Mortgage Reform on the Horizon?

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One of the biggest issues facing lawmakers today is mortgage reform.

A bill that had been in committee, the Mortgage Reform and Anti-Predatory Lending Act, sponsored by Financial Services Committee Chairman Barney Frank, D-MA, along with Brad Miller, D-NC, and Melvin Watt, D-NC, was an all-inclusive means to ending the out-of-control subprime mortgage lending roller coaster ride.

This bill provided for safe-harbor provisions to protect mortgage securitizers—those who buy mortgages and bundle them for sale as securities on the secondary market—from liability if they meet certain due-diligence requirements. Buyers of loans that do not fit into safe-harbor provisions would have legal responsibilities to the borrowers—meaning borrowers could take legal action on subsequent holders of their mortgages should they discover an abusive feature.

But politicians being politicians, in order to gain enough support to get the bill to the floor, a substitute amendment was introduced to gain broad support—at the expense of watering down one of the bill’s key pro-consumer provisions.

This amendment made the safe-harbor provisions so broad as to leave very little remedy for the borrower. It also prevents borrowers from taking class-action lawsuits against holders of bad loans. Under this system, borrowers have very little recourse should they default due to an abusive term on their loan, and Wall Street won’t have enough incentives to stop buying up loans of this type.

Subprime loans were originally intended to serve higher-risk borrowers who could not qualify for prime loans. But in addition to higher interest rates, lenders have tacked on abusive loan terms and features that are not seen in the prime lending industry.

Those lending practices have contributed to the explosion in foreclosures. As it was written, this new legislation would have outlawed the most abusive of these features and include measures to restore integrity to the market. The bill would have:

• Required subprime lenders to determine whether the borrower has the ability to repay the loan when taking into account the fully indexed interest rate and fully-amortized payment on adjustable-rate loans over the life of the loan.
• Established a “duty of care” so that loan originators are subject to a fiduciary responsibility to their borrowers, and would require mortgage originators to be licensed and to act in the best interest of consumers by presenting them with loan products that are appropriate for each borrower’s financial circumstances.
• Prohibited so-called yield-spread premiums, which gave incentives to mortgage brokers to steer borrowers to higher-cost loans.
• Required subprime lenders to determine that a refinanced loan would provide a net tangible benefit to the consumer, curbing repeated refinancings that bring in additional lender fees.
• Prohibited prepayment penalties on subprime loans.

While some are still pressing to water down other parts of the bill, Congress must ensure that a strong bill, which will clean up the market, is passed.

The bill is written so that its provisions would not supersede any state laws that provide for stronger remedies. The bill would set a high bar for states having no substantive predatory mortgage lending laws.

Some feel that the last thing Congress ought to do is set up federal regulation that limits states’ abilities to police abuses within their own borders. They would rather see Congress focus on improving the federal regulators that passively looked on as abuses rose.

On the one side, mortgage bankers are asking federal lawmakers to enact a national consumer-protection standard that they say would simplify the lending and borrowing environment.

On the other side, states and some consumer groups say consumer protection is best done at the local level. Who knows their communities better, they argue, than the people who live there?

The question becomes: When it comes to protecting mortgage borrowers, who can do a better job, Washington or the states?

Or maybe the question is: Who truly cares the most about the interests of consumers? Federal or state regulators?