create risks and
    costs for secondary market purchasers may close off the seller's access to
    the secondary market.

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

      Assignee Liability May Help Deter Predatory Lending but Can Also Have Negative
      Unintended Consequences

    Some states have enacted predatory lending laws that have assignee
    liability provisions under which purchasers of secondary market loans may
    be liable for violations committed by the originators or subject to a
    defense by the borrower against collecting the loan. Assignee liability is
    intended to discourage secondary market participants from purchasing loans
    that may have predatory features and to provide an additional source of
    redress for victims of abusive lenders. However, depending on the specific
    nature of the provision, assignee liability may also have unintended
    consequences, including reducing access to or increasing the cost of
    secondary market capital for legitimate loans. For example, assignee
    liability provisions of a predatory lending law in Georgia have been
    blamed for causing several participants in the mortgage lending industry
    to withdraw from the market, and the provisions were subsequently
    repealed.

        Several States Hold Secondary Purchasers Liable for Predatory Lending
        Violations

    Antipredatory lending laws in several states have included some form of
    assignee liability. Typically, with assignee liability, little or no
    distinction is made between the broker or lender originating a loan that
    violates predatory lending provisions and the person who purchases or
    securitizes the loans. Under these provisions, secondary market
    participants that acquire loans may be liable for violations of the law
    committed by the original lenders or brokers whether or not the purchasers
    were aware of the violations at the time they bought the loans. Further,
    borrowers can assert the same defenses to foreclosure against both
    originating lenders and entities in the secondary market that hold the
    loans (the assignees). Depending on the specific provisions of the law,
    assignees may have to pay monetary damages to aggrieved borrowers.

    As of December 2003, at least nine states and the District of Columbia had
    enacted predatory lending laws that expressly included assignee liability
    provisions, though the nature of these provisions varies greatly,
    according to the database of state and local legislation we reviewed.
    Other states have passed predatory lending laws that do not explicitly
    provide for assignee liability, but debate has occurred in some of these
    states about whether assignee liability can be asserted anyway under
    existing laws or legal principles. The federal HOEPA statute includes an
    assignee liability provision, but, as noted in chapter 2, only a limited
    number of subprime loans are covered under HOEPA.

    Assignee liability can take a variety of forms. For example, an assignee
    can be held liable only in defensive claims (defense to foreclosure
    actions and

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

    to claims regarding monies owed on a loan) or can also be assessed for
    damages directly, including punitive damages.11 Similarly, some laws
    include "safe harbor provisions," under which assignee liability may not
    arise if the assignee has taken certain measures to avoid obtaining a
    highcost loan. For example, under New Jersey law, no assignee liability
    arises if the assignee demonstrates, by a preponderance of evidence, that
    a person exercising reasonable due diligence could not determine that the
    mortgage was a high-cost home loan.12 However, many secondary market
    participants told us that the value of these safe harbor provisions is
    limited, in part because of difficulties in demonstrating compliance with
    safe harbor standards. For example, some secondary market participants say
    that the New Jersey law does not adequately define what constitutes
    "reasonable" due diligence.

        Assignee Liability May Help Combat Predatory Lending but May Also Hinder
        Legitimate Lending

    The issue of whether to include assignee liability provisions in state and
    local predatory lending laws has been highly controversial, because such
    provisions can potentially both confer benefits and cause problems.
    Assignee liability has two possible primary benefits. First, holding
    purchasers and securitizers of loans liable for abusive lending violations
    provides them with an incentive not to purchase predatory loans in the
    first place. If secondary market participants took greater action-through
    policy decisions or stricter due diligence-to avoid purchasing potentially
    abusive loans, originators of predatory loans would likely see a steep
    decline in their access to secondary market capital. Second, under some
    forms of assignee liability, consumers who have been victimized by such
    lenders may have an additional source of redress. In some cases,
    originators of abusive loans that have been sold in the secondary market
    are insolvent or cannot be located, leaving victims dependent on assignees
    for relief from foreclosure or other redress.

    11Under New York's law, an assignee seeking to enforce a loan against a
    borrower in default or in foreclosure is subject to the borrower's claims
    and defenses to payment that the borrower could assert against the
    original lender. See NY Banking Law S: 6-l (2003). Under Maine's law, an
    assignee may be subject to all claims and defenses that the borrower may
    assert against the creditor of the mortgage. See Maine Rev. Stat. Ann.
    Title 9-A S: 8-209 (2003).

    12See, e.g., N.J. Stat. Ann. S: 46:10B-27 (West 2003); see also, 815 Ill.
    Comp. Stat. 137/135 (2003).

    Chapter 4
    The Secondary Market May Play a Role in
    Both Facilitating and Combating Predatory
    Lending

    However, assignee liability provisions may also have the serious if
    unintended consequence of discouraging legitimate secondary market
    activity. Secondary market participants say that because they do not
    originate the loans they purchase, even the most stringent due diligence
    process cannot ensure that all loans comply with applicable law. In
    addition, some secondary market participants state that assignee liability
    provisions require them to make subjective determinations about whether
    the loans are in compliance with law, and this ambiguity can create legal
    and financial risk. These factors, industry participants say, can actually
    end up harming consumers by raising the costs of ensuring compliance with
    the law and thus increasing the cost of loans to borrowers. Further, if
    secondary market participants are not willing to risk having to assume
    liability for violations committed by originators, they may pull out of
    the market altogether, reducing the availability and increasing the costs
    of legitimate subprime credit. Finally, if states' predatory lending laws
    have different terms and provisions regarding assignee responsibilities,
    the secondary market as a whole could become less efficient and liquid,
    further increasing rates on legitimate subprime mortgages.

    Credit rating agencies have been among the secondary market players that
    have expressed concern about assignee liability provisions in state
    predatory lending laws. When a residential mortgage-backed security is
    created from a pool of loans, an independent credit rating agency examines
    the security's underlying loans and assigns it with a credit rating, which
    represents an opinion of its general creditworthiness. Credit rating
    agencies need to monetize (measure) the risk associated with the loans
    underlying a security in order to assign a credit rating. Because assignee
    liability can create additional legal and financial risks, the major
    credit rating agencies typically review new predatory lending legislation
    to assess whether they will be able to measure that risk adequately to
    rate securities backed by loans covered under the law.

    We talked with representatives of two major credit rating agencies, firms
    that issue mortgage-backed securities, and the GSEs Fannie Mae and Freddie
    Mac to better understand how specific assignee liability provisions might
    affect their ability to conduct secondary market transactions. In general,
    the representatives told us that the most problematic assignee liability
    provisions for secondary market participants are those with two
    characteristics:

    o 	Ambiguous language. Credit rating agencies and other secondary market
    players seek clear and objective descriptions of the loans

                                       Chapter 4
                        The Secondary Market May Play a Role in
                       Both Facilitating and Combating Predatory
                                        Lending

    covered by the statutes and the specific actions or omissions that
    constitute a violation. For example, some participants cited concerns
    about an ordinance enacted in Toledo, Ohio, that prohibited taking
    advantage of a borrower's "physical or mental infirmities" but did not
    define what constituted such infirmities.13 Secondary market participants
    noted that without objective criteria, there is no way to ensure that an
    originator has complied adequately with the law.

    o 	Punitive Damages. Under some assignee liability provisions, the
    potential damages a borrower can receive are restricted to the value of
    the loan, while other provisions allow for punitive damages, which are not
    necessarily capped. Secondary market participants say that the potential
    for punitive damages can make it very difficult to quantify the risk
    associated with a security.

        Georgia's Statute Illustrates Possible Effects of Assignee Liability
        Provisions

    According to officials of industry and consumer advocacy organizations,
    the Georgia Fair Lending Act, which became effective on October 1, 2002,
    was one of the strictest antipredatory lending laws in the nation.14 It
    banned single-premium credit insurance and set restrictions on late fees
    for all mortgage loans originated in the state and, for a special category
    of "covered loans," prohibited refinancing within 5 years after
    consummation of an existing home loan unless the new loan provided a
    "tangible net benefit" to the borrower. The act also created a category of
    "high-cost loans" that were subject to certain restrictions, including
    limitations on prepayment penalties, prohibitions on balloon payments, and
    prohibitions on loans that were made without regard to the borrower's
    ability to repay.

    13City of Toledo Ordinance No. 291-02 (Oct. 4, 2002).

    14The Georgia Fair Lending Act is codified at GA Code Ann. S:S: 7-6A-1 et.
    seq. OTS, NCUA, and OCC have determined that the Georgia law does not
    apply to the institutions they supervise because it is preempted by
    federal law. See Office of Thrift Supervision, P-2003-1, Preemption of
    Georgia Fair Lending Act (Jan. 21, 2003); National Credit Union
    Administration, 02-0649, Applicability of Georgia Fair Lending Act to
    Federal Credit Unions (July 29, 2002); National Credit Union
    Administration, 03-0412, NCUA Preemption of the Georgia Fair Lending Act
    (Nov. 10, 2003); and OCC Preemption Determination and Order, Docket No.
    03-17 (July 30, 2003). Because Georgia law contains a parity provision
    under which its state-chartered banks are treated similarly to national
    banks, Georgia's Commissioner of Banking and Finance ruled that
    Georgia-chartered banks also are not subject to the Fair Lending Act. See
    Declaratory Ruling: Effect of Preemption of Georgia Fair Lending Act by
    the OCC on July 30, 2003 (Aug. 5, 2003).

    Chapter 4
    The Secondary Market May Play a Role in
    Both Facilitating and Combating Predatory
    Lending

    The act also included fairly strict assignee liability. Secondary market
    participants that purchased high-cost loans were liable for violations of
    the law committed by the originator of the loans they purchased, while
    purchasers of covered loans were subject to borrower defenses and
    counterclaims based on violations of the act. The act also expressly made
    mortgage brokers and loan servicers liable for violations. Remedies
    available to borrowers included actual damages, rescission of high-cost
    loans, attorney fees, and punitive damages. Most of the violations were
    civil offenses, but knowing violations constituted criminal offenses.

    Shortly after the Georgia Fair Lending Act took effect, several mortgage
    lenders announced that they would stop doing business in the state due to
    the increased risk they would incur. In addition, several secondary market
    participants stated their intention to cease doing business in Georgia. In
    January 2003, the credit rating agency Standard & Poor's announced it
    would stop rating mortgage-backed securities in Georgia because of the
    uncertainty surrounding potential liability under the act. Standard &
    Poor's decision extended to securitizations of virtually all loans in the
    state, not just those of covered or high-cost loans. The company said that
    because the act did not provide an unambiguous definition of which loans
    were covered (and therefore subject to assignee liability), it could not
    adequately assess the potential risk to securitizers. In addition, the
    company said that it was concerned about an antiflipping provision that
    did not adequately define what constituted the "net tangible benefit" to
    borrowers that certain refinancings had to provide. The two other major
    credit rating agencies, Moody's and Fitch, also said that the law would
    limit their ability to rate mortgage-backed securities in Georgia.

    In response to these events, the Georgia legislature amended the Georgia
    Fair Lending Act on March 7, 2003. The amendments eliminated the category
    of "covered home loans" and the restrictions that had existed for that
    category of loans. In addition, the amendments greatly reduced the scope
    of assignee liability under the law, restricting such liability to
    "highcost" loans, and then only when the assignee is unable to show that
    it has exercised reasonable due diligence to avoid purchasing them. In
    addition, the amendments capped the amount of damages an assignee can face
    and prohibited assignee liability in class-action lawsuits. Once these
    amendments were passed, credit rating agencies announced that they would
    once again rate securities backed by mortgage loans originated in Georgia,
    and lenders said they would continue to do business in the state.
    Advocates of the original Georgia law argued that the legislature
    overreacted to actions by some members of the lending industry, and many

    Chapter 4
    The Secondary Market May Play a Role in
    Both Facilitating and Combating Predatory
    Lending

    activists said that Standard & Poor's and others had engaged in an
    orchestrated effort to roll back the Georgia Fair Lending Act. Industry
    representatives said that the response by lenders and others was a
    reasonable response to a statute that created unacceptable risks of legal
    liability for lenders and assignees.

    Policymakers and industry representatives have frequently cited the events
    in Georgia as a lesson in what can happen when secondary market
    participants are held liable for violations by the original lender.
    Industry representatives assert that assignee liability creates undue
    risks to the secondary market, or makes assessing risks difficult, and
    ultimately reduces borrowers' access to credit. In the case of Georgia,
    however, it is unclear whether the problem was assignee liability itself
    or the scope and characteristics of the specific assignee liability
    provisions contained in the original law. Georgia's original law created
    concern in large part because of perceived ambiguities in defining which
    loans were subject to assignee liability and because assignees' liability
    was subject to unlimited punitive damages. Not all states with
    antipredatory lending statutes that include assignee liability provisions
    have had lenders and credit agencies threaten to withdraw from the market
    to the same extent, largely because these laws generally cap an assignee's
    liability, create a safe harbor, or contain less ambiguous language. The
    challenge to states that choose to impose assignee liability is to craft
    provisions that may serve their purpose of deterring predatory lending and
    providing redress to affected borrowers without creating an undue adverse
    effect on the legitimate lending market.

    Chapter 5

    The Usefulness of Consumer Education, Counseling, and Disclosures in Deterring
    Predatory Lending May Be Limited

    A number of federal, state, nonprofit, and industry-sponsored
    organizations offer consumer education initiatives designed to deter
    predatory lending by, among other things, providing information about
    predatory practices and working to improve consumers' overall financial
    literacy. While consumer education efforts have been shown to have some
    success in increasing consumers' financial literacy, the ability of these
    efforts to deter predatory lending practices may be limited by several
    factors, including the complexity of mortgage transactions and the
    difficulty of reaching the target audience. Similarly, unreceptive
    consumers and counselors' lack of access to relevant loan documents can
    hamper the effectiveness of mortgage counseling efforts, while the sheer
    volume of mortgage originations each year makes universal counseling
    difficult. While efforts are under way to improve the federally required
    disclosures associated with mortgage loans, their potential success in
    deterring predatory lending is likewise hindered by the complexity of
    mortgage transactions and by the lack of financial sophistication among
    many borrowers who are the targets of predatory lenders.

