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Liars and Teasers: Regulating Subprime Lending

Lawmakers at state and federal levels have responded to the subprime-lending crisis by doing what’s expected of them – proposing new legislation.           

Legislative responses generally fall into two major categories: tighter lending standards and aid for struggling borrowers. While mortgage lenders resist many of the proposals that would impose stricter requirements, they support others – such as federal proposals to harmonize the patchwork of state laws that complicate the lending process and increase administrative costs. Examples of recent legislation include:

- Iowa: State Senate In March 2007 approved S.F. 541, which forbids so-called “liar” loans that misrepresent the source or amount of a borrower’s income or assets.

- Minnesota: The legislature passed House File 1004, which bans “no-doc” loans, forbids negative amortization (in which minimum monthly payments are too small to cover interest charges) and imposes limits on fees and points charged to borrowers. It also creates a fiduciary duty for mortgage brokers to act in the best interests of borrowers.

- Nevada: The state assembly is considering multiple bills (ABs 329, 375 and 440) that would instruct Nevada regulators to tighten lending standards, and would prohibit some types of no-doc and stated-income loans.

- Ohio: Senate Bill 185 became effective in January 2007, prohibiting prepayment penalties for first mortgages totaling less than $75,000. (Many subprime loans carry prepayment penalties.)
Texas: Multiple bills are being considered. HB 1057 would require lenders to disclose orally and in writing if a loan has a prepayment penalty, and HB 716 would give Texas regulators the power to suspend the licenses of mortgage brokers indicted for a crime. It also would define lying on a mortgage-related document as a 2nd degree felony, punishable by up to 99 years in prison.

- Several states are working on bond programs to underwrite bailouts for subprime borrowers. The Ohio Housing Finance Agency is expected to issue $100 million in taxable bonds to refinance 1,000 troubled loans, and Maryland, Massachusetts, Rhode Island and Virginia are funding similar bailouts.

- Various proposals in the U.S. Congress would address the subprime-lending meltdown, including a possible six-month national moratorium on foreclosures; a “rescue fund” for the Federal Housing Authority to acquire failed mortgages; and federal regulations for mortgage brokers and agents who now are regulated only by state laws. Lawmakers are considering other proposals to increase penalties for violating existing federal lending laws, and to establish national suitability standards for determining borrowers’ ability to pay a loan.

Even more controversially, senior legislators in the House Financial Services Committee have discussed legislation that would make investors in mortgage bonds liable for the deceptive practices of banks and brokers writing those loans. Committee Chairman Barney Frank (D-Mass.) excoriated underwriters for providing “liquidity without responsibility,” and said the legislation would aim to keep markets liquid while minimizing the chance of another subprime-lending meltdown.

“The effect this has on the ability of people in the bond market to make money is simply not a factor,” Schumer said.

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Featured Articles :

• Subprime Shakeout: Best Practices, Market Forces Avoid Need for Onerous Regulation
  The recent subprime-lending meltdown invites comparisons with other major crises.

• Regulating Subprime Lending
  Lawmakers at state and federal levels have responded to the subprime-lending crisis by doing whatís expected of them ñ proposing new legislation.

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