The much-celebrated "Credit Cardholders' Bill of Rights" is a fresh example of how the Democratic Party tries to have it both ways--avoiding the tough votes while mollifying the folks. The credit card reform measure imposes new rules on the industry and does away with many of the most outrageous gimmicks bankers use to extract more money from debtors. Banks cannot raise interest rates retroactively on old credit card balances or pile on hidden fees or fail to give advance notice for rate increases. These and other changes are worthy.
The achievement seems less courageous if you know that Congress was largely ratifying the regulatory rules already adopted by the Federal Reserve last year. Or that the legislation gives the industry another nine months to gouge their customers before the new rules go into effect. Or that Visa and MasterCard, Citigroup and JPMorgan Chase are free to raise future interest rates to the sky--without limit. That is the industry's intention, as bank lobbyists reported after the bill was passed.
These folks will soon fixated on the concept of predatory lending. You can also bet that at some point President Obama will try and take up legislation against this concept. Nothing says that you are sticking up for the little guy than going after "predatory lending". I am here to say that the concept is bunk and any and all legislation to curb it will turn out to be totally counter productive.
To crysallize the problem of countering "predatory lending" let's first look at this article from a North Carolina paper.
There is no specific definition about what exactly predatory lending entails, though most observers believe that the description applies when lenders take advantage of borrowers by charging high interest rates and consider only the value of a borrower’s assets, as opposed to what the borrower can afford to pay.
In other words, predatory lending is like porn, no one knows exactly how to define it but we know it when it's in front of us. I'm here to tell you that if you can't define it, you aren't going to be able to legislate against it.
To really understand how absurd predatory lending is, I will tell you a story about my mentor in the mortgage business. At it's height he was making several hundred thousand yearly. He wound up purchasing several pieces of property including a home, for himself, with eight bedrooms that went for nearly a million dollars. When the business turned the wrong way, he began struggling with all his debt.
He fell behind on his real estate taxes, and needed a new loan to pay them off. Because he couldn't show income, he found another mortgage broker to do the loan for him. Initially, he was promised a rate of 8.99%, but when he showed up to the closing, the rate was 10.99%. My mentor was stuck. He needed his past due taxes paid, but he knew he couldn't afford the new loan. He finally relented and took the loan.
Of course, he fell behind on this loan. When the bank went to foreclose, he counter sued under several predatory lending laws. First, there was the issue of the rate changing at the end. There were other technical issues like a closing document, the right to cancel, being missing from his closing documents. My mentor was explaining in detail exactly how the law was on his side when I got bored. I realized something and so I asked him this critical question.
Let me see if I understand you. You are suing on the concept that you are too dumb to realize that you're being ripped off. Only, the reason you know how to sue is because you're so sophisticated that you know exactly how you were ripped off and how it was illegal.
My mentor won and eventually was allowed to sell and walk away with $25,000 in cash. If a mortgage broker can sue under the concept of predatory lending, then you know the concept is bunk.
Think of predatory lending as the financial version of hate crimes. Most things under "predatory lending" are already illegal: fraud for instance, but legislators feel it is so egregious they must legislate it even more.
The problem is that the concept is vague and so legislating it becomes counter productive. Often, legislators put caps on interest rates because "excessive rates" is one common description of "predatory lending". Of course, the problem is that "excessive" is in the eye of the beholder. As such, rather than the market determining the maximum rate charged a bureaucrat does. In Illinois, we have something known as the Illinois High Cost law. This sets the maximum rate that anyone can charge and also a maximum amount of fees. I've been fortunate to only run up against Illinois High cost on a few occasions however in each case perfectly good loans were taken away even though all parties agreed to the terms because the rates wound up being just over the maximum allowed by the law. This law, like all like it, is very vague and so each bank interprets it differently so often a loan isn't discovered to be out of bounds of Illinois high cost until the end. Here is one example.
The term Clear to Close is an industry term indicating what all of you should infer. This is the last step before closing. This is the step that my protege got the loan to before Illinois High cost took over. The loan was sent to the closing department only to have the closing department determine at the end that the loan in its current form was ILLEGAL. In other words, the closing department determined that the loan exceeded Illinois high cost regulations. Yes, despite carrying it through the process, signing all the necessary documents, and most importantly having complete borrower approval, the rate on this loan was too high. Not too high for the borrower mind you, but rather for some bureaucrat in Springfield, Illinois.
The bank of course was not immune for criticism. The rate on this loan was the same at the end as it was in the beginning. Only an incompetent or cruel bank could possibly allow for such a determination to be made in the end rather than in the beginning. The situation is complicated by the fact that this loan is an adjustable rate mortgage meaning its rate was only fixed for the beginning of the process. As a result when the bank determines the APR, they ACTUALLY allow a software system to project future rates and let that play a determination in the APR.
There is another concept that people associate with predatory lending and the concept is "transparency". You can bet that when law makers take up predatory lending legislation they will make sure to talk about "transparency". I am all for "transparency" except in mortgages. That's because "transparency" really means that the government will create yet another document for borrowers to sign before they can close. For instance, in Illinois, lawmakers started to notice that borrowers were being taken advantage of by being put into loans that didn't benefit the borrowers. Lawmakers thought that if borrowers knew what benefit said loan had they would be in a better position to judge if they should move forward.
As such, the state of Illinois passed into law the Illinois Fairness in Lending Act. In this act, Illinois law now mandated the Net Tangible Benefits disclosure. This disclosure stated just exactly how the borrower was benefitting from the loan (lower rate, lower payment, fixed rate, cash out, etc) In reality, borrowers were forced to sign yet another document they didn't understand or care about and made the process for them even more overwhelming. The whole idea was absurd. If someone didn't know how a loan was benefitting them and still was ready to close, no document was going to help them anyway. All the Illinois legislature did was make sure that everyone had to sign yet another document.
More predatory lending legislation will only mean that closing a mortgage will now require two hundred signatures not just one hundred. It's yet another practical example of what "predatory lending" legislation will mean in practicality.