      Many Consumer Education and Mortgage Counseling Efforts Exist, but Several
      Factors Limit Their Potential to Deter Predatory Lending

    In response to widespread concern about low levels of financial literacy
    among consumers, federal agencies such as FDIC, HUD, and OTS have
    conducted and funded initiatives designed in part to raise consumers'
    awareness of predatory lending practices. In addition, a number of states,
    nonprofits, and trade organizations have undertaken consumer education
    initiatives. Prepurchase mortgage counseling-which can include a third
    party review of a prospective mortgage loan-may also help borrowers avoid
    predatory loans, in part by alerting them to the characteristics of
    predatory loans. In some circumstances, such counseling is required.
    However, a variety of factors limit the potential of these tools to deter
    predatory lending practices.

                                       Chapter 5
                         The Usefulness of Consumer Education,
                        Counseling, and Disclosures in Deterring
                            Predatory Lending May Be Limited

        Some Federal Agencies Have Initiatives to Promote Awareness of Predatory
        Lending

    A number of federal agencies and industry trade groups have advocated
    financial education for consumers as a means of improving consumers'
    financial literacy and addressing predatory lending. The Department of the
    Treasury, as well as consumer and industry groups, have identified the
    lack of financial literacy in the United States as a serious, widespread
    problem.1 Studies have shown that many Americans lack a basic knowledge
    and understanding of how to manage money, use debt responsibly, and make
    wise financial decisions.2 As a result, some federal agencies have
    conducted or funded programs and initiatives that serve to educate and
    inform consumers about personal financial matters. For example:

    o 	FDIC sponsors MoneySmart, a financial literacy program for adults with
    little or no banking experience and low to moderate incomes. FDIC
    officials told us that the program, in effect, serves as one line of
    defense against predatory lending. The MoneySmart curriculum addresses
    such topics as bank services, credit, budgeting, saving, credit cards,
    loans, and homeownership. MoneySmart is offered free to banks and others
    interested in sponsoring financial education workshops.

    o 	The Federal Reserve System's Community Affairs Offices issue media
    releases and distribute consumer education publications to financial
    institutions, community organizations, and to consumers directly. These
    offices also have hosted conferences and forums on financial education and
    predatory lending and have conducted direct outreach to communities
    targeted by predatory lenders.

    1The Fair and Accurate Credit Transactions Act of 2003 (Pub. L. No.
    108-159), which was enacted on December 4, 2003, addresses financial
    literacy in a number of its provisions. Among other things, it establishes
    a financial literacy and education commission consisting of
    representatives of FTC, the federal banking regulators, HUD, the
    Department of the Treasury, and other federal agencies.

    2See National Endowment for Financial Education, "Financial Literacy in
    America: Individual Choices, National Consequences," report based on the
    symposium "The State of Financial Literacy in America: Evolutions and
    Revolutions," October 2002 (Greenwood Village, Colorado, 2002), 1 and 6;
    Maude Toussaint-Comeau and Sherrie L.W. Rhine, "Delivery of Financial
    Literacy Programs," Policy Studies, Consumer Issues Research Series,
    Consumer and Community Affairs Division, Federal Reserve Bank of Chicago
    (2000), 1; Marianne A. Hilgert, Jeanne M. Hogarth, and Sondra Beverly,
    "Household Financial Management: The Connection between Knowledge and
    Behavior," Federal Reserve Bulletin, July 2003, 309 and 311.

    Chapter 5
    The Usefulness of Consumer Education,
    Counseling, and Disclosures in Deterring
    Predatory Lending May Be Limited

    o 	OTS and NCUA have worked with community groups on financial literacy
    issues and have disseminated financial education materials, including
    literature on predatory lending issues, to their respective regulated
    institutions.

    o 	HUD has developed and distributed a brochure titled Don't Be a Victim
    of Loan Fraud: Protect Yourself from Predatory Lenders, which seeks to
    educate consumers who may be vulnerable to predatory lending, especially
    the elderly, minorities, and low-income homeowners.

    o 	Federal banking regulators give positive consideration in Community
    Reinvestment Act performance reviews to institutions for providing
    financial education to consumers in low- and moderate-income communities.

    o 	OCC issued an advisory letter in 2001 providing detailed guidance for
    national banks, encouraging them to participate in financial literacy
    initiatives and specifying a range of activities that banks can provide to
    enhance their customers' financial skills, including support for
    educational campaigns that help borrowers avoid abusive lending
    situations.3

    o 	FTC and DOJ disseminate information designed to raise consumers'
    awareness of predatory lending practices, particularly those involving
    fraudulent acts. Brochures and other consumer materials are distributed on
    the agencies' Web sites, as well as through conferences and seminars,
    local consumer protection agencies, consumer credit counselors, state
    offices, and schools. FTC has also supported public service announcements
    on radio and television, including Spanish-speaking media.

    Some of these initiatives are general financial education programs that do
    not specifically address predatory home mortgage lending, some address
    predatory lending practices as one of a number of topics, and a few focus
    specifically on predatory lending. Some of these initiatives are directed
    to a general audience of consumers, while others are directed toward
    lowincome or other communities that are often the targets of predatory
    lenders. A number of different media have been used to deliver the
    messages, including print and online materials, speeches and spot

    3OCC Advisory Letter 2001-1, Financial Literacy, January 16, 2001.

                                       Chapter 5
                         The Usefulness of Consumer Education,
                        Counseling, and Disclosures in Deterring
                            Predatory Lending May Be Limited

    announcements, and materials for the hearing- and visually impaired. In
    some cases, consumer financial education materials have been produced in a
    variety of languages, including Arabic, Chinese, Korean, and Spanish.
    Federal agencies' consumer education campaigns typically take place in
    partnership with other entities, including community and nonprofit groups
    and state and local agencies.

    Federal agencies have taken some actions to coordinate their efforts
    related to educating consumers about predatory lending. For example, in
    October 2003, the Interagency Task Force on Fair Lending, which consists
    of 10 federal agencies, published a brochure that alerts consumers to
    potential pitfalls of home equity loans, particularly high-cost loans. The
    brochure Putting Your Home on the Loan Line is Risky Business describes
    common predatory lending practices and makes recommendations to help
    borrowers avoid them.

        State Agencies, Nonprofits, and Industry Organizations Have Also Initiated
        Consumer Education Efforts

    Some state agencies have also sponsored consumer education initiatives
    that address predatory lending. For example, the Connecticut Department of
    Banking offers an educational program in both English and Spanish that
    partners with neighborhood assistance groups and others to promote
    financial literacy and educate consumers on the state's antipredatory
    lending statute. The Massachusetts Division of Banks maintains a toll-free
    mortgage hotline to assist homeowners about potentially unethical and
    unlawful lending practices. The hotline helps consumers determine whether
    loan terms may be predatory and directs them to other sources of
    information and assistance. The New York State Banking Department
    distributes educational materials, including a video, that describe
    predatory lending practices. The department has also conducted educational
    outreach programs to community groups on the issue.

