Fines for Lenders

Here's the Barack Obama Financial Times op-ed that got him criticized as FDResque in Forbes. The essence of the matter is that he's proposing "to establish a fund to help people refinance or sell to avoid foreclosure" and that "We can partially pay for this fund by imposing penalties on lenders that acted irresponsibly or committed fraud."

A separate FT article covering the plan describes it as "among the most radical yet from a leading Democrat" but it sounds to me like understanding the real nature of this proposal would require us to see more details than seem available from scanning Obama's website.

Comments

What kind of quantifiable hardship will a homeowner need, exactly, to demonstrate to qualify for Obama's program? As Matt's implying, the basic premise here seems a little shaky, since everyone who can do so will try to refinance at the lowest possible rate.

Posted by James Gary | August 30, 2007 8:09 AM

I thought it was Forbes and not the Financial Times that thought that the term "FDResque" was an insult? The Financial Times is probably the best business paper out there, and Forbes the worst. They shouldn't be confused.

Also, I think fining people for acting irresponsibly or commiting fraud is what they think the "radical" part of the plan is.

Posted by Ed | August 30, 2007 8:14 AM

Fining lenders for committing fraud is not exactly controversial. Fining lenders because they "acted irresponsibly" is absurd.

Posted by ostap | August 30, 2007 8:36 AM

While we're on the topic--I'm under the impression that at one time (the 1970s?), actual legal limits were in place on how much interest a lender could charge a borrower. What happened to that--or am I mistaken that such laws ever existed? Please advise.

Posted by James Gary | August 30, 2007 9:03 AM

Or, to put it better--what legal guidelines exist in this case to distinguish between "committing fraud" and "acting irresponsibly?"

Posted by James Gary | August 30, 2007 9:06 AM

I can think of worse things than being called FDResque; Bushesque, Nixonesque, Republican-esque all leap to mind. FDR's policies gave hope to millions and helped lift our country out of a horrific global depression. He brought sensibility back to stock market and banking practices. Sounds like we could use some FDResque thinking for a change.

Posted by DanF | August 30, 2007 9:32 AM

And here I thought there was some kind of Constitutional prohibition on ex post facto laws. I guess to Obama the Constitution is optional.

Posted by Al | August 30, 2007 9:39 AM

And here I thought there was some kind of Constitutional prohibition on ex post facto laws.

OK, I'm stupid. What exactly are you referring to, Al?

Posted by James Gary | August 30, 2007 10:02 AM

" And here I thought there was some kind of Constitutional prohibition on ex post facto laws. I guess to Obama the Constitution is optional. "

ex pacto punishment is a a issue here, but Obama's not nearly so out to lunch as you make it sound. Enforcement of mortgage laws and regulations really sucks in a lot of states. There could be a lot of violators that haven't punished or investigated at all. I looked up reports of mortgage related fraud for my job last year and they had been increasing by rapidly each year. It would have been impossible for enforcement officials to increase their staff by say 60% each year to investigate new reports.

"Fining lenders for committing fraud is not exactly controversial. Fining lenders because they "acted irresponsibly" is absurd."

Yeah that's kind of confusing but "acted Irresponsibly" could include civil violations. Lenders have forked over lots of money in settlements in the past. Those funds might not be correctly called 'fines', but they are big bucks that could be used to pay for part of Obama's program.

Posted by Christopher Colaninno | August 30, 2007 10:06 AM

An ex post facto law is a law that retrospectively changes the legal consequences of acts committed or the legal status of facts and relationships that existed prior to the enactment of the law. That is, it criminalizes behavior that occurred prior to the enactment of the law. They are specifically prohibited in Article I of the Constitution.

(Note that if we are talking about enforcing fraud laws that are already on the books, I'm all for that. But Obama isn't - he's talking about a brand new law.)

Posted by Al | August 30, 2007 10:12 AM

But Obama isn't - he's talking about a brand new law.

It's not clear to me that he is. I'm all in favor of tighter enforcement of lending laws (or even new laws mandating more transparency in the future) but absent any specifics, I can't even imagine how Obama's proposal might be put workably into effect--there are just enormous practical issues with what he's proposing.

Posted by James Gary | August 30, 2007 10:23 AM

...let me add, with or without the Constitutional prohibition on ex post facto lawmaking.

Posted by James Gary | August 30, 2007 10:25 AM

I dunno. He specifically calls for a number of new laws in the op-ed, including the following: "I have also introduced a bill in the US Senate called the Stop Fraud Act that would treat those who commit mortgage fraud as the criminalsthey are."

Op-eds are always vague. So it is not clear to me what he's talking about either. But that's my interpretation.

Posted by Al | August 30, 2007 10:32 AM

It's worth noting that whatever the government may do, the class-action lawyers are going to be all over this. If a lender has engaged in unfair business practices, these lawyers are quite skilled at extracting a penalty from them and redistributing it to the victimized individuals - with a healthy slice taken off the top, of course!

There's a school of thought that says since these highly-motivated private actors are going to pursue this, there's no need for government to spend its resources. There's another school of thought that says if government gets involved, the injured victims can be compensated in a more efficient manner and without a big chunk taken out for the lawyers. But it's at least worth considering.

It's fine to pass new laws, of course, punishing behavior that wasn't illegal before, but that's simply closing the barn door after the horses are gone.

Posted by Steve | August 30, 2007 10:38 AM

(Note that if we are talking about enforcing fraud laws that are already on the books, I'm all for that. But Obama isn't - he's talking about a brand new law.)

I don't see any real indication from the two sentences Obama devotes to the "fining lenders" issue that he would create a brand new law rather than simply enforcing existing fraud laws and using the money to partially fund this new temporary program.

The "brand new laws" he proposes would be an update to the regulatory apparatus surrounding the lending market (the "Home Score system" etc.), which is really the thrust of this thousand word column, but isn't really what everyone is talking cause it's not quite as sexy as the meaning that can be injected into those two vague sentences.

I'm going to go with the assumption that the constitutional scholar in the race is up to speed on ex post facto.

Posted by Dave White | August 30, 2007 10:42 AM

He specifically calls for a number of new laws in the op-ed, including the following: "I have also introduced a bill in the US Senate called the Stop Fraud Act that would treat those who commit mortgage fraud as the criminalsthey are."

Here is the press release concerning the Stop Fraud Act, from April. It essentially looks to federalize prosecution of mortgage fraud:

The STOP FRAUD Act, which is aimed at stopping mortgage transactions that promote fraud, risk, abuse and underdevelopment, will provide the first federal definition of mortgage fraud and authorize stiff criminal penalties against fraudsters.

...

If a borrower receives a subprime mortgage with any one of several high-risk characteristics, the Act protects the rights of borrowers to challenge lending practices in foreclosure proceedings. The high-risk characteristics targeted by this Act include loans for which the borrower does not have the ability to repay at the maximum rate of interest, loans whose true long-term costs are not clearly disclosed to the borrower, stated-income and no-documentation loans, and loans with unreasonable prepayment penalties.

Posted by Dave White | August 30, 2007 10:51 AM

Obama is calling for a new law, but part of a new law could include mechanisms that insured existing laws were followed and previously committed crimes were prosecuted. Most particularly I think it’s plausible that there are substantial funds that could obtained without ex post facto rules or punishments being involved.

Posted by Christopher Colaninno | August 30, 2007 10:55 AM

Mortgage Banks are already highly regulated at both the federal and state levels. There are usury laws limited rates, laws regulating fees and states audit lenders regularly. Institutionally, banks do all they can to control fraud; and while it may happen on an individual basis, a majority of the fraud occurs at the broker level, which Obama does mention at one point.

All in all, I think this misses the point because fraud isn’t the issue here. The problem is falling housing prices and high-risk loans. Those doing the majority of the high risk lending, the subprime lenders, are out of business.

Posted by DM | August 30, 2007 11:17 AM

Obama is just another pandering empty suit prez wannabe offering bread and circuses to the morons.

Maybe he can answer the question as to how we are going to distinguish between someone who can't meet the mortgage payments because they can't meet the mortgage payments and someone who can't meet the mortgage payments because they heard a bailout is in the offing and spent the money on a big flat screen TV instead?

Just asking.

Posted by kafka | August 30, 2007 11:36 AM

Re: --I'm under the impression that at one time (the 1970s?), actual legal limits were in place on how much interest a lender could charge a borrower. What happened to that--or am I mistaken that such laws ever existed? Please

These laws were enacted at the state level and varied state by state. A court decision held that the applicable law was the one that was in effect where the lender was located, not where the borrower lived. So the credit card companies flocked to a small number of states with no usury limits at all (South Dakota, Delaware and Nevada were popular) and as a result the laws pretty much ceased to have any real force.

