U.S. Senate Committee on Banking, Housing, and Urban Affairs
Feb 7, 2007 - - The Committee will please come to order. Today's hearing is entitled Preserving the American Dream: Predatory Lending Practices and Home Foreclosures. This hearing is particularly timely in light of news that has been coming out in recent days about the wave of delinquencies and foreclosures facing American homeowners.
Let me start by recognizing the work of Senators Allard, Bunning, Reed, and Schumer, who held joint subcommittee hearings last year to examine the impact of exotic mortgages on home buyers and homeowners. They deserve credit for raising the awareness of many of us to the risks of these products. I consider today's hearing a continuation of their good work.
Today, the Committee will focus its attention more specifically on predatory lending practices that are found primarily in the subprime market and how these practices may be eroding the foundations of homeownership for millions of American families.
Let me make myself clear on one important point: I do not believe that all subprime or exotic lending is predatory or abusive. To the contrary, subprime credit can be a valuable tool in helping people become homeowners, and in unlocking the equity in their homes.
For many years, the battle so many of us fought was to make credit available to neighborhoods that had been redlined, or to people, particularly minorities, who felt the sting of rejection regardless of their creditworthiness.
In response to this injustice, and after years of hard work by people like Reverend Jackson, Hilary Shelton, and many, many others, we passed the Community Reinvestment Act and the Fair Housing Act, so that credit to buy a home or build a business would be available to all Americans.
As a result, we have seen homeownership grow. Every one of us has spoken about homeownership-- how it provides stability and a chance to build wealth for the vast majority of Americans. It is the most valuable asset that most of us own. Our homes provide us with a financial cushion on which we can draw to send our children to college, pay for unexpected health care expenses, or finance a secure retirement.
To the extent that the creation of the subprime market has added to this flow of credit in a positive and constructive way, in a way that helps build wealth-- I welcome the development.
However, it is not enough simply to create homeownership-- we must sustain, preserve, and protect it as well. Yet, today, we are seeing increasing evidence that this important source of wealth for so many American families is under a grave threat from predatory, abusive, and irresponsible lending practices undertaken by too many subprime lenders.
The borrowers who are too frequently targeted for these loans are minorities, immigrants, the elderly, and the unsophisticated. For these families, failure means the loss of a home, the loss of wealth, the loss of middle class status, and the loss of the opportunity for financial security.
The growth of the subprime market has been incredible-- the amount of subprime lending more than tripled from 2000 to the end of 2005, from about $150 billion to nearly $650 billion; it is now over 20% of the entire market.
But this incredible growth has come at what FHA Commissioner Brian Montgomery has called "a tremendous cost. A cost that often outweighs the benefits of home ownership."
Today, there are too many incentives in the subprime market to make loans that put borrowers at too great a risk of failure.
* Over half of subprime mortgages are stated-income loans, loans which the industry often refers to as "liars loans." The question is, who's lying? According to a survey of over 2,000 mortgage brokers, 43% of brokers who make these loans do so because they know that their borrowers don't have the income to qualify for the loan. Why do they make these loans? Because they are paid more to do so.
* Brokers "upsell" borrowers. That is, they put borrowers in loans with higher interest rates than they could otherwise qualify for, because the brokers make greater commissions, called "yield spread premiums," by doing so. YSPs are a perfectly legitimate tool to provide borrowers with no closing cost loans. But HUD has told us that half of the YSPs paid, about $7.5 billion, do not go to closing costs, but go simply to increase broker profits.
* Minority borrowers are being targeted for higher cost subprime mortgages, regardless of their financial health. The 2005 Home Mortgage Disclosure Act (HMDA) data show that over half of African-American borrowers and 46% of Hispanic borrowers were given high cost subprime loans. By comparison, only 17% of whites took out such loans. Yet, according to the Federal Reserve, borrower-related characteristics such as income could explain only about 20% of this disturbing difference.
* About 70% of subprime loans have costly prepayment penalties that trap borrowers in high cost mortgages, mortgages that strip wealth rather than build it, and these penalties keep borrowers from shopping for a better deal. Unfortunately, living in a minority neighborhood puts a homeowner at significantly higher risk of having a prepayment penalty.
* Approximately 8 in 10 subprime loans today are 2/28 adjustable rate mortgages, mortgages whose monthly payments will spike up by as much as 30% to 50% or more. Many of the borrowers who take these loans-- unaware of the payment shocks that await them-- have no prospects of being able to make the higher payments, and are forced to refinance the loan, if they have sufficient equity to do so. Each refinance generates new fees for the lenders and brokers, and strips more equity from the homeowner. One lender, in discussions with my office, called subprime 2/28 loans "foreclosure loans."
Late in 2006, federal financial regulators issued guidance to require that lenders underwrite borrowers for certain non-traditional mortgages so that, even after the payment shock hits, the lender can be reasonably certain that the borrowers will be able to continue to make their mortgage payments.
Late last year, I wrote a letter with several of our colleagues-- Senators Allard, Bunning, Reed, Schumer, and former Senator Sarbanes, asking the regulators to extend these same protections to borrowers who have been given these subprime 2/28 ARMs, borrowers that are disproportionately black and Hispanic.
I believe these borrowers deserve every bit as much protection as the homeowners who take out interest-only and option ARM loans, and I want to urge the regulators to move expeditiously to provide the same protections to these particularly vulnerable borrowers.
The results of these aggressive and abusive practices are becoming clear. The Center for Responsible Lending, whose CEO, Martin Eakes, will testify this morning, released a study saying that nearly 1 in 5 subprime loans made in 2005 and 2006 will end in foreclosure, in large part because of the abusive loan terms with which many low income borrowers are saddled. According to this study, up to 2.2 million families will lose their homes at a cost of $164 billion in lost home equity.
Other reports confirm the trend: Realty Trac announced that there were more than 1.2 million foreclosure filings in 2006, up 42% from 2005, blaming the increase on the higher payments generated by the resets on option and subprime ARMs.
Monday's edition of the American Banker has a story entitled: "Subprime Defaults at Recession Level." The article focuses on a study conducted by Friedman, Billings, Ramsey, an investment banking firm specializing in mortgages, which says that 10.09% of securitized subprime loans are seriously delinquent (over 90 days late), in foreclosure, or already turned into seized properties. This is nearly double the rate from May, 2005, and higher than at any time since the recession of 2001.
I understand that many argue that the impact of the economy and other "life events" such as illness, job loss, divorce, and the like, are the key variables in determining mortgage delinquencies and foreclosures.
No doubt this is true. But those economic and personal factors do not fully explain the precipitous rise in defaults and foreclosures. It is time for the Congress, the Administration, and the lending industry to face up to the fact that predatory and irresponsible lending practices are creating a crisis for millions of American homeowners at a time when general economic trends are good.
Indeed, Mark Zandi, Chief Economist at Moody's Economist.com, notes that the current high delinquency rates are unusual because the economy is relatively strong. Zandi attributes the increasing delinquencies, in part, to the resetting of subprime and other ARMs at higher rates. This is particularly worrisome given the fact that about $600 billion in ARMs will reset this year.
The problem is, most of these loans are perfectly legal, even as they do real harm to borrowers and neighborhoods.
In short, the system is out of balance. There is a chain of responsibility that makes these abusive loans possible. I look forward to working with each link in that chain-- the brokers, the bankers, Wall Street, the regulators, my colleagues on the Committee and in the Congress, and the Administration-- to help restore this balance for the sake of the safety and soundness of the banking system; for the sake of the homeowners who are being victimized; and to make sure that subprime credit can, once again, play a constructive role in the marketplace.