Consumer Law & Policy Blog

Angela Littwin Paper on How Low-Income Borrowers Respond to Restraints on Credit Card Use

Angela K. Littwin of Harvard has written a  paper, Testing the Substitution Hypothesis: Would Credit Card Regulation Force Low-Income Borrowers Into Less Desirable Lending Alternatives?, available at http://ssrn.com/abstract=1014460.  Here's the abstract:

One of the strongest arguments against regulating credit cards is the substitution hypothesis, which states that if a restriction on one form of credit decreases access, borrowers will respond by using other, less desirable forms of credit. For low-income consumers, the argument is more powerful still, because their other options are high-cost lenders such as pawn shops and rent-to-own stores. But the substitution hypothesis has been more frequently assumed than investigated, and the empirical research that has taken place does not support the theory as strongly as has been supposed. The theory is based on a naïve presumption about the constancy of demand for consumer credit and a failure to account for a more nuanced view of the role of credit supply. This Article presents original data from a study of low-income women. The findings suggest that lenders such as pawn shops and rent-to-own stores may function as complements more than substitutes. In addition, the research uncovered another form of credit that low-income families routinely use and participants evaluated favorably, but that has never been discussed in the academic literature. These findings suggest a more nuanced formulation of the hypothesis that better predicts the consequences of credit card regulation.

Engel & McCoy Paper on Improving Sustainability of Minority Homeownership

Two leading writers on predatory lending, Kathleen C. Engel and Patricia McCoy have written a paper titled From Credit Denial to Predatory Lending: The Challenge of Sustaining Minority Homeownership, available at http://ssrn.com/abstract=1011489  Here's the abstract:

Years of discriminatory behavior against minority households have damaged their ability to build wealth. One of the most financially destructive practices endured by minority households is the excessive overpayment to finance a home purchase or access accumulated equity in a home. The market conditions that position blacks, and to a lesser extent, Latino households, to be the principal targets of predatory mortgage lending have their roots in decades of legally sanctioned housing market discrimination. Some minority households lack the financial knowledge or awareness to protect themselves. In other cases, years of discriminatory financial practices have contributed to rendering them ineligible to access low-cost financing. And, finally, vestiges of discrimination continue today with minority consumers convenient targets of unscrupulous lending behavior.

Starting in the early 1990s, federal antipoverty policies placed new emphasis on asset creation for low- and moderate-income people, especially the working poor. While federal policy embraced wealth creation as the new antidote to poverty, it failed to anticipate threats to preserving home equity once it has been created, including rising consumer debt and predatory lending. To date, the federal government has failed to combat predatory lending consistently and effectively. The failure to curb predatory lending has spawned high levels of home loan foreclosures across the U.S. and threatens the largest asset of many minority households, i.e., their homes. This paper proposes policies to improve the sustainability of minority homeownership.

Mortgage standards improving?

Has the mortgage market self-corrected by tightening up underwriting? Not according to blownmortgage.com. In this post, the author describes lender junk mail aimed at brokers, touting aggressive undewriting, no-doc loans and other questionable practices.

Times Reports on Federal Bailout for Mortgage Crisis, the Riegel v. Medtronic Medical Device Case, and CPSC

The lead story in today's Times reports that "the Bush administration and Congress are considering costly new proposals for the government to rescue hundreds of thousands of homeowners whose mortgages are higher than the value of their houses."  According to the article, "nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater."  Among the ideas being considered are "a federal mortgage guarantee for troubled borrowers . . . [and us[ing] government funds to purchase and refinance billions of dollars in mortgages now in danger of default."`  Meanwhile, on Monday the Times ran a story, "No Lull in Mortgage Pitches," about just that.  The article mentions advertising by Countrywide and the Bank of America, which is in the process of acquiring Countrywide, while today's piece notes that the Bank of America has proposed that a federal agency buy delinquent mortgages at a "deep discount."  Bank of America knows how to make a strong argument.

The Times has devoted a lot of space to the Supreme Court's Riegel v. Medtronic decision on medical devices and preemption.  An editorial in today's paper, "No Recourse for the Injured," criticizes the decision.  Here is an article about the effect of the decision on pending law suits.  Yesterday's issue had a news analysis, "Justices Add Legal Complications to Debate on F.D.A.'s Competence."  An excerpt:

The Institute of Medicine, the Government Accountability Office and the F.D.A.’s own science board have all issued reports concluding that poor management and scientific inadequacies have made the agency incapable of protecting the country against unsafe drugs, medical devices and food.

