In pursuit of safety and soundness: an analysis of the OCC's anti-predatory lending standard.

AuthorMcMonagle, Diana
PositionComptroller of the Currency

To borrow a concept from the animal kingdom ... a classic predator traps the unwary and preys on the weak. Put in the lending context, a predatory lender ensnares ... vulnerable customers, offering loan products designed to prey on their weakness, bleed them financially and ... strip them of their most precious possessions. (1) PROLOGUE

George Campbell lived his entire life in the same home in Queens, New York. (2) Disabled, living solely on monthly Supplemental Security Income checks, Mr. Campbell had one significant financial asset: the value of his home appreciated substantially over the years and he amassed considerable equity in the property. (3) A few years ago, an aggressive mortgage broker persuaded Mr. Campbell to take out a second mortgage to finance much-needed repairs. (4) The broker claimed Mr. Campbell, with neither a checking account nor an established credit history, was ineligible for a bank loan. (5) Unable to read well, Mr. Campbell did not understand his obligations under the agreement; like countless other unsuspecting borrowers in the United States, Mr. Campbell became the victim of a predatory lender. (6) The terms of the mortgage required monthly payments almost equal to Mr. Campbell's social security income. (7) Predictably, he defaulted. (8)

INTRODUCTION

Predatory lenders are unscrupulous, aggressively marketing their loans to borrowers who cannot afford their credit on the onerous terms offered. Their prey are some of the most vulnerable members of society: the elderly, persons living in low-income areas, the socially and economically disadvantaged, the financially unsophisticated. The consequences are devastating, and include enormous personal losses, foreclosures on homes, and the devastation that foreclosure brings to entire neighborhoods. Many common abusive lending practices are already illegal under federal law, (9) yet predatory lending continues to destroy communities. (10)

In response to this escalating problem, the Office of the Comptroller of the Currency ("OCC"), a federal regulator of the national banking industry, issued a Final Rule on January 7, 2004 ("Final Rule"). (11) The OCC has always prohibited banks from engaging in predatory lending, but difficulties defining "predatory" and the problematic application of conflicting state-lending laws has caused significant supervisory and enforcement problems. (12) The Final Rule addresses these problems and sets forth a uniform federal standard to guide banking policies on predatory practices and to aid regulators' identification of predatory loans. (13) The Final Rule forbids national banks from making consumer loans, including mortgage loans, car loans, and student loans, (14) based predominantly on the foreclosure value of the borrower's collateral. (15) The rationale lies in the OCC's belief that the value of a borrower's collateral does not indicate their ability to repay the loan. As a result, such loans are now per se predatory, and for that reason, prohibited. (16)

The Final Rule also preempts several categories of state banking laws (17) that are no longer enforceable against national banks. (18) States now have little authority to regulate the lending practices of those national banks situated within their jurisdictions. (19) Specifically, the Final Rule preempts state regulation of lending licenses, loan terms, interest rates, terms of credit, disclosure requirements, and other conditions of lending. (20) The Final Rule also codifies the judge-made determination that the OCC has authority to enforce Section 5 of the Federal Trade Commission Act ("FTC Act") (21) and regulations thereunder against unfair and deceptive trade practices in banking. (22)

Effectively, as a result of the Final Rule national banks are no longer subject to state anti-predatory lending laws. (23) The OCC standard has replaced a multitude of state laws, and national banks are now only accountable to the OCC and its single standard. (24)

This Comment will analyze the potential ineffectiveness and possible consequences of the OCC's anti-predatory lending standard and argue that, despite the perceived comfort in having a single federal standard for evaluating predatory lending, the standard set forth in the Final Rule is inadequate, and inherently flawed.

