Balance Needed in Regulating Subprime Lending

By Catherine Hubbard, M.A., CCH Washington News Bureau.

Federal and state efforts to curb predatory lending could force subprime lenders out of the market, according to a panel that spoke at a recent American Enterprise Institute (AEI) conference in Washington, D.C. “If this occurred, it would be a tragedy for subprime borrowers,” said Peter J. Wallison, a fellow at AEI.

Predatory lending is ill defined and difficult to track, said Federal Reserve Board governor Edward M. Gramlich. “The predatory lending story is largely one of anecdotes. It is very hard to get hard data on this,” he said.

Yet predatory lending clearly is a growing problem in the subprime market, Gramlich said. Some lenders are guilty of providing too little or unclear information to borrowers on the terms of their loans, approving asset-based loans with “foreclosure in mind” and selling unnecessary insurance, he said. Also, some lenders are engaging in “loan flipping” and are allowing borrowers to refinance their houses five or six times per year when rates are stable, he said, adding that “not all borrowers know what they’re getting into” when they refinance that often.

Over the last 10 years, “there has been a tremendous expansion of subprime credit,” particularly mortgage credit, said Gramlich. Between 1993 and 2000, he noted, conventional home purchase loans to low-income borrowers more than doubled.

The federal Home Ownership Equity Protection Act prevents lenders from engaging in certain practices, such as balloon payments in the first five years, prepayment penalties after five years and a pattern and practice of asset-based loans, Gramlich said. He added that the law “is not impeding growth too much,” noting that the overall volume of subprime lending has held steady since implementation.

Nevertheless, the current patchwork of state laws is making it difficult for lenders to operate, said Gary Gilmer, vice chairman of Household International. Household, along with Citigroup Inc., recently agreed to settlements regarding alleged predatory lending.

Gilmer urged the industry and regulators to develop an industry-wide standard to ensure that customers fully understand the process, their options and the penalty for failing to adhere to the loan terms, particularly when using real estate to secure the loans. “Those kinds of things have to be addressed in a consistent way…so that everybody is singing out of the same hymnbook,” he said. He added that the effort: “has to be at the federal level.”

Michael Staten, director of the Credit Research Center at the McDonough School of Business, Georgetown University, Washington, D.C., said that since passage of North Carolina’s anti-predatory lending law in 1999, mortgage originations declined roughly 14 percent and the number of second mortgages to lower-income borrowers fell 5 percent. “Significant declines occurred only in North Carolina and only among the lower-income borrowers,” he said in a working paper released in October. “It appears that the North Carolina statute did impede the flow of mortgage credit to higher-risk borrowers, and any reductions in predatory lending were achieved at the expense of many legitimate loans,” he said in the report, co-authored by Gregory Elliehausen Senior Research Scholar, Credit Research Center.

However, Roy E. Green, principal lobbyist for housing and financial services issues at the American Association of Retired Persons, noted that another study found that North Carolina law reduced the overall level of subprime lending activity. This report indicated that the decline in mortgage originations was caused by reduced application volume, not by a change in loan denial rates. The research, by Boise State University researcher Keith Harvey and Peter J. Nigro at the Office of the Comptroller of the Currency, suggests there is “less aggressive marketing in the state after the imposition of the law,” Green said. He concluded that when crafting laws and regulations to address predatory lending, “finding the right balance in consumer protections and product choice is critical.”