Morning Session of Public Hearing on Home Equity Lending
FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 4 1 TABLE OF CONTENTS 2 MORNING SESSION PAGE 3 OPENING REMARKS BY MODERATOR LONEY . . . . . . 6 4 OPENING REMARKS BY GOVERNOR GRAMLICH . . . . . 8 5 6 OPENING REMARKS BY PANELISTS: 7 BY MR. LEHMAN . . . . . . . . . . . . . . 15 8 BY MR. COUDRIET . . . . . . . . . . . . . . 18 9 BY MS. CRAWFORD . . . . . . . . . . . . . . 20 10 BY MR. MAYNARD . . . . . . . . . . . . . . 24 11 BY MR. CREEKMAN . . . . . . . . . . . . . . 27 12 BY MR. EAKES . . . . . . . . . . . . . . . 30 13 BY MS. EGGERS . . . . . . . . . . . . . . . 33 14 BY MR. BOST . . . . . . . . . . . . . . . . 38 15 BY MR. LAMPE . . . . . . . . . . . . . . . 41 16 BY MS. MARKS . . . . . . . . . . . . . . . 44 17 BY MR. BURFEIND . . . . . . . . . . . . . . 47 18 BY MR. STOCK . . . . . . . . . . . . . . . 50 19 BOARD MEMBER AND PANELIST DISCUSSION . . . . . 55 20 21 22 23 24 25 FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 6 1 P R O C E E D I N G S 2 3 MR. LONEY: Thank you all for being so 4 responsive to my request to begin the session. Good 5 morning, my name is Glenn Loney and I'm the deputy 6 director of the division of consumer and community 7 affairs at the Federal Reserve Board in Washington, 8 and I'm going to act as the moderator for the 9 hearings today. 10 We're happy to be in Charlotte at the first 11 of four hearings the Board is holding this summer on 12 home equity lending. We will be in Boston on 13 August 4, Chicago on August 16, and we will hold the 14 fourth hearing in San Francisco on September 7. 15 Let me first start by introducing the panel 16 of participants from the Federal Reserve. To my 17 immediate right is Governor Edward M. Gramlich, who 18 is a member of the Board of Governors of the Federal 19 Reserve System, and he is chairman of the Board's 20 committee on consumer and community affairs and as 21 such has primary oversight responsibilities for the 22 matters we're discussing today. 23 To my immediate left is Jim Michaels, who is 24 the managing counsel in our division, and Adrienne 25 Hurt, who is an assistant director in our division, FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 7 1 and they are responsible for truth in lending 2 matters among the Board's staff. On Governor 3 Gramlich's right is Jack Blanton, who is the vice 4 president and community affairs officer from the 5 Federal Reserve Bank of Richmond. 6 I would like to thank the Federal Reserve 7 Bank of Richmond for hosting this meeting today with 8 all the logistical and other care and feeding that 9 you've done for this exercise. 10 The Truth in Lending Act requires creditors 11 to disclose the cost of credit for consumer 12 transactions. In 1994 the Congress enacted the Home 13 Ownership Equity Protection Act, or HOEPA as it's 14 called and we'll probably call it for the rest of 15 the day, which added special protections to the 16 Truth in Lending Act for consumers who use their 17 homes as security for loans with rates or fees above 18 a certain percentage or amount. 19 The Congress acted in response to anecdotal 20 evidence about abusive lending practices whereby 21 unscrupulous lenders made unaffordable home-secured 22 loans to "house-rich but cash-poor" borrowers. 23 These cases often involved elderly and sometimes 24 unsophisticated homeowners who were targeted for 25 loans with high rates or high closing fees and with FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 8 1 repayment terms that were difficult or impossible 2 for the homeowners to meet. 3 HOEPA requires creditors to provide 4 additional disclosures at least three days before 5 consumers become obligated for such loans. It 6 prohibits lenders from including certain terms in 7 their loan agreements; for example, balloon payments 8 for short-term loans and from relying on a 9 consumer's home as a source of repayment without 10 considering whether the consumer's income, debt, and 11 employment status would support repayment of the 12 debt. 13 HOEPA also requires that the Board is to 14 hold hearings periodically to keep abreast of the 15 home equity credit market targeted by HOEPA, which 16 is one of the reasons we're here today. We also 17 held hearings in 1997, about two years after HOEPA 18 became effective. 19 I would ask Governor Gramlich now if you 20 would care to make a few opening remarks. 21 GOVERNOR GRAMLICH: Thank you very much, 22 Glenn. It's a pleasure for all of us to be here in 23 Charlotte. This is the branch of the Richmond Fed 24 which is the one that encompasses Washington, and 25 North Carolina is also, as you know, the home of one FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 9 1 of the most significant state laws in this general 2 area. 3 The last few years have seen enormous growth 4 in subprime lending. The statistics indicate that 5 the growth in subprime lending has been roughly 6 twice the rate of growth of normal mortgage 7 lending. This is mainly, surely, a good thing in 8 the sense that this growth in the subprime lending 9 market has brought credit to low and moderate income 10 households that, had the growth not occurred, they 11 probably would have been denied credit, so there are 12 some good things going on out there. But there are 13 also seemingly some abuses. 14 There have been a series of anecdotes, a 15 series of TV programs mentioning some of these 16 abuses, there has been a rise in the foreclosure 17 rate, and these adverse statistics have attracted 18 our attention. This mixed message symbolizes some 19 of the difficulties that we have today. We want to 20 encourage the growth in the subprime lending market, 21 but we also don't want to encourage the abuses; 22 indeed, we want to do what we can to stop these 23 abuses. 24 The Fed has some authority in this area, 25 mainly under HOEPA, the law that Glenn just referred FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 10 1 to; there's also some authority under some other 2 statutes. These hearings are fundamentally about 3 whether we should use this authority or what parts 4 of the authority we should use. We want to keep a 5 relatively analytical focus and focus on specific 6 things that the Fed might do, trying to make sure 7 that, in technical talk, the benefits of what we do 8 outweigh the costs. 9 One thing that we should all keep in mind is 10 that the Federal Reserve can't do it all. If 11 predatory lending is as significant a problem as 12 some people are alleging, there will have to be a 13 lot of types of activities. Other regulators of 14 financial institutions may have to make some 15 changes. The private sector could play a role in 16 checking some of its own practices; say, in the 17 secondary mortgage market or other such aspects. 18 Consumer education is undoubtedly an 19 important facet here because a lot of what we're 20 going to be talking about are people who are taking 21 loans that they probably wouldn't have taken if they 22 had fully understood the implications of all of the 23 transactions. And so the Fed has already started on 24 an effort to improve financial literacy, consumer 25 education, and will keep doing that, as will other FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 11 1 agencies. So a multifaceted approach will be 2 undoubtedly necessary. This should not distract 3 attention from the Fed because there are some things 4 we can do, but just so that nobody has the 5 impression that we can do it all. We certainly 6 can't. 7 As Glenn mentioned, these hearings build on 8 others the Board held back in '97. Those hearings 9 led to a report that we made to the Congress jointly 10 with HUD suggesting a number of legislative options, 11 some of which are still on the table, none of which 12 have been enacted, but some are still on the table. 13 This year both the Treasury and HUD had 14 other hearings and they culminated in a report that 15 was just made jointly by those agencies that had a 16 number of suggestions for the Federal Reserve. This 17 Treasury-HUD report had a lot of suggestions -- only 18 a minority of these were for the Federal Reserve but 19 there were some -- and these suggestions and others 20 that people raise will be the focus of these 21 hearings. 22 So at this point I will stop and again thank 23 you all for attending and for speaking and helping 24 us with what I think is a difficult problem and one 25 on which the Federal Reserve will try to use its FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 12 1 authority wisely. Thank you. 2 MR. LONEY: Thank you, Governor Gramlich. 3 The morning, the way we set this up, is as follows. 4 The morning will be devoted to discussions of ways 5 the Board might use its rule-writing authority under 6 TILA and HOEPA to curb predatory lending practices 7 in home equity lending while preserving access to 8 credit for borrowers with less than perfect credit. 9 I want to emphasize that what we would like 10 to talk about at both this morning and this 11 afternoon at the other hearings that we're going to 12 hold is practical, useful, sensible ways that we can 13 use the Board's authority, as Governor Gramlich 14 said, to try to address this issue, and keep it as 15 constructive and useful as we can. 16 This afternoon, however, we're also going to 17 be discussing alternatives to regulation that might 18 address predatory lending, such as consumer outreach 19 and education, and hear about studies or research on 20 subprime or equity lending that would inform the 21 Board in its deliberations. 22 What we're going to do is, we're going to 23 start each session with brief opening remarks by the 24 participants and follow that with what we hope will 25 be a round table discussion of the various issues. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 13 1 We've also set aside time to hear from members of 2 the public, and anyone in the audience who wishes to 3 participate in the open-mike session later in the 4 afternoon and is not already signed up outside -- I 5 don't know if it's outside this room or downstairs, 6 there's a sign-up sheet out there -- should do so. 7 This list will be used to order the appearances and 8 will help us gauge the length of time the 9 participants may be asked to observe in expressing 10 their views. 11 Let me start by just pointing out a few 12 simple, I hope, rules of procedure for this 13 morning's session. We are asking -- because of the 14 fact that time will be very tight, we're asking that 15 the panelists confine their prepared remarks to 16 about three minutes, and so therefore you should be 17 thinking about really what's the important point you 18 want to make about this matter as you prepare to 19 speak. We are going to have a timekeeper, this 20 gentleman over here, and he's going to give you the 21 high sign at about one minute to go. I would ask 22 that you be considerate of the others who are 23 speaking and observe the time constraints as best we 24 can. 25 When I call on you, I would ask that you FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 14 1 introduce yourselves and indicate the organization 2 that you represent. We do have a very varied panel; 3 I think it'll be a very useful discussion because of 4 the fact that it is so varied. 5 What we will do is we'll start with 6 Mr. Lehman over here when we get ready and proceed 7 to his left around the room, and each panelist will 8 present prepared remarks if they wish to do so. 9 There will be a few questions maybe for 10 clarification at the end of your individual 11 statement, but a general discussion, hopefully, 12 again, in the form of some kind of a round table, 13 will follow. 14 We'll discuss the possible changes to 15 HOEPA's scope from about the end of the panelists' 16 introductory remarks to about 10:30, then we'll 17 break for about ten minutes, and then reconvene to 18 discuss possible additional restrictions or 19 prohibitions for specific acts or practices under 20 HOEPA for the rest of the morning until lunch. 21 Again, let me emphasize that we're 22 particularly interested in concrete, practical 23 suggestions about how the Board can use its 24 authority under HOEPA and we would like for the 25 period after the prepared remarks to be in the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 15 1 nature of a give-and-take discussion, taking into 2 account time constraints. We do want to try to get 3 to as many of the questions the Board posed in the 4 notice of these hearings as possible. 5 I would also point out that the proceedings 6 are being recorded as we speak, and the young lady 7 has asked that everybody try to accommodate her by 8 speaking one at a time. Is that good enough? Okay. 9 So with that introduction, and assuming 10 there are no questions about the procedures, 11 Mr. Lehman, if you would begin. 12 MR. LEHMAN: Thank you. I'm Phil Lehman, 13 I'm an assistant attorney general in the consumer 14 protection section of the North Carolina Department 15 of Justice. I'm here because I participated 16 extensively in the drafting and legislative advocacy 17 for North Carolina's predatory lending law. 18 As Governor Gramlich noted, North Carolina 19 was the first, and I believe is still the only state 20 to have enacted comprehensive legislation dealing 21 with predatory lending. I would like to briefly 22 describe how we got to where we did and what model 23 we tried to follow to focus on this problem. 24 The process that we followed in ending up 25 with this legislation was one of consensus and FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 16 1 negotiation and compromise among most of the players 2 in the lending marketplace, including banks, 3 mortgage bankers, mortgage brokers, consumer 4 advocates, and government regulators. It was a 5 long, involved process but we were focusing -- what 6 we were trying to do was to focus on specific 7 problems of predatory lending and to restrict those 8 specific practices so that responsible lenders would 9 not be affected or would not be unduly burdened by 10 the law and without restricting the flow of 11 reasonable credit to the subprime marketplace in 12 North Carolina. 13 I think the end result was a careful 14 balancing act and I think we succeeded in large 15 part. Most of the provisions of the law did not 16 take effect until July 1 of this year, so it is 17 really too soon to comment on what has happened and 18 what specific effects it has. 19 When we drafted the legislation one of the 20 first models that we looked at was HOEPA, and there 21 was some suggestion that North Carolina could simply 22 enact the provisions of HOEPA as state law and then 23 add some remedies to that. But on closer analysis 24 we found that HOEPA was seriously deficient in 25 several respects and I want to show how our law FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 17 1 differed from HOEPA. Specifically, we felt that 2 HOEPA was primarily a disclosure statute and we 3 believe that disclosures in this sector of the 4 marketplace simply do not work, that more 5 substantive provisions are necessary, that the real 6 estate closing process is already document-heavy and 7 disclosure-intensive. 8 We added specific prohibitions such as a 9 prohibition on financing fees on high-cost loans, a 10 prohibition on all balloon payments in high-cost 11 loans, and a requirement that borrowers undergo 12 credit counseling before loans are closed. 13 We also believe that the fees threshold in 14 HOEPA was too high. We arrived at the figure of 15 5 percent of points and fees versus 8 percent in 16 HOEPA. We added a separate threshold for prepayment 17 penalties, for high prepayment penalties, because in 18 North Carolina law prepayment penalties have been 19 disfavored and we believe that it can be an abusive 20 practice for borrowers. 21 Finally, we added some general protections 22 that apply to all consumer home loans, including a 23 prohibition on the financing of prepaid lump-sum 24 credit insurance, which we feel is very, very 25 important and something the Board should look at. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 18 1 Thank you. 2 MR. LONEY: Thank you very much, 3 Mr. Lehman. 4 I'm afraid I would butcher your name, sir, 5 so if you'll introduce yourself. 6 MR. COUDRIET: I'm Charles Coudriet. I'm 7 president of the National Home Equity Mortgage 8 Association and I'm also chairman of Saxon Mortgage, 9 which is a lender in the subprime market. 10 The modern home equity industry is a 11 relatively new phenomenon fueled by capital market 12 innovation and entrepreneurship at many levels of 13 the delivery process. Subprime home equity loans 14 were previously made by private, totally unregulated 15 lenders, some of which still operate below the 16 surface of the economy. The legitimate market has 17 provided widespread access to credit to the people 18 who need it most. We need to be mindful of the 19 strides that have been made in favor of the consumer 20 as we seek solutions to the problem. There are 21 abusive lending practices occurring on an isolated 22 basis in the U.S. today. Some of these abuse 23 borrowers, others abuse lenders through fraud and 24 misrepresentation. The home equity industry 25 addresses a broad spectrum of borrowers, including FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 19 1 lower and higher income families. The subprime 2 sector is similar and its clients share the 3 condition that they are credit-impaired in some 4 fashion. The largest percentage of these loans are 5 refinancing versus purchase. Care must be taken not 6 to disenfranchise a greater group of borrowers who 7 only in recent years have gained access to credit. 8 These families are the ones who need credit most to 9 restructure the family financial picture and avoid 10 catastrophe. Many solutions to the issue of 11 predatory lending involve tactics that sound good 12 initially from the consumer's point of view, but 13 upon further analysis work against the true 14 interests of a cash-strapped family. Not all 15 balloon mortgages are good for every consumer; 16 however, there are cases where balloon usage 17 perfectly fits the family's predicament as the best 18 way out of trouble. Prepayment penalties sound 19 terrible until you peel back the onion and you find 20 that lenders hope they never collect them and their 21 existence helps hold down mortgage rates to the 22 consumers. If HOEPA's triggers are left as is, we 23 would be fine with including prepayment penalties in 24 the refinance calculation. Prohibitions on 25 financing closing costs don't sound good to anyone FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 20 1 who is in need of cash. If the borrower could come 2 up with out-of-pocket closing expenses, he probably 3 wouldn't need to refinance. 4 HOEPA is good law as written. It 5 establishes today a threshold which protects 6 consumers without restricting their access to 7 credit. 8 My company very rarely buys or originates 9 HOEPA loans today because we feel the necessity of 10 an expensive legal review to avoid inadvertently 11 transgressing its stipulations. This extra caution 12 usually makes these loans uneconomic for us. 13 Lowering HOEPA's triggers would 14 significantly decrease access to credit for most 15 lenders, including our company. Changing the 16 covered points and fees would have the same effect 17 on exclusion. Let's enforce HOEPA. 18 MR. LONEY: Thank you. Ms. Crawford? 19 MS. CRAWFORD: My name is Kate Crawford and 20 I am the legislative chairperson for the North 21 Carolina Association of Mortgage Professionals. I'm 22 a past president of the association and I am a 23 working mortgage broker with First Financial 24 Services, which is headquartered in Charlotte, and 25 my branch is in Burlington. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 21 1 I have been in the mortgage industry for 2 over 24 years and been a mortgage broker for over 3 20. The mortgage brokerage industry has enabled 4 Americans to purchase and remain in homes. Home 5 ownership is up. We originate over 60 percent of 6 all the home mortgages. Prospective borrowers call 7 our offices all the time shopping for the rate and 8 program that suits their needs. Mortgage brokers 9 offer extremely competitive rates, creative 10 programs, and great service. 11 The main question the borrower wants to know 12 is how much is it going to cost me. Mortgage 13 brokers who specialize in conventional and 14 government lending can consistently offer the 15 consumer lower rates than they receive at other 16 lending institutions. The wholesale lending market 17 has become a viable entity for most large lending 18 institutions. 19 This system allows for brokers to act as the 20 origination, processing, and closing department for 21 their mortgage products, without incurring the 22 expensive overheads of bricks and mortar, equipment, 23 employee salaries, benefits, workmen's compensation, 24 payroll taxes, et cetera. Wholesale lenders do not 25 have to incur as much overhead so competitive rates FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 22 1 can be passed along through the wholesale mortgage 2 channels to the broker. All this has done to 3 agency, lender, and industry guidelines supplied by 4 our lenders, GFC, FHA, and VA. 5 All these goods and services clearly meet 6 the test provided by RESPA and the HUD policy 7 statement concerning yield spread premiums. This 8 subject has been studied for years. In 1999 HUD 9 issued a lengthy statement of policy stating that 10 yield spread premiums were not illegal per se. 11 With the advent of automated underwriting 12 engines more borrowers are becoming homeowners. The 13 mortgage brokerage industry is a consumer-oriented 14 industry. We help and counsel potential borrowers. 15 There have been statements that borrowers were 16 qualified for an agency loan but were given a 17 subprime loan. Being qualified and being approved 18 do not mean the same thing. If the applicant cannot 19 meet the conditions of the approval, then the loan 20 is not given a final approval. When this is the 21 case, the borrower has to look at other options for 22 home financing. 23 The subprime market arose from the emergence 24 of a stop-gap form of lending which allowed 25 consumers who do not meet the criteria of agency or FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 23 1 government loans to fulfill their need for home 2 ownership. 3 Mortgage brokers have filled the void left 4 by banks and savings and loans. I believe that all 5 people should be treated fairly and equally; 6 however, all credit histories cannot be treated the 7 same. The mortgage market is built on the premise 8 that the borrower has the ability to repay their 9 loan. If an individual does not pay their bills, 10 they will not qualify for certain types of loans. 11 The subprime market is a definitive substitute for 12 people who have credit problems or who do not meet 13 the underwriting guidelines set forth by the 14 agencies. 15 Subprime and predatory are not 16 interchangeable terms. All types of businesses and 17 groups have bad and unscrupulous people. There is 18 no place for this in the mortgage market. The North 19 Carolina Association of Mortgage Professionals 20 supported the consensus approach taken in the 21 drafting of the North Carolina predatory lending 22 bill and the National Association of Mortgage 23 Brokers have been proactive in bringing to the House 24 of Representative the Consumer Mortgage Protection 25 Act. Thank you. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 24 1 MR. LONEY: Thank you very much. 2 Mr. Maynard? 3 MR. MAYNARD: Thank you. My name is Mal 4 Maynard, I'm an attorney in a small town in 5 southeastern North Carolina and I'm here today to 6 ask the Board for help on behalf of my clients. 