Financial Institutions Committee Chairman Burt Solomon is reasonable and fair in approaching the issue of state regulation of financial institutions. His comments introducing last week’s hearing on the foreclosure crisis in Texas reflect the careful and conservative approach that many Southern states have taken toward defining the state’s role in addressing the crisis.
Listen to Chairman Solomons’ comments in the video below.
Because the federal government regulates national financial institutions state legislatures fear they are preempted from enacting legislation controlling the activities of these lenders. As Robert Doggett pointed out in his testimony on our behalf before the committee, the federal government often does not exercise this preemption when states take reasonable action to ensure the quality of lending within their borders. But setting aside actions against federally regulated lenders, there is still plenty for state legislatures to do to curb abuses by those that the federal government does not regulate–namely mortgage brokers.
A study recently released by the Brookings Institution entitled “Tackling the Mortgage Crisis: 10 Action Steps for State Government” points out that much of the foreclosure crisis can be attributed to individuals and institutions that are not regulated by the federal government.
…while states may not regulate federally regulated financial institutions, most mortgage originators, particularly of subprime mortgages, are not federally chartered banks, thrifts, or their subsidiaries, but independent mortgage brokers who work with lenders—who themselves are often not subject to federal regulation. Given that brokers originated 71 percent of all subprime mortgage loans in 2005, state action in this area is not only possible, it is critical.
I have flagged six reforms from the Brookings Report the Texas Legislature could enact.
1) Adopt a “suitability” or “best available product” standard for mortgages, requiring the broker to certify that, based on the borrower’s credit and other information, the loan suits the borrower’s needs or represents the best loan terms for which the borrower qualifies.
2) Establish an “ability to repay” standard, barring loans except where the borrower’s documentation clearly establishes that he or she will be able to make the mortgage payments.
3) Require that refinancing transactions show a “tangible net benefit” to the borrower.
4) Prohibit yield spread premiums, in which lenders offer brokers larger commissions for making higher-interest loans. Such premiums constitute an inherent conflict of interest.
5) Establish clear standards for appraisals and require arm’s length relationships between broker and appraiser. Inflated appraisals, including many where the broker and appraiser shared a common interest or where the broker may have motivated the appraiser to arrive at an unrealistic value, contributed to the foreclosure crisis. Mortgages that reflect unrealistic values not only impose higher costs on the borrower, but prevent refinancing because the debt exceeds the real value of the property.
6) Ensure that brokers fully disclose not only the terms of a mortgage, but all of the options and alternatives that may be available to the borrower. A recent Illinois statute provides, with respect to prepayment penalties, that the broker must offer the borrower a loan without such penalties and disclose the difference in rate between the two. The borrower must decline the offer in writing.