State Laws, Federal Laws, and Predatory Lending

A couple weeks ago, I read and analyzed this article by Eliot Spitzer. The article hypothesized that the states made an aggressive move to curb predatory lending and they were turned back by an obscure arm of the government (the Office of the Comptroller of the Currency (OCC). I researched Mr. Spitzer's claim and I believe he is accurate in his description.

In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks.

The federal government's actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation.

My problem with all of this starts with this nugget from a Winston Salem 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 fact, there is no agreed upon definition on predatory lending. That means each individual state would be able to make their own laws. Now, what Governor Spitzer would have us do is allow each state to define for itself "predatory lending" and then prosecute it aggressively against National Banks that would be forced to work within 50 different standards all at once. That may sound like no problem to an aggressive prosecutor however it can be nothing less than an albatross on the bank. Mortgages are already an incredibly complicated animal. Now, you would add fifty standards for a nebulous term like "predatory lending".

Here is the practical effect. Here is just one example. Within the definition of predatory lending, there would be maximum rates that banks could charge any borrower. Each state would decide for itself and banks would have to tailor their product line the fifty different sets of rules. One state would be at 13% maximum and another 10%. I believe my state, Illinois, is just under 11%.

Furthermore, I have done my fair share of loans that neared the maximum and they were always a nightmare because every bank had their own quirky way of determining how the maximum was determined. The problem was further complicated on any Adjustable Rate Mortgage because the APR is figured over thirty years and the loan is only fixed for 2, 3, or 5 years. Many times brokers would get their commissions cut back at the last minute on loans that approached the rate that was most allowed.

If predatory lending were ever defined, I would be all for going after it aggressively. Except it isn't any specific action but rather a provocative phrase that gets people worked up. If it isn't defined, it leaves to each state to define it and to prosecute it aggressively. How would that work with a vague term like "predatory lending"?

For instance, Minnesota just came up with anti predatory lending law. Some have called North Carolina's anti predatory lending law the gold standard (though I would certainly NOT be one of those people). I have already pointed out two anti predatory lending measure that my state has enacted. The North Carolina has a provision that

prohibits pre payment penalties on loans of $150,000 and less

Everything from pre payment penalties, maximum fees, maximum rates, the validity of stated, no money down loans, and even loans without escrows could all be legislated under so called "predatory lending", and unless there is a specific definition it will be up to each state to define it. As you can see, the laws could get so complicated that sometimes a pre payment penalty would be predatory and other times it wouldn't. Imagine trying to deal with that sort variation on a plethora of different concepts associated with mortgages and then add the interpretation of fifty different states (and even more prosecutors and judges).

The Bush action that Spitzer referred to protected the national banks from having to face all of these standards and fifty motivated Attorney Generals ready to implement these sweeping and varied standards.

Now, Spitzer can claim that if he and his cohorts had had a chance to implement their goals, the crisis wouldn't have happened. I believe the crisis is much more complicated than that. First, there has been fraud in mortgages as long as there has been mortgages. What Spitzer and his colleauges noticed wasn't an increase in fraud. Rather, what happened was that significantly more loans were created that were easy to exploit. The problem was a lot more systemic than could be solved by enforcement. Especially if the enforcement came in the form of fifty different standards.