7 We are facing an unprecedented rate of 8 foreclosures among moderate-income borrowers in 9 southeastern North Carolina. In most cases they 10 have very little access to any remedy, and in 11 instances where they do have access to lawyers, the 12 lawyers there find that they in many cases are 13 stripped of North Carolina consumer protections by 14 AMPTA preemption or that the HOEPA protections do 15 not reach enough of these transactions. 16 I want to take a minute to share with you 17 the experience that we've been through down in 18 southeastern North Carolina. In my hometown a 19 mortgage broker originated nearly $200 million worth 20 of loans over a three-and-a-half-year period through 21 approximately 4,000 loans. These fees ranged from 22 5 to 12 percent, nearly all of them were refinances, 23 they had very high percentage rates, and a very high 24 percentage of these loans were flipped within one 25 year. While holding itself out as a mortgage FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 25 1 broker, it had a secret exclusive deal with a 2 subprime lender to whom more than 90 percent of the 3 loans were directed at rates typically in the range 4 of 14 percent. 5 At the sale of these mortgages, the lender 6 and the mortgage broker split the premiums that were 7 earned from the sale to the secondary market. At 8 one point in time the president of this mortgage 9 brokerage corporation was earning $200,000 to 10 $300,000 per month in the premiums that were 11 garnished from the sale at the secondary market. 12 All of the capital was extracted from the mortgage 13 brokerage corporation. They filed for bankruptcy 14 protection shortly after they were sued for these 15 abuses. The only recovery in sight is against the 16 assignees. They created the market for these 17 practices and there's no other remedy for our 18 clients. 19 Only about half of these loans meet the 20 HOEPA guidelines. For those other borrowers there's 21 very little prospect of any recovery for these 22 borrowers. They are facing an economic disaster and 23 to a large extent there is no remedy. 24 Another phenomenon that we see growing daily 25 is the capacity of lenders to craft transactions FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 26 1 that avoid applicable North Carolina laws because of 2 the AMPTA preemption. The balloon payment 3 provisions and the prepayment penalties that might 4 otherwise be prohibited by North Carolina law are 5 evaded by lenders who have learned how to qualify 6 for the AMPTA preemption. It's a very serious 7 problem in our area. We believe that there should 8 be concurrent application of these laws, not 9 preemptive rule by Washington that avoids North 10 Carolina law for these borrowers. 11 I look forward to seeing some help with 12 HOEPA with regard to the level of fees that would 13 invoke the HOEPA jurisdiction. Thank you. 14 MR. LONEY: You kept saying AMPTA 15 preemption. What is that? 16 MR. MAYNARD: The Alternative Mortgage 17 Parity Transaction Act is a piece of legislation 18 that the federal Congress passed which otherwise 19 avoids applicable state law. It primarily is 20 targeted toward mortgages that are structured with 21 balloon payments and in other creative financing 22 sorts of arrangements. 23 GOVERNOR GRAMLICH: I have a question as 24 well. I'd like to go back to Mr. Coudriet. You 25 ended by saying, let's enforce HOEPA, as if -- the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 27 1 implication was that it wasn't being properly 2 enforced. Is that your meaning, and if so, what do 3 you have in mind? 4 MR. COUDRIET: No, I don't think it's being 5 improperly enforced. What I'm saying is it's good 6 law as written. The triggers are in place and are 7 effective to discourage most lenders from even 8 writing a loan that comes under HOEPA. So I don't 9 think -- once you start changing that I think you're 10 going to bring about a situation where access will 11 be severely denied to people who really need the 12 money. And HOEPA itself -- any transgression of any 13 regulations, we find, is generally enforced by the 14 bar in particular jurisdictions that transgressions 15 are found. 16 GOVERNOR GRAMLICH: So when you say let's 17 enforce HOEPA, you're really saying that present law 18 is just fine? 19 MR. COUDRIET: Yes, sir. 20 MR. LONEY: Mr. Creekman? 21 MR. CREEKMAN: My name is Jim Creekman. I 22 serve as in-house counsel with First Citizens Bank, 23 a midsize bank which has operations -- which is a 24 multistate operation. Prior to that I was engaged 25 in the general practice of law as a small-town FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 28 1 practitioner in a town in western North Carolina and 2 was principally a dirt and death lawyer. In that 3 capacity I handled literally thousands of consumer 4 residential mortgage loan transactions, so I come to 5 this table with two different perspectives. 6 I have two basic observations. First, we 7 need to start over. Second, we need to combat 8 predatory lending with precision and on a national 9 basis. 10 The history of Regulation Z, RESPA, and the 11 other regulations which govern residential lending 12 is one of layering. Over the years the regulations 13 have been revised, amended, and tweaked. Additional 14 layers of regulations have been added to address 15 each new concern. This is the approach that we're 16 being asked to endorse today. How do we add onto 17 the existing regulatory structure to curb predatory 18 lending practices. I urge us to resist this myopic 19 approach. The rules which govern residential 20 lending are already second in complexity only to the 21 federal tax code. There aren't four people in this 22 room today who truly understand the existing 23 regulations. They're all lawyers and they 24 disagree. 25 The purpose of the disclosures is to permit FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 29 1 a consumer to make an informed decision. 2 Disclosures are now so numerous and so complex that 3 they no longer fulfill their purpose. Sophisticated 4 borrowers don't understand or rely on them. To an 5 unsophisticated borrower the disclosures are 6 meaningless, complex, and confusing. Lenders are 7 lost in the morass of regulations and have pleaded 8 for simplicity, objectivity, and safe harbors. 9 Adding another layer to the regulatory 10 structure to address predatory lending practices 11 will only further complicate an already intolerable 12 situation. 13 It's time to step back, take a new look at 14 residential lending, and start over; to develop 15 meaningful disclosure requirements for those few key 16 elements which will permit the average consumer to 17 make an informed decision, to ensure that the 18 regulatory burden is both comprehensive and 19 comprehensible. And it must be objective. Lenders 20 need safe harbors. In other words, we need to 21 reevaluate and simplify. And we can do this, still 22 addressing the issue of predatory lending. 23 My second observation deals specifically 24 with predatory lending. If a problem is pervasive, 25 it needs to be treated as a pervasive problem. If FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 30 1 the problem is limited to a few key players, the 2 remedies need to be precisely targeted to those few 3 bad apples. We need to attack the problem with a 4 rifle, not with a shotgun. Consumers come in all 5 shapes and sizes; some are young, some are old, some 6 are credit worthy, some are less credit worthy. 7 Sometimes the economy is good, sometimes it's 8 chaotic. Whatever is done to combat predatory 9 lending should not limit the ability of a 10 responsible, market-driven lender to deal flexibly 11 with a wide range of consumers in different economic 12 circumstances. 13 The rules need to be on a national basis. 14 At this point we can't tell what rules apply. From 15 state to state multistate lenders are in a morass. 16 There needs to be a national standard which preempts 17 virtually all state laws on the subject. 18 MR. LONEY: Thank you, Mr. Creekman. 19 Mr. Eakes? 20 MR. EAKES: Good morning. My name is 21 Martin Eakes. I come to you as the CEO of 22 Self-Help, which is the largest community 23 development financial lending organization in the 24 country. With $550 million in assets, that makes us 25 about the size of one of Jim Creekman's branches, to FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 31 1 put it in perspective. 2 I will also tell you that Self-Help is one 3 of the oldest and longest subprime mortgage lenders 4 in the nation. For the last 17 years we have been 5 making loans to credit-impaired individuals, 6 primarily minority families, and have provided about 7 $700 million of loans to 11,000 families. During 8 that time we have had virtually no defaults and no 9 foreclosures. So subprime lending can be done 10 responsibly, but often it is not. 11 I also was the spokesperson for the 12 Coalition of Responsible Lending in North Carolina 13 which helped, along with a lot of panelists here, 14 put together the bill in North Carolina. 15 The first point I want to make is to say 16 that predatory lending or loans that have abusive 17 characteristics are not anecdotal as the Federal 18 Reserve notice and your opening comments mentioned. 19 We've documented that in North Carolina there are at 20 least 10,000 borrowers per year who have 21 single-premium credit insurance financed into their 22 loan. Most people agree that that is -- I know Bill 23 doesn't but most people agree that that is predatory 24 per se to have credit insurance financed into the 25 loan. So 10,000 per year at a minimum in North FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 32 1 Carolina. 2 Regarding HOEPA, there are really three 3 different components: There's what Congress passed, 4 there is what the Federal Reserve has the authority 5 to issue as regulation, and then there's the 6 enforcement, primarily by courts and by borrowers. 7 I believe there is no problem with either the first 8 or the third, that Congress passed sufficient 9 authority and that borrowers can enforce, that the 10 real problem has been that the Federal Reserve has 11 not acted to flesh out the regulations under HOEPA. 12 I cite the authority under HOEPA that says 13 the Board, by regulation or order, shall prohibit 14 acts or practices in connection with mortgage loans 15 the Board finds to be unfair, deceptive, or designed 16 to evade provisions of this section. It's not 17 discretionary, it's mandatory; it says you shall 18 come up with regulations for acts you find to be 19 unfair. 20 The fact that the Federal Reserve in 1997-98 21 recommended to Congress that we prohibit the 22 financing of credit insurance and recognized the 23 potential abuse there seems to me to put the duty on 24 the Federal Reserve to actually put in regulation 25 form the prohibition that Congress clearly granted FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 33 1 authority for. 2 There are five areas we'd like for you to 3 look at. Credit insurance should be prohibited for 4 all home loans across the board in single-premium 5 format. Number two, prepayment penalties should be 6 prohibited, or at a very minimum, included in the 7 definition of points and fees for subprime loans. 8 Number three, yield spread premiums paid to brokers 9 should be included in the points and fees definition 10 under HOEPA. Number four, there should be a 11 prohibition against flipping of loans for all home 12 loans under the general discretionary authority that 13 I just mentioned. And number five, there should be 14 a provision that says the first purchaser of a loan 15 is held accountable for any abuses by the broker 16 that originated that loan. We agree with Kate that 17 most brokers are extremely honorable, but for the 18 ones that create loans that are not, the very first 19 lender who purchases those loans should be held 20 accountable for whatever abuses so that there can be 21 self-policing take place in the marketplace. Thank 22 you very much. 23 MR. LONEY: Thank you very much, 24 Mr. Eakes. Ms. Eggers? 25 MS. EGGERS: My name is Helen Eggers and I FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 34 1 am the president of EquiCredit Corporation, which is 2 a subsidiary of Bank of America. EquiCredit is the 3 largest bank-owned subprime lender in the 4 marketplace today. 5 As a context for the discussion today, we 6 want to make one point as a starting point for our 7 thinking. And that is, it is critical to recognize 8 that responsible subprime lenders cannot and should 9 not be confused with predatory lending practices. 10 There are abuses in the home-equity lending 11 industry. We are committed to working with all of 12 you to find solutions that actually benefit the 13 consumer and maintain the availability of credit in 14 the marketplace. 15 We urge the Board to focus on three things 16 in particular: Enforcement of existing consumer 17 protection laws and regulations; secondly, the 18 simplification of disclosures, and finally, consumer 19 education and awareness. 20 A challenge that we share as we face these 21 priorities is that we are working in an environment 22 that is confusing and hampered with rash conclusions 23 and multiple labels. For example, predatory 24 lending, high-cost loans, subprime lending, and 25 threshold loans are all use synonymously when they FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 35 1 are very different things. This kind of language 2 has led to an unfair indictment of the entire 3 subprime home-equity lending industry. Predatory 4 lending involving unfair or deceptive practices or 5 fraud of any kind is engaged in by a minority of 6 unscrupulous lenders and it should be stopped. But 7 why is subprime lending necessary in the marketplace 8 today? Until a decade ago consumers with credit 9 problems or those who wanted to finance 10 nonconventional properties faced little hope of 11 finding mortgage financing. Now responsible 12 subprime home-equity lending meets the needs of this 13 important consumer market. It legitimately serves 14 borrowers who otherwise would be unable to find 15 credit. This market, by the way, is estimated to be 16 about 20 percent of the mortgage market today. 17 EquiCredit is primarily a wholesale risk-base 18 subprime lender that sources for mortgage brokers 19 and correspondents. We are subject to the same 20 lending regulations and use substantially the same 21 documentation as the conforming industry. 22 Bank of America is the industry leader in 23 fair and responsible lending and we are committed to 24 serving the subprime lending market in a fair and 25 ethical manner. Our subsidiaries and Bank of FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 36 1 America do not condone or engage in unfair or 2 deceptive practices. As a subsidiary of Bank of 3 America, EquiCredit has established standards of 4 operation to ensure that we maintain Bank of 5 America's highest standards of fair and equitable 6 lending. EquiCredit loans are originated to the 7 same high standards of agency loans with appraisals, 8 title insurance, income verification, and 9 debt-to-income ratio consideration. The loan 10 documents and disclosures provided to borrowers are 11 actually very similar to those used by Fannie Mae 12 and Freddie Mac. 13 This brings us to our first area of focus. 14 We strongly believe that existing laws and 15 regulations, if consistently enforced across the 16 entire industry, are sufficient to combat abusive 17 and deceptive lending practices. Increased 18 enforcement of existing laws and regulations is 19 needed for those in the industry who have not been 20 as highly regulated or supervised as banks. If 21 additional legislation is enacted we stand at risk 22 of containing credit availability in the market. As 23 an example, EquiCredit volumes are likely to 24 decrease by almost 30 percent due to the North 25 Carolina legislation. That translates to about FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 37 1 $9 million in credit availability in a six-month 2 period of time, or think about 500 families that 3 need to find a new source of financing for their 4 credit needs. And in Chicago, where the city is 5 looking at its own ordinance, our preliminary 6 figures indicate that our business could be impacted 7 by as much as 60 percent. That's $125 million in 8 financing over a 12-month period of time. That's 9 1500 families that have to find a new source of 10 financing. 11 The demand for credit will not disappear. 12 The question is, without federally regulated 13 providers who will meet the consumer's need; who 14 will be there for them? We urge the Board to 15 spearhead an effort working with the Federal Trade 16 Commission and state attorneys general to increase 17 the enforcement of existing laws and regulations, 18 both state and federal, to ensure that those that 19 don't comply with the law are put out of business. 20 We agree -- 21 MR. LONEY: Could I ask you to wrap up. 22 MS. EGGERS: Yes. We agree with the need to 23 simplify disclosures. We'd just like to reinforce 24 our commitment and participation to consumer 25 education. Thank you. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 38 1 MR. LONEY: Thank you. Mr. Bost? 2 MR. BOST: My name is Bill Bost and I'm a 3 member of the Ragsdale William law firm in Raleigh, 4 North Carolina, and I serve as general counsel to 5 the North Carolina Association of Mortgage 6 Professionals. In that role I participated as a 7 member of the working group of industry participants 8 who drafted the North Carolina Predatory Lending 9 Act. In my legal practice I also represent mortgage 10 brokers, mortgage bankers, and other financial 11 services providers. 12 As an initial matter, North Carolina 13 mortgage brokers and lenders agree with regulators 14 and consumer advocates that lending practices that 15 use deception to take advantage of a customer's 16 ignorance and circumstances are intolerable. The 17 North Carolina mortgage industry applauds the 18 efforts of the Board, legislators, and regulatory 19 agencies to eliminate predatory lending. 20 In their recent report, HUD and the 21 Department of Treasury identified four practices 22 they consider predatory: Loan flipping, excessive 23 fees, lending without regard to a borrower's ability 24 to repay, and fraud. North Carolina's law makers, 25 with assistance from an array of interested parties, FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 39 1 addressed these issues with the passage in 1999 of 2 the North Carolina Predatory Lending Act, which, 3 among other things, made loan flipping unlawful, 4 placed significant restrictions on transactions in 5 which fees and interest rates exceed reasonable 6 levels, prohibited the financing of single-premium 7 credit insurance, and required lenders on certain 8 loans to examine borrowers' abilities to repay 9 them. These measures were accompanied by strict 10 penalties for violations. 11 While the provisions of the Predatory 12 Lending Act have been in effect for only a short 13 time, by all accounts the law has had the effect of 14 limiting the frequency of predatory practices and 15 has driven from the market lenders and brokers 16 notorious for them. 17 The Predatory Lending Act, however, also has 18 some undesirable consequences that should be 19 considered as potential rule changes are discussed. 20 Certain common loan products such as FHA loans and 21 loans involving mortgage insurance are difficult to 22 make profitably under the new laws and nonpredatory 23 lenders and brokers must either forego them or risk 24 the drastic remedies of the Predatory Lending Act. 25 Other nonpredatory lenders have decided that the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 40 1 risks of litigation under North Carolina's ambiguous 2 law are too great and have taken their capital to 3 more friendly states. Those that remain spend 4 heavily on compliance measures and have become 5 extremely cautious in their underwriting. 6 We have yet to determine the effect of the 7 new laws on the availability of credit to low- and 8 moderate-income borrowers. 9 HUD reports that home ownership is at an 10 all-time high in American history. The rapid rise 11 in the rate of home ownership can be attributed to 12 the change in the number and types of entities that 13 now deliver a wide variety of mortgage products in 14 an increasingly complex regulatory and economic 15 environment. Experts estimate that subprime loans 16 currently constitute approximately 15 percent of the 17 home mortgage market, and everyone agrees that not 18 all subprime lending is predatory. 19 Current regulations under Section 32 of 20 Regulation Z provide adequate protection in any of 21 these transactions. Stringent additional 22 regulations that address anecdotal ills in the 23 relatively small number of remaining loan 24 transactions can unnecessarily and adversely affect 25 a broad range of important mortgage activities and FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 41 1 can stifle competition. Accordingly, the North 2 Carolina mortgage industry encourages the Board to 3 focus its efforts on identifying and limiting only 4 truly unfair practices occurring in the mortgage 5 industry, with an emphasis on educating customers as 6 to the availability of mortgage products, the 7 effects of credit history on their ability to 8 borrow, and the terms and consequences of the loan 9 transactions into which they enter. We strongly 10 discourage any changes to HOEPA's rates or fee 11 thresholds which could hinder competition and choice 12 in a very effective home equity market. 13 We look forward to participating in this 14 process and thank you for having us. 15 MR. LONEY: Thank you, Mr. Bost. 16 Mr. Lampe? 17 MR. LAMPE: My name is Don Lampe and I'm a 18 partner at the Smith, Helms, Mulliss & Moore law 19 firm here in North Carolina. I provided a technical 20 commentary to the predatory lending legislative 21 working group with our new law, and I also served as 22 a public member of the North Carolina general 23 assembly's credit insurance and mortgage credit 24 committee this past year where we looked at 25 reforming and amending certain aspects of North FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 42 1 Carolina's new law. 2 I urge the Fed to move slowly and cautiously 3 into the expansion of HOEPA regulation. There are 4 several factors which show that caution and moving 5 slowly is warranted. No one really knows at this 6 time the effect of expanded HOEPA regulations on the 7 availability of credit. North Carolina now is in 8 effect a living laboratory for the Fed's 9 consideration, as well as New York with its new 10 Part 41 regulations. And of course there are other 11 states and municipalities that are considering 12 HOEPA-like high-cost home loan laws, and of course 13 data from these places will not be available at 14 least until months from now. In fact, in North 15 Carolina, the North Carolina general assembly 16 recognized the importance of measuring the effect of 17 our high-cost home loan statute on the availability 18 of credit by providing for a legislative study 19 committee to look into the issue and to report to 20 the general assembly's future sessions. 21 A related issue is the effect of expanded 22 high-cost home loan laws on the securitization of 23 home loans. It is well known that much of the 24 capital flowing into residential mortgage lending is 25 provided through securitization or secondary market FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 43 1 transactions. Subjective legal standards such as 2 those contained in North Carolina's high-cost home 3 loan statute increase the due diligence burden and 4 magnify legal risk in securitization transactions, 5 again with the potential to adversely affect the 6 availability of loan funds to otherwise deserving 7 mortgage borrowers. An example of a troublesome 8 subjective standard would be, for example, to change 9 HOEPA's pattern and practice test for unaffordable 10 loans to North Carolina's case-by-case 11 determination. 