    Nonprofits provide a significant portion of consumer financial education
    on predatory lending, sometimes with support from federal, state, or local
    agencies. These efforts include both general financial literacy programs
    with a predatory lending component and initiatives that focus specifically
    on predatory lending issues. For example, the National Community
    Reinvestment Coalition, with funding support from HUD, distributes a
    training module to help communities across the country educate consumers
    about predatory lending.

    Chapter 5
    The Usefulness of Consumer Education,
    Counseling, and Disclosures in Deterring
    Predatory Lending May Be Limited

    Some industry trade organizations and companies also have consumer
    education initiatives related to predatory lending:

    o 	Freddie Mac has developed the CreditSmart program in partnership with
    universities and colleges. CreditSmart is a curriculum on credit education
    that is available online and has been used in academic programs and in
    community workshops, seminars, and credit education campaigns. Freddie Mac
    also helps fund and promote the "Don't Borrow Trouble" campaign, a
    comprehensive public education campaign with counseling services that is
    designed to help homeowners avoid falling victim to predatory lenders. The
    campaign uses brochures, mailings, posters, public service announcements,
    transit ads, and television commercials. Its media toolkit and marketing
    consultant services have been provided to the U.S. Conference of Mayors
    for use in local communities.

    o 	Fannie Mae supports financial literacy programs through its Fannie Mae
    Foundation, which sponsors homeownership education programs that focus on
    improving financial skills and literacy for adult students and atrisk
    populations, such as new Americans and Native Americans. Fannie Mae also
    offers a Web-based tool that allows home-buyers to compare loan products
    and prices.

    o 	The Jump$tart Program for Personal Financial Literacy, sponsored by a
    coalition of corporations, industry associations-such as the Insurance
    Education Foundation and the American Bankers Association Education
    Foundation-and several government and nonprofit agencies, includes a
    series of modules covering topics such as managing debt and shopping for
    credit that are designed to improve the personal financial literacy of
    young adults.

    o 	The Mortgage Bankers Association of America, a trade association
    representing mortgage companies and brokers and the real estate finance
    industry, disseminates a package of information describing some common
    warning signs of mortgage fraud and predatory lending, a consumer's bill
    of rights, and appropriate contacts for consumers who believe they have
    been victimized by predatory lenders.

    o 	The National Association of Mortgage Brokers makes presentations to
    first-time homebuyers to educate them on the mortgage process and credit
    reports, among other topics.

                                       Chapter 5
                         The Usefulness of Consumer Education,
                        Counseling, and Disclosures in Deterring
                            Predatory Lending May Be Limited

    o 	The American Financial Services Association's Education Foundation
    develops educational materials designed to improve consumers' use of
    credit and overall financial literacy.

        Mortgage Counseling Can Warn Borrowers of Predatory Lending and Can Offer a
        "Third Party" Review of Proposed Mortgage Loans

    Mortgage counseling can be part of general "homeownership counseling" for
    new homeowners but may also be offered prior to a refinancing. It gives
    borrowers an opportunity to receive personalized advice from a
    disinterested third party about a proposed mortgage or other loan. In
    addition to providing general advice about the mortgage process and loan
    products, counselors typically review the terms of proposed loans for
    potentially predatory characteristics. Studies evaluating the impact of
    homeownership counseling have found that it helps homeowners maintain
    ownership of their homes and avoid delinquencies, particularly when the
    counseling is provided one on one.4 HUD supports a network of
    approximately 1,700 approved counseling agencies across the country. The
    agencies provide a wide variety of education and counseling services,
    including homebuyer education and prepurchase counseling. HUD makes grant
    funds available to some of these agencies, and a portion of these funds
    has been earmarked exclusively for counseling for victims of predatory
    lending.

    A number of state antipredatory lending laws, such as those in New Jersey
    and North Carolina, require some lenders to document that a borrower has
    received counseling before taking out certain types of high-cost loans. In
    a few cases, however, borrowers may waive their right to receive such
    counseling. Several states, including Colorado, New York, and
    Pennsylvania, require lenders to provide notice to borrowers of certain
    loans that mortgage counseling is available and encourage them to seek it.

    4See, for example, Abdighani Hirad and Peter M. Zorn, "A Little Knowledge
    is a Good Thing: Empirical Evidence of the Effectiveness of Pre-Purchase
    Homeownership Counseling," in Low-Income Homeownership: Examining the
    Unexamined Goal, ed. Nicolas P. Retsinas and Eric S. Belsky (Washington,
    D.C.: Brookings Institution Press and Harvard University Joint Center on
    Housing Studies, 2001), 2.

                                       Chapter 5
                         The Usefulness of Consumer Education,
                        Counseling, and Disclosures in Deterring
                            Predatory Lending May Be Limited

        A Variety of Factors May Limit the Effectiveness of Consumer Education and
        Mortgage Counseling in Deterring Predatory Lending

    Limitations of Consumer Education

    In testimony before Congress and elsewhere, representatives of the
    Mortgage Bankers Association, the Consumer Mortgage Coalition, and other
    industry organizations have promoted the view that educated borrowers are
    more likely to shop around for beneficial loan terms and avoid abusive
    lending practices. In searching the literature for studies on the
    effectiveness of consumer financial education programs, we found evidence
    that financial literacy programs may produce positive changes in
    consumers' financial behavior.5 However, none of the studies measured the
    effectiveness of consumer information campaigns specifically on deterring
    predatory lending practices.

    The majority of federal officials and consumer advocates we contacted said
    that while consumer education can be very useful, it is unlikely to play a
    substantial role in reducing the incidence of predatory lending practices,
    for several reasons:

    o 	First, mortgage loans are complex financial transactions, and many
    different factors-including the interest rate, fees, specific loan terms,
    and borrower's situation-determine whether the loan is in a borrower's
    best interests. Mortgage loans can involve dozens of different documents
    that are written in highly technical language. Even an excellent campaign
    of consumer education is unlikely to provide less sophisticated consumers
    with enough information to properly assess whether a proffered loan
    contains abusive terms.

    o 	Second, abusive lenders and brokers may use high-pressure or "push
    marketing" tactics-such as direct mail, telemarketing, and door-to-door
    contacts-that are unfair, deceptive, or designed to confuse the consumer.
    Broad-based campaigns to make consumers aware of predatory lending may not
    be sufficient to prevent many consumers- particularly those who may be
    uneducated or unsophisticated in financial matters-from succumbing to
    aggressive sales tactics.

    o 	Third, the consumers who are often the targets of predatory lenders are
    also some of the hardest to reach with educational information. Victims of
    predatory lending are often not highly educated or literate and may

    5See for example, B. Douglas Mernheim, Daniel M. Garrett, and Dean M.
    Maki, Education and Saving: The Long-Term Effects of High School Financial
    Curriculum Mandates

    (Cambridge, Mass.: National Bureau of Economic Research, 1997), 29-30.

                                       Chapter 5
                         The Usefulness of Consumer Education,
                        Counseling, and Disclosures in Deterring
                            Predatory Lending May Be Limited

    not read or speak English. Further, they may lack access to information
    conveyed through the Internet or traditional banking sources, or they may
    have hearing or visual impairments or mobility problems.

    Limitations of Mortgage Consumer education campaigns have encouraged
    borrowers to seek

    Counseling	counseling before entering into a mortgage loan, particularly a
    subprime refinancing loan. However, unreceptive consumers, lack of access
    to loan documents, fraudulent lending practices, and the uneven quality of
    counseling services can affect the success of these counseling efforts.
    For instance, some consumers may simply not respond to counseling.
    Officials at HUD have noted that not all first-time homebuyers avail
    themselves of prepurchase counseling, and that some consumers who do
    attend counseling sessions ignore the advice and information given to
    them. Further, counselors may not have access to loan documents containing
    the final terms of the mortgage loan. Although lenders are required to
    provide a good-faith estimate of the mortgage terms, they are not required
    to provide consumers with the final and fixed terms and provisions of a
    mortgage loan until closing.6 Moreover, predatory lenders have been known
    to manipulate the terms of a mortgage loan (sometimes called "bait and
    switch") so that the terms of the actual loan vary substantially from that
    contained in the good faith estimate.

    In addition, counseling may be ineffective against lenders and brokers
    that engage in fraudulent practices, such as falsifying applications or
    loan documents, that cannot be detected during a prepurchase review of
    mortgage loan documents. Finally, the quality of mortgage counseling can
    vary because of a number of factors. For example, one federal official
    cited an instance of a mortgage company conducting only cursory telephone
    counseling in order to comply with mandatory counseling requirements.

    Although some states have mandated counseling for certain types of loans,
    serious practical barriers would exist to instituting mandatory
    prepurchase mortgage counseling nationally. HUD officials have noted that
    instituting a mandatory counseling program for most regular mortgage
    transactions nationwide would be an enormous and difficult undertaking
    that might not

    6For example, TILA requires federal lenders to make certain disclosures on
    mortgage loans within 3 business days after the receipt of a written
    application. It also requires a final disclosure statement at the time of
    closing that includes the contract sales price, principal amount of the
    new loan, interest rate, broker's commission, loan origination fee, and
    mortgage and hazard insurance, among other things.

                                       Chapter 5
                         The Usefulness of Consumer Education,
                        Counseling, and Disclosures in Deterring
                            Predatory Lending May Be Limited

    be cost-effective. Lenders originated about 10 million mortgage loans in
    2002 in the United States. The cost of providing counseling for all or
    many of these loans would be high, and it is unclear who would or should
    be responsible for paying it. In addition, there is a need for trained,
    qualified counselors, according to federal officials and representatives
    of consumer and advocacy groups, and currently no system exists for
    effectively training large numbers of counselors while maintaining quality
    control.

    HUD requires counseling for its reverse mortgages. These mortgages allow
    homeowners to access the equity in their home through a lender, who makes
    payments to the owner.7 Borrowers who receive a home equity conversion
    mortgage insured through FHA must attend a consumer information session
    given by a HUD-approved housing counselor. Mandatory counseling for
    reverse mortgages may be reasonable because these products are complex and
    subject to abuse. However, reverse mortgages are also relatively uncommon;
    only approximately 17,610 HUDinsured reverse mortgages were originated in
    fiscal year 2003.

      Disclosures, Even If Improved, May Be of Limited Use in Deterring Predatory
      Lending

    Federally mandated mortgage disclosures, while helpful to some borrowers,
    may be of limited usefulness in reducing the incidence of predatory
    lending practices. TILA and RESPA have requirements concerning the
    content, form, and timing of information that must be disclosed to
    borrowers. The goal of these laws is to ensure that consumers obtain
    timely and standardized information about the terms and cost of their
    loans. Federal agencies, advocacy groups, and the mortgage industry have
    said that mortgage disclosures are an important source of information for
    borrowers, providing key information on loan terms and conditions and
    enabling borrowers to compare mortgage loan products and costs.
    Representatives of the lending industry in particular have said that
    disclosures can play an important role in fighting predatory lending,
    noting that clear, understandable, and uniform disclosures allow borrowers
    to understand the terms of their mortgage loans and thus make more
    informed choices when shopping for a loan.

    However, industry and advocacy groups have publicly expressed
    dissatisfaction with the current scheme of disclosures as mandated by TILA
    and RESPA. A 1998 report by the Board and HUD concluded that

    7The loan is not repaid in full until the homeowner permanently moves out
    of the home, passes away, or other specified events have occurred.

    Chapter 5
    The Usefulness of Consumer Education,
    Counseling, and Disclosures in Deterring
    Predatory Lending May Be Limited

    consumers cannot easily understand current disclosures, that disclosures
    are often provided too late in the lending process to be meaningful, that
    the information in disclosures may differ significantly from the actual
    final loan terms, and that the protections and remedies for violations of
    disclosure rules are inadequate.8

    Improving the disclosure of pertinent information has been part of efforts
    under way over the last few years to streamline and improve the real
    estate settlement process. HUD issued proposed rules in July 2002 to
    simplify and improve the process of obtaining home mortgages and reduce
    settlement costs for consumers. HUD stated that the proposed changes to
    its RESPA regulations would, among other things, "make the good faith
    estimate [settlement cost disclosure] firmer and more usable, facilitate
    shopping for mortgages, make mortgage transactions more transparent, and
    prevent unexpected charges to consumers at settlement."9 Debate over the
    proposed rules, which as of December 2003 were still under review, has
    been contentious. Industry groups claim that the proposal would help fight
    predatory lending by helping consumers understand loan costs up front and
    thus enable consumers to compare products, or comparison shop. Several
    advocacy organizations and an industry group say the proposed rules would
    still allow unscrupulous mortgage originators to hide illegal or
    unjustified fees.

    Although streamlining and improving mortgage loan disclosures could help
    some borrowers better understand the costs and terms of their loans, such
    efforts may play only a limited role in decreasing the incidence of
    predatory lending practices. As noted above, mortgage loans are inherently
    complex, and assessing their terms requires knowing and understanding many
    variables, including interest rates, points, fees, and prepayment
    penalties. Brokers and lenders that engage in abusive practices may target
    vulnerable individuals who are not financially sophisticated and are
    therefore more susceptible to being deceived or defrauded into entering
    into a loan that is clearly not in their interests. Even a relatively
    clear and transparent system of disclosures may be of limited use to
    borrowers who lack sophistication about financial matters, are not highly
    educated, or suffer physical or mental infirmities. Moreover, as with
    prepurchase counseling, revised

    8Board of Governors of the Federal Reserve System and the 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 (Washington, D.C.: July 1998).

    9See 67 Fed. Reg. 49134 (Jul. 29, 2002).

    Chapter 5
    The Usefulness of Consumer Education,
    Counseling, and Disclosures in Deterring
    Predatory Lending May Be Limited

    disclosure requirements would not necessarily help protect consumers
    against lenders and brokers that engage in outright fraud or that mislead
    borrowers about the terms of a loan in the disclosure documents
    themselves.

    Chapter 6

    Elderly Consumers May Be Targeted for Predatory Lending

    Although little data is available on the incidence of predatory lending
    among the elderly, government officials and consumer advocacy
    organizations have reported consistent observational evidence that elderly
    consumers have been disproportionately victimized by predatory lenders.1
    Abusive lenders are likely to target older consumers for a number of
    reasons, including the fact that older homeowners are more likely to have
    substantial equity in their homes and may be more likely to have
    diminished cognitive function or physical impairments that an unscrupulous
    lender may try to exploit. Most educational material and legal activity
    related to predatory lending targets the general population rather than
    elderly borrowers in particular. Some federal agencies and nonprofit
    organizations provide consumer education materials on predatory lending
    that specifically target the elderly.

      A Number of Factors Make Elderly Consumers Targets of Predatory Lenders

    Nearly all federal, state, and consumer advocacy officials with whom we
    spoke offered consistent observational and anecdotal information that
    elderly consumers have disproportionately been victims of predatory
    lending. Little hard data exist on the ages of victims of predatory
    lending or on the proportion of victims who are elderly. Nonetheless,
    several factors explain why unscrupulous lenders may target older
    consumers and why some elderly homeowners may be more vulnerable to
    abusive lenders, including higher home equity, a greater need for cash to
    supplement limited incomes, and a greater likelihood of physical
    impairments, diminished cognitive abilities, and social isolation.

    On average, older homeowners have more equity in their homes than younger
    homeowners, and abusive lenders could be expected to target consumers who
    have substantial home equity. 2 By targeting these owners, unscrupulous
    lenders are more easily able to "strip" the equity from a borrower's home
    by including unjustified and excessive fees into the cost

    1No clear agreement exists on the age at which someone is considered
    "elderly." While we do not designate any specific age in this report with
    reference to the terms "older" or "elderly," we are generally referring to
    persons over the age of 65.

    2For example, a study by the Board found that in 1997, some 55 percent of
    the homeowners who had fully paid off their mortgage were 65 years of age
    or older. See Glenn B. Canner, Thomas A. Durkin, and Charles A. Luckett,
    "Recent Developments in Home Equity Lending," Federal Reserve Bulletin,
    April 1998, 241-51. Borrowers may have substantial equity in their homes
    but still not qualify for a prime loan because their capacity to repay the
    loan is limited or their credit score is beneath a certain threshold.

    Chapter 6
    Elderly Consumers May Be Targeted for
    Predatory Lending

    of the home equity loan.3 Federal officials and consumer groups say that
    abusive lenders often try to convince elderly borrowers to repeatedly
    refinance their loans, adding more costs each time. "Flipping" loans in
    this way can over time literally wipe out owners' equity in their homes.

    In addition, some brokers and lenders aggressively market home equity
    loans as a source of cash, particularly for older homeowners who have
    limited cash flows and can use money from a home equity loan for major
    home repairs or medical expenses. In the overall marketplace it is common,
    and can be advantageous, to tap into one's home equity when refinancing.
    However, unscrupulous brokers and lenders can take advantage of an elderly
    person's need for cash to steer borrowers to loans with highly unfavorable
    terms.

    Further, diseases and physical impairments associated with aging can make
    elderly borrowers more susceptible to abusive lending. For example,
    declining vision, hearing, or mobility can restrict elderly consumers'
    ability to access financial information and compare credit terms. In such
    situations potential borrowers may be susceptible to the first lender to
    offer what seems to be a good deal, especially if the lender is willing to
    visit them at home or provide transportation to the closing. Physical
    impairments like poor hearing and vision can also make it difficult for
    older borrowers to fully understand loan documents and disclosures.

    Similarly, while many older persons enjoy excellent mental and cognitive
    capacity, others experience the diminished cognitive capacity and judgment
    that sometimes occurs with advanced age. Age-related dementias or mental
    impairments can limit the capacity of some older persons to comprehend and
    make informed judgments on financial issues, according to an expert in
    behavioral medicine at the National Institute on Aging. Furthermore, a
    report sponsored by the National Academy of Sciences on the mistreatment
    of elderly persons reported that they may be more likely to have
    conditions or disabilities that make them easy targets for financial abuse
    and they may have diminished capacity to evaluate proposed courses of
    action. The report noted that these impairments can

    3For example, a loan might be offered to a borrower who owns a home worth
    $100,000 and owes $20,000 from a previous mortgage. An abusive lender
    might refinance the loan for $25,000 (providing the borrower with a $5,000
    "cashout") but then charge fees of $15,000, which are financed into the
    loan. The borrower then would owe $40,000, but might not be aware of the
    excessive fees that were charged because the monthly repayment schedule
    had been spread over a much longer period of time.

    Chapter 6
    Elderly Consumers May Be Targeted for
    Predatory Lending

    make older persons more vulnerable to financial abuse and exploitation. 4
    Representatives of legal aid organizations have said that they frequently
    represent elderly clients in predatory lending cases involving lenders
    that have taken advantage of a borrower's confusion and, in some cases,
    dementia.

    Finally, both the National Academy of Sciences report and representatives
    of advocacy groups we spoke with noted that elderly people-particularly
    those who live alone-may feel isolated and lonely, and may lack support
    systems of family and friends who could provide them with advice and
    assistance in obtaining credit. Such individuals may simply be more
    willing to discuss an offer for a home equity loan made by someone who
    telephones or knocks on their door, makes personal contact, or makes an
    effort to gain their confidence. These personalized marketing techniques
    are common among lenders and brokers that target vulnerable individuals
    for loans with abusive terms.

    Federal officials, legal aid services, and consumer groups have reported
    that home repair scams targeting elderly homeowners are particularly
    common. Elderly homeowners often live in older homes and are more likely
    to need someone to do repairs for them. The HUD-Treasury report noted that
    predatory brokers and home improvement contractors have collaborated to
    swindle older consumers. A contractor may come to a homeowner's door,
    pressure the homeowner into accepting a home improvement contract, and
    arrange for financing of the work with a highcost loan. The contractor
    then does shoddy work or does not finish the agreed-on repairs, leaving
    the borrower to pay off the expensive loan.

    The result of lending abuses, such as losing a home through foreclosure,
    can be especially severe for the elderly. The National Academy of Sciences
    report noted that losing financial assets accumulated over a lifetime can
    be devastating to an elderly person, and that replacing them is generally
    not viable for those who are retired or have physical or mental
    disabilities. The financial losses older people can suffer as a result of
    abusive loans can result in the loss of independence and security and a
    significant decline in quality of life. Moreover, older victims of
    financial exploitation may be

    4Richard J. Bonnie and Robert B. Wallace, eds., "Elder Mistreatment:
    Abuse, Neglect, and Exploitation in an Aging America," Panel to Review
    Risk and Prevalence of Elder Abuse and Neglect, National Research Council
    (Washington, D.C.: National Academies Press, 2003), 393.

                                       Chapter 6
                         Elderly Consumers May Be Targeted for
                                   Predatory Lending

    more likely to become dependent on social welfare services because they
    lack the funds to help compensate them for their financial losses.

