Consumer Law & Policy Blog

"Predatory Structured Finance": Is it time for a new label within the lexicon of predatory lending?

by Christopher Peterson

Over the past five years commentators in the debate over subprime home mortgage lending have ironed out a standard list of practices and contract terms that serve as warning signs of "predatory lending." These terms and practices include high interest rates, high fees and closing costs, balloon payments, negative amortization, inflated appraisals, insurance packing, mandatory arbitration, unaffordable loans based on the value of collateral, rushed closings, multiple refinancing, abusive collection, prepayment penalties, and misleading or fraudulent disclosure. This list is both necessary and useful.

However, in a new article entitled "Predatory Structured Finance" (forthcoming in the Cardozo Law Review) I suggest that the concept of predatory lending has nevertheless been cast too narrowly.  In today’s subprime mortgage market, originators and brokers quickly assign home loans through a complex and opaque series of transactions involving as many as a dozen different strategically organized companies.  Loans are typically transferred into large pools, and then income from those loans is "structured" to appeal to different types of investors. 

The article includes a useful illustration (pictured above) of a typical subprime home mortgage securitization structure.  This process, usually referred to as securitization, can lower the cost of funds for lenders, allowing them to offer better prices.  But, it can also capitalize fly-by-night companies that specialize in fraud, deceptive practices, abusive collections, and other predatory behavior.  Some of the institutions that sponsor and administer securitization of mortgage backed securities are complicit in predatory lending.  By encouraging, facilitating, and profiting from predatory loans, these financiers have themselves slipped into predation. In addition to transferring liability to the secondary market through assignment based rules (such as the Federal Trade Commission’s holder-notice rule or the Home Ownership and Equity Protection Act’s assignee liability provisions), courts and policy makers should explore common law imputed liability theories such as civil conspiracy, aiding and abetting, and joint venture.  Unlike assignee liability rules, these older common law theories can reach architects of predatory structured finance that never actually own predatory loans themselves.

Race, Price, and the Mortgage Market

by Deepak Gupta

Professor Lauren Willis of Loyola-Los Angeles (whose new article on price disclosures was discussed by Jeff Sovern here last week), had an op-ed in yesterday's Washington Post entitled "The Fleecing of Black Borrowers."   Willis cites new Federal Reserve Board data showing that less than one-fifth of non-Hispanic whites took out high-priced loans last year, as opposed to more than half of African-Americans.  "Black borrowers paid--and will continue to pay for the life of these loans--high prices at more than triple the rates that whites did."   

Neither racial discrimination nor the relative risk of lower-income minorities as borrowers, she says, fully explain these disparities:

The home loan market is what economists call "inefficient" and what the rest of us might call plain unfair: Minorities -- and many whites -- receive high-priced loans when they are financially qualified for lower-priced loans.

Why? As an official of the American Bankers Association, quoted in The Post, put it: "People shop more for a loaf of bread than they do for a mortgage."

Lauren E. Willis on Predatory Lending

by Jeff Sovern

Though the Truth in Lending Act ("TILA") was not necessarily aimed at predatory lending--I don't think the phrase "predatory lending" had even been coined when TILA was enacted--its disclosure rules should theoretically have prevented predatory lending to the extent predatory lending is based on consumer ignorance.  Consequently, the question of why predatory lending survives, if not thrives, despite the TILA disclosure requirements is worth exploring.  My co-blogger, Chris Peterson, in his book Taming the Sharks: Towards a Cure for the High-Cost Credit Market 291 (2004) addressed this question, concluding that TILA is  "a collective lie.”  See also Gian Ho & Anthony Pennington-Cross, The Impact of Local Predatory Lending Laws 7 (Fed. Reserve Bank of St; Louis Working Paper 2005-049B 2005) (“If borrowers actually read all the documents required by law at the time of closing it would take all day.  Moreover, many of the documents are written in a manner that is difficult for non-lawyers to understand.  . . . [T]he seller, buyer, and/or refinancer rely on the representations and interpretations of closing agents. . . . This makes it possible for unscrupulous agents to take advantage of that information gap.”).  The remarkable testimony of the pseudonymous “Jim Dough," a former employee of a predatory lender, before a hearing of  the Senate Special Committee on Aging on March 16, 1998, titled “Equity Predators: Stripping, Flipping and Packing Their Way to Profits,” about the tactics he used to persuade consumers to agree to onerous loan terms also sheds light on the issue. 

Now Loyola of LA Professor Lauren E. Willis, in a lengthy but important article Decisionmaking and the Limits of Disclosure: The Problem of Predatory Lending: Price, 65 Maryland Law Review 707 (2006), brings behavioral economics to bear on the problem.  A sample:

CL&P Roundup

by Deepak Gupta

• Congress to Limit Predatory Lending to the Military:  The groundbreaking Talent-Nelson amendment--which imposes limits on predatory lending to the military--is now part of the must-pass defense authorization bill.   Paul Bland and Elizabeth Warren make similar observations about different aspects of this legislation.  Paul, discussing the bill's precedent-setting ban on arbitration clauses, asks:

"If Congress recognizes that binding mandatory arbitration provisions are unfair as applied to all members of the military who deal with lenders, how does that jibe with the assertion often made that binding arbitration is fairer, cheaper, and better for other consumers who deal with lenders?" 

And Professor Warren, discussing the bill's 36% usury cap for interest rates on loans to servicemembers, asks:

"Soon it will be OK to roll an elderly person with a 400% interest rate, or a Hispanic worker, or a college student, but not someone in the military.  How long will that last?"

• Most Identity Thieves Are Unknown:  The other day, Jeff Sovern observed that Judge Posner, in his discussion of identity theft, seemed to operate on the mistaken belief that "much, maybe most" identity theft is the work of "friends or relatives" and is easily prevented by potential victims.  Similar claims have been made repeatedly in the media in recent weeks, particularly by industry representatives.  Now privacy expert Chris Hoofnagle of Berkeley has demonstrated, using FTC data, the problem with those claims.  He even includes a colorful pie-chart.  (via Ed Mierzwinski)

• More on Consumer Cases in the Supreme Court:  Over at the Credit Slips blog, Katie Porter of Iowa has some thoughts on the recently-granted Fair Credit Reporting Act cases and so-called "off-label" uses of credit reports; we discussed the cases here on Tuesday.   And Bob Lawless speculates about the practical implications of Watters v. Wachovia, the OCC preemption case.  We'll surely have a lot to say about the Watters case here in the coming months, including its administrative law implications.  (Disclosure:  Public Citizen joined an amicus brief in Watters and we'll be providing assistance to petitioner's counsel.  We're counsel for the respondents in the FCRA cases.)

• Emerging Issues in Class Actions:  The UCLA Law Review has published an interesting batch of papers from its symposium on emerging issues in class actions.  The papers include an empirical study on incentive awards to class action plaintiffs by Theodore Eisenberg and Geoffrey Miller; an article on Backdoor Federalization by Samuel Issacharoff and Catherine Sharkey; an article considering various proposals to enhance fairness hearings by William Rubenstein; and a piece by Richard Nagareda discussing the implications of Eisenberg & Miller's empirical research.

• An Ideological Flip-Flop?:  It used to be the case, back in the 1960's, that the conservatives were the ones who supported tort law and the liberals/progressives were the ones that thought it needed to be "reformed" (with statutory consumer protection regimes).  Now it's just the opposite, and the reasons are complex and worth pondering.  So says Stephen Sugarman of Berkeley in a draft paper posted at SSRN, Ideological Flip-Flop: American Liberals are Now the Primary Supporters of Tort Law.  (via Point of Law)

Defense Department Appropriations Bill Includes Precedent-Setting Ban on Arbitration Clauses for Service People

by Paul Bland

I've just seen what I understand is the final language of Sen. Talent's amendment to the DoD appropriations bill, which is aimed at protecting service people against the predations of payday lenders.  Several weeks ago, the Defense Department released a ground-breaking report, which discussed how predatory lending by pay day lenders was harming our national security. There is a body of evidence showing that pay day lenders have particularly targeted service people for years (co-blogger Chris Peterson has published a study on this point that left little doubt), and many service people have had their military careers interrupted as they were unable to extricate themselves from the cycle of debt.  The DoD study brought a torrent of publicity -- USA Today broke the story on the front page a few weeks ago, and in the intervening weeks, literally dozens of newspapers have editorialized in support of the DoD's recommendations.  Senator Talent and a number of other legislators decided to take action.

While the centerpiece of the legislation is a hard 36% usury cap on loans to covered military personnel, there is also a provision dealing with mandatory arbitration.  This provision, which was also strongly supported by the DoD, states

"Notwithstanding section 2 of title 9, or any other Federal or State law, rule, or regulation, no agreement to arbitrate any dispute involving the extension of consumer credit shall be enforceable against any covered member [of the U.S. armed forces] or dependent of such member, or any person wh owas a covered member or dependent of that member when the agreement was made."

This language apparently has made it out of the conference committee!

CL&P Roundup

by Deepak Gupta

• Industry Takes Aim at UDAP Statutes: If you care about the future of the American consumer class action, this article in the National Law Journal is a must-read. According to the article, industry lobbyists plan to introduce amendments to state consumer protection statutes as early as December in jurisdictions such as Massachusetts, Illinois, and the District of Columbia, and eventually in all 50 states. Based on model legislation championed by the American Tort Reform Association in this alarming report, the amendments would require a plaintiff to demonstrate individual "reliance upon an act or practice declared unlawful"--a requirement that is patently designed to defeat class certification. We'll explore this issue in depth in the coming weeks.

• Mann on Payday Lending: Over at the excellent Credit Slips blog, professor Ronald Mann of the University of Texas offers some thoughts on payday lending to military personnel, a hot topic on which co-blogger Chris Peterson testifed to Congress and posted about here last week. Among other things, Mann says "Congress should view the military as an illustration of a general problem, not as a special case of activity that in other settings is benign."

• FTC on Mortgage Lending, Identity Theft: The Federal Trade Commission today filed these comments on mortgage lending abuses with the Federal Reserve Board and announced the interim recommendations of its Identity Theft Task Force.

Senate Banking Hears Testimony on Predatory Lending to Military

by Chris Peterson

Yesterday in Washington, D.C. the Senate Banking Committee held a hearing on predatory payday lending to military personnel. The issue creates some interesting political dynamics, with many conservatives taking offense at loans to marines, sailors, and other members of the military with intrest rates of between 390 and 900%. As far as committee meetings go, the hearing is pretty fun to watch (which admittedly is not saying much). A video can be easily watched on the Senate banking committee website. Here's a link.

Some of the highlights: At minute 1:29:50 Senator Mel Martinez (R-FL) aggressively questions the president of the payday loan bar association ("Q: Do you think an 18-year-old taking out a 390% loan is conscionable; can you really, with a straight face tell me, that that is actually what you believe?"). At minute 1:06:26 Lynn Drysdale, a widely respected consumer lawyer from Jacksonville, Florida, shares some of the horror stories of her clients. And, somewhere around minute 1:20:50, I speculated that George Washington probably would not have tolerated 500% interest rate loans to the Continental Army.

A fun time was had by all--or at least by me.