Part I of this Comment attempts to define predatory lending and distinguishes predatory lending from non-predatory subprime lending. (25) Part I also explains the OCC's role in regulating predatory lending. (26) Part II examines the standard set forth in the Final Rule and analyzes it in light of the agency's justifications for adopting the rule, (27) which include agency concerns for the maintenance of the safety and soundness of the national banking system and the goal of ensuring fair and equal access to financial services for all Americans. (28) Part II concludes that the OCC's preemption of state anti-predatory lending laws and substitution of a single anti-predatory lending standard cannot reasonably be justified on these grounds. (29) Part II also explores the potential negative social and economic consequences that this regulation may have for low-income borrowers. (30) Part II suggests that this effect may increase the predatory lending problem by forcing these individuals to seek subprime loans from the largely unregulated non-bank sector, the segment of the financial industry notorious for committing predatory lending. (31) Part III proposes a solution to ameliorate the potential social and economic costs of the regulation. (32) It suggests that the OCC should interpret and enforce the regulation so that it only prohibits loans extended with a calculated intent to foreclose, and provides guidelines for determining a bank's intent. (33)

  1. PREDATORY LENDING IN THE SUBPRIME MARKET AND THE ROLE OF THE OCC

    1. Defining the Problem

      John D. Hawke, Comptroller of the Currency, defines predatory lending as "the aggressive marketing of credit to people who simply cannot afford it." (34) This may be an oversimplification. Other commentators argue that the term in fact applies to a catalogue of exploitative lending practices that generally fall into one of two categories. (35) The first consists of illegal and unconscionable lending tactics, such as forging signatures on loan documents, fraudulently misrepresenting the terms of a loan, double billing, hidden fees, and charging for services that were never rendered. (36) The second category addresses activities which are not as obviously abusive--legal lending practices which are misused by unprincipled lenders. This includes loan flipping, (37) equity stripping, (38) high interest rates and hidden fees, (39) among other abusive lending practices. (40) Still others believe that the term defies traditional definition, since it encompasses loan terms and products that, on their face, are impossible to differentiate from legitimate lending practices. (41) These commentators instead characterize predatory lending on a "you know [it] when you see it" (42) basis, recognizing that any practice "targeted at vulnerable populations [that causes] devastating personal losses, including bankruptcy, poverty, and foreclosure" is predatory. (43)

      Another problem in defining predatory lending arises because predatory lending occurs primarily in the subprime market. (44) Subprime loans are loans with higher interest rates designed for borrowers who would not qualify for loans at the prime rate because of a blemished, or nonexistent, credit history. (45) The emergence and growth of the subprime market is considered a national economic success, (46) and has given low-income borrowers access to credit where they did not have access before. (47) By allowing families and individuals who are ineligible for prime rate loans to obtain subprime rate mortgages, the increased availability of subprime credit has been critical in aiding a recent increase in rates of homeownership. (48) Subprime lending has also been credited with increasing mortgage lending to minority borrowers, particularly Hispanics and African-Americans during the 1990s. (49) The difficult question is whether regulators can proscribe predatory lending while at the same time encouraging beneficial subprime lending.

      While not all subprime lenders are predatory, nearly all predatory loans are subprime. (50) Although predatory loans constitute only a subset of subprime lending, the whole is sometimes mistaken for the part, resulting in an overly-broad and inaccurate definition. (51) A primary distinction between subprime and predatory lending lies in the lender's intent in extending the loan. (52) Predatory lenders profit from intentionally and systematically taking advantage of unsophisticated borrowers, and purposefully structure loans to cause economic harm to the borrower--at a significant profit for the lender. (53) Non-predatory subprime lenders lend with a different intent, that is, to provide valuable credit to individuals with a higher risk of default. The higher interest and foreclosure rates that accompany subprime loans result from the additional risk inherent in lending to an individual with imperfect credit, not from intentional planning on the part of the lender. The substance of "ground level" interactions between the lender and the borrower is often indicative of a lender's intent. (54) Some lenders intentionally seek out vulnerable loan candidates, (55) going so far as to review public property lien records to find homeowners with serious debt. (56) After identifying their victims, these lenders become salesmen, aggressively promoting loans that the frequently desperate borrowers cannot afford.

      Predatory lenders prey on the most vulnerable members of society. (57) Their typical victims are financially unsophisticated individuals (58) who are often "disconnected" from the traditional credit economy, (59) in that they have limited experience with banks and often have not...

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