    Elderly consumers represent just one of several classes of people that
    predatory lenders appear to target. The HUD-Treasury task force report
    noted that many predatory lenders also specifically target minority
    communities. Consumer advocacy and legal aid organizations have reported
    that elderly African American women appear to be a particular target for
    predatory lenders. This population may be targeted by predatory lenders at
    least in part because of their relatively low literacy levels-the result
    of historical inequalities in educational opportunities-which, as
    discussed earlier, may increase vulnerability to abusive lending.5

    Some Education and Because elderly people appear to be more susceptible to
    predatory lending,

    government agencies and consumer advocacy organizations have
    focusedEnforcement Efforts some educational efforts and legal assistance
    on this population. Several Focus on Elderly booklets, pamphlets, and
    seminars are aimed at helping inform elderly Consumers borrowers about
    predatory lending. In addition, while most legal activities

    related to predatory lending practices are designed to assist the general
    population of consumers, some have focused on elderly consumers in
    particular.

        Federal and Nonprofit Agencies Sponsor Some Financial Education Efforts
        Targeted at Older Consumers

    Consumer financial education efforts of government and nonprofit agencies
    and industry associations generally seek to serve the general consumer
    population rather than target specific subpopulations. However, some
    federal and nonprofit agencies have made efforts to increase awareness
    about predatory lending specifically among older consumers. For example:

    o 	DOJ has published a guide entitled Financial Crimes Against the
    Elderly, which includes references to predatory lending. In 2000, the

    5For example, about 25 percent of elderly black Americans had graduated
    from high school in 1992, compared with about 58 percent of elderly white
    Americans, and about 57 percent of elderly black Americans were reported
    to have had fewer than 9 years of formal education. See Robert Joseph
    Taylor and Shirley A. Lockery, "Socio-Economic Status of Older Black
    Americans: Education, Income, Poverty, Political Participation and
    Religious Involvement," African American Research Perspectives 2 (1): 3-4.

                                       Chapter 6
                         Elderly Consumers May Be Targeted for
                                   Predatory Lending

    agency cosponsored a symposium that addressed, among other topics,
    financial exploitation of the elderly.

    o 	OTS has produced an educational training video addressing financial
    abuse of the elderly.

    o 	The U.S. Department of Health and Human Services' Administration on
    Aging provides grants to state and nonprofit agencies for programs aimed
    at preventing elder abuse, including predatory or abusive lending
    practices against older consumers. Supported activities include senior
    legal aid programs, projects to improve financial literacy among older
    consumers, and financial educational materials directed at senior
    citizens.

    o 	FTC publishes a number of consumer information products related to
    predatory lending and home equity scams that discuss abusive practices
    targeted at the elderly.

    o 	AARP, which represents more than 35 million Americans age 50 and over,
    offers a borrowers' kit containing consumer tips for avoiding predatory
    lenders, supports a toll-free number to call for assistance regarding
    lending issues, and distributes fact sheets on predatory lending. Some of
    these materials are provided in Spanish and in formats accessible to the
    hearing- and visually impaired. AARP also provides information on its Web
    site that is designed to educate older Americans on predatory lending
    issues. In addition, the organization has conducted focus groups of older
    Americans to gather data on their borrowing and shopping habits in order
    to better develop strategies for preventing older people from becoming the
    victims of predatory lending.

    o 	The National Consumer Law Center has developed a number of consumer
    materials aimed in part at helping elderly consumers recover from abusive
    loans, including a brochure titled Helping Elderly Homeowners Victimized
    by Predatory Mortgage Loans.

    Some Legal Assistance Is Federal consumer protection and fair lending laws
    that have been used to Aimed Specifically at address predatory lending do
    not generally have provisions specific to Helping Older Victims of elderly
    persons. For example, age is not a protected class under the Fair

    Housing Act, which prohibits discrimination in housing-relatedPredatory
    Lending transactions. In addition, HMDA-which requires certain financial

    Chapter 6
    Elderly Consumers May Be Targeted for
    Predatory Lending

    institutions to collect, report, and disclose data on loan applications
    and originations-does not require lenders to report information about the
    age of the applicant or borrower. However, ECOA does specifically prohibit
    unlawful discrimination on the basis of age in connection with any aspect
    of a credit transaction. In the case against Long Beach Mortgage Company
    noted earlier, the lender was accused of violating ECOA by charging
    elderly borrowers, among other protected classes, higher loan rates than
    it charged other similarly situated borrowers.

    Federal and state enforcement actions and private class-action lawsuits
    involving predatory lending generally seek to provide redress to large
    groups of consumers. Little hard data exist on the age of consumers
    involved in these actions, but a few cases have involved allegations of
    predatory lending targeting elderly borrowers. For example, FTC, six
    states, AARP, and private plaintiffs settled a case with First Alliance
    Mortgage Company in March 2002 for more than $60 million. According to
    AARP, an estimated 28 percent of the 8,712 borrowers represented in the
    class-action suit were elderly. The company was accused of using
    misrepresentation and unfair and deceptive practices to lure senior
    citizens and those with poor credit histories into entering into abusive
    loans. The company used a sophisticated campaign of telemarketing and
    direct mail solicitations, as well as a lengthy sales presentation that
    FTC said was designed to mislead consumers in general and elderly
    consumers in particular about the terms of its loans.

    Some nonprofit groups provide legal services focused on helping elderly
    victims of predatory lending:

    o 	The AARP Foundation Litigation, which conducts litigation to benefit
    Americans 50 years and older, has been party to 7 lawsuits since 1998
    involving allegations of predatory lending against more than 50,000
    elderly borrowers. Six of these suits have been settled, and the other is
    pending.

    o 	The National Consumer Law Center has a "Seniors Initiative" that seeks
    to improve the quality and accessibility of legal assistance with consumer
    issues for vulnerable older Americans. One focus of the initiative is
    preventing abusive lending and foreclosure. The center publishes a guide
    for legal advocates to help them pursue predatory lending cases, and has
    been involved in litigation related to cases of predatory lending against
    senior citizens.

    Chapter 6
    Elderly Consumers May Be Targeted for
    Predatory Lending

    o 	Some local legal aid organizations that help victims of predatory
    lending have traditionally served older clients. For example, the majority
    of clients assisted by South Brooklyn Legal Services' Foreclosure
    Prevention Project are senior citizens.

    The limited number of education and enforcement efforts related to
    predatory lending that specifically target older consumers-as opposed to
    the general population-is not necessarily problematic. Given limited
    resources, the most efficient and effective way to reach various
    subpopulations, including the elderly, is often through general education
    and information campaigns that reach broad audiences. Similarly,
    enforcement actions and private lawsuits that seek to curb the activities
    of the worst predatory lenders in general are likely to aid the elderly
    borrowers that these lenders may be targeting.