12 Finally, caution is warranted because there 13 can be unintended consequences of even the best 14 intentioned consumer protection regulation which I 15 think everyone at this table would advocate. If 16 there is a rush to regulate in this area we may have 17 similar experiences nationally to the extent we use 18 the North Carolina law as a template. Examples of 19 unintended consequences -- Mr. Bost mentioned 20 broker-originated VA and FHA loans no longer being 21 available in North Carolina. Even though these 22 loans have been specifically designed to target 23 low-income borrowers, those loans probably won't be 24 made in North Carolina because of the broad and 25 ambiguous points and fees test in our law. Also, FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 44 1 payments of closing related fees to affiliates are 2 being discouraged even in a time when the free 3 market and other federal initiatives such as 4 Gramm-Leach-Bliley point the other way. 5 And finally, the compliance burden and risk 6 of noncompliance have become so high in North 7 Carolina, a consequence of lenders leaving our 8 market, which final information on that of course is 9 not known. 10 I thank the Board for permitting me to speak 11 here today and look forward to participating in the 12 process. 13 MR. LONEY: Thank you, Mr. Lampe. 14 Ms. Marks? 15 MS. MARKS: Everybody knows who I am, I 16 hope. Well, I want to thank you for the opportunity 17 to express the views of my company; thank you so 18 much. Fannie Mae has long been concerned about this 19 problem of predatory lending and we commend the 20 Federal Reserve for calling this hearing and 21 gathering information. 22 As you mentioned my name is Fe Morales 23 Marks, and I'm a vice president in Fannie Mae and I 24 run a policy shop. I've submitted a full set of my 25 testimony which is available in the back, but I'd FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 45 1 like to highlight a few things for you this 2 morning. 3 Today I'd like to reaffirm Fannie Mae's 4 determination to be a leader in the housing finance 5 industry and in efforts to stem predatory lending, 6 predatory practices which rob borrowers of 7 opportunity and hard-earned equity. We have 8 approached the issue of predatory lending from a 9 perspective of the consumer but cognizant of the 10 role that we play in the marketplace, being that 11 we're in the secondary market. Our approach aims to 12 bring value to consumers in eight ways. 13 First, we want to expand the application of 14 conventional conforming practices and standards to 15 more borrowers. Second, we seek to advance a 16 mortgage consumer's rights agenda. Third, we are 17 committed to provide innovation and flexibility 18 through new products and services. Fourth, we will 19 use technology to expand markets and reduce costs. 20 Fifth, we will continue to work very hard to keep 21 homeowners in their homes. Sixth, we will continue 22 support for our nonprofit partners in the home 23 counseling industry and in turn rely on their 24 efforts to increase homebuyer readiness. Seventh, 25 we will continue our strong support for the Fannie FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 46 1 Mae Foundation, which is a national leader in 2 consumer outreach for home ownership. Eighth, we 3 are developing and advancing responsible policies 4 for serving consumers with blemished credit. 5 Let me highlight four things for you today. 6 First, we recently announced the DU 5.0, which is 7 the new version of our Desktop Underwriter which is 8 our automated underwriting system. Through this new 9 version, lenders will be able to receive much more 10 information, customize messages around a consumer's 11 profile, which will help inform a consumer as to why 12 they're having difficulty accessing credit and will 13 in turn help them to improve their own credit 14 standing. 15 Secondly, we also recently announced our 16 True Cost Calculator, which is a calculator that is 17 available on our Web site and we're also making it 18 available to lenders so they can use it on their own 19 Web sites. This is a tool that will allow consumers 20 to compare the cost of products that they have under 21 consideration and will also help them avoid 22 predators. 23 Third, we've developed a new product, the 24 Timely Payment Rewards mortgage. This is an 25 alternative to products that are now available to FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 47 1 consumers in the subprime market. It offers 2 consumers an alternative which generally will be 3 about two percentage points lower than the options 4 they now have available. It allows for an automatic 5 one percentage point reduction in rate automatically 6 after -- oops, time is up; let me not tell you the 7 details of my Timely Payment Rewards mortgage. 8 Let me go on and tell you that we do have a 9 lender letter that lays out our policies around the 10 business that we will buy. We speak to issues such 11 as steering, excessive fees, and prepayment 12 penalties, which are issues that are under 13 consideration here. 14 I will close by saying that we believe that 15 competition and good money drives out bad money and 16 we're prepared to help bring good money to drive out 17 the bad money and the predatory behavior. 18 MR. LONEY: Nicely wrapped up. 19 Mr. Burfeind? 20 MR. BURFEIND: Good morning and thank you 21 very much. I'm here on behalf of credit insurers. 22 The credit insurance issue is really just one small 23 aspect of the overall issue or issues that are 24 subject to your inquiry today, but I'm probably the 25 only one here best prepared to respond to those FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 48 1 issues. I think the critical policy decision that's 2 already been laid out in one way or another for the 3 Board is whether or not to prohibit the financed 4 single-premium credit insurance in connection with 5 home loans. 6 I would like to first emphasize that credit 7 insurance is not a lending practice. Credit 8 insurance is a product like any other product, and 9 when financed out of loan proceeds or out of home 10 equity, it is financed no differently than any other 11 product. Consider one of the main products, I 12 guess, or forces for which home equity is borrowed 13 against: the consolidation of credit card loans. 14 Think of the things that you and I charge on credit 15 cards -- restaurant meals, oil changes, blue jeans 16 at the store -- all financed out of home equity. 17 Would we prohibit the consumer from financing those 18 products by utilizing their home equity? 19 We the credit insurance companies believe 20 that the availability of the financed single-premium 21 should be retained. Proponents for prohibition 22 point to some particularly egregious examples where 23 borrowers were victimized by a broker or lender that 24 included credit insurance premium financing in the 25 loan package. However, a conscientious examination FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 49 1 compels a distinction between some fraudulent or 2 abusive lending examples and the whole universe of 3 good credit insurance product servicing. 4 Credit insurance is a valuable option that 5 protects home equity from the predators of time and 6 nature, predators like death and disability and 7 accident. The availability of premium financing 8 makes the product more affordable to many more 9 consumers. Mr. Eakes mentions 10,000 borrowers with 10 financed credit insurance premium on their loans. 11 Absent this financed credit insurance premium, many, 12 maybe all, but at least many of these borrowers 13 would have no or substantially no insurance 14 protecting that home equity. 15 Credit insurance critics allege that the 16 borrowers are coerced or otherwise tricked into 17 purchasing the coverage and that the coverage is of 18 little value. Let me just say in the short time 19 allotted here that there have been numerous studies 20 done with respect to credit insurance consumer 21 buying habits. Two of them were done by the Federal 22 Reserve Board, and I do have the findings available 23 to recite into the record at a later time. The most 24 recent one done by the Credit Research Center, and I 25 would just highlight the general conclusion, that FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 50 1 consumer loans, including home equity, that the 2 purchase patterns for credit insurance are readily 3 explainable without reliance on seller coercion as a 4 factor. 5 There's also the allegation of low value. 6 Credit insurance critics embrace a 60 percent loss 7 ratio standard as the measure of value. Well, 8 credit life and disability insurance written in 9 connection with real estate secured loans do meet or 10 exceed that standard. 11 In summation, I would just say that the 12 financed single-premium is a valuable insurance 13 product to many consumers and its availability is to 14 be preserved. 15 MR. LONEY: Thank you. Mr. Stock? 16 MR. STOCK: Governor Gramlich, Mr. Loney, 17 distinguished members of the panel, my name is Paul 18 Stock. I'm executive vice president of the North 19 Carolina Bankers Association. Batting clean up, I 20 wish I had some precise, final, pointed comments 21 that would bring us all to a sharp focus before our 22 panel discussion. 23 MR. LONEY: Me too. 24 MR. STOCK: In lieu thereof, I would like 25 to submit a couple of observations from one of the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 51 1 participants in our drafting experience here in 2 North Carolina. 3 First, I'd like to say that from the 4 perspective of the banking industry there's been a 5 lot of discussion nationally about what was the 6 banking industry thinking about in North Carolina. 7 We discussed at a policy level with our leadership 8 extensively both the nature of the problem that had 9 been identified and the potential risks and rewards 10 of moving forcefully ahead into this arena. I think 11 that the thousands of person hours that went into 12 the drafting process are testimony to the complexity 13 of the problem with which you deal, which is only 14 magnified by the fact that you're dealing with a 15 tapestry of laws in the various states and the 16 preemptions that have already been mentioned of 17 federal law, and dealing within some pretty 18 meaningful restraints as to what you can do under 19 HOEPA. 20 I think that much like the problem with 21 defining obscenity, a lot of people think they know 22 a predatory loan when they see one, and they 23 identify certain characteristics. Yet these are all 24 very small puzzle pieces, and when put together 25 wrong those puzzle pieces, I think, can lead to a FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 52 1 loan that maybe everybody in this room would say is 2 predatory. When put together in a different fashion 3 for a borrower of different circumstances, you may 4 have a loan that's creative and innovative and is 5 helping a family in a time of real need. 6 In my first 48 years of life I never heard 7 the word "anecdotal" but I've heard it a bunch for 8 the last two years. And I think the time has come, 9 given that we've gotten a law in North Carolina and 10 a regulation in New York, for there to be some 11 scientific analysis and see which of those puzzle 12 pieces at least most often occur in predatory loans 13 and to see if the Board, with its authority under 14 HOEPA, can address those particular pieces. 15 I think that we don't know what we've 16 wrought here yet. I think that we have certainly 17 dealt with some of the most common problems of 18 predatory lending as it's existed in the past. But 19 one thing we've learned is predatory lenders are 20 most creative, and if all we've accomplished in 21 doing this is forcing them to shift their modus 22 operandi and to take a different approach, maybe 23 unsecured loans that are reduced to judgments 24 against homeowners and still homeowners are going to 25 be losing their homes, then we've accomplished FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 53 1 little despite the best intentions and a great deal 2 of effort. So I would encourage the Board as part 3 of this process of analyzing what steps can be taken 4 under HOEPA to analyze what's been done in the 5 jurisdictions that have acted and as scientifically 6 as possible analyze what those effects have been. 7 Thank you. 8 MR. LONEY: Thank you, Mr. Stock. That 9 concludes the prepared remarks, but I'd like to 10 emphasize to the panelists, first of all, our thanks 11 for going to the trouble to do this, and also that 12 if you want to embellish those remarks or give us 13 the complete prepared text, some already have, we'll 14 be glad to have them. 15 What I'd like to do now is start talking 16 about some of the specific issues that the Board 17 raised in the notice of these meetings, and the 18 first issue I wanted to raise with you -- and again, 19 I'd like to emphasize that people can chime in, ask 20 questions, fill in, whatever, as we talk -- but 21 HOEPA covers mortgage loans that meet one of the 22 act's two high-cost triggers. A loan is covered if 23 the APR exceeds the rate for Treasury securities 24 with a comparable maturity by more than ten 25 percentage points, the points and fees paid by the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 54 1 consumer exceed the greater of 8 percent of the loan 2 amount, or $400, or $451 or something this year. 3 The Board has the authority to expand 4 HOEPA's coverage under both triggers and I'd like to 5 discuss the possible expansion of the triggers 6 first, if we could, then discuss the possible 7 effects of expanded triggers on credit 8 availability. 9 Starting with the APR trigger, HOEPA 10 authorizes the Board to adjust the HOEPA trigger by 11 two percentage points from the current standard of 12 ten percentage points above the Treasury rate, 13 Treasury securities with comparable maturities. 14 Several of you, as you've mentioned, were active in 15 crafting the North Carolina statute which keys off 16 HOEPA's requirements, and under the North Carolina 17 law the points and fees trigger is lower than HOEPA 18 but the rate trigger is the same as HOEPA's. We 19 were wondering what the thinking was in keeping the 20 APR trigger at ten percentage points and whether 21 there was debate about that and was data offered in 22 support of the various positions. 23 One thing that is obvious to us is that the 24 Board must wrestle with the issue of, if it were to 25 adjust the rate trigger, what gives the Board the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 55 1 basis to peg it to a particular percentage point. 2 The Congress narrowed the range of possibilities to 3 two percentage points, but the question is why would 4 eight be the right number or why would nine or nine 5 and a half percentage points. So if we can start -- 6 oh, and one issue that Mr. Stock mentioned that is 7 very relevant I think to this discussion is, does 8 anybody have any data? I think I was almost 48 9 before I heard the word "anecdotal", or knew what it 10 meant anyway, but one of the issues we face is 11 whether anybody can come up with data. 12 We've been looking and I suspect you have 13 too, so I'd like to hear about anything you have to 14 say about the availability of data, especially on 15 how many loans would be covered if we dropped the 16 rate to eight or nine or whatever the number may be; 17 how do we know what the impact would be of dropping 18 that rate on the number of covered loans. 19 I'd like to offer that as a suggested topic 20 for discussion for the next little while. Anybody 21 want to say something? Mr. Lehman, you look ready. 22 MR. LEHMAN: I'm sure everybody else is 23 too. 24 MR. BLANTON: Can I expand the question a 25 little bit? In effect changing the trigger, how FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 56 1 would that change the availability of credit? I 2 know Ms. Eggers' remarks about the fact that it 3 would reduce the ability of her company to make -- 4 if we went to eight how would that reduce your 5 ability to make credit available? 6 MR. LONEY: Mr. Lehman? 7 MR. LEHMAN: I'd just like to address the 8 question about why we ended up with what we did, why 9 the points and fees standard was lowered from what 10 HOEPA has and the APR was not. 11 We discussed these issues at some length and 12 it was I think our general conclusion that points 13 and fees, high points and fees, are more abusive by 14 far than high interest rates, the reason being is 15 that somebody with a high interest rate loan can 16 refinance out of the loan if his position improves, 17 if his credit position improves. 18 Fees, high fees, are earned when the loan is 19 closed. The money is gone, the equity in the 20 person's house is lost to that extent. We certainly 21 had evidence of lots of high-fee loans where the 22 loans had not appeared to be -- the fees did not 23 appear to be justified or fully earned, and I think 24 there was consensus that eight points was more than 25 enough and that five points provided enough room for FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 57 1 reasonable origination costs and reasonable 2 compensation to mortgage brokers. 3 But we definitely focused on the fee 4 threshold more than the APR threshold because we 5 thought that's where the problems were. 6 MR. COUDRIET: I could address availability 7 impact. We at Saxon consider ourselves one of the 8 most highly ethical lenders in the subprime 9 business. We had to exit the state of North 10 Carolina for our refinance products because we were 11 concerned about the suitability standards and dear 12 friends at the bar being able to help us interpret 13 those. So to the extent that we were active, and we 14 are active, in our neighboring state in the 15 refinance business, we had to withdraw. 16 MS. EGGERS: I would add to the 17 availability concerns to address the question asked 18 earlier. Bank of America currently does not 19 participate in the Section 32 loan market for 20 several reasons: The additional liability issues, 21 the additional cost of supporting those loan 22 programs, and importantly the reputational risk 23 because of the unfortunate confusion of the 24 assumption that a high-cost loan is a predatory 25 loan, so we don't participate in that market. We FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 58 1 would need to make a business decision about whether 2 we could participate in the Section 32 market if 3 those triggers were changed. 4 We've also looked at the numbers to get some 5 sense of impact to the marketplace, and when we 6 looked at our production for the first six months of 7 the year and we assumed that the APR trigger drops 8 from 10 to 8 percent, we've estimated an approximate 9 6.2 percent volume impact. In other words, if we 10 maintain our position of not participating in 11 Section 32 loans, that would reduce Bank of 12 America/EquiCredit's production by 6.2 percent. 13 Extrapolate that out, that's half a billion dollars 14 of mortgage availability in a year. 15 I think our key concern, and I think the 16 Board has to wrestle with this in some way, is that 17 the credit demand doesn't go away. So if your 18 supervised, federally regulated lenders are not 19 going to be the ones providing the credit, then who 20 will. 21 MR. LONEY: I just got a note that people 22 can't hear. Is that true, you can't hear where -- 23 in the back? I'd ask the panel -- I'm not sure what 24 I can do about it technically myself but if anybody 25 can help me out back in the wall somewhere, but I FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 59 1 ask the panelists to make sure they're speaking 2 clearly into the mike. Thank you. 3 MS. CRAWFORD: I have found that we are 4 losing lenders in North Carolina on a weekly basis. 5 Lenders that have been in our market for years are 6 exiting because they don't understand the law and 7 they're afraid of getting sued. In my family, my 8 husband is a compliance officer and they deal in 23 9 states, and he said this is the most complex of the 10 laws that he deals with. 11 I would just like to ditto what everybody 12 has said, that we need to go slow, we need to think 13 about what we're doing and maybe look at what is 14 going to happen in North Carolina instead of just 15 jumping on this bandwagon. Predatory lending is a 16 problem, it's a huge problem, but I think that 17 before we start denying credit to people and the 18 credit availability is diminished, we need to think 19 about them too. Because North Carolina is going 20 to -- the borrowers are going to have a problem 21 getting loans in North Carolina. I've already had 22 brokers say I'm not doing loans under $50,000, and 23 that excludes a lot of people in North Carolina from 24 getting houses or keeping their houses. 25 MR. LONEY: This law just went in effect FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 60 1 what, a month ago? 2 MS. CRAWFORD: It's been in effect since -- 3 part of it's been in effect since last October, 4 really. 5 GOVERNOR GRAMLICH: I wonder if I could ask 6 if those who are pulling out of North Carolina could 7 be a little more specific about what it is that is 8 forcing you to do that. Because we've already heard 9 that North Carolina didn't change the rate trigger, 10 it only changed the points trigger, and there were a 11 few -- Mr. Lehman mentioned a few things that were 12 prohibited. But is it those prohibitions that are 13 bothering you or is it the fact that the effect of 14 HOEPA's net is a little wider or is it something 15 else? Exactly what is it that is the problem? 16 MS. CRAWFORD: I think one of the problems 17 that we're hearing is, what is a net tangible 18 benefit. And that is, we have to prove net tangible 19 benefit and there's no definition of net tangible 20 benefit and the lenders are scared to death to make 21 a loan because of those three words. 22 MR. LONEY: Net tangible benefit to the 23 refinancing? 24 MS. CRAWFORD: To the borrower for a 25 refinance, yes. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 61 1 MR. LAMPE: The lenders that I have been 2 representing that have been pulling out of North 3 Carolina have explained to me that -- there's two 4 related reasons that I'm hearing. One is that the 5 high-cost home loan statute, coupled with the other 6 consumer protections in the predatory lending bill, 7 which includes the anti-flipping provision, are 8 highly subjective, and I cannot give them -- I 9 cannot design a compliance program for them that 10 they can follow objectively and know that if they 11 followed it they've complied with the law. And that 12 is -- I don't think that would have been a big 13 problem in North Carolina, but for the first time in 14 North Carolina we have unfair and deceptive trade 15 practice with treble damages and attorneys fee 16 shifting built into the new law, so the risk of 17 legal noncompliance has become so much higher in 18 North Carolina, because we didn't have that; we 19 didn't have unfair and deceptive trade practice, 20 treble damage and attorneys fees if a lender went 21 wrong in some way. 22 That's what I'm seeing out in the field. I 23 guess I must say that my experience is anecdotal and 24 I haven't done a scientific survey. I've yet to do 25 a top-to-bottom compliance program for a lender that FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 62 1 wants to make high-cost home loans in North 2 Carolina, and I've been advising dozens of lenders 3 how to stay out of the net of the high-cost home 4 loan statute, which addresses the availability of 5 credit issue in some way. 6 MR. LONEY: What I'm hearing is that it's 7 not the rate trigger or the points and fee trigger, 8 it's these other elements of the North Carolina 9 law. The question that we posed was what about 10 changing the rates and fees. People have argued we 11 ought to change it to eight, the APR trigger. What 12 about that? 13 MR. CREEKMAN: I don't think your 14 understanding is accurate. I think that the rate 15 trigger is not the big issue, I agree with you 16 there. And that was not -- although that was an 17 initial issue that was debated in the ad hoc 18 drafting group, it was not one of the great sticking 19 points in the discussions. 