City governments and predatory lending.

• Author: Entin, Jonathan L.

Predatory lending has generated increasing attention in recent years. The practice involves loans to homeowners who frequently cannot pay the associated costs and therefore lose their homes. Predatory lending is heavily concentrated in low--and moderate-income neighborhoods (1) and disproportionately affects minorities (2) and the elderly. (3) The consequences of predatory lending are devastating not only to the consumers who fall prey to unscrupulous lenders' tactics, but to the community as a whole. (4) For these reasons, many cities have tried to regulate or prohibit the practice.

This Article assesses the legal challenges that cities can face in trying to deal with predatory lending. (5) Part I provides an overview of the problem. Part II focuses on the common law and statutory claims that cities might bring, with particular emphasis on the evidentiary issues that cities can face and the requirements of standing that could severely limit the effectiveness of lawsuits brought by municipalities. The Article then turns to city efforts to regulate predatory lending pursuant to their home rule authority, efforts that can be stymied both by state laws that supersede municipal ordinances and federal regulations that preempt state and local initiatives. Part III focuses on home rule, explaining that most courts that have addressed the question have held municipal initiatives to be preempted by state laws. Part IV shows that the federal government might override much of what cities and states try to do to attack the problem. The Article concludes that, despite the legal obstacles facing cities that want to regulate predatory lending, local efforts have served as a catalyst for predatory lending policies at the state level and might stimulate more effective national policies as well.

1. A PRIMER ON PREDATORY LENDING

   Predatory lending has yet to be defined in a comprehensive fashion. A joint report issued in June 2000 by the U.S. Department of the Treasury and U.S. Department for Housing and Urban Development ("HUD") noted: "Although home mortgage lending is regulated by state and federal authorities, none of the statu[t]es and regulations governing mortgage transactions provides a definition of predatory lending." (6)

   Defining predatory lending is difficult for two reasons. First, loan attributes may or may not be "predatory" depending on the sophistication or financial position of the borrower. (7) Second, the definition of predatory lending cannot be static because the lending market is always evolving in light of technological, regulatory, and judicial advancements.

   It is important to distinguish predatory lending from subprime lending. Subprime lending--the extension of credit to consumers who would be unable to obtain credit in the primary market--typically involves higher interest rates and fees to account for the increased risk associated with a particular consumer's credit history. The higher rates are not predatory per se. It is the circumstances surrounding the loan that typically make the loan predatory. (8) For that reason, most government agencies and academic experts define predatory lending in terms of specific elements, practices, or effects. In 2001, then-Federal Reserve Governor Edward Gramlich proposed an approach to predatory lending that defined the practice in terms of elements:

   [T]ypically predatory lending involves at least one, and perhaps all three, of the following elements:

   making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay an obligation ("asset-based lending") inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced ("loan flipping") engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower. (9) More expansive government definitions include a list of specific practices. The U.S. Government Accountability Office (formerly known as the General Accounting Office) provides perhaps the most comprehensive definition:

   While there is no universally accepted definition, predatory lending is associated with the following loan characteristics and lending practices:

   Excessive fees. Abusive loans may include fees that greatly exceed the amounts justified by the costs of the services provided and the credit and interest rate risks involved. Lenders may add these fees to the loan amounts rather than requiring payment up front, so the borrowers may not know the exact amount of the fees they are paying.

   Excessive interest rates. Mortgage interest rates can legitimately vary based on the characteristics of borrowers (such as creditworthiness) and of the loans themselves. However, in some cases, lenders may charge interest rates that far exceed what would be justified by any risk-based pricing calculation, or lenders may "steer" a borrower with an excellent credit record to a higher-rate loan intended for borrowers with poor credit histories.

   Single-premium credit insurance. Credit insurance is a loan product that repays the lender should the borrower die or become disabled. In the case of single-premium credit insurance, the full premium is paid all at once--by being added to the amount financed in the loan--rather than on a monthly basis. Because adding the full premium to the amount of the loan unnecessarily raises the amount of interest borrowers pay, single-premium credit insurance is generally considered inherently abusive.

   Lending without regard to ability to repay. Loans may be made without regard to a borrower's ability to repay the loan. In these cases, the loan is approved based on the value of the asset (the home) that is used as collateral. In particularly egregious cases, monthly loan payments have equaled or exceeded the borrower's total monthly income. Such lending can quickly lead to foreclosure of the property.

   Loan flipping. Mortgage originators may refinance borrowers' loans repeatedly in a short period of time without any economic gain for the borrower. With each successive refinancing, these originators charge high fees that "strip" borrowers' equity in their homes.

   Fraud and deception. Predatory lenders may perpetrate outright fraud through actions such as inflating property appraisals and doctoring loan applications and settlement documents. Lenders may also deceive borrowers by using "bait and switch" tactics that mislead borrowers about the terms of their loan. Unscrupulous lenders may fail to disclose items as required by law or in other ways may take advantage of borrowers' lack of financial sophistication.

   Prepayment penalties. Penalties for prepaying a loan are not necessarily abusive, but predatory lenders may use them to trap borrowers in high-cost loans. Balloon payments. Loans with balloon payments are structured so that monthly payments are lower but one large payment (the balloon payment) is due when the loan matures. Predatory loans may contain a balloon payment that the borrower is unlikely to be able to afford, resulting in foreclosure or refinancing with additional high costs and fees. Sometimes, lenders market a low monthly payment without adequate disclosure of the balloon payment. (10)

   In the legal arena, Professors Engel and McCoy have produced a definition of predatory lending that focuses on the composition of the loan to determine whether it is predatory. While most of the Engel-McCoy definition is encompassed in the GAO definition, Professors Engel and McCoy also include waiver of meaningful legal redress--usually through mandatory arbitration clauses that require borrowers to waive judicial redress and class action participation--as an indicator of a predatory loan. (11)

   From the above definitions, one can distill a definition of predatory lending in its broadest conception: predatory lending occurs when a lender extends to a consumer a loan with unfavorable terms that are structured to strip the equity from the home, possibly resulting in foreclosure on the home used to secure the loan and personal bankruptcy for the consumer.

   The definitional complexity makes it difficult to quantify the aggregate costs of predatory lending. The Home Mortgage Disclosure Act (12) ("HMDA") requires that mortgage lenders with an office in a metropolitan statistical area disclose data related to all the home mortgages they make each year. (13) HMDA data cover approximately eighty percent of all home loans nationwide. (14) The HMDA data show that 26.2 percent of covered loans had annual percentage rates sufficient to trigger coverage by the federal predatory lending laws, (15) but not all loans covered by the federal predatory lending laws are necessarily predatory in nature. Even if comprehensive data were available about every home loan, it would still be impossible to identify the number of loans that are predatory, as no data set could accurately measure the lender's intent--a critical element of predatory lending. Despite the problems of data availability, some researchers have attempted to quantify the costs: an oft-cited 2001 report estimated that predatory lending cost consumers roughly $9.1 billion annually. (16)

2. CITIES AS LITIGANTS: STANDING AND OTHER DIFFICULTIES

   Because the direct victims of predatory lending are disproportionately the elderly, minorities, and the less affluent, one might expect that cities would seek to represent these victims by asserting claims on their behalf against those engaging in these destructive practices. After all, the Supreme Court has long recognized the legitimacy of parens patriae suits in which governments represent the interests of their constituents. The earliest decision to this effect came in the 1900 case of Louisiana v. Texas, (17) which rejected the claim on the merits but nevertheless observed that "the State is entitled to seek relief in this way because the matters complained of affect her citizens at large."...