Consumer Protection at the Fed: July, 2000

Let’s look at the transcript from “Morning Session of Public Hearing on Home Equity Lending, July 27, 2000″, moderated by Glenn Loney, the Deputy Director of the Division of Consumer and Community Affairs, and one of the four signers of the proposal that the Federal Reserve would not regulate non-banks mortgage lenders the same way as they would banks, even if they were held by banks.

I am not a historian or a journalist, but I’ll do my best to see what I can find. This conference is Loney gathering several representatives from subprime banks, community banks, and consumer watchdog groups in North Carolina, along with several Federal Reserve people, including someone whom may be his boss. I love when you do historical research, and someone who is known for other things wanders into the frame. And sure enough, Martin Eakes, 2 years before he founds The Center For Responsible Lending, is there talking. He founds the CRL based in part from how ignored he was by regulators, and this conference gives me a sense of where he’s coming from. Here’s his introduction:

My name is Martin Eakes. I come to you as the CEO of Self-Help, which is the largest community development financial lending organization in the country….

The first point I want to make is to say that predatory lending or loans that have abusive characteristics are not anecdotal as the Federal Reserve notice and your opening comments mentioned….

I believe there is no problem with either the first or the third, that Congress passed sufficient authority and that borrowers can enforce, that the real problem has been that the Federal Reserve has not acted to flesh out the regulations…

There are five areas we’d like for you to…Number two, prepayment penalties should be prohibited, or at a very minimum, included in the definition of points and fees for subprime loans. Number three, yield spread premiums paid to brokers should be included in the points and fees definition under HOEPA…..

A couple of points. Some of the disclosures are actually harmful; for example, APR, which was set up to give you one rate. The fact that APR takes eight or ten points of fees and spreads it across 30 years in the calculation of an APR…So you could have ten points on the front end which attach immediately and are gone, but the APR actually gives you this false sense of security that is misleading.

In North Carolina, we said if it’s a high-cost loan by interest rate, fine, but let’s put everybody on the same playing field. Because what I hear from lenders directly is that I can’t eliminate prepayment penalties for my loans unless all the other lenders in my marketplace are eliminated at the same time; if everyone is constrained then we can compete on the same playing field and we will be competing on interest rate.

It’s worth noting once again that community investment groups weren’t looking for subprime to extend credit – the idea that subprime loans, that were modeled on the logic of credit cards with high interest jumps and gotcha penalties, were called out as crap very early like we see above.

I also understand where the community bankers are coming from. Here they are, complaining about the subprime lenders and how the Fed isn’t doing their job. A decade later, now that all the subprime lenders are bankrupt, or were bought by Too Big To Fail institutions that are receiving cash infusions from the government, the idea that they would be pissed about having to fill out new paperwork makes a lot of sense to me, even if it would clear a market space for them.

Here’s a representative community banker, who is also now my hero:

My name is Jim Creekman. I serve as in-house counsel with First Citizens Bank, a midsize bank which has operations — which is a multistate operation. Prior to that I was engaged in the general practice of law as a small-town practitioner in a town in western North Carolina and was principally a dirt and death lawyer. In that capacity I handled literally thousands of consumer residential mortgage loan transactions, so I come to this table with two different perspectives.

I have two basic observations. First, we need to start over. Second, we need to combat predatory lending with precision and on a national basis…

The rules which govern residential lending are already second in complexity only to the federal tax code. There aren’t four people in this room today who truly understand the existing regulations. They’re all lawyers and they disagree.

But we are here to figure out what’s going through the regulator’s mind. What are the Federal Reserve’s consumer group people thinking when they see Eakes give this smackdown?:

COUDRIET: I’m Charles Coudriet. I’m President of the National Home Equity Mortgage Association and I’m also chairman of Saxon Mortgage, which is a lender in the subprime market…

Prepayment penalties sound terrible until you peel back the onion and you find that lenders hope they never collect them and their existence helps hold down mortgage rates to the consumers….

MR. EAKES: Lehman Brothers issued a report last Friday about prepayment penalties.In that report they state for 130,000 loans that roughly 50 percent of the borrowers who have prepayment penalties using the California prepayment, which is basically half a year’s interest above 20 — half a year’s interest, that 50 percent of the borrowers actually end up paying the prepayment penalty.That if you had no prepayment penalty, it would slow the rate of prepayment by 15; you would have another 15 percent that would prepay.So the statement that Mr. Coudriet had that lenders hope they never receive a prepayment penalty, that is simply inaccurate with regard to securitization of mortgages.

Are they thinking “Why does Eakes want to stop poor people from getting capital?” Are they thinking “These subprime lenders are much shadier than I imagined; should we crack down?” Are they nodding along bored, while their minds wander towards Euler equations and recursive equilibrium? I can’t tell. It’s worth recording the opening remarks by Governor Gramlich, Loney’s boss. Loney doesn’t express any opinions since he is moderating. But Gramlich certainly sets the tone at the very beginning with the following:

LONEY:…To my immediate right is Governor Edward M. Gramlich, who is a member of the Board of Governors of the Federal Reserve System, and he is chairman of the Board’s committee on consumer and community affairs and as such has primary oversight responsibilities for the matters we’re discussing today….

GOVERNOR GRAMLICH:…The last few years have seen enormous growth in subprime lending. …This is mainly, surely, a good thing in the sense that this growth in the subprime lending market has brought credit to low and moderate income households…But there are also seemingly some abuses.

There have been a series of anecdotes, a series of TV programs mentioning some of these abuses, there has been a rise in the foreclosure rate, and these adverse statistics have attracted our attention….

We want to keep a relatively analytical focus and focus on specific things that the Fed might do, trying to make sure that, in technical talk, the benefits of what we do outweigh the costs….

If predatory lending is as significant a problem as some people are alleging….

Consumer education is undoubtedly an important facet here because a lot of what we’re going to be talking about are people who are taking loans that they probably wouldn’t have taken if they had fully understood the implications of all of the transactions. And so the Fed has already started on an effort to improve financial literacy, consumer education, and will keep doing that, as will other agencies.

Note: “seemingly some” ; “as some…are alleging” ; “a series of anecdotes, a series of TV programs” ; etc. Eakes calls him out on it in his first blockquote above, but I doubt it matters. It’s very clear here whose side they are on – maintaining the soundness of the banking sector. And note that it is only worth taking action here if it passes cost-benefit; but benefits and costs for whom? Could they have figured out the hundred of billions in subprime losses at the time? And the call for more education is always a dodge in my book; it’s important of course, but to say that someone will be contracted a nice pamphlet writing job is avoiding the responsibilities of the job, instead of doing them.

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One Response to Consumer Protection at the Fed: July, 2000

  1. Pingback: How The Federal Reserve’s Failed Consumer Protection Alone Makes Elizabeth Warren The Only Choice « Rortybomb

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