20 I think the two principal problems for 21 lenders, and these include prime lenders as well as 22 subprime lenders, is, number one, the calculation of 23 the points and fees, particularly in the environment 24 that we now face where lenders have been given 25 greater authority under Gramm-Leach-Bliley to engage FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 63 1 in insurance activities. So the issue is, what 2 comes into both the numerator and the denominator in 3 the calculation of the five percentage points. And 4 that is an extremely complex calculation and has to 5 be done on a loan-by-loan basis, and quite honestly, 6 there aren't a whole lot of us -- in fact, we have 7 not figured out yet how to systemize it, and if you 8 can't systemize it you can't engage in bulk lending, 9 as a practical matter. 10 MR. LONEY: That is one of the things 11 that's causing these lenders to leave North 12 Carolina? 13 MR. CREEKMAN: I can't tell you why they're 14 leaving because we're still here and we're staying. 15 I can tell you that that is the experience that 16 lenders are having in trying to deal with the new 17 North Carolina statute. The other is the very 18 nebulous nature of the flipping provision, and both 19 of those are very troublesome. 20 I think Don Lampe's comments as to his 21 discussions with lenders as to exactly why they are 22 leaving is probably the best indication we have as 23 to true reasons. 24 MR. STOCK: I might note that on the idea 25 of changing the triggers, if you change the HOEPA FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 64 1 triggers it requires disclosure on a greater number 2 of loans. And I think -- and Phil and Martin will 3 certainly correct me if I'm wrong, they have been 4 for a long time -- but I think they would say that 5 the design of the consequences for tripping the 6 triggers in North Carolina was intended to be 7 sufficiently draconian that no one would make a 8 high-cost home loan in this state. That's very 9 different from the HOEPA approach. Martin is 10 shaking his head; I think I got a nod out of Phil. 11 But at the very least there are substantial 12 consequences beyond disclosure if you trip the 13 triggers in North Carolina. 14 And I know throughout the discussions -- 15 because I would say that our initial perspective was 16 to try to better tailor disclosures to the subprime 17 market when we went into these negotiations and we 18 were told over and over and over again, I think Jim 19 Creekman made the point initially, that another 20 layer of disclosures on top of the huge stack that 21 are already overwhelming to the borrower was not 22 going to solve this problem. So if the result of 23 changing the triggers is just providing more 24 meaningless disclosures to a greater number of 25 people, I'm not sure how it's going to effect the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 65 1 problem. 2 GOVERNOR GRAMLICH: I wonder if I could ask 3 about that. You've mentioned it and several other 4 people mentioned the disclosures. There seems to be 5 a plea for simplifying the disclosures, and are 6 there -- I'm a novice to this area but are there 7 practical suggestions for how to do that, that 8 matter X really doesn't have to be disclosed, it's 9 just added print and doesn't do anything, or would 10 you want more safe harbors or -- what is the 11 practical guidance about that? 12 MR. STOCK: I think -- I mentioned the 13 Stock theorem, the five disclosures. I think that 14 perhaps what we ought to do is take every disclosure 15 that's currently required, and through groups like 16 this, attempt to prioritize them and then go down 17 the list and just using common sense say, you know, 18 if we have more than this number we've lost the 19 effect of all of them. And it's got to be a much 20 smaller number, in English, with a few numbers that 21 are the important numbers for the consumer to look 22 at to say this is a worse deal than that. 23 Of course that was the whole concept behind 24 the truth in lending when it was enacted. But with 25 the other laws that have been layered onto it and FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 66 1 things like HOEPA, it's absolutely daunting to even 2 somebody that's reasonably proficient in the field. 3 You've got to stop, step back, and think about it 4 again before you even try to explain it to someone. 5 MS. EGGERS: We completely agree with his 6 point. 7 MR. EAKES: A couple of points. Some of the 8 disclosures are actually harmful; for example, APR, 9 which was set up to give you one rate. The fact 10 that APR takes eight or ten points of fees and 11 spreads it across 30 years in the calculation of an 12 APR actually could end up having a consumer think 13 when their rate on the loan was 10 percent and their 14 APR shows up at 11 percent, to misunderstand the 15 timing of when those fees really took effect. So 16 you could have ten points on the front end which 17 attach immediately and are gone, but the APR 18 actually gives you this false sense of security that 19 is misleading. 20 In response to Paul's point about what we 21 were intending to do with high-cost loans, we really 22 had two different categories of high-cost loans in 23 North Carolina just as you do under HOEPA. For a 24 high-cost loan that trips the fee triggers, we 25 essentially had very draconian consequences in the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 67 1 North Carolina bill. It basically said you can't 2 finance any fees. Well, really that comes out 3 essentially to meaning that you can't make a 4 high-cost loan a high-fee loan because most of the 5 borrowers would need to finance it if they were 6 going to have those high fees. 7 On the other hand, we had the specific 8 philosophy of saying we are not capping in any way 9 the amount of risk premium that can come to a 10 credit-impaired lender, to a lender -- to 11 credit-impaired individuals. So we were basically 12 encouraging lenders to put their pricing in the 13 interest rate. And the interest rate -- if you are 14 a high-cost loan through the interest rate, which 15 under current standards would be about 16 percent, 16 just as HOEPA -- HOEPA does not have anything that 17 is very onerous if you kick in the high cost except 18 for the pass-through liability, and that scares 19 lenders. And we think that that does what it was 20 intended to too, which was say there should be some 21 due diligence and self-policing. That certainly was 22 Congress's intent, and we think that ought to be 23 expanded. 24 In North Carolina, we said if it's a 25 high-cost loan by interest rate, fine, but let's put FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 68 1 everybody on the same playing field. Because what I 2 hear from lenders directly is that I can't eliminate 3 prepayment penalties for my loans unless all the 4 other lenders in my marketplace are eliminated at 5 the same time; if everyone is constrained then we 6 can compete on the same playing field and we will be 7 competing on interest rate. 8 So from the community advocate's point of 9 view, our view was that many of us got into this 10 lending business to help minority borrowers own 11 homes. We felt like that was the only way for many 12 people to enter the middle class, and probably for 13 many of the people who are sitting here who are part 14 of that community, the single most unacceptable 15 economic fact in American society for us is the 16 disparity in wealth between black and white 17 families. You probably know this number from 1990: 18 The median net wealth for black families was $4,000, 19 for white families it's $44,000. What we were 20 seeing that was not -- I guess it was anecdotal, but 21 there were hundreds and hundreds of cases that the 22 black borrowers that we had been helping to get home 23 loans to build family wealth over the last 17 years 24 were losing the entire amount of built-up wealth 25 they had because of the fees that were being charged FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 69 1 and the prepayment penalties that were essentially 2 deferred fees. And so the focus in North Carolina 3 was specifically on trying to prevent the wealth 4 stripping, particularly as it impacted Latino and 5 African-American families. 6 MR. LONEY: Can I take one more shot at 7 trying to focus the question here on the question 8 of -- I'm going to take one more shot at trying to 9 focus the question on what is thought about the 10 Board dropping the trigger rate and why, what basis 11 would we have for choosing one lower number than 12 another, or is that -- I mean, because that is one 13 of the very live issues, we should drop the trigger 14 rate, and I'm not hearing -- 15 MR. EAKES: One response: At the banking 16 committee hearings, Assistant Secretary Gensler 17 reported, and I don't know where his data came from, 18 that less than 1 percent of the subprime loans were 19 triggered by the 10 percent APR HOEPA trigger. So 20 the real question is, how many loans do you want in 21 the subprime arena to be subject to the pass-through 22 liability; that's really the significant issue. And 23 if EquiCredit says that for their lending it would 24 be an additional 6 percent in moving from 10 percent 25 above Treasury trigger to 8 percent above Treasury FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 70 1 trigger, my guess is that you would want to drop 2 further than what Congress has enabled you to do, 3 that you really would want to cover, in the subprime 4 arena, 20 to 30 percent of loans under HOEPA. 5 Because it doesn't prohibit them, it simply says 6 that you have some scrutiny and some self-policing. 7 So maybe the question I would reflect back to you 8 is, what level of loans do you want to fall under 9 the HOEPA category. 10 Right now I think we have a chicken and egg 11 situation. Because it's such a small number, you 12 know, 1 percent or less, that fall into the HOEPA 13 trigger, you get the stigma attached to a Section 32 14 loan that wouldn't be there if it were 25 or 15 35 percent. So perversely it may be that the more 16 loans you cover the less cutoff of credit 17 availability that you have. I really believe that's 18 true. There is a stigma that we've had with lenders 19 that said we're not going to do any Section 32 loans 20 because we're afraid of the headline risk. If 21 that's the 1 percent highest cost loans, since 22 that's the only ones that get covered, they're 23 saying we're just going to stay out of it. 24 GOVERNOR GRAMLICH: Could I follow up? I 25 hear what you say, but then it strikes me that it FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 71 1 would have made sense for North Carolina to lower 2 the rate trigger, if what you say is right. I mean, 3 you know, because you expressly didn't -- maybe not 4 you personally -- 5 MR. EAKES: I can personally tell you what 6 I think, at least from the coalition, which had 7 three million members, is that we felt that the 8 Federal Reserve would be forced or would consider 9 and would end up lowering the rate to eight. 10 GOVERNOR GRAMLICH: So it's unnecessary for 11 North Carolina to -- 12 MR. EAKES: In our early drafts of the 13 North Carolina legislation we had lower thresholds 14 on the interest rate test. In the negotiation and 15 compromise that went back and forth, the community 16 and civil rights folks ended up saying no, we are so 17 much more concerned about the fees that if we have 18 to give up we'd rather give up on the interest rate 19 threshold and tie it. This was -- also, a number of 20 the lenders' attorneys were saying to the extent 21 possible let's track the North Carolina bill to 22 HOEPA so that we only have one standard procedurally 23 to implement. 24 This was one of those places that we felt, I 25 felt, that eventually the standard would get lowered FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 72 1 from ten to eight, and we didn't really want to 2 push. I mean, I have this disagreement with some of 3 my colleagues in Chicago who want to have an 4 interest rate threshold at 6 percent or 5 percent, 5 that's very, very low, lower to the Treasury. Well, 6 that's a simple standard, but what we believe here 7 in North Carolina was that we really need to focus 8 on the wealth stripping, that that is the key 9 problem, particularly for minority communities, that 10 is leading to such great foreclosure rates. 11 MR. CREEKMAN: Let me just add one aspect 12 to that which I think is important, and that is that 13 the North Carolina law is not like Section 32. The 14 North Carolina law is, in essence, a usury law 15 substitute. The decision was made very early on 16 that we could not regulate fees, points and fees, or 17 rates. We recognize that federal preemption would 18 then permit a lender to overcome those 19 restrictions. So the object was to design a 20 series -- a threshold above which a lender would be 21 required to do things or not do things which would 22 essentially strip the loan of its economic value to 23 the lender and make it virtually impossible for him 24 to comply and to comply with a profit. And so the 25 object of the North Carolina law is to prevent any FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 73 1 high-cost home loan. 2 MR. EAKES: High cost by fees. 3 MR. CREEKMAN: No, it's high cost by fees 4 or rates. If you go over the 10 percent, the same 5 penalties apply. 6 MR. BOST: Threshold. 7 MR. CREEKMAN: If you exceed any one of the 8 three thresholds, the 10 percent being one of the 9 three thresholds, you're going to fall into that 10 category. Now, that means that -- the way the North 11 Carolina law is written now, because the rate 12 threshold parallels Section 32, it means in North 13 Carolina there are dire consequences for a lender 14 who makes a Section 32 loan by exceeding the 15 10 percent rate. 16 MR. EAKES: The reason I'm saying there's a 17 difference between interest rate and fees in terms 18 of the North Carolina bill is that you have multiple 19 pieces of pricing that you can attach to get the 20 risk return you need for a loan so that you don't 21 have credit rationing. If you put it into interest 22 rate and not into fees, the primary restricting 23 category in the consequences of a high-cost loan in 24 North Carolina is the inability to finance fees. So 25 if you put your risk return premium into interest FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 74 1 rate rather than putting it into fees, which is what 2 basically the finance companies in North Carolina 3 have been restricted to doing for decades, then the 4 consequences are not -- certainly that very powerful 5 consequence doesn't become constraining. So if you 6 put your return into interest rate instead of fees, 7 the prohibition against financing fees is not a 8 binding constraint, that's my point. 9 MR. LAMPE: I think Mr. Creekman's point is 10 that there are three thresholds in the North 11 Carolina law. How you get there is your business, 12 but one of the ways you get there is through 13 interest rate, one of the ways you get there is 14 through fees, and there's an independent threshold 15 for prepayment penalties. And the market effect of 16 this, in my anecdotal experience, is that lenders do 17 not want to make these loans no matter how they get 18 there. 19 Mr. Eakes is also correct in saying that one 20 of the prohibitions is the financing of points and 21 fees in the law, but that's beside the point if one 22 way or another lenders say we don't want to be 23 within that net, whether it's by way of fees, by way 24 of interest rate, or by way of prepayment penalty. 25 So maybe that's cutting the bologna a little thin on FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 75 1 the analytical side, but thresholds are thresholds 2 as far as lenders are concerned. 3 GOVERNOR GRAMLICH: Let me -- you're 4 disagreeing on a number of things but there does 5 seem to be one thing that everybody is at least 6 implicitly agreeing on, and that is that the point 7 of the North Carolina law was to make the provisions 8 so difficult that it really closes down the North 9 Carolina definition of the high-cost loan market. 10 Right? 11 MR. EAKES: For high fee loans. 12 GOVERNOR GRAMLICH: However it's defined, 13 there are different triggers, but the point is to 14 really close that market down, whereas the point of 15 HOEPA seems to be somewhat different, which is just 16 that you have added disclosures and whatnot in the 17 HOEPA segment but not to close the HOEPA segment 18 down. Is that something that you're all more or 19 less -- an idea that you all more or less hold? 20 MS. EGGERS: Governor, I think that is the 21 intent. I think one of the challenges -- so that 22 HOEPA is geared to more disclosures and North 23 Carolina wants to suggest that high-cost loans are 24 automatically predatory and therefore should not be 25 done. But I think the confusion that we're finding FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 76 1 in the marketplace is, if you just went out and 2 polled people to describe the difference between a 3 high-cost loan and predatory loan or a threshold 4 loan, there isn't clarity around that. So we're 5 indicting a broader base of lending than I think we 6 intend. So I wouldn't assume that if you get more 7 loans in the arena of high-cost loans that that's 8 going to assuage all of the lenders' concerns and 9 that we are going to flow back into that 10 marketplace; I'm not certain about that, for all the 11 reasons the panel members have indicated. 12 MR. CREEKMAN: Let me make one more 13 observation. If the rate is lowered under Section 14 32 to 8 percent, it will automatically be lowered 15 under the North Carolina law to 8 percent. The 16 result of that will be -- the result of that will be 17 that in North Carolina loans won't be made over that 18 8 percent threshold. So it isn't a question of just 19 giving more disclosures to a greater number of 20 people. Because the North Carolina law is pegged to 21 Section 32, in North Carolina it's going to have the 22 effect of cutting off credit as to those loans that 23 are over 8 percent. 24 MR. MAYNARD: Because of the litigation 25 that I'm involved with, over the last six months FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 77 1 I've looked at literally thousands of HUD statements 2 and promissory notes for loan transactions that 3 occurred in southeastern North Carolina. Rarely 4 have I ever seen a loan where the interest rate 5 pushed the T-bill rate plus 10 percent. I can't 6 imagine that a reduction in that 10 percent rate to 7 8 percent would force an exodus of lenders providing 8 capital here in North Carolina. 9 I hope the audience understands what we're 10 talking about is really a range of interest that's 11 16 to 18 percent. It's the T-bill rate plus the 8 12 to 10 percent that we've been discussing, so it's 13 not an 8 or 10 percent rate of interest but rather 14 the T-bill rate plus that. 15 I've looked at a lot of abusive loan 16 transactions and rarely have I seen the lenders even 17 in those transactions push the 18 percent or 18 16 percent limit as may be applicable, and I can't 19 imagine that would force the lender community to 20 leave North Carolina. The great harm has been the 21 abuse of fees and to -- it has afflicted the 22 minority community in a wildly disproportionate 23 number. It is something that has been exacerbated 24 by the practice of flipping. And when we heard 25 earlier about the problem with the statute -- I FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 78 1 wasn't involved in drafting the statute, but what I 2 read was the net tangible benefit language in the 3 statute, I quite frankly was relieved. I have so 4 many clients who have been involved with the same 5 mortgage broker who have gone back time after time, 6 each transaction -- sometimes as many as two or 7 three within a single year, each transaction 8 extracting $5,000 to $6,000 in fees which get added 9 to their mortgage which increases their debt load 10 which gets them closer to foreclosure. 11 The flipping language that's in our statute, 12 if it is subjective to the extent that it must 13 relate to a net tangible benefit, so be it. If that 14 is the part of the North Carolina statute, and I 15 think it is, if that's the part that's causing 16 equity lenders to decide not to lend in North 17 Carolina, I would say respectfully it's serving a 18 good purpose to that extent and I don't think it 19 reflects to the issues that we're addressing in 20 HOEPA. I don't think the concern about the North 21 Carolina law should cause the Fed to say that we 22 should be more reserved with respect to these 23 triggers. 24 The issue of the triggers, the 5 percent 25 trigger in North Carolina or the 8 percent trigger FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 79 1 in HOEPA, is so important to our clients, to North 2 Carolina homeowners, because of the fact that there 3 is nobody home when the litigation concerning these 4 loans starts with respect to the broker or the 5 lenders that originated these loans. Those entities 6 fold up day after day, they're gone, there's no 7 recourse against whoever it is who holds that loan. 8 There's no way for them to defend themselves from 9 the foreclosures they're facing unless we can go 10 against the assignees, the holders of that paper. I 11 think -- while I don't believe that reducing the APR 12 would materially affect the access of capital here 13 in North Carolina, I strongly believe that the 14 reduction of the HOEPA trigger with respect to fees 15 is a very important part of access to justice for 16 people here. Otherwise, there's just simply no 17 recourse on these loans. 18 MR. LONEY: Thank you. Let me just ask one 19 question for my own clarification. What I've heard 20 is that certain lenders are leaving and they're 21 leaving because of this net benefit test. 22 MS. CRAWFORD: That's one of the reasons. 23 MR. LONEY: One of the reasons, one of the 24 things that's scaring people I guess, but it is only 25 those lenders who exceed the triggers who have to FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 80 1 worry about the net benefit test -- or not? 2 MS. CRAWFORD: No. 3 MR. MAYNARD: It's only the lenders who 4 engage in flipping. 5 MR. LONEY: In any refinancing, whether it 6 exceeds the HOEPA triggers or not. 7 MR. EAKES: The classic case that we use -- 8 I mean, the Federal Reserve needs to have -- whether 9 you like our standard for flipping or not, you need 10 to address that problem. That is clearly one of the 11 abuses in the refinance market. 12 We tried six or seven different formulations 13 and ended up with what is clearly a subjective 14 standard. Like due process, like free speech, there 15 are lots of things that we revere that are 16 standards, and when you have a standard that is less 17 bright line, what it says is you've got to stop 18 short of a cliff, you cannot get too close to it. 19 In North Carolina that standard really was 20 motivated as much as anything else by the number of 21 Habitat for Humanity borrowers that we had seen 22 flipped. And it was not just repeated, it was with 23 a single refinance transaction. Hundreds of people 24 who had zero percent, $40,000 Habitat for Humanity 25 mortgages ended up in 14 percent finance company FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 81 1 mortgages that had large fees attached to them. And 2 so what that net tangible benefit -- we had the 3 discussion should it be just that every loan must 4 have a tangible benefit to the borrower. In every 5 one of these Habitat for Humanity loans, if there 6 was an advance of $200, even though the fees were 7 $10,000 added, you would have a tangible benefit. 8 So somehow there has to be this weighing -- and 9 honestly, I think our definition of flipping is like 10 that old definition, you know the definition of 11 democracy, that it's the worst possible definition 12 you could possibly come up with except that all the 13 other ones we tried to come up with were worse than 14 that. So we ended up with a standard that said 15 don't get very close to the cliff. 16 MR. LONEY: But the point is, for my feeble 17 brain, is that it doesn't turn on the rate triggers. 18 MR. CREEKMAN: That's correct, applicable 19 across the boards. 20 MS. HURT: Can I just ask that the 21 creditors, notwithstanding North Carolina law, 22 notwithstanding North Carolina law and assuming 23 nothing else was done except the lowering of the 24 rate trigger for HOEPA, what would be the impact of 25 that in your opinion on access to credit? FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 82 1 MR. BOST: I just have a couple of points 2 if I can make them. Firstly, I think when you talk 3 about a smaller loan, and that's kind of -- when you 4 talk about a smaller loan, which is what we're 5 talking about, we're talking about the APR, and the 6 moderate fee on a small loan can really affect the 7 APR. So if you drop the APR threshold down, then 8 it's going to be difficult for lenders and brokers 9 to charge a reasonable fee without going over the 10 APR threshold and receiving a risk premium for the 11 credit that they're extending. That's one point 12 that we need to bear in mind is the APR, and 13 included in the calculation of APR are the fees. 14 And secondly, to answer your other question, 15 another reason that lenders are leaving is that 16 calculating these points and fees and interest rates 17 is incredibly complex, and the risk that lenders 18 take making loans that violate these standards is 19 great, so you have a lot of lenders who are standing 20 on the sidelines waiting to see how these provisions 21 are going to be construed. That's another reason 22 that they're leaving and it relates to both the 23 Section 32 type loans and to the rates and fees test 24 that we have in North Carolina. 25 MS. HURT: The current APR test doesn't FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 83 1 typically throw you into HOEPA, but you're saying 2 lowering the triggers either one percentage point or 3 two would throw a lot more loans into HOEPA? 4 MR. BOST: I think so. 5 MR. EAKES: There is data about interest 6 rate profiles. It's less than 10 percent of the 7 subprime market that currently have interest rates 8 greater than 14 percent, so it's a small amount 9 but -- 10 MR. BOST: But we're not talking about 11 interest rate, we're talking about APR, I guess is 12 my point. 13 MR. EAKES: On a 30-year loan the APR 14 doesn't change much based on one or two points; it's 15 a quarter point on APR because you're spreading it 16 over such a long period. 17 MR. CREEKMAN: I think I'm one of the few 18 that actually represents as part of a lender; Helen 19 is the other -- and Martin, excuse me. My bank, I 20 don't believe that my bank engages significantly in 21 any subprime lending, but I can tell you that -- and 22 I'm just trying to think it through, where would the 23 pressure point be. Two issues. First of all, if 24 you reduce the APR threshold from ten to eight are 25 you really helping to solve the predatory lending FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 84 1 problem, if the predatory lending problem is not in 2 fact driven by the APR? So there may not be a 3 reason to do it. 4 The second point is, okay, where would I be 5 exposed, where would I have to start raising my 6 radar antenna to see whether or not I'm coming close 7 to that threshold. I think the answer is going to 8 be, for us, it is going to be in the relatively 9 short term financing of mobile homes for borrowers, 10 because those are not -- they are frequently not 15- 11 and 30-year traditional home loans. They're shorter 12 term, they are somewhat higher -- they're handled as 13 consumer loans, they're not handled as traditional 14 mortgage loans, but they're going to be swept into 15 the residential mortgage loan pool for purposes of 16 the HOEPA calculations. There, I think, would be 17 our greatest risk of approaching that threshold. 18 MS. EGGERS: And just to follow up on 19 Mr. Creekman's comment, I think we've stated our 20 position thus far; if we continue not to participate 21 in the Section 32 marketplace for all the reasons 22 that have been discussed today, it would impact 23 volumes by 6.2 percent, which may not sound like a 24 lot percentage-wise but think about a half a billion 25 dollars in credit. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 85 1 And I think one thing we haven't really 2 discussed on the panel and someone brought it up 3 earlier, these credit needs are not going away. 4 They are just not being served by companies like 5 EquiCredit. So the question is, how are these needs 6 being served and what credit alternatives are people 7 taking advantage of? I think someone raised concern 8 about options that consumers might see, and I don't 9 have any insight on that but I think that's 10 something the Board would want to understand if 11 Section 32 is so prohibitive that supervised lenders 12 choose to leave the marketplace. 13 MR. EAKES: I wanted to say that we 14 intended, when we passed the North Carolina law, to 15 eliminate ten to -- we intended to have folks exit 16 certain pieces of the market. If they could not 17 make these loans with fees less than 5 percent, we 18 wanted you to exit this market. And so if that's 19 the basis on which EquiCredit will see a 30 percent 20 reduction, that's precisely what we wanted to see 21 happen. With other lenders where they were across 22 the board high-fee, wealth stripping, we wanted them 23 to leave the state of North Carolina. We welcome 24 that announcement. 25 MS. EGGERS: Mr. Eakes, do you have any FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 86 1 insight on how those credit needs are currently 2 being filled in North Carolina? 3 MR. EAKES: I know on the secondary market 4 we've got two players, two conventional, Fannie and 5 Freddie, and there's plenty of competition even 6 between the two of them. 7 The fact that you stop making those loans 8 does not tell me that they will not be served. I 9 see folks from Household Finance, that there are a 10 number of different channels that mortgage credit 11 gets delivered through, and really what I think 12 we're going to have to look at, and I'll look at the 13 data, is a year from now to see whether we have a 14 reduction that's greater than 20 percent in the 15 subprime market. If we have a reduction that is 16 huge, then yes, I will agree with you that we should 17 go back and look at the North Carolina bill. If you 18 lose some loans, 30 percent, and they're picked up 19 by someone else who says we don't need to charge 20 those fees, then I think that's a good thing for the 21 marketplace. 22 MS. EGGERS: I think one clarification and 23 then we've got a lot of other people that have some 24 things to say, but one clarification is it's not 25 necessarily being picked up by individuals who FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 87 1 aren't charging a fee. It may be being picked up by 2 individuals who are willing to assume the risk of 3 Section 32 loans or by alternative financing, which 4 perhaps might be a greater concern. I don't know 5 the answer but I think it's worthy of exploration. 6 MS. CRAWFORD: They've made a comment about 7 home equity lenders leaving North Carolina and that 8 was the intent, but there are conventional lenders 9 leaving North Carolina, not just home equity 10 lenders. And you're talking about people with good 11 credit, that we are curtailing them from the 12 availability of credit too, so we need to think 13 about this really strongly. 14 MR. BLANTON: I want to make sure I 15 understand something with the chain of events. 16 Martin talks about the social impact of wealth 17 stripping and it sounds like that happened when you 18 get the flipping and the flipping is what scares the 19 lenders with the net tangible benefits test, so I'm 20 not sure if it weren't the high fees and the 21 up-front costs that got financed into -- this sort 22 of speaks to the fee test rather than the rate 23 test -- but if you didn't have all of these in there 24 and then that happening on multiple occasions that 25 stripped the equity from the homeowner, then that's FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 88 1 what the social cost is, that the wealth is stripped 2 away from low-income and low-wealth families. But 3 it sounds also like another problem in that is that 4 once the lender sells the loan then the homeowner 5 has recourse against no one because the assignee 6 does not have the burden, is that correct, in North 7 Carolina? 8 MR. EAKES: We talk about enforcing 9 existing rules, but really that's hard to do because 10 you've got first a broker where you say -- and I 11 think for the few bad brokers who are out there, if 12 they do misrepresented loans and then it is 13 originated let's say by First Citizens, they have 14 this independent contractor status so that the 15 lender who evolved that loan is normally under state 16 law in most states not held responsible for abuses 17 by that bad broker. Then if there was an abuse by a 18 lender who did it directly and sold the loan, you 19 have the holder in due course doctrine which says 20 that the assignee cannot be held responsible for the 21 claims against the original originator. 22 MR. BLANTON: Are there any data to 23 indicate to what agree these loans are automatically 24 sold to avoid that? 25 MR. EAKES: I don't think -- you're really FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 89 1 looking at an issue of intent. The only place you 2 will get evidence of that would be in litigation. I 3 would say Mal would probably have a better view of 4 whether that's the intent or not. 5 MR. COUDRIET: There's a body of litigation 6 that is very to the point on the related subject of 7 yield spread premium, most of which has been settled 8 or found in favor of the lenders. But for the most 9 part, the plaintiffs went after the lenders, not the 10 brokers. 11 MR. CREEKMAN: I think there's some 12 misunderstanding as to what the North Carolina law 13 says about flipping, and perhaps it might be good to 14 focus on that for just a moment. 15 We think of flipping collectively as a 16 lender who repeatedly lends to the same borrower and 17 strips the borrower of equity, but that's not what 18 the North Carolina law actually deals with. The 19 North Carolina law is not tied -- the North Carolina 20 flipping rule is not tied to the predatory lending 21 rule with the thresholds. It's a standalone rule 22 and it says basically that any lender that makes a 23 consumer loan to a borrower which refinances an 24 existing consumer loan when the new loan does not 25 have reasonable tangible net benefit to the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 90 1 borrower, considering all of the circumstances, is 2 engaged in flipping. That means when my bank, First 3 Citizens Bank, refinances any loan, regardless of 4 who loans that loan, when a borrower comes in and 5 says I want to refinance my loan, whether it's with 6 NationsBank -- Bank of America, excuse me -- First 7 Union, Wachovia, whoever, when he comes in we have 8 to make that analysis to determine whether our 9 making that first loan with our first contact with 10 that borrower constitutes a flipping arrangement. 11 And that's what has scared lenders coming in from 12 the outside and lenders in North Carolina, because 13 this rule is so nebulous. And because it applies at 14 the first contact for a lender with a borrower, it 15 really is a difficult one for us to get our hands 16 around. 17 MR. BLANTON: Would it be helpful if the 18 mechanism required due diligence with respect to the 19 ability to pay, the income test, to the exclusion of 20 making a loan based on the asset value? 21 MR. CREEKMAN: Yes and no. One of the 22 difficulties that you face with an income test is 23 that frequently you're dealing with a retiree who 24 may have an asset that is going to be liquidated in 25 the future and has very little -- and I'm not FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 91 1 talking about land, he may have stocks or bonds that 2 are going to be liquidated in the future or a piece 3 of property that's going to be sold, and they are 4 truly income-poor at that point but they've got the 5 assets readily available to pay and the plan to pay 6 it. 7 When you have strictly a means test, it's 8 only a part of the picture and it doesn't apply to 9 everybody. The wealthy may be the ones that are 10 most affected because the wealthy may be the ones 11 that do not have the need for this great cash flow 12 in relation to their debt coverage because they have 13 other assets that they can liquidate when they need 14 to to satisfy it. 15 MR. LONEY: Can I just suggest that we take 16 a few minutes? Maybe we can take a quick break, ten 17 minutes, be back here at five after 11:00 by that 18 clock, and we'll pick up where we left off. 19 (A recess.) 20 MR. LONEY: Thank you for your patience. 21 Despite my best efforts we are behind and I suspect 22 that was expectable. One thing I would like to say 23 before -- we can't seem to make it not buzz if I get 24 close to it, okay. 25 One thing I wanted to mention is that at FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 92 1 about five minutes to 12:00 a group of folks that 2 are in the audience right now are going to get up 3 and leave and go downstairs and have an exercise 4 event, is that what it is, Peter -- something out in 5 front of the Federal Reserve Bank, and we will 6 proceed. Don't be alarmed, it's not a fire drill; 7 we'll just keep on going and maybe they'll come back 8 and join us later. I just wanted to let everybody 9 know that. 10 I do want to talk -- I know we're in North 11 Carolina, just barely in North Carolina, right, and 12 it's been interesting to hear a lot about what's 13 going on here. And I'm sure that will be very 14 germane to what we have to do going forward 15 ourselves, but we have a job to do that we have to 16 worry about, what to too about HOEPA, changing 17 triggers and other sorts of things, and I'd like to 18 try to get the conversation focused a little on what 19 we should do. 20 We've talked about flipping, we've talked 21 about the rate triggers. One thing we didn't talk 22 about in much detail is the issue of points and 23 fees, the points and fees test under HOEPA. I 24 thought we might talk a little bit about that. In 25 the Board's notice about these hearings we FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 93 1 identified three possible fees that could be added 2 possibly to the fee trigger calculation. Those 3 things were credit life insurance, certain 4 prepayment penalties, and points on refinanced 5 loans, and I was wondering if we could talk a little 6 bit, spend a little time talking about whether the 7 Board should in fact do those, make changes to 8 include those fees and why or why not. So to 9 reiterate, credit life insurance, prepayment 10 penalties, and points on refinanced loans, if I 11 could just direct the conversation in that 12 direction. Yes, sir? 13 MR. COUDRIET: I'd like to address 14 prepayment penalties and clarify that. I can't 15 really address credit life, but prepayment 16 penalties, once again, are fees that lenders hope 17 they never collect. They're there for the purpose 18 of stabilizing the secondary market, they have a 19 limited life; they allow the lender to recoup the 20 costs of making the loan before it's paid off. 21 Lenders that securitize hate flipping more than 22 anybody else in the world because it robs us of our 23 profit, believe me. So if you're talking about 24 including prepayment penalties on a previous loan in 25 the points for a high-cost loan, I think we would be FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 94 1 in favor of that. If you're talking about including 2 an unpaid prepayment penalty for the future loan, we 3 don't see how that makes sense and how that helps 4 the situation in any way. 5 MR. LONEY: I think that's a good 6 clarification. 7 MR. EAKES: Lehman Brothers issued a report 8 last Friday about prepayment penalties. In that 9 report they state for 130,000 loans that roughly 10 50 percent of the borrowers who have prepayment 11 penalties using the California prepayment, which is 12 basically half a year's interest above 20 -- half a 13 year's interest, that 50 percent of the borrowers 14 actually end up paying the prepayment penalty. That 15 if you had no prepayment penalty, it would slow the 16 rate of prepayment by 15; you would have another 17 15 percent that would prepay. So the statement that 18 Mr. Coudriet had that lenders hope they never 19 receive a prepayment penalty, that is simply 20 inaccurate with regard to securitization of 21 mortgages. 22 The Lehman and Greenwich and other 23 securitizers actually have a class of security that 24 is specifically aimed at receiving the cash flow 25 from prepayment penalties. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 95 1 To the extent that prepayment penalties 2 represent a protection of origination costs, they 3 are identical to an up-front origination fee and a 4 point, so to the extent that that's what it's 5 helping to cover, which is the up-front origination 6 costs, the prepayment penalty on the existing loan 7 should be included in points and fees. Not the old 8 loan, because that's really cumbersome to figure 9 out, you know. If you don't include the prepayment 10 penalty on the existing loan that -- on the loan 11 that you are currently making, then you allow an 12 ability to circumvent the fee threshold wherever you 13 set it. 14 MR. LONEY: That would be a fee that may or 15 may not be paid. 16 MR. EAKES: Okay, let's take that. The 17 intuitive sense is saying this is a fee that may be 18 contingent and never recovered. Well, in this 19 market the reason a prepayment penalty is valuable 20 is to protect an excess servicing or an excess 21 premium in that loan, excess -- or a piece of yield 22 in that loan from being able to refinance out of it; 23 that's what it's there for. 24 So one of two things happens: Under the 25 Lehman statistics 50 percent will pay that FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 96 1 5 percent, they will actually pay it; another 13 to 2 15 percent will default and be foreclosed on. So 3 only 35 percent of the borrowers under existing 4 subprime securitization, which are not the worst 5 ones, the ones that get securitized, the majority of 6 those borrowers will actually pay that fee. The 7 ones that didn't pay that fee meant that they paid 8 an interest rate, the extra amount, higher than what 9 they could have gotten if they had refinanced, 10 assuming that they wanted to refinance. 11 So you get it one of either way: Either 12 you're paying an interest yield in the subprime 13 arena for a longer period of time, which is meant to 14 recover your origination costs, or you actually 15 pay. And what I think would be really a problem is, 16 if you have a fee standard, whether it's 5 percent 17 or 8 percent, whatever you choose, if you allow a 18 calculated statistic known incidence of that fee to 19 not count, then you simply shift the pricing from 20 the front end to the back end. And it's just 21 inaccurate to say, I think, for the majority of 22 securitizations that no one hopes to ever recover 23 this prepayment penalty, because it makes very 24 little difference in the prepayment speed. 25 MS. EGGERS: Just a couple of comments on FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 97 1 the philosophy of prepayment penalties. We would 2 not see them adding any real value in preventing 3 flipping by being added into the points and fees 4 calculation. A couple of reasons: First of all, I 5 think we're missing a real opportunity in terms of 6 defining what flipping really is, because we've 7 heard with Jim earlier how it's defined in the North 8 Carolina legislation, or is it really just a 9 transaction that occurs within an affiliate or 10 same-party lender. We need to be clear about that. 11 We really need to educate the consumer so they are 12 in a position to make the best decision for 13 themselves. 14 Every refinance that occurs within, pick a 15 time period, 18 months, isn't automatically the 16 predatory flipping action, so a couple of things 17 that we have done which we'll just identify as 18 things to address from our perspective of flipping, 19 we don't include -- we do not charge or collect 20 prepayment penalties on loans that we refinance 21 within a year or any of our affiliates, and 22 prepayment penalties are always optional. Our 23 products are available with or without a prepayment 24 penalty, because for us it is a pricing dynamic, 25 it's part of the economics of this business. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 98 1 MR. EAKES: What percentage of the loans 2 that refinance to another company do you actually 3 end up collecting for one year's origination of 4 loans at EquiCredit? What percent do you actually 5 over the five-year period that you have prepayment 6 penalties, what percent of them actually end up 7 paying a prepayment penalty? 8 MS. EGGERS: I would need to get that 9 percentage, Martin, but I will tell you it's not a 10 flat-out number. It depends on -- it's a situation 11 that's relative to the economy. We've had a slowing 12 in prepayment curves as rates have slowed down and, 13 you know, the percentage you see now would be 14 different than in a declining rate environment. So 15 I don't have that number; I could track that down. 16 MR. EAKES: What do you track as your 17 annual prepayment rate for loans that have a 18 prepayment penalty; what is your CPR? 19 MS. EGGERS: It depends again on the 20 particular type of loan and the particular 21 situation, because one of the dangers we've got is 22 trying to put a rule in place that works for all the 23 different consumer situations. I think we need to 24 be very cautious about that. We can identify -- you 25 know, we can tell stories about situations that seem FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 99 1 to not make sense for the consumer; there are an 2 equal number of stories of situations where the 3 consumer was the true benefit by merit of the 4 refinance. 5 I just would suggest caution about simple 6 rules as the solution to these issues. 