A result, said David Vladeck, a professor at Georgetown University Law Center, is that the public is facing the worst of both worlds: a government health agency that cannot protect them and rules that block them from winning compensation when injured.

Wednesday's paper included "Sears Case Cited by Critics of Safety Panel," which reported on criticism of the CPSC by Public Citizen.

Short Refis coming?

By Alan White

A big stumbling block to renegotiating mortgages in danger of foreclosure is the reality that many homeowners now owe more than their home is worth. This situation is sometimes referred to as being "underwater." Servicers of securitized mortgages (prime and subprime) are often willing to write down the amount due on the mortgage if the homeowner is selling (and has a buyer.) Servicers are much less willing to write down the principal loan amount to the home value to allow a homeowner to refinance with a cheaper or less risky mortgage that will permit them to save their home: a "short refi." The concept of writing loan balances down to market value is familiar in the commercial real estate sector, but seems for some reason more controversial for consumer and residential loans, despite the fact that in many cases a short refi will yield a better return for the investor than a foreclosure.

Buried in a story in today's Wall Street Journal is a report that some servicers may start getting strong federal agency encouragement to do short refis. John Reich, director of the Office of Thrift Supervision, regulator of federal savings banks (like WaMu) revealed that OTS is working on a short refi plan. The other part of his announcement today was that the thrift industry lost $5.2 billion in the 4th quarter of 2007, and that we should expect to see some thrift failures in the coming year.

Today's Washington Post provides more details (login required). Lenders writing down mortgages would receive negative equity certificates that might have some market value, to mitigate their losses. Not clear how the negative equity interest would retain value yet permit the refinancing lender to get an insurable first mortgage.

OCC's Response to Spitzer's Charge that the Bush Administration Worsened the Mortgage Crisis by Preempting State Laws

Last week, Brian blogged here about Governor Spitzer's claim that the Bush administration contributed to the mortgage crisis by preempting state attempts to bar predatory lending.  Comptroller of the Currency John C. Dugan responded by issuing the following statement last Thursday:

Almost everyone who has paid attention to the subprime lending crisis has concluded that OCC-regulated national banks were not the problem.  Instead, the worst abuses came from loans originated by state-licensed mortgage brokers and lenders that are exclusively the responsibility of state regulators.

However, comments from today assert that the OCC and national bank preemption have prevented the states from taking action against predatory or abusive lenders.  That’s just plain wrong.

The OCC extensively regulates the activities of national banks, including mortgage lending.  The OCC established strong protections against predatory lending practices years ago, and has applied those standards through examinations of every national bank.  As a result, predatory mortgage lenders have avoided national banks like the plague.  The abuses consumers have complained about most — such as loan flipping and equity stripping — are not tolerated in the national banking system.  And the looser lending practices of the subprime market simply have not gravitated to national banks: They originated just 10% of subprime loans in 2006, when underwriting standards were weakest, and delinquency rates on those loans are well below the national average.

Nothing the OCC has done has prevented the states from regulating and preventing abuses among the lenders that they license – lenders that are the source of most of today’s problems.  The states have ample authority – as well as clear responsibility – to set standards for these lenders and enforce them.  It defies logic to argue that preemption was an impediment.  National banks are bound to obey the strict standards enforced by the OCC everywhere they operate – even in states that had far less rigorous standards.  The states should have applied equally rigorous standards to the non-bank lenders that were responsible for the bulk of the problems.

I'm not sure who Comptroller Dugan means when he refers to "[a]lmost everyone who has paid attention to the subprime lending crisis" since he doesn't cite any sources (not that one would necessarily expect that in a statement of this sort).  Here, by the way, is an excerpt from our casebook, written before the subprime crisis burst, that cites some relevant sources, though they cover an earlier time period than the one Comptroller Dugan is referring to:

One critic claims that national bank operating subsidiaries originated nearly a quarter of total subprime loans in 2003.  See Baher Azmy, Squaring the Predatory Lending Circle: A Case for States as Laboratories of Experimentation, 57 Fla. L. Rev. 295, 359 (2005). See also Arthur E. Wilmarth, Jr., The OCC’s Preemption Rules Exceed the Agency’s Authority and Present a Serious Threat to the Dual Banking System and Consumer Protection, 23 Ann. Rev. Banking & Fin. L. 225, 314-15 (2004) (“most of the largest subprime mortgage lenders are nonbank affiliates of major bank holding companies. . . . a number of [national bank subsidiaries] have produced serious allegations of abusive lending practices.”).    Preemption of state law as to nonbank subsidiaries is particularly significant because such subsidiaries are not routinely examined by federal regulators.  GAO Report at 49, 51-53

One Option: Nationalization

By Alan White

The British government decided Sunday to nationalize Northern Rock, the troubled U.K. mortgage bank, rather than permit its sale to private investors. Northern Rock, a mortgage lender that relied heavily on securitization, faced a classic bank run in August when its depositors learned of its precarious financial position. (More background on the Northern Rock collapse.) In his comments to the press, PM Gordon Brown credited this bold approach with protecting the U.K. from experiencing the financial meltdown now facing U.S. markets. While there have been proposals in the U.S. for various sorts of bail-outs of insurers and mortgage investors, I am not aware of any proposals to nationalize Countrywide.

Predatory Lending -- Short and to the Point

On Monday, the Washington Post published an article on payday lending in Virginia. Today, the Post published a letter to the editor written by someone named Leonard J. Koenick, whose letter was apparently prompted by Monday's article.  Here it is:

Payday loans are not the only predatory lending system allowed in Virginia.

I'm a lawyer, and a client recently came to me with something called a "motor vehicle equity line of credit." For the "privilege" of borrowing $300, she had to first pay a $150 "membership fee" and was charged 300 percent interest. Her finance charge was $79.44 per month and, of course, that was only the interest. Her collateral was her car, and she had to give the lender a duplicate car key. She missed one payment; they took her car and sold it.

If that isn't criminal, it should be.

New Study Shows Disproportionate Numbers of Payday Lenders in Bible Belt and Mormon West

by Christopher Peterson

A new study, conducted by Steven Graves and myself, finds a surprising relationship between populations of conservative Christian Americans and the proliferation of payday lenders. A draft of the study can be downloaded from SSRN, free of charge.

The natural hypothesis is to assume that given strenuous Biblical condemnation  of usury there would be more aggressive regulation and less demand for payday loans in these states, but ironically, the numbers show the opposite is true. 

The study is based on the largest and most comprehensive database of payday lender locations yet created. We developed an index that measures the density of payday lender locations based on the number of lenders within a geographic area, the number of payday lenders relative to population, and the number of payday lenders relative to bank branches. We also developed an index that measures the political power of conservative Christians within a state. This index has three components. First it is based on voting scores given to a state’s Congressional delegation by a panel of three leading Christian Faith based advocacy organizations including the Christian Coalition, the Family Research Council, and the Christian Action Network. Second, the Christian power index also included Congressional delegation scores compiled by Poole and Rosenthal, two widely respected political scientists that study these issues. And finally the index was also based on the percent of a state’s Evangelical or Mormon population. Our results are based on a simple correlation coefficient test comparing the payday lending density index to the Christian power index. Our hope was to create transparent results, that simply describe a commercial and spatial pattern of high cost lending that exists in our society.

One thing our data does not show is a causal relationship between faith and payday lending. For example, we believe there are many other variables that help explain why this pattern has emerged, in addition to faith. Nonetheless, our findings should serve as a wake up call to pastors, religious leaders, and people of faith that usurious lenders are thriving in their neighborhoods, communities, and states. Given the Bible’s injunction against usury, Christ’s example of expelling usurious money changers, and the ancient Christian tradition of sound financial stewardship, our study suggests that Christian Americans may want to pressure their political leaders to better effectuate Biblical values on consumer finance.

We believe it is sad that states with a pious and honorable religious heritage now disproportionately host predatory lenders.

Eliot Spitzer: Bush Administration Stymied States In Efforts to Stop Predatory Lending Crisis

by Brian Wolfman

Check out this op-ed by Eliot Spitzer in today's Washington Post. The N.Y. Governor and former N.Y. attorney general argues that the Bush Administration, by insisting that federal law preempted the states' efforts to curb predatory lending, created and perpetuated the mortgage crisis. Spitzer explains that the states enacted laws and filed suits to try to curb predatory practices because they saw the current crisis looming. Sptizer explains the federal government's role:

"What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no."

"Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye."