Predatory lending laws debated

Liability for fraud might curdle credit

WASHINGTON -- Banks that package mortgage securities -- and the institutional investors who buy them -- are fearful that in the future lawmakers could make them legally responsible for fraud committed by lenders.

As the housing crisis worsens and foreclosures mount, federal predatory lending legislation is moving to the front burner. But industry groups are warning the Democratic-led Congress that imposing such liability would dry up funding for mortgage loans.

Consumer advocates, meanwhile, say it is the best way to rein in Wall Street's aggressive role in the increasingly complex mortgage market, which boomed in recent years amid lax standards for borrowers with weak, or subprime, credit.

Ira Rheingold, executive director of the National Association of Consumer Advocates in Washington, foresees a heated battle on the issue this fall. If companies that package mortgage securities and investors in them knew they could be liable, "they might actually look at the loans that they're buying, which they haven't' been doing," Rheingold said.

But George Miller, executive director of the American Securitization Forum, which includes buyers and sellers of securities backed by mortgages and other assets, said it is unrealistic for investors to be expected to check to see whether loans were fraudulently issued. "The investor isn't sitting there when a lender and broker are ... at the table," he said.

Lawsuits mount

The issue of assigning liability is gaining attention as lawsuits stemming from foreclosures rise.

"Many of those borrowers didn't know what kind of loans they were getting and have a good argument that misrepresentations were made," said Kurt Eggert, a professor at Chapman University's law school.

Nevertheless, Eggert said, in the majority of states, most borrowers are not able to hold the current owners of their home loans responsible for the actions of the original lender.

Consumer groups say that prevents borrowers from successfully arguing in court to stop foreclosures -- even if they are victims of predatory loans.

Seven states -- North Carolina, New Jersey, New Mexico, New York, Illinois, Massachusetts and Rhode Island -- have some level of mortgage liability for investors, according to the Center for Responsible Lending, a Durham-based consumer group. Federal law limits that liability to the loans defined as "high-cost" by the government, of which few are made.

If investors in mortgage-backed bonds face broad, unlimited liability, "the market will dry up," said Scott DeFife, co-head of legislative affairs at the Securities Industry and Financial Markets Association, which spent $2.6 million lobbying the federal government in the first half of the year.

Historically, banks and thrifts made home loans to borrowers and held them on their books. But residential mortgages have increasingly been packaged into securities, sliced into different levels of risk and then sold to investors in a process called securitization.

Georgia changed law

At a hearing earlier this year, Republicans warned against overzealous efforts to create legal responsibilities, citing Georgia's experience as a textbook case. Georgia's 2002 predatory lending law allowed borrowers to seek punitive damages from anyone who bought a loan or a security that included the loan.

In response, major credit-rating agencies decided they would no longer rate the quality of securities containing Georgia home loans, leading to a mass withdrawal of lenders from the state. Georgia lawmakers subsequently changed their law limiting liability for loan abuses to original lenders.

House lawmakers, led by Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, plan to introduce multifaceted mortgage legislation in the coming weeks. The details are still being worked out, but Frank said in an interview last month that investment banks that package mortgages into securities should have the responsibility to make sure loans are not predatory.

Rep. Brad Miller, D.-N.C., who plans to co-sponsor a bill with Frank, said the House bill will probably include protections against lawsuits for loans that don't show obvious signs of being predatory. Among those signs, he said, are requirements that borrowers pay penalties if they want to pay off their loans early.

"What we want to do is end predatory loans, but make sure that we don't regulate lending to death," Miller said.