7 MR. COUDRIET: I'd just like to clarify 8 something that Mr. Eakes said about defaulted loans 9 or loans that had to be taken into asset recovery, 10 assuming that those with prepayment penalty that the 11 penalty was actually collected. We rarely collect 12 principal or any interest on foreclosed loans so the 13 chances of us collecting the prepayment penalty are 14 two: slim and none. 15 MR. BURFEIND: Regarding the credit 16 insurance premium charge, if we're ready to move to 17 that, it would be our position that these not be 18 included within the fees and points of fees subject 19 to the trigger calculation. The credit insurance 20 product and premium is, as I said earlier, a 21 voluntary purchase, not a required purchase. It's 22 an option that is presented to the borrower for 23 consideration by the lender. If you include the 24 premium charge in the points and fees, it's likely 25 to reach the trigger along with the other required FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 100 1 charges that are customarily assessed. Since 2 lenders don't want to be in that category subject to 3 the requirements of HOEPA, the credit insurance 4 option -- the expectation would be that it simply 5 would not be presented to the borrower as an 6 option. Some borrowers, many borrowers, without 7 adequate insurance protection, other insurance 8 protection, would be denied the opportunity to at 9 least consider the credit insurance as a way to 10 protect the equity in their home. 11 MR. BLANTON: Can I ask a question on that. 12 It's my understanding that the credit insurance is 13 to protect the lender, not the borrower, so why 14 would it be an option for the borrower? 15 MR. BURFEIND: The law requires that it be 16 an option for the borrower, for one thing, but it is 17 the borrower's -- well, the proceeds will go to pay 18 off the loan in the event of death or maintain the 19 repayment schedule in the event of disability. The 20 benefit inures to the borrower, he -- or his estate 21 in the event of death -- is relieved of the 22 obligation to pay off that loan or maintain those 23 payments. The equity in the home is preserved for 24 the benefit of the borrower and/or the estate. 25 MR. BLANTON: So this is distinguished from FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 101 1 PMI? 2 MR. BURFEIND: Oh, yes, very much so. If 3 there's some confusion we too need to distinguish 4 those products, yes. 5 MR. MICHAELS: Can I follow up on something 6 just to clarify a point I think you made. In the 7 report that the HUD and Treasury issued in June, one 8 of the recommendations they made was that the sale 9 of credit insurance be delayed until after the loan 10 closing. Would the effect of adding the credit 11 insurance into the points and fees test under HOEPA, 12 would that essentially result in that happening? 13 MR. BURFEIND: I don't think the proposal 14 is a reasonable proposal in the practical sense. 15 The single-premium financed credit insurance is sold 16 in connection with a closed-end transaction, when 17 the loan is closed. To sell it after the fact would 18 require the reopening of the loan and the reclosing 19 of the loan, which means you then couldn't present 20 the insurance again until after you've closed the 21 loan again. So you first of all get into that 22 pattern. If you're going to -- if you have to 23 present it after the closing but you have to reopen 24 a loan in order to sell it, you're back into a 25 closing environment again. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 102 1 You do have to reopen the loan on the 2 single-premium approach. It wouldn't be any 3 different than if the individual came back after the 4 loan was closed and said, you know, I need another 5 thousand dollars for something or other; can you 6 loan me another thousand dollars. Well, they'd 7 reopen the loan to handle the transaction. 8 I think we get into a difficult situation if 9 you've got to do it after the closing but you can't 10 do it until you're at the closing. 11 MR. EAKES: Your point is a good one. It 12 shows why it needs to be a prohibition, not simply 13 included in the points and fees. I mean, a couple 14 of data points: On a 16 percent 30-year loan, let's 15 say $100,000 with $10,000 of credit insurance 16 financed up front, at the end of five years, which 17 is almost the whole amount of the portfolio, it 18 would refinance within five years. That's a pretty 19 good outward frame. Only 1 percent or $104 of the 20 $10,000 of up-front credit insurance would have been 21 paid off in principal balance by the end of the life 22 of that loan. So virtually all of the payments -- 23 does that make sense? So virtually all of the 24 payments that the borrower was making on a monthly 25 basis for the financed credit insurance, almost all FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 103 1 of that was going for interest only, and 2 essentially, then, that $10,000 gets paid directly 3 out of the equity. 4 That's one of the reasons in North Carolina 5 we were so adamant, not about preventing credit 6 insurance -- we really believe that poor people are 7 underinsured and that credit insurance, though it 8 may be expensive on a monthly basis, is something we 9 think should be a choice the consumers have. What 10 we really objected to was saying that you finance 11 it. The industry data showed that 40 to 50 percent 12 of the up-front premium was the commission to the 13 lender for selling it, that that is sort of a 14 standard, and the financing of it adds no benefit to 15 the borrower whatsoever. 16 So what it meant was, if I gave you the 17 option of paying your electric bills every month on 18 a monthly basis for the next five years and then I 19 came to you and I said, well, I'm going to give you 20 a better deal and I want it to be a consumer option 21 for you; that we're going to lump all of your 22 monthly utility bills together and let you pay for 23 them up front and we're going to charge you 24 13 percent interest on it for the next five years. 25 There is no real debate, I don't think, on FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 104 1 this issue once you really understand the 2 economics. That we want people to continue to 3 purchase monthly credit insurance if they want it, 4 but don't allow for any loan the financing of an 5 up-front premium when you could have paid for it on 6 a monthly basis. 7 MR. BURFEIND: Thank you very much. First 8 of all, again, credit insurance is a product like 9 any other product. Anything that they have borrowed 10 from that equity to pay for and financed over 25 11 years, at the end of five years you've got less than 12 5 percent of the principal that's been repaid. The 13 argument Martin makes would apply to the blue jeans 14 example, to an automobile, to any other product or 15 service that was paid for out of loan proceeds. 16 Secondly, with regard to the cost, monthly 17 cost versus the financed single premium, the 18 advantage of the financed single premium to many 19 consumers lies in the fact that the payments are in 20 fact amortized for a longer period of time. It 21 keeps the monthly payment within their manageable 22 budget. A pure monthly outstanding balance premium 23 program, that premium charge in the first month for 24 credit insurance is more than the incremental cost 25 in the monthly payment of the single-premium finance FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 105 1 charge. The financing is what makes the coverage 2 available to so many people who do not have other 3 coverage to protect that equity. 4 MR. EAKES: But that's precisely why HOEPA 5 was passed. HOEPA said if you can't afford credit 6 without looking solely to the equity of the home, 7 then we don't want that practice, whether it's a 8 choice or not a practice. What HOEPA said in 1994 9 was, we do not want you in determining affordability 10 or availability or anything else to look exclusively 11 at the equity. And for single-premium financed 12 insurance 99 percent of the payment of the premium 13 comes out of the equity, not out of the monthly 14 payment. 15 MR. BURFEIND: Congress didn't want the 16 lender to look at that. We're talking about an 17 election that the borrower is making, how the 18 borrower wants to spend his funds, his equity. 19 MR. LEHMAN: The issue of credit insurance 20 is very important to us as a matter of public 21 policy. This is another one of those issues where 22 disclosures don't work, as borrowers do have to sign 23 a disclosure saying the credit insurance is 24 voluntary and they elect to have the coverage. We 25 have seen many cases where borrowers were not aware FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 106 1 that they had purchased the insurance, were not 2 aware that they had the coverage. Even more than 3 that, borrowers are not aware that they are paying 4 for this insurance up-front and financing it over a 5 period of years at a very high interest rate. It 6 does not make sense to any reasonable, well-informed 7 borrower to buy that much insurance and have it 8 financed the way it is. 9 We have seen some outrageous examples: 10 $19,000 of insurance added on to a $66,000 home loan 11 so the amount financed becomes $85,000 and that much 12 equity is out of the person's home at that time. 13 $9,000 in insurance premiums on a $30,000 home 14 loan. These are very, very high amounts. So the 15 problem is, if you put it into the trigger term it 16 would effectively prohibit the sale of at least that 17 much credit insurance, so to that extent I would say 18 fine. But I think the approach to take is to look 19 at it head-on and determine whether or not the sale 20 of prepaid single-premium credit insurance is a 21 reasonable product that ought to be available. 22 It was our opinion that, on the whole, the 23 way in which the product is sold and financed it is 24 basically an unfair practice and ought to be 25 prohibited up-front. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 107 1 MR. BURFEIND: There's no doubt that there 2 have been some egregious examples. I think it's the 3 handful of egregious examples that drove the North 4 Carolina determination. But consider the whole 5 environment of subprime lending. You've got a huge 6 environment out there, and how many of those loans 7 get into foreclosure? Relatively speaking, a small 8 percentage, and that small percentage was the focus 9 of Mr. Martin Eakes and others in North Carolina. 10 They were troubled by what was happening in a small 11 segment of the market. 12 Now look at that small segment even further 13 of those foreclosures. How many of those loans even 14 had credit insurance on them? I've ask -- I don't 15 know and I've asked the question not of Martin but 16 in Chicago in a similar forum and environment in an 17 organization that tracked the Cook County 18 foreclosures, the nearly 3,000 foreclosures in Cook 19 County. I asked them how many of those loans had 20 credit insurance on them; well, we don't know. I 21 would maintain that not very many did. 22 Out of that broader universe of subprime 23 lending how many of those loans were paid off by the 24 proceeds of credit insurance? How many of those 25 payment schedules were maintained by the credit FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 108 1 disability coverage and how much of that equity in 2 those home mortgages were preserved? 3 Now, HUD estimates that 46 percent, I think 4 I recall the number correctly, 46 percent of 5 foreclosures result from disability. I think that's 6 a conventional market figure but I'm not certain. 7 But the point is, the distress and the stress that 8 causes a loan to go into foreclosure is not related 9 to the credit insurance. It's an inability to make 10 the monthly payment for some cause or another. In 11 46 percent of the cases perhaps that cause is 12 disability. In some of those 46 percent of the 13 cases perhaps there's credit insurance that has 14 saved that homeowner and that equity in that home. 15 MR. MICHAELS: Let me ask one question. 16 I'm sitting here wondering, as a lawyer, and maybe 17 this is naive because I don't understand the 18 economics of it; maybe you can explain it. If PMI 19 is affordable on a monthly basis what's the 20 economics that makes credit life insurance not 21 affordable on a monthly basis? 22 MR. BURFEIND: For some people it may be 23 affordable on a monthly basis; for others, they need 24 to finance it. Just why is it that some people buy 25 a car and finance it over two years where others buy FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 109 1 a car and finance it over five years, you know, or 2 seven in some cases. They've got to manage that 3 monthly payment. 4 MR. MICHAELS: Is credit life insurance 5 that much more expensive than PMI? 6 MR. BURFEIND: I think we're comparing 7 apples and oranges there, and I don't have any 8 particular expertise in the PMI area; I don't even 9 know what it costs. But that is a totally different 10 risk assessment and a totally different insurance 11 product. 12 MR. LONEY: Clarify for me, what did North 13 Carolina do? Is it outlawed? 14 MR. EAKES: North Carolina said that 15 monthly premium credit insurance is legal and okay 16 but that you cannot finance any insurance premiums 17 into a home loan in North Carolina for all home 18 loans, regardless -- not just for high-cost home 19 loans. 20 We looked earlier, in the earlier 21 negotiations, at including the cost of credit in the 22 single premium as part of the points and fees test, 23 and basically it was the sort of initiative from the 24 lenders that we needed to go ahead and be clear and 25 the judgment was that in every case credit insurance FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 110 1 would most likely kick you above the 5 percent fee 2 limits so we may as well go ahead and prohibit it, 3 and be clearer. 4 MR. CREEKMAN: It's not limited, that's not 5 limited to high-cost home loans. That is an 6 absolute bar across the board for home loans. 7 MR. LONEY: If we could just go back to 8 prepayment penalties for a second, one of the 9 questions I guess I've had is, is there a difference 10 in how we would treat them if it's a prepayment 11 caused by a refinance by a different lender or the 12 same lender; would you treat those two differently? 13 MR. EAKES: I don't think you're going to 14 find that it's administratively easy -- let's take 15 the case where you have a different lender, and it 16 had a prepayment penalty of 5 percent. So now -- 17 and let's say that it charged 7.99 up-front fees on 18 that loan so it managed to not hit the high-cost 19 trigger for the first loan. 20 Now you have a situation where you would 21 like to refinance out of that loan, and even if it 22 is -- so the borrower has a new lender who says I'm 23 willing to refinance, it's going to cost me 24 3 percent to originate, and I have to include the 25 5 percent prepayment penalty from the previous FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 111 1 loan. You basically are penalizing the new lender 2 and the borrower in a new, improved circumstance for 3 basically compensation that all went to the old 4 lender. What you need to do is include the 5 prepayment penalty on the new loan and so this 6 confusion about whether or not it's prepayment 7 penalty of the old loan or the new loan -- the old 8 loan makes no sense. You really do help lock in a 9 borrower even worse. 10 MR. LONEY: If it's the same lender you 11 wouldn't say that; right? 12 MR. EAKES: I think even under HOEPA now, 13 if it's the same lender, that they're prohibited 14 from charging prepayment penalties. So that's 15 not -- 16 MR. LONEY: That's true in North Carolina? 17 MR. EAKES: North Carolina has a general 18 prohibition against prepayment penalties across all 19 loans up to $150,000, but we recognize that there 20 are federal preemption statutes that would allow 21 some lenders to override that, so then we had a 22 separate door or threshold in the high-cost that 23 said prepayment penalties would actually count 24 towards the fees and towards its own threshold. 25 MR. STOCK: Over a certain amount. Don't FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 112 1 we have -- isn't it 2 percent to up to 30 months? 2 MS. CRAWFORD: One in, one out. 3 MR. CREEKMAN: Can I clarify on that? You 4 have to start with what the North Carolina law used 5 to be. The North Carolina law in a home loan used 6 to prohibit prepayment penalties if the loan was 7 $100,000 or less. That rule was in large measure 8 preempted by almost every lender in sight so it was 9 a meaningless rule. So the decision was made to try 10 to address the prepayment penalty issue in the 11 high-cost home loan statute, and it was done in two 12 ways. 13 The first is that prepayment penalties 14 regardless of what they are in the new loan are 15 included in the calculation of points and fees. 16 Secondly, prepayment penalties are an 17 independent threshold to determine whether or not a 18 loan is a high-cost home loan, if the loan has more 19 than a certain number of prepayment points and 20 fees. Then in the calculation of points and fees 21 there is a very complex formula for determining when 22 you can exclude points and fees for the 23 calculation -- correction -- prepayment penalties 24 from the calculation of points and fees, and that 25 was a result of, quite frankly, a political FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 113 1 compromise. 2 So right now prepayment penalties are 3 probably the most complex issue, but the real bottom 4 line is that if you've got more than two prepayment 5 penalty points built into the loan you're a 6 high-cost home loan. 7 MR. EAKES: Two. 8 MR. CREEKMAN: If you charge a prepayment 9 penalty for more than 30 months or you have more 10 than one prepayment penalty as a practical matter, 11 it's going to be included, the excess is going to be 12 included in the calculation of points and fees. So 13 it's a very complex formula. 14 MR. EAKES: I think prepayment penalties 15 are analytically the most complicated of all issues 16 that we've looked at. 17 Under HOEPA you have the option to say we're 18 going to count prepayment penalties as part of the 19 trigger; then you have the option of saying we're 20 going to have it be a consequence of passing the 21 trigger. And that's what HOEPA currently says, that 22 if you pass the trigger there are limitations that's 23 relatively complicated even in HOEPA. But we chose 24 in North Carolina to not have that be circular. We 25 felt like it needed to be included in the trigger FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 114 1 and hence there are no prohibitions against 2 prepayment penalties as a consequence of being a 3 high-cost loan. It's included in the trigger 4 because the lenders articulated to us that 5 prepayment is basically tied to the origination cost 6 function, the same as points and origination fee 7 is. 8 MR. LONEY: Could I ask in the interest of 9 time if we could change the topic. We've talked a 10 little about flipping, I don't know that we need to 11 go back there, but one issue that we have a great 12 deal of interest in is the issue of unaffordable 13 lending. 14 MR. EAKES: Before you leave points and 15 fees, there's one more item that we think was 16 mandated by Congress to be included in points and 17 fees when it said that all broker compensation was 18 in the definition of points and fees under HOEPA. 19 It says it tracks a lot of truth in lending 20 categories but then it separately said all 21 compensation to mortgage brokers, and we believe 22 that Congress's intent and I think from the 23 committee reports was to include both the direct 24 payment by the borrower and also the yield spread 25 premium that is paid by the lender in that FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 115 1 definition of points and fees, that that was 2 something explicit that Congress looked at. And we 3 agree, certainly recognize that RESPA and HUD made a 4 statement that yield spread premiums are not illegal 5 per se, but neither are discount points and 6 origination fees and they are still included in the 7 points and fees definition. So we think that is 8 really quite critical. 9 MR. LONEY: I can't imagine that you have 10 something to say about that, Ms. Crawford. 11 MS. CRAWFORD: We disagree. And because 12 you do have different tests for HOEPA, one of the 13 tests is rate, so you already have that trigger and 14 the yield spread premium is included in the rate. 15 So you would be basically double dipping, and we 16 don't feel that -- and it has already been taken out 17 and we don't feel it needs to be put back in. 18 GOVERNOR GRAMLICH: I have a question about 19 that. Is it double dipping if there's alternative 20 tests? You put something in one test, whether it 21 ought to be in or not I leave aside, but let's say 22 we decide it ought to be in; it's in the rate test, 23 but the point fee test is an alternative. So just 24 because it's in the rate test doesn't mean 25 logically, I don't think, that it should not be in FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 116 1 the points and fees test. 2 MS. CRAWFORD: Yield spread premium is a 3 pricing issue just like prepayment penalty, and it 4 would be -- we're the only lending entity that has 5 to disclose our profit, period, and we have to put 6 it on the HUD-1 settlement statement. The banks 7 don't have to disclose their profit, the credit 8 unions don't have to disclose their profit, the 9 savings and loans don't have to disclose their 10 profit. So we are in an uneven playing field right 11 from the beginning. 12 We can go in -- you can shop our rates on 13 conventional rates, go up against any bank in this 14 room, and we probably will have a lower rate that 15 day, any day. We still might be -- but the way we 16 look -- the way we receive our rate sheets and the 17 way the lenders give us our price, there is a 18 premium on that price, and a lot of times there is 19 no par pricing. You either have an 8 percent and it 20 costs an eighth to the customer or we might have 21 eight and a eighth and we might get an eighth. So 22 it's in the rate. 23 GOVERNOR GRAMLICH: I know it's in the 24 rate, yeah. 25 MR. EAKES: I just wanted to comment that FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 117 1 the double dipping argument goes too far, because if 2 you take just points and fees -- I mean discount 3 points and origination fee, which everyone would 4 agree should go in points and fees, that also gets 5 calculated into the APR. So the double dipping 6 argument goes too far because everything that's in 7 the points and fees test now also gets calculated to 8 a much -- 9 GOVERNOR GRAMLICH: They're alternative 10 tests. They don't add onto each other, there's one 11 test or another test. 12 MR. EAKES: All the components of the 13 points and fees already do what I think Kate was 14 worried about. 15 MR. COUDRIET: I think the theory behind the 16 lenders covering broker compensation is, at least at 17 the point of closing, to have the lender defray part 18 of the cost of originating the loan and not the 19 borrower up-front. Then to scoop up more people 20 into HOEPA by changing that rule will have the 21 effect, I believe, of limiting availability to a 22 whole new class of people that we've worked hard to 23 enfranchise. 24 MS. CRAWFORD: You also are going to bring 25 in FHA and VA loans into HOEPA, and I don't know if FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 118 1 you want to do that because you are going to be -- 2 as Mr. Coudriet said, we are going to be denying 3 credit to people that don't need to have credit 4 denied to them. 5 MR. EAKES: FHA and VA premiums are already 6 counted in HOEPA. 