Ohio Attorney General to Investigate Subprime Lending
On May 15, 2007, Ohio Attorney General Marc Dann declared war on the subprime lending industry – not just the loan originators and mortgage brokers, but apparently everyone involved in the process of making subprime loans possible. Attorney General Dann has likened the subprime lending industry to armed robbery. He was quoted “If somebody was buying guns and giving them to people to go and take people’s houses at gunpoint in Ohio, we’d be prosecuting them and throwing them in jail.”
In issuing his press statement, his targets extended all the way to “Wall Street firms” because the sale of mortgage-backed securities pools provided the funds that permitted borrowers to get mortgages they couldn’t afford. The Attorney General is participating in the bankruptcy proceedings of New Century Financial Corp., the California subprime lender that filed chapter 11 in April. Dann says he wants to see the e-mails and documents behind the pooling and sales of these mortgages as securities. He said “I’m guessing somebody at some or all of these places were predicting the bottom was going to fall out.”
The clear message from Dann is that he believes subprime borrowers were victims of a conspiracy to exploit homeowners and home buyers. Few people would argue that many subprime borrowers were victims of unscrupulous lenders and mortgage brokers but to attack the entire subprime market seems to be either overkill or a failure to focus on the correct target – predatory lending practices.
By definition, subprime borrowers have low credit scores and the likelihood of their defaulting on a loan is greater than average. But denying the whole subprime market the credit necessary to purchase homes by attacking the funding mechanism that supplies the credit would seem to be a bit drastic. Most subprime loans are not made by banks. They are funded by sale of participations in pools of high risk loans assembled by “Wall Street.”
Because the risks in these loans are greater, clearly non-traditional mortgages are required. There are higher interest rates and fees to offset expected losses. Often repayment schedules are structured to increase over the life of the loan, providing the only access subprime borrowers have for entry into the home market. Without many of these alternative structures, home ownership would not be an option for many families. The lending industry would rightfully be criticized if it failed to accommodate the needs of these marginal borrowers. Declaring war on the industry that makes home ownership possible for these borrowers simply because these loans are more likely to result in a higher foreclosure rate seems to focus on the wrong target.
The correct target for Mr. Dann and other advocates is anyone engaging in predatory lending. Certainly not everyone in the subprime market has engaged in predatory practices. The root of the problem has to be unethical loan originators who may have misled borrowers into taking out loans that were doomed to fail. These would include loans with payments escalating beyond any reasonable expectation of repayment, loans made without any credit check, loans made without full disclosures or loans simply made with false disclosures. Borrowers victimized by such practices clearly have been wronged and they have remedies against the loan originators and anyone acting in concert with them, even the companies providing the funding for the loans if they are knowingly involved in the deceptive scheme
However, a blanket indictment of the whole lending industry, all the way to the companies who package loans for sale to individual or corporate investors, appears to be misdirected. Without these lenders and packagers, subprime borrowers have little prospect of finding the credit they need to enjoy home ownership. A more appropriate solution would seem to be better regulation or policing of those companies and individuals who actually lied to or misled the borrowers. Sue them. Bring criminal charges if appropriate. Impose strict licensing requirements.
The cure has to start with better regulation of mortgage brokers. In most states, brokers have no duty to the borrower to arrange for the “best” loan available. Some brokers steer the borrower to the loan that results in the largest fees for the broker. See Your Mortgage Broker: Friend or Foe?, Wall Street Journal, May 24, 2007, p. D1. Subprime borrowers might be better protected if the Attorney General were to focus his efforts on regulation of brokers, not the sources of the money borrowed.
For further information, please contact Gerald Baldwin at gbaldwin@fbtlaw.com or any other member of the FBT Banking Litigation Group.