Posted by JonF | August 30, 2007 12:21 PM

Yes, I agree.

I would like to be able to irresponsibly make a home purchase that is way beyond my means and then have the taxpayers bail me out for my stupidity. Maybe they could also do the same with a car!!

Posted by El Viajero | August 30, 2007 12:22 PM

There are legal limits to fees and interest than can be charged on loans in some states, but most usury caps on interest rates don't have much teeth today, because they are very high (start at 16% typically and go up from there usually based on an index rate) due to their being passed at a time when interest rates in general were significantly higher than today.

Mostly federal laws are aimed at disclosure of terms rather than substantive regulation of them, through the Truth-in-lending and Real Estate Settlement Procedure Acts and amendments therein. In the 1990s, Congress did amend the Truth-in-lending laws to require additional (HOEPA) disclosure and homeownership counseling for certain high-cost loans - loans which had an interest rate 8% higher than a fed note yield of the same term, and closing/settlement costs of 8% of the total loan amount.

By the late 90s, states like North Carolina began to see that HOEPA was not effectively protecting borrowers from being lured into bad loans b/c lenders simply avoided the threshold for the added disclosure by charging fees of less than 8% the loan amount. As a result, North Carolina passed a High-cost loan act of it's own which reduced the threshold for fees to 5% and prohibited most prepayment penalties. After more states followed NC, national banks and lenders began to pressure the federal regulatory agencies to enact broad pre-emption rules which effectively gutted the state laws for National banks and their subsidiaries. The GOP congress wanted, but could not get enough support for passing legislation that would have weakened the Truth-in-lending act and pre-empted states from having tougher laws than the federal level. this is the lobbying that I think Obama is referring to.

I'm not sure about how Obama plans on "fining" the lenders, though stepped up prosecution by the FTC of practices of some of the major sub-prime lenders would be a start. Another way to help borrowers who have been defrauded would to be to force the current holders of the mortgage notes at a discount to a federal agency, like Fannie Mae and to rework the terms of the mortgage so the borrower could afford the loan. A simple modification for people lured into an ARM would be to return it to a market rate fixed rate loan.

As for how you is tell who can do this and who heard theere was going to be a bailout so they bought (that ever present bogeyman of any assistance aimed at low-income populations) THE BIG SCREEN TV, you look at their income. Unlike the originator of their current loan, most likely, you look at paystubs and tax returns and you verify that the cause of their problem is do to an adjusting ARM rate or some other cause. A bailout program that doesn't do a thorough underwriting would just create the same problems we have now.

But it's a free world, so be cynical and irrelevant if you must.

Posted by arcbender | August 30, 2007 12:53 PM

JonF: thanks for the comment at 12:21.

The fundamental problem in mortgage lending (and many other activities) is that the rewards come for making any loan not for making a sound loan.

Everyone at the executing level - realtors, escrow officers, lending officers and clerks - gets paid when the transaction is made. But none are personally hurt when a given loan later fails.

It makes no sense for workers in the industry to be careful when the market is hot. And when things cool or collapse the prudent employee is hurt as much as the reckless.

The borrower may or may not suffer. It depends upon whether he remains able to make the payments and is content to live in the home for several years.

Posted by K | August 30, 2007 1:14 PM

"As for how you is tell who can do this and who heard theere was going to be a bailout so they bought (that ever present bogeyman of any assistance aimed at low-income populations) THE BIG SCREEN TV, you look at their income...."

I'll make this point once again: truly low income people don't need to be bailed out because they don't have any skin in the game. They got no down ARMs with low teaser rates. They have no equity in the houses, so how can they "lose" something they never even partially owned in the 1st place? And look at the bright side of foreclosure - for the 6 months it takes on average they're living rent free, after which they will move back into an apt. and rent, just like they always did.

Take some time off from the pity party and learn. At least Matt admits he doesn't know much about this mess.

Posted by kafka | August 30, 2007 1:29 PM

The WSJ's Holman Jenkins raised a broader question last week: whether government policies to encourage low-income home ownership were even beneficial to low-income households. Citing research by Carolina Katz Reid, his conclusion was that, in many cases, they aren't.

Some excerpts from Jenkins's column:

* Of low-income households from a nationally representative sample who became homeowners between 1977 and 1993, fully 36 percent returned to renting in two years, and 53 percent in five years.