7 MS. CRAWFORD: If there's yield spread 8 premium, you put that in there. If you have points 9 and fees triggers, it probably will go over the 10 points and fees triggers that I've read that some of 11 the people want. 12 GOVERNOR GRAMLICH: Let me make my position 13 clear. I'm not taking a position on whether this 14 ought to be in either test, but the fact that it's 15 in one test strikes me as not saying anything about 16 whether it should be in the other test. Right? I 17 mean, it's just a technical point on how these tests 18 work. 19 MR. CREEKMAN: I think the practical 20 consequence is going to be this: The issues from 21 our perspective are, number one, what is going to go 22 into the calculation of enumerator; that's what are 23 the points and fees. Number two, what is going to 24 be the total loan definition for determining the 25 denominator in making this fraction. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 119 1 It really doesn't matter to us what you say 2 is in that pot that we have; for me, it doesn't 3 matter. Because what we're going to do then is look 4 at the loan and see whether or not we're in 5 violation of that rule, and if it throws us over the 6 5 percent or the 8 percent, we're not going to be 7 able to make the loan. So really it doesn't matter 8 how you bunch them together. Whatever the rule is, 9 we're going to have to live with it. 10 If you decide that yield spread premiums are 11 going to be included in the calculation, then what 12 that's going to do is drive yield spread premiums 13 out of the marketplace in large measure if there are 14 other points and fees that are included in that 15 calculation that are of greater importance to the 16 lender. It's really a prioritization issue with us. 17 GOVERNOR GRAMLICH: Earlier Glenn raised 18 the issue of whether if you changed the HOEPA 19 trigger however it would drive lenders out of the 20 HOEPA market, and so you seem to be answering that 21 question yes; right? 22 MR. EAKES: If they're a conventional 23 lender. 24 MR. CREEKMAN: We're a conventional 25 lender. Let me give you a simple example. Let's FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 120 1 assume that a conventional mortgage loan with one 2 point loan origination fee, and let's assume that 3 what you're doing is financing an executive moving 4 from point A to point B whose company reimburses him 5 for two discount points up-front in order to reduce 6 the interest rate to what he had in the city that he 7 left, okay. All three of those points are already 8 included in the calculation. 9 MR. EAKES: If the lender paid it directly 10 it's not included either in HOEPA or North Carolina. 11 MR. CREEKMAN: Wait a minute; I'm not 12 talking about North Carolina calculation. If that 13 discount point is paid by the borrower to the lender 14 and if you have a one-point loan origination fee, 15 you're up to three points already in the 16 calculation. If you throw a mortgage broker into 17 that transaction, then the mortgage broker is going 18 to push us up to the -- potentially he's going to 19 push us up to the limit. So the presence of a 20 mortgage broker in the transaction is enough of a 21 red flag for us to beware of the transaction, 22 regardless of whether that broker is compensated 23 directly by the borrower or through a yield spread 24 premium arrangement, if the yield spread premium 25 arrangement is going to be included in the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 121 1 calculation of points and fees. 2 We just need to know what the rule is and 3 then we'll do those calculations. But we may not be 4 able to give those loan discount points to that 5 executive who moves into the area and we may not be 6 able to compensate the broker what the broker is 7 charging based upon his agreement with the 8 borrower. It becomes a very simple mathematical 9 test for us. 10 Our greatest difficulty at this point is the 11 calculation, trying to systemize the calculation of 12 the denominator. And this is just an aside, but we 13 struggle with the total loan definition; that's just 14 a nightmare for us. If you can simplify that it 15 would be great. 16 MR. MICHAELS: You're saying that's true 17 under HOEPA, North Carolina law, or both? 18 MR. CREEKMAN: Everybody. It's the same 19 definition. But trying to figure that total loan 20 based upon the commentary is real difficult for us. 21 MR. LAMPE: I would echo that by saying 22 from strictly a compliance viewpoint, regardless of 23 what your politics are, which I think is what Jim is 24 saying, if there's an opportunity to have HOEPA 25 points and fees calculation clarification in this FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 122 1 exercise, I think there would be universal 2 acceptance of the correction of the math. What goes 3 into the math or what factors go into the math is 4 one reason why we're here today to discuss and 5 debate, but HOEPA calculations simplification would 6 be welcomed. 7 MS. EGGERS: I would just add that I think 8 even this discussion is pointing out that we need to 9 have clarity on whether we want HOEPA loans to be 10 considered those that we absolutely don't really 11 want to have happen, or whether they are loans that 12 we think exceptional consumer protection needs to be 13 provided for. Because one of the things, and I 14 think it's been said; we talk about expanding the 15 scope but half of the conversation is about that we 16 shouldn't be doing that lending at all, and I think 17 we put some of the numbers on the table about the 18 implications of that. I find that very concerning 19 in terms of pulling that credit out of the market. 20 GOVERNOR GRAMLICH: I wonder if I could -- 21 this gets away from Glenn's list here and I 22 apologize, but there does seem to be at least a few 23 people saying that the point of the North Carolina 24 law was to shut down the high-cost market. I have 25 never heard that said about HOEPA. Does anybody FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 123 1 here think that's the intent of the HOEPA law? 2 MS. CRAWFORD: There's some people that do, 3 there's some brokers that do. 4 MR. LONEY: But the intent -- 5 MS. EGGERS: I would respond to that by 6 saying that I think the original intent was never 7 portrayed that way. I think, given all the 8 confusion that exists in the market today -- the 9 North Carolina legislation, discussions in Chicago, 10 discussions in New York -- I think it is becoming 11 very confusing about what HOEPA's forward intentions 12 should be, need to be. And it calls into question 13 how much discretion we want the consumer to have in 14 making their own financial decisions and how much we 15 think the legislature should decide or lenders 16 should decide or brokers should decide. 17 Our proposal is really focused on getting 18 the consumer educated, the consumer prepared, and 19 the consumer enabled with simplified disclosures to 20 make their own decisions. We don't want to be 21 making all their decisions. We are not sure the 22 Board wants to either. 23 MR. EAKES: When I was in graduate school 24 in economics, if we had a perfectly working market 25 we wouldn't -- Congress would never have passed FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 124 1 HOEPA. If we had information where borrowers had 2 equal knowledge, perfect knowledge, and rational 3 decision-making, we wouldn't need any of this. So 4 the very fact that we have a bill passed says that 5 we know we've got inequality of bargaining power and 6 we know that we have information gaps for 7 borrowers. That's just an assumption of the real 8 world that we know we have by looking at HOEPA. And 9 when I hear people, particularly on prepayment 10 penalties, tell me, well, let's look at making this 11 an option for borrowers, I come back to them and 12 say, well, let's look at the place where the market 13 works the best, which are conventional mortgages, 14 and we have less than 1 to 2 percent of borrowers 15 who actually choose or get prepayment penalties. 16 So in the context where we have the best 17 working market and where we have the most 18 information and the most sophisticated players, only 19 1 to 2 percent choose it. So why all of a sudden do 20 people, when they get to subprime, do 80 percent? 21 I think the rhetoric of consumer choice 22 takes you too far, because we wouldn't be discussing 23 this if we didn't think there were market 24 imperfections. 25 MR. COUDRIET: Once again, because there are FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 125 1 differences between the A market and the subprime 2 market and those differences lie in the cost of 3 underwriting and the cost of servicing, which must 4 be covered if you're going to provide that 5 service -- let me answer the Governor's question. 6 Yes, we have avoided HOEPA loans because we 7 thought that was backhanded advice from Congress, 8 that they really didn't want these loans made. Now, 9 we might have been wrong about their intent but 10 that's what we took it for. Because of the 11 complexity of the law, because of that complexity we 12 have so much up-front diligence to do we have 13 effectively assumed that we can't make those loans 14 profitably and we stay away from them. So yes, the 15 effect was to limit the participation. 16 MS. CRAWFORD: Mr. Eakes said something 17 valid about 1 percent of -- I'm not sure what his 18 statistic was. But in the conventional market -- 19 and I am a conventional broker -- we do have on 20 almost all my ARM products, my adjustable rate 21 mortgage products, prepayment penalties. 22 Bank of America offers two different 23 products -- give you an ad here. They have a 24 prepayment penalty ARM and they have a 25 non-prepayment penalty ARM. The prepayment penalty FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 126 1 ARM was at six and a half last week, with the -- 2 without it it was at seven and a half. So a 3 borrower in North Carolina would choose the 4 prepayment penalty ARM on a purchase. And that's 5 his option to do that, and they know the 6 consequences going in. 7 MR. EAKES: But only 1 percent actually 8 choose that nationwide, actually choose to have a 9 prepayment penalty. 10 MS. CRAWFORD: Who gave you those 11 statistics? 12 MR. EAKES: Freddie Mac, Fannie -- 13 MS. CRAWFORD: Freddie doesn't have -- 14 MR. EAKES: I can get you the data. I'm 15 really confident of that number, 1 to 2 percent. 16 MS. CRAWFORD: I don't think that's true. 17 MR. EAKES: Very confident. 18 MR. LONEY: Okay. Can we now switch -- I 19 guess we've heard everybody's views on the yield 20 spread premium. What I wanted to talk about was 21 affordability and the question of what the Board 22 should do, if anything, with respect to the issue of 23 affordable loans or prohibiting or somehow 24 restricting, under HOEPA, making loans that the 25 creditors should know can't be paid back based on FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 127 1 the income, et cetera, that the borrower has. 2 Should there be, for example, additional 3 documentation requirements regarding whether or not 4 a particular customer can afford the loans. There's 5 a number of issues that come up with respect to 6 that, and I thought it might be useful to talk about 7 that a little bit. Anybody want to start us off? 8 Ms. Eggers? 9 MS. EGGERS: On pattern and practice we 10 don't see any real need for any additional 11 guidelines to be offered along that direction. 12 What we would advocate and suggest the Board 13 to consider is the development of a safe harbor, 14 that we would be more than happy to work with you on 15 in the definition of it as guidelines, including 16 debt to income, loan to value, medium income, other 17 credit characteristics. I think what that enables 18 is it encourages the lending market to continue to 19 stretch and afford credit that is reasonable and 20 sort of covers all the issues that we've heard 21 discussed about what has pulled a lot of lenders out 22 of the marketplace in terms of the lack of safe 23 harbors. So that's our perspective on those 24 issues. 25 MR. LAMPE: Just as a point of information, FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 128 1 the North Carolina statute adopts -- while providing 2 for a case-by-case determination rather than pattern 3 or practice, it does adopt a certain safe harbor. I 4 think the New York part regulation more or less 5 follows, the last time I looked, verbatim what we've 6 done in North Carolina. So there's precedent in the 7 law books right now for that sort of approach. 8 MS. HURT: Just so that I understand, where 9 you have a case-by-case basis I can understand the 10 need for a safe harbor, but where you have the 11 varying general standards in HOEPA and you have to 12 prove pattern or practice -- and maybe Mr. Maynard 13 would want to weigh in on this -- why would you need 14 safe harbors from the Board? Within pattern or 15 practice, why would you need a safe harbor? I can 16 see the case-by-case. 17 MS. EGGERS: We prefer pattern or practice, 18 but what we're suggesting is, because of the nature 19 of the marketplace being what it is in terms of the 20 energy around finding the exception and making it an 21 example versus dealing with what Mr. Creekman said 22 early on, let's regulate to support providing credit 23 into the marketplace and deal with the exceptions. 24 The safe harbor just encourages lenders to take on 25 the additional challenges of the marketplace that FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 129 1 we're operating in, that's all. I don't think it's 2 a requirement. We'd be supportive of it. 3 MR. LONEY: Did you have something? 4 MR. MAYNARD: No. 5 MR. LEHMAN: Talking about the pattern and 6 practice issue, I think that term creates a very 7 high barrier for anybody who's seeking to enforce 8 the prohibition on lending without regard to payment 9 ability, and certainly restricts private enforcement 10 for those like Mr. Maynard who defend people in 11 foreclosure situations. 12 I don't think there's any lender -- no 13 lender I've ever talked to has acknowledged, and I 14 don't think they do, make loans to somebody who's 15 not going to repay them or make loans purely based 16 on the assets. So this is not something, if 17 properly worded, that should cause any heartburn to 18 any responsible lender, prime or subprime. 19 MS. EGGERS: I think the one challenge that 20 connects into this issue, and I'll be brief with it, 21 is just when you try to determine and who's going to 22 determine what the value is to the customer. You've 23 heard some discussion around that. That is a huge 24 issue, and I think you've heard the lenders say 25 that's a very difficult proposition for us, to be in FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 130 1 the place of judge and jury, and I think that factor 2 needs to be considered when you look at the ability 3 to deal with issues about affordable loans. 4 MR. LONEY: What about the documentation 5 issue? Anybody want to weigh in on that? 6 MR. COUDRIET: Only that it's one more piece 7 of paper to put in the mortgage file and we've got a 8 lot of them right now. 9 I think, getting back to the suitability 10 standard, yeah, it's nice to have a bright line in 11 the law. On the other hand, you are also looking at 12 the potential of, once again, disenfranchising 13 certain people. You have an underwriter in a 14 mortgage company whose job it is to protect the 15 company on the one hand, and he's pressured on the 16 other hand to make that exception, include another 17 person, give them a chance. 18 Now, from the standpoint of the mortgage 19 company, we're going to lose money if he includes 20 too many people, and we have our own guidelines that 21 we like to adhere to so that we don't have too many 22 foreclosures. On the other side, if we take away 23 that underwriter's discretion when he uses it, we're 24 disenfranchising that many more people who can't 25 live within the box. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 131 1 MR. BOST: I just was going to offer -- I 2 think what you do on this issue depends on how you 3 view Section 32, whether you view it as a rule that 4 provides guidance or whether it's a rule that 5 anything that goes above its threshold is 6 undesirable and you want to see prohibited. Because 7 a change to this rule, this rule right here, would 8 put people in a position where they either could 9 make those loans safely or they would be scared to 10 death to make them. So I think any change you make 11 to that provision depends on how you view Section 32 12 loans. 13 MR. CREEKMAN: In dealing with the specific 14 question that you raised about repayment ability, 15 the way the current Section 32 reads, it's a matter 16 of considering the consumer's current and expected 17 income, current obligations, and employment status. 18 I think it would be appropriate to include in that 19 laundry list the other assets of the borrower 20 exclusive of the property which will secure 21 repayment of the loan. I think that would be a very 22 reasonable thing to include in there. And the 23 reason for that is -- I'll give you a very clear-cut 24 example. 25 Yesterday I had a customer complaint on my FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 132 1 desk. We denied a loan to a customer who had a 2 74 percent debt-to-income ratio and she was 3 protesting and she said, look at what I've got. And 4 what she had was a million dollar-plus net worth 5 with heavy debt, with relatively low income, but the 6 nature of the business that she was engaged in was 7 fixing up and selling properties and she's been 8 doing it successfully for 20 years, and the 9 loan-to-value ratio for the particular piece of 10 property that we would be taking as collateral would 11 be 34 percent. It didn't make sense to deny that 12 loan and we're reconsidering it for that reason. 13 There are situations where simply the 14 earnings of the borrower are not a good indication 15 of the borrower's ability to repay the loan. 16 MR. LONEY: Anybody? 17 MS. HURT: Just to clarify, would that have 18 been a HOEPA-covered loan? 19 MR. CREEKMAN: In this instance it was not, 20 it was a request for home equity line of credit, but 21 it could just as easily have been the refinancing of 22 that 34 percent loan to value, her primary 23 residence; we would have had the same result. 24 MR. LONEY: Anybody else? Okay. There 25 were a couple of items that the Board included in FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 133 1 its notice and I just wanted to throw it open for 2 the group to talk about. 3 The Board asked for comments on a number of 4 disclosures concerning, for example, credit 5 insurance and similar products, referrals to 6 counseling services, and I'm not talking here 7 about -- we're going to be talking about counseling 8 service issues this afternoon, but just the issue of 9 whether we ought to require a disclosure of the 10 availability of counseling services. Balloon 11 payments, improvements to the HOEPA disclosures and 12 foreclosure notices, those are a few things that the 13 Board specifically asked for views on. 14 We're particularly interested in your views 15 on a federal standard for foreclosure notices, but 16 we'd like your comments on any of the items that I 17 talked about. Just to reiterate: Credit insurance 18 and similar products, referrals to counseling 19 service, balloon payments, improvement to the HOEPA 20 disclosures, and foreclosure notices. Anybody want 21 to pick one and say something? 22 MR. BURFEIND: The disclosure with regard 23 to credit insurance as provided in Regulation Z, we 24 think is pretty plain, pretty straightforward, and 25 the studies indicate that it has had an impact in FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 134 1 the marketplace. Right on the front of the 2 document, you know, the notice that the credit 3 insurance is optional, it's not a condition of 4 credit, this is the cost; if you want it, sign 5 here. 6 The comment was made that consumers aren't 7 aware of it; the studies suggest otherwise. Without 8 going through a lot of detail, in the most recent 9 one by the Credit Research Center one of the 10 interesting points was that -- two interesting 11 points. One, that the borrower's awareness of the 12 insurance purchase appears to rise with the size of 13 the loan to be insured. Clearly the mortgage loans 14 and equity loans would fall into the larger 15 category. 16 And as far as -- they studied recall errors 17 in that study; you know, did you or didn't you buy 18 it. Some people thought they bought and didn't, 19 others bought and thought they didn't, you know, the 20 small percentage. But one of the interesting 21 findings was that it was not the older borrowers or 22 those with the lower income and less education that 23 had these errors. It was the older borrowers and 24 the ones with the less education that had the better 25 recall and awareness of the purchase. And this is FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 135 1 the market segment that people of good will promoted 2 and subscribed to the kinds of disclosures that are 3 evident in Regulation Z right now. 4 MR. LONEY: One of the concerns that's been 5 raised -- you mentioned one, that they're not 6 aware. The other concern is that the sales tactics 7 have been -- 8 MR. BURFEIND: I think somebody else said 9 they were not aware. My point is there is a high 10 level of awareness. 11 MR. LONEY: I understand, but you addressed 12 the issue that they weren't aware. The other issue 13 that has been raised is that sales tactics have led 14 consumers to believe the insurance is required. Do 15 we have any comment -- 16 MR. BURFEIND: That same study that I said, 17 the Consumer Research Center study, I know a copy is 18 with the staff of the Board; I don't know who all 19 has had a chance to look at it yet. But one of the 20 other findings was that of the purchasers of credit 21 insurance only 1 percent indicated they believed it 22 was required. 23 MR. MAYNARD: One of the things that my 24 clients express surprise at when they are discussing 25 credit insurance purchases with me is that often the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 136 1 credit insurance that they purchased was purchased 2 from a wholly-owned affiliate of the lender. So 3 when they look back at this transaction they realize 4 that this suggestion by the loan officer to purchase 5 credit insurance actually resulted in the purchase 6 of a credit insurance product from a wholly-owned 7 subsidiary of the lender. 8 When Mr. Eakes was mentioning a 40 percent 9 commission that's often a part of these premiums, 10 you wind up with the scenario where you've got a 11 lender who is making interest on this premium and an 12 insurance company that's making money, rightfully so 13 of course, on a product. But here you've got what I 14 think is largely unknown by consumers, the fact that 15 in a greater number of these transactions the 16 product is being sold to a wholly-owned subsidiary 17 of the lender itself. The insurance company is 18 actually owned by the lender. 19 Now, I know in Regulation X there is a 20 requirement that affiliate relationships be 21 disclosed. In the disclosure that Mr. Burfeind was 22 speaking of there, that is not clearly disclosed to 23 consumers; that if they buy this product that 24 they're, you know, apprised of the fact that it is 25 in fact an affiliate of the lender. I think that FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 137 1 might give rise to a bit more inquiry by the 2 purchaser as to whether or not there's an arm's 3 length transaction involved, as to whether or not 4 this is fair pricing for the product that's being 5 sold, and I don't think that's clearly disclosed in 6 the current disclosures. 7 MR. BURFEIND: Two points of 8 clarification. First, there's only a hundred 9 pennies in a dollar and -- 10 MR. LONEY: Are you sure? 11 MR. BURFEIND: In my dollar there's only a 12 hundred pennies. In the real estate secured market, 13 as I indicated in my opening remarks, the experience 14 is that the claims cost is at or above 60 percent; 15 60 cents out of these hundred pennies is being paid 16 out in benefits. 