Loss of State Consumer Powers Contributed to Mortgage Crisis

Sept. 21, 2009 at 9:10 PM
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The assumption of states' powers to enforce consumer protection laws by the Federal government over the past 13 years is a significant cause of irresponsible lending and the housing crisis, according to a new white paper issued by the National Consumer Law Center.

"Banks like to blame the mortgage crisis on nonbank lenders, but in the peak year of 2006, 32 percent of subprime loans, 40 percent of alt-A loans, and 51 percent of the toxic payment-option and option ARM loans were made by national banks, federal thrifts, or their subsidiaries who were immune from state laws," said Lauren Saunders, the paper's author and the Managing Attorney of NCLC's Washington, DC office. "Overall, $700 billion of the riskiest loans in 2006 were made by banks who could ignore state law. Federal law also prevented states from addressing the most dangerous terms of mortgages offered by nonbank lenders. Credit card and overdraft fee abuses can also be traced to preemption."

Many of the irresponsible loans that led to the foreclosure crisis were made by financial entities that could ignore state law. Mortgage lending by national banks, federal thrifts, and their operating subsidiaries made up 31.5 percent – nearly a third – of the most dangerous, subprime loans during the peak year of 2006. Subprime loans typically were made with no documentation of income, without regard to ability to repay, and with a host of other problems such as exploding rates, failure to include escrow in affordability analysis, and inflated appraisals. Not surprisingly, they have failed in large numbers, the study found.

In 2006, the peak year of irresponsible lending, national banks, Federal thrifts, and their subsidiaries made 32 percent of subprime loans, 40 percent of Alt A loans, and 51percent of interest-only and option adjustable rate mortgage (ARM) loans. A total of over $700 billion in risky loans were made by entities that states could not touch. States were also preempted from regulating any mortgage lender on the very terms that made many mortgages dangerous: balloon payments, negative amortization, variable rates, and other nontraditional terms.

"The current crisis should be a wake-up call that everyone—consumers, the financial industry, and the economy as a whole—is better off with serious consumer protection. Effective regulatory reform demands a comprehensive system that does not leave significant gaps in protection, allow new destructive practices to spring up unhindered by reforms aimed at yesterday's problems, or ignore local problems until they reach the point where they command national attention," the study concluded

The National Consumer Law Center, Inc. is a non-profit corporation specializing in low-income consumer issues, with an emphasis on consumer credit. NCLC publishes a series of treatises on consumer laws and provides assistance and training to legal services, government, and private attorneys representing low-income consumers across the country.

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