With the landscape littered with wreckage of banks, thrifts and mortgage banking companies, it might be instructive for regulators to read a court filing by H&R Block, which owned Option One Mortgage Corp.
Massachusetts attorney general Martha Coakley has H.R. Block and its subsidiary Option One Mortgage for making "structurally unfair" subprime loans from 2004 through 2007.
The state claims that Option One loan officers and mortgage brokers originated high-cost loans that borrowers could not afford and its lending practices created an "explosion of foreclosures" in Massachusetts.
Option One's business model relied on serial refinancings, the AG says in the complaint, and on rising house prices since many of the loans were or at nearly 100% loan-to-value ratios. "As soon as the housing market flattened, the HRB entities already misleading promises of future refinancing became wholly illusionary."
Of course H.R. Block's lawyers are urging the U.S. district court judge to dismiss the AG's complaint. But it is notable that they are using regulatory guidance issued by the Comptroller of the Currency, FDIC, Office of Thrift Supervision and Federal Reserve Board to defend Option One’s lending practices.
First, they claim Option One conducted it's business in conformity with industry practices and state requirements, but the AG wrongly contends the "business as a whole was unfair and deceptive under Massachusetts laws."
The AG is asking "nothing less than that the most basic elements of the American mortgage industry be examined retrospectively and declared illegal," the tax preparer's lawyers say in the motion to dismiss.
Next HRB's attorneys point to subprime lending guidance issued by the federal banking regulators in July 2007 - when subprime lending was already in a tailspin and subprime defaults were beginning to spook financial markets.
The subprime guidance signaled to the marketplace that stated-income, prepayment penalties, low introductory rates and piggyback features were "legitimate components of subprime lending," the defense attorneys assert.
They also point out that the Federal Reserve Board addressed some of the AG’s concerns about prepayment penalties and the ability of the borrower to repay the loan after the introductory rate expires, when the Fed tightened its Home Ownership and Equity Protection Act regulations in July 2008.
However, the new HOEPA rules do not go into effect until October 1, 2009 "underscoring that the practices at issue have never heretofore been regarded as unlawful or improper," the motion to dismiss says.
As Congress sits down next year to restructure the regulation of the mortgage industry, the lawmakers might want to why federal banking regulators would rely on "guidance" as opposed to stronger action to stop lending abuses. And why the guidance was issued in the ninth inning of the subprime lending boom and its only practical effective may be in defending subprime lenders from lawsuits.
Just for the record, it seems the Office of the Comptroller of the Currency and Office of Thrift Supervision spent most of their energy from 1999 to 2007 asserting their preemptive powers and undermining state efforts to regulate subprime lending.
As soon as a state enacted a predatory lending law, the OTS would preempt it so federally chartered thrifts could ignore the state lending standards.
OCC also asserted preemption powers (later upheld by the U.S. Supreme Court) so national banks were free to employ their own lending standards.
As Congress tries to impose uniform regulation on all mortgage lenders, federal preemption will likely be central to debate.
In the past, mortgage industry groups pushed for legislation that creates a federal lending standard and blocks (or preempts) the states from implementing tougher standards.
But this time around, the anti-regulation forces will not be control at the federal level. And Congress is not likely to defer to the regulators' better judgment. The lawmakers can be expected to push for really tough lending standards and even limit the type of mortgage products lenders can offer consumers.
When it comes to loan products, "innovation" no longer has the ring it used to have.
Lenders also have to be wary that Democratic lawmakers will seek changes to the bankruptcy code so struggling homeowners that cannot get help from servicers can go to a bankruptcy judge to restructure their mortgage.
Proponents of bankruptcy changes are arguing that it is "discriminatory" to deny bankruptcy relief for struggling borrowers with only one home, when it is available to property flippers/investors and owners of second homes.
Knowing Chapter 13 relief is available - regulators, credit rating agencies and mortgage insurers are going to think twice before allowing mass marketing of innovative or risky mortgage products again.