    Appendix I

    FTC Enforcement Actions Related to Predatory Lending

          Primary     Date of        Federal laws   Alleged unfair or deceptive
         defendant    settlementa       cited                practices
                                         FTC Act,                           Using
        Capital City   (litigation    TILA, ECOA,  deception/misrepresentation to
          Mortgage       ongoing)            Fair                      manipulate
                                     Debt         borrowers into loans, ECOA
        Corporationb                 Collection   recordkeeping and
                                     Practices
                                         Act       notice violations, unfair and
                                                          deceptive loan
                                                       servicing violations
    OSI Financial                                           Using
         Services,    November 2003    FTC Act    deception/misrepresentation to
                                                              charge
    Inc., and Mark                                   excessive loan fees
          Diamondc
                                                               Using
    First Alliance   March 2002     FTC Act,   deception/misrepresentation to
          Mortgage                       TILA                 charge
          Companyd                                      excessive loan fees

        Associates First  September FTC Act, Using deception/misrepresentation to
            Capital         2002     TILA,                             manipulate
                                     ECOA,
          Corporation,                FCRA      borrowers into loans, packing
           Associates                                    undisclosed
         Corporation of                      products (insurance) into loans,
             North                           unfair debt
    America, Citigroup                                 collection
           Inc., and
         CitiFinancial
             Credit
            Company

         Mercantile    July 2002       FTC Act, Using deception/misrepresentation
          Mortgage                 TILA, HOEPA,                     to manipulate
    Company, Inc.e             RESPA, Credit borrowers into loans, illegal
                                      Practices kickbacks, HOEPA
                                      Rule      disclosure violations, taking
                                                unlawful security
                                                            interests
         Action Loan     August        FTC Act, Packing undisclosed products
    Company, Inc.f     2000     TILA, RESPA, (insurance) into
                                     Credit     loans, kickbacks for the referral
                                    Practices   of loans, ECOA
                                      Rule,
                                   ECOA, FCRA   violation for failing to meet
                                                requirements upon
                                                 adverse actions, taking unlawful
                                                                security interest
          FirstPlus
          Financial      August                 Using deception/misrepresentation
           Group,         2000    FTC Act, TILA                     to manipulate
            Inc.                                borrowers into home equity loans,
                                                              TILA
                                                      disclosure violations
                                       FTC Act, HOEPA disclosure violations,
        Nu West, Inc.  July 2000    TILA, HOEPA right of rescission
                                                           violations

          Delta Funding     March 2000 HOEPA, RESPA, Pattern or practice of
           Corporation                         ECOA, asset-based lending and
    and Delta Financial             Fair Housing  other HOEPA violations,
                                            Act      paying kickbacks and
           Corporationg                              unearned fees to brokers,
                                                     intentionally charging
                                                         African American females
                                                          higher loan prices than
                                                       similarly situated white
                                                                males

    Fleet Finance, Inc.                                 Failure to provide, or
               and         October 1999 FTC Act, TILA     provide accurately, (1)
                                                                           timely
        Home Equity USA,                                 disclosures of the costs
              Inc.                                       and terms of home equity
                                                                 loans and/or (2)
                                                         information to consumers
                                                                            about
                                                      their rights to cancel
                                                      their credit transactions
          Barry Cooper                    FTC Act,    Pattern or practice of
           Properties       July 1999       HOEPA     asset-based lending and
                                                        other HOEPA violations
                                                      HOEPA disclosure
                                             FTC Act, violations, right of
        Capitol Mortgage    July 1999     TILA, HOEPA rescission
           Corporation                                        violations
          CLS Financial                   FTC Act,    Pattern or practice of
            Services,       July 1999       HOEPA     asset-based lending and
              Inc.                                      other HOEPA violations
        Granite Mortgage,                    FTC Act, Pattern or practice of
             LLC and        July 1999     TILA, HOEPA asset-based lending and
             others                                     other HOEPA violations

                                       Appendix I
                           FTC Enforcement Actions Related to
                                   Predatory Lending

                             (Continued From Previous Page)

         Primary defendant   Federal laws  Alleged unfair or deceptive practices
        Date of settlementa      cited
        Interstate Resource    FTC Act,         HOEPA disclosure violations
             July 1999           HOEPA
            Corporation
           LAP Financial     FTC Act,      Pattern or practice of asset-based
        Services, July 1999  TILA, HOEPA   lending and
               Inc.                           other HOEPA violations, right of
                                                         rescission
                                                         violations
          Wasatch Credit     FTC Act,      Pattern or practice of asset-based
    Corporation July 1999 TILA, HOEPA   lending and
                                              other HOEPA violations, right of
                                                         rescission
                                                         violations
          R.A. Walker and       FTC Act    Using deception/misrepresentation to
    Associates July 1991                convince
                                               borrowers to transfer title to
                                                         defendant
        Nationwide Mortgage                  Using deception/misrepresentation to
             May 1988        FTC Act, TILA                             manipulate
            Corporation                    borrowers into unaffordable loans with
                                           balloon
                                                          payments

    Source: FTC.

    Note: In addition to the cases listed, FTC has also recently addressed
    abuses in the mortgage loan servicing industry. In November 2003, it
    announced settlements with Fairbanks Capital Holding Corp., its wholly
    owned subsidiary Fairbanks Capital Corp., and their founder and former CEO
    (collectively, Fairbanks) on charges that Fairbanks violated the FTC Act,
    RESPA, and other laws by failing to post consumers' mortgage payments in a
    timely manner and charging consumers illegal late fees and other
    unauthorized fees. The settlement will provide for $40 million in redress
    to consumers. The case was jointly filed with HUD. United States of
    America v. Fairbanks Capital Corp. et al., Civ. Action No. 0312219-DPW (D.
    Mass.)(filed 11/12/03).

    aIn some cases, the date of settlement listed is the date of the press
    release announcing the settlement.

    bDOJ filed an amicus curiae brief in a private suit alleging
    discrimination in violation of the ECOA and Fair Housing Act, which was
    joined with the FTC case, but settled separately.

    cThe state of Illinois was also a plaintiff in this case.

    dThe states of Arizona, California, Massachusetts, Florida, New York,
    Illinois, AARP, and private attorneys were also plaintiffs in this case.

    eHUD and the state of Illinois were also plaintiffs in this case.
    Violations of Illinois state law were also claimed.

    fHUD was also a plaintiff in this case, and DOJ formally filed the
    complaint on behalf of FTC and HUD.

    gDOJ and HUD were also plaintiffs in this case.

    Appendix II

    Comments from the Board of Governors of the Federal Reserve System

    Appendix II
    Comments from the Board of Governors of
    the Federal Reserve System

    Appendix II
    Comments from the Board of Governors of
    the Federal Reserve System

                                      Appendix III

                        Comments from the Department of Justice

    Appendix III
    Comments from the Department of Justice

    Appendix III
    Comments from the Department of Justice

    Appendix IV

    Comments from the Department of Housing and Urban Development

    Appendix IV
    Comments from the Department of Housing
    and Urban Development

    Appendix IV
    Comments from the Department of Housing
    and Urban Development

    Appendix IV
    Comments from the Department of Housing
    and Urban Development

    Appendix V

    Comments from the National Credit Union Administration

    Appendix V
    Comments from the National Credit Union
    Administration

    Appendix VI

                         GAO Contacts and Staff Acknowledgments

    GAO Contacts	David G. Wood, (202) 512-8678 Harry Medina, (415) 904-2000

      Staff Acknowledgments

    (250118)

    Jason Bromberg
    Emily R. Chalmers
    Randall C. Fasnacht, Jr.
    Rachelle C. Hunt
    Alison J. Martin
    Marc W. Molino
    Elizabeth Olivarez
    Carrie Puglisi
    Mitchell B. Rachlis
    Peter Rumble
    Paul Thompson
    James D. Vitarello

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