* Even among those who held on to their homes for 10 years, the average price-appreciation gain was 30 percent -- less than if their money had been invested in Treasury bills; this meager capital gain was about half that enjoyed by middle-income homeowners.

A typical low-income household might spend half the family income on mortgage costs, leaving less money for a rainy day or investing in education. Their less-marketable homes apparently also tended to tie them down, making them less likely to relocate for a job. Reid's counterintuitive discovery was that higher-income households were "twice as likely to move long distance if they're unemployed."

Almost needless to add, the great squarer of circles for middle-income homeowners, the mortgage-interest deduction, won't turn a house into a paying proposition for those with little income to shelter.

Posted by Fred | August 30, 2007 1:43 PM

Um, Fred--contending that poor people aren't financially responsible enough to own houses seems entirely beside the point here.

Posted by James Gary | August 30, 2007 4:05 PM

Looks like Obama is trying to do something worthwhile. The problem with a general bailout is that it creates moral hazard and doesn't punish the businesses that are making bad loans.

He's trying to do it in a more fine-tuned way. As he says at the end of his op-ed,

"If we are serious about stopping this crisis and preventing much larger turmoil in US housing markets, Washington needs to stop acting like an industry advocate and start acting like a public advocate."

Punish the people who should know better.

Posted by Peter K. | August 30, 2007 4:55 PM

James Gary,

Either you didn't read my post or you didn't understand it: the point Jenkins and Reid were making wasn't that low-income folks aren't "financially responsible" enough to own homes, but that in most cases -- for the reasons cited in the excerpts -- it's been a bad deal for them.

To the extent that the government's zeal for increasing home ownership helped fuel the sub prime lending boom, it is relevant to the discussion here. Contrary to Sen. Obama's spin, the government has long acted as a "public advocate" in the housing markets, and the mortgage lending industry was, to a large extent, responding to this advocacy.

Posted by Fred | August 30, 2007 5:09 PM

Coming from the far left here, Obama's proposal is like a self-parody.

First of all, the recent action in the mortgage business has all but destroyed the business of subprime lending for years to come. You can pass laws making these loans more difficult, but they won't have any effect on anyone for years until the subprime market comes back.

Some points:

You can't fine the mortgage lenders because they're on the verge of insolvency.

When a borrower defaults on a loan, it's the lender that gets hurt, not the borrower. This is a crucial point that many people seem to forget. No mortgage issuer wants to push anyone into foreclosure, especially in this housing market where the property they'd seize is declining in value very quickly.

I haven't seen any allegations that mortgage issuers committed fraud. The people committing fraud, sadly, were borrowers who often lied about their income to get mortgages. You can blame some of the mortgage brokers for this behavior, but anyone who applied for a loan read and signed a piece of paper saying that the information they provided was the truth and nothing but under penalty of perjury.

The fact that some mortgage issuers didn't do the due diligence and ended up lending to people who they wouldn't otherwise have considered as candidates for loans, is being portrayed by many on the left as some kind of malfeasance. That's absurd. The borrowers who got these mortgages should thank their lucky stars the bank didn't investigate them and they got their loans. I don't understand how this is fraud or predatory lending on the part of lenders. At the end of the day, the whole crisis we have now was caused by borrowers defaulting on their loans and seriously damaging their balance sheets. The lenders go bankrupt, and so do the borrowers.

The reason borrowers are now having trouble paying their mortgages is simple: the federal reserve raised rates seventeen straight times and this increased the rate that anyone with an adjustable rate mortgage has to pay. Alan Greenspan was touting ARMs, so I don't see how anyone can blame Countrywide Financial for making the loans people wanted.

Finally: IF WE TIGHTEN UP SUBPRIME LENDING STANDARDS, POOR(ER) PEOPLE WILL NOT BE ABLE TO BORROW MONEY. Let the bankers take on the extra risk, let the other half borrow money.

Posted by Cliff Mason | August 31, 2007 6:04 AM

Cliff Mason,

You make some good points. Unfortunately, it looks as if President Bush is planning to out-pander Obama in a speech today. If we are lucky, he will just be blowing smoke, and nothing will actually come from it.

BTW, two additional points:

~20% of mortgage defaults are on mortgages taken out by speculators on homes they didn't live in. Should these speculators get bailed out?

Also, many of the sub prime borrowers put little or nothing down on their houses. How do you bail someone out who has no skin in the game?

Posted by Fred | August 31, 2007 8:28 AM