17 Since there are expenses associated with the 18 program as well, it's very unlikely that in this 19 market segment anybody is paying 40 percent 20 commissions. 21 Secondly, in the captive environment, if I 22 understood Mr. Maynard correctly, my understanding 23 is that usually there aren't commissions paid in 24 that environment, that ultimately whatever profit 25 might enure from the credit insurance transaction FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 138 1 would simply be moved upstream as a dividend at some 2 time in the future and not paid out as a commission 3 between the parent and the subsidiary or between the 4 loan officer and the parent or subsidiary. That's 5 my understanding. 6 Now, there's a number of ways which 7 compensation can be arranged, but before we simply 8 accept that statement at face value let's just 9 indicate -- if it's a matter of real interest to the 10 Board, we ought to look at it a lot more closely. 11 MR. EAKES: It doesn't matter whether it's 12 an implicit commission or explicit, it's still the 13 same 40 to 50 percent. 14 MR. BURFEIND: Maybe your dollar has more 15 pennies than mine, Mr. Eakes. 16 MR. EAKES: I don't understand. 17 MR. BURFEIND: I just said you can't -- if 18 you're paying 60 percent out in claims you can't be 19 paying 40 percent in commission. 20 MR. EAKES: In North Carolina the credit 21 insurance claims payment is under 40 percent, right; 22 40, 41? 23 MR. BURFEIND: Not for the real estate 24 secured. If you look at the real estate secured 25 segment, which we've begun to -- and the data that's FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 139 1 publicly available for the most part -- in fact, I 2 think exclusively -- doesn't carve out the real 3 estate secured. The credit insurance reporting had 4 never been required to differentiate between 5 unsecured and secured, so the only reference numbers 6 you've got for North Carolina generally have to do 7 with the aggregate, unsecured and secured. 8 MR. EAKES: Does that mean that if the real 9 estate which is roughly half is 60 percent payout 10 and our average is 40, that for consumer loans the 11 payout is 20 percent? 12 MR. BURFEIND: I don't know where you come 13 up with half. 14 MR. EAKES: You must have it broken out 15 between real estate and non-real estate. What's the 16 number you've got? 17 MR. BURFEIND: I don't think we have that 18 kind of penetration, or that our industry has that 19 kind of penetration in the real estate secured 20 marketplace. 21 MR. MICHAELS: Can I ask a question? 22 MR. BURFEIND: I'm really not in a position 23 to venture an allocation at this point. 24 MR. MICHAELS: I have a question about the 25 consumer's understanding of credit insurance and the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 140 1 disclosure issues that we can deal directly with 2 under HOEPA, and that is, usually when is the 3 consumer first asked about credit insurance or asked 4 to agree to credit insurance? What is the timing on 5 that? At application, at loan closing, in between? 6 MR. BURFEIND: Perhaps some of the lender 7 representatives might indicate what their individual 8 practice is, but my understanding of the general 9 practice is that it is presented as an option at the 10 closing. And this is largely as a result of being 11 responsive to concerns expressed by consumers in the 12 past that consumers are led to believe that it's a 13 requirement of the loan. We say no. You don't show 14 up until the loan closing, you know your loan is 15 approved by the time you get to the loan closing; it 16 can't be a requirement of credit. So that's the 17 time that generally, by my understanding, the option 18 is presented. 19 MR. MICHAELS: Anybody else have a view on 20 that? 21 MR. EAKES: I just wanted to cite -- in the 22 written testimony that I submitted, I think it may 23 be the same industry study or an earlier one from 24 the Credit Research Center study, Purdue, 1994; it 25 cited that 40 percent of the borrowers of who have FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 141 1 prepaid credit insurance either didn't know they had 2 it or thought that it was required. This is an 3 industry study -- 40 percent. 4 I would argue the other 60 percent can't 5 have known that they were paying -- is that '94? 6 The other 60 percent can't have known that they were 7 paying 99 percent of that premium out of the equity 8 in their home. The Federal Reserve's rules in truth 9 in lending only require an initialization at 10 closing; that's the only requirement for it to be 11 excluded from the finance charge, which is -- 12 MR. BURFEIND: I handed Mr. Eakes the study 13 so that maybe he could thumb through and identify 14 the page where that figure presents itself. When I 15 reviewed the study last night the only reference I 16 found to anything close to 40 percent was related to 17 some finding, a questionable finding by the way, in 18 a 1976 study, not a finding of the current survey 19 results. 20 MR. LONEY: While you're doing that, would 21 some of the other lenders try to answer Jim's 22 question? 23 MR. BOST: I would like to say what doesn't 24 happen. Generally the brokered loan transaction in 25 North Carolina that's a conforming loan -- our FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 142 1 brokers generally don't sell credit insurance. I 2 mean, it's not common across the mortgage market, 3 especially in the broker loan market. It's only 4 common in certain kinds of transactions. And if I 5 could offer this question, I'd like to know what 6 kinds of transactions it is offered in, because I 7 deal with a lot of lenders and most of my lenders 8 don't offer it and most of my brokers don't offer 9 it. So maybe Martin or -- 10 MR. MAYNARD: Do you want names of 11 lenders? 12 MR. BOST: I guess my question is -- the 13 point I want to make is, credit insurance is not 14 from the bottom to the top, it's somewhere -- 15 MR. MICHAELS: Where it is offered, when is 16 the consumer usually asked to make a designation? 17 MR. EAKES: At closing. 18 MR. CREEKMAN: In our case, our mortgage 19 department, the conventional 15- and 30-year loans, 20 we actually don't have the ability to be able to 21 offer credit insurance at closing. It's offered by 22 letter to the customer after closing. 23 In the case of consumer loans, we have a 24 loan documentation preparation system which you have 25 to tell up-front do credit insurance or don't do FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 143 1 credit insurance, so before the loan documents are 2 prepared the customer normally makes that choice. 3 However, it is not our practice to charge 4 single-premium insurance in any case. And in North 5 Carolina, the credit insurance rates are set by 6 statute, so it really doesn't matter whether you're 7 dealing with a subsidiary or nonsubsidiary; the 8 rates are the same. It's plain vanilla. 9 MS. CRAWFORD: When I first started out in 10 lending I worked for a finance company -- well, I 11 worked for three finance companies; I thought they 12 would get better as I went along. But the main 13 problem that I had was, we were trained to not 14 disclose until closing that the customer had credit 15 life insurance on their loan. We were told, just 16 tell them sign here, sign here, sign here. That was 17 back in the mid-seventies, and I know since then 18 disclosure is a lot better, I would hope, but back 19 then we were just -- we just told the customer to 20 sign here, sign here, sign here. And we were told 21 that we had to tell them it was required. 22 MR. LONEY: What are you doing now? You 23 don't sell it? 24 MS. CRAWFORD: I'm a broker, I just 25 don't -- my lenders do not offer it and I would not FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 144 1 sell it because of what I have been through in those 2 first four years. 3 MS. EGGERS: I'd like to answer the 4 question from EquiCredit and Bank of America's 5 perspective. We have an approach that's a hundred 6 percent offer, offer the product to everyone, but 7 obviously we are either not doing that or the 8 consumer has other ideas because our penetration of 9 product is exceptionally low for EquiCredit. 10 MR. EAKES: 15 percent? 11 MS. EGGERS: No, actually, Martin, it's a 12 little short of 9 percent penetration. And as we 13 have worked through it there's a couple of points 14 where we would engage the consumer; one is actually 15 prior to closing, which is the preferred situation 16 because then all of our documentation is better set 17 up at the closing table. And when we are closing 18 open items on the credit, you know, we haven't 19 gotten this form, haven't gotten that form, then our 20 account officer is in the position to offer the 21 product to the consumer. And again, it's a 22 situation where it's a hundred percent offer, but 23 our penetration is exceptionally low. 24 MR. MICHAELS: Let me tell you why I ask 25 the question. I think there's a compliance issue FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 145 1 under HOEPA that doesn't necessarily arise under 2 non-HOEPA loans, and that's under HOEPA the consumer 3 is supposed to get a disclosure three days before 4 closing that has the monthly payment in it, and the 5 monthly payment in that disclosure is not supposed 6 to include credit insurance as part of the payment 7 if the consumer has not already asked for credit 8 insurance. So it seems to us that if the consumer 9 is presented with the insurance option at closing 10 and chooses it, the monthly payment will change and 11 then you're back into a situation where you have to 12 give the HOEPA disclosures all over again, wait 13 three more days. Either that's happening or HOEPA 14 isn't being complied with. That's what we're trying 15 to figure out. 16 MS. EGGERS: This gets back to the whole 17 idea of simplifying disclosures. One point I put on 18 the table, whether you like credit insurance or not, 19 one way to think about that is that's not completely 20 a Section 32 HOEPA issue as much as it's a Reg Z 21 issue, because credit insurance is regulated under 22 Reg Z. 23 One perspective we've got is yes, it needs 24 to be regulated and disclosures need to be a lot 25 clearer. If this is a key focus, when we take Jim's FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 146 1 idea of redoing all the disclosures and making them 2 simpler and starting from beginning to end, we might 3 want to consider putting more emphasis on the 4 insurance disclosures in the process, if that's a 5 heightened area of consumer concern. We would be in 6 complete support of that. 7 MR. MICHAELS: We're just trying to figure 8 out how credit insurance can be sold with HOEPA 9 loans and brought up only in closing and still be 10 compliant with HOEPA. 11 MS. EGGERS: Just to clarify too, we don't 12 do HOEPA loans. 13 MR. BURFEIND: Let me make some independent 14 inquiries on that and respond to that in written 15 testimony that I'll submit prior to September 1. 16 MR. MICHAELS: I'd appreciate that. If 17 anybody else has a view on it -- 18 MR. LONEY: Another issue that we've talked 19 about is balloon payments and whether we should do 20 anything in connection with our review of HOEPA. 21 Would it be, for example, helpful if we had 22 additional disclosures or -- can you elucidate on 23 when borrowers learn their payment schedule includes 24 a balloon payment so that we can kind of understand 25 the process. Is it typically at or near application FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 147 1 or is it the case that consumers might first learn 2 about the balloon payment feature at closing, and if 3 it's the latter, is there a class of home-secured 4 loans that should receive information about the 5 balloon payment earlier than closing. 6 These are some questions that we've been 7 sort of kicking around in thinking about what we 8 ought to do next, and anything you can do to help us 9 think through some of this would be useful. 10 MS. CRAWFORD: Balloon payments -- any kind 11 of terms of the loan are supposed to be disclosed 12 within three business days and that is taken care 13 of -- they have a balloon disclosure, and they also 14 have -- it's also reflected in the truth in lending 15 statement. So if they are following truth in 16 lending, they are giving a truth in lending 17 statement within three business days of application 18 and they are being disclosed, three business days of 19 application. 20 MR. EAKES: I just wanted to respond to 21 Bill's point since -- 22 MR. LONEY: You haven't been paying 23 attention for the last three minutes? 24 MR. EAKES: I've been listening to every 25 word. In Chapter 6, Page 12, it has a chart and it FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 148 1 says 19.3 percent of folks that got credit insurance 2 were never told that the insurance was optional; an 3 additional 27 percent felt pressured to purchase or 4 felt buying the insurance would improve their 5 ability to get the loan. So a total of like 6 46 percent -- 7 MR. BURFEIND: What's the page on that so I 8 can look at it. 9 MR. EAKES: Chapter 6, Page 12. 10 MR. LEHMAN: On balloon payments, it's been 11 our experience -- we had a case with a North 12 Carolina very high-rate lender, probably half of its 13 loans were balloon payment loans; we interviewed a 14 number of the borrowers who had balloon payments and 15 a surprising number of them, not all but a very 16 large percentage were not aware that there was a 17 balloon payment. It was almost embarrassing to talk 18 to an elderly borrower who had a balloon payment 19 provision after 15 years and give her the bad news 20 that after paying on it for 15 years she still owes 21 almost what she started with. 22 There were disclosures, it was disclosed -- 23 Kate indicated it was disclosed on the good faith 24 estimate. As I recall the only disclosure was a 25 figure of 30/15 up in the corner, which to a lender FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 149 1 means a 30-year amortization with a 15-year balloon, 2 but it means nothing to the average borrower. It 3 was disclosed at closing and there would be a 4 separate statement in this lender's file indicating 5 that there was a balloon payment and the consumer 6 signed off on it, as the consumer signed off on 7 about 30 other pieces of paper. 8 MR. LONEY: What kind of a loan was this? 9 A straight-up purchase money mortgage or -- 10 MR. LEHMAN: Refinanced first mortgage. You 11 know, the disclosure provision in this case and in 12 other cases is sort of the last refuge of 13 scoundrels. You've got your client or your consumer 14 who says I had no idea about it and you try and take 15 that to court and the lender's got these disclosure 16 documents; well, you signed here, you signed here; 17 that fully disclosed that there was a balloon 18 payment. 19 MR. LONEY: Then what does one do about 20 it? I mean, if disclosure doesn't work -- 21 MR. LEHMAN: What we did about it on 22 high-cost home loans was to prohibit balloon 23 payments. We thought that was the way to go. 24 MR. MAYNARD: North Carolina has a 25 particular piece of legislation known as RISA that a FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 150 1 lot of other states have, the Retail Installment 2 Sales Act. It applies particularly in other 3 instances to -- among other instances, it applies to 4 mobile homes, and North Carolina, under the Retail 5 Installment Sales Act, prohibits balloon payments 6 with the sale of financing of mobile homes. 7 A sector of the lending industry has 8 penetrated this by avoiding the North Carolina 9 statute through the AMPTA legislation that I 10 mentioned earlier. This may not be within the 11 purview of the Board's HOEPA's powers, but the idea 12 now is that a lender who packs a balloon payment 13 into a mortgage may avoid applicable state law by 14 virtue of the preemptions that, in our view -- 15 especially with mobile home loans where quite 16 frequently the land is secured and maybe there's 17 some slight appreciation in the land value over time 18 but quite frequently there's no appreciation in the 19 value of the unit itself, it depreciates over time, 20 toward the end of that loan you've got a balloon and 21 it's very difficult at that point with an older 22 mobile home unit to come up with the same value that 23 was there at the time the loan was originally 24 closed, so you wind up with very difficult 25 circumstances. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 151 1 Aside from these balloon payments being 2 prohibited in high-cost loans, I think with 3 manufactured housing it is something of great 4 concern, to eastern North Carolina in particular 5 right now with the events of Hurricane Floyd. There 6 are just, you know -- every county has got very 7 extensive efforts underway to replace housing with 8 manufactured units. First Citizens, one of the 9 conventional lenders that extends credit on 10 manufactured housing, is greatly appreciated. They 11 generally play by the rules, to my knowledge; always 12 play by the rules to my knowledge. 13 Unfortunately, the out-of-state lenders that 14 come in here don't do that and they will use AMPTA 15 to avoid those specific prohibitions. 16 MR. LONEY: So you would say what, for 17 manufactured housing loans we ought to consider 18 outlawing balloon payments? 19 MR. MAYNARD: I think that that's a sector 20 of the market that deserves particular protection. 21 I don't purport to know exactly the remedy or the 22 approach as how it may within HOEPA and within 23 purview of the Board's jurisdictions, but I would 24 treat manufactured housing very similar to the way I 25 would treat high-cost loans with respect to FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 152 1 protection for consumers. 2 MR. LONEY: The Board has some authority 3 for non-HOEPA loans to take action. I mean, as you 4 in North Carolina have outlawed balloon payments in 5 HOEPA loans, that's one thing, but what do you do in 6 non-HOEPA loans. That's sort of one of the 7 questions here. Yes, Mr. Creekman? 8 MR. CREEKMAN: Carrying on a little bit 9 more about the mobile home issue, because a little 10 history is worthwhile, North Carolina used to have a 11 statute, a usury statute, which prohibited a lender 12 from making a variable rate loan secured by a mobile 13 home except under very limited circumstances which 14 were almost impossible to meet. That was repealed 15 several years ago. 16 The Retail Installment Sales Act that he is 17 mentioning actually applies only to the seller of 18 the mobile home, not to a third-party lender. So 19 when he's talking about the restriction on balloon 20 payments, that applies for seller financing; a 21 mobile home dealer, for example. It does not 22 apply -- and for the bank that would purchase that 23 if it is dealer paper, but it does not apply to a 24 third-party lender making a loan secured by a mobile 25 home. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 153 1 Here's where we get into a little bit more 2 of a difficult issue. When you look at the issue of 3 balloon payments outside the context of predatory 4 lending practices, whether it be a mobile home or 5 not, there are a lot of situations, particularly in 6 consumer loans -- I'm not talking about the 15- and 7 30-year mortgages -- but particularly in consumer 8 loans secured by real property or the borrower's 9 residence where a balloon payment is not only 10 anticipated, it's the plan. The idea is that you're 11 going to amortize a loan over a 30-year period in 12 order to keep the loan payments as low as possible, 13 but you're going to balloon it in three to five 14 years with the intention that at that point there's 15 going to be an economic change on the borrower's 16 part where he's going to repay the loan. 17 It is a substitute for an interest-only 18 loan, because it does amortize. And it has a very 19 real place in the economy. So when you start 20 thinking in terms of what do we do with balloon 21 payments, keep in mind that you're dealing with a 22 universe of loans that is much greater than the 15- 23 and 30-year traditional conventional loans. 24 And this applies -- I'll give you another 25 very simple reason for having a balloon loan. If FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 154 1 it's a portfolio loan and it's not going to be sold 2 in the secondary market, then we're not willing to 3 accept the interest rate risk associated with a 4 fixed rate loan for 30 years. We're going to either 5 have a balloon on that fixed rate loan or it's going 6 to be a variable rate loan, in order to address the 7 interest rate risk issue. 8 So there are legitimate business reasons, 9 both from the consumer's perspective and from the 10 lender's perspective, to keep the balloon payment as 11 a viable tool to meet the credit needs of the 12 customer and to meet the concerns of the bank for 13 safety and soundness issues. 14 MR. LONEY: Does that get us into some of 15 the same issues, though, about something akin to net 16 tangible benefit; that is, you make some judgment 17 whether this balloon payment is good for the 18 consumer in one case and isn't good for the consumer 19 in another case? 20 MR. CREEKMAN: Yes, it does. But I'll tell 21 you that the result of that is that -- where the 22 challenge will come is after default, and so all 23 you're doing is inviting litigation on whether or 24 not the bank or the lender should have made the loan 25 in the first instance, and that challenge will only FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 155 1 come when there has been a default down the pike. 2 And it's a setup for litigation, it invites 3 litigation. 4 MR. EAKES: I wanted to add that I actually 5 agree with Jim on there may be some situations 6 where -- I agree with him a lot. He's smarter than 7 me so I have to. But just to point out it is an 8 area where we've had abuses, where we've had loans 9 that were originated that have a balloon feature and 10 then was used as a rationale to flip the loan; I'm 11 sure many of you have seen these news reports. So 12 it's people who have a lower payment but are 13 basically not paying anything off on the loan, it 14 ends up being a rationale for flipping, and it's one 15 of those difficult, tricky places that there can be 16 situations where it's valuable and there can be 17 situations where it's abused. 18 MR. BLANTON: What is the solution? 19 MR. LONEY: What would you do? 20 MR. EAKES: I think you would probably 21 prohibit them for high-cost loans, for balloon 22 payments. Honestly, I don't think you have the 23 authority to prohibit -- I think you have a lot of 24 authority, but with AMPTA there, the parity act, I 25 doubt that you have authority to prohibit balloon FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 156 1 payments for all home loans. 2 MR. MICHAELS: Do you think earlier 3 disclosure would help at all? 4 MR. EAKES: The one thing I think that -- 5 among this group, they may or may not accept me as a 6 lender after today, but the advocates and the 7 lenders pretty much agreed in our North Carolina 8 process that disclosure will not solve much of 9 anything, that there was agreement that we have so 10 much disclosure now, whether it's the Stock theorem 11 or somebody else, that disclosure is ultimately, 12 with the level we have now, useless, and it adds 13 paperwork and cost to us lenders that's just as 14 unnecessary. 15 MR. MICHAELS: I didn't mean to close it; I 16 meant much earlier. If somebody had to be told at 17 application or within a certain period of time after 18 application that this was going to be a balloon 19 loan, would that help? 20 MR. EAKES: I don't think that the balloon 21 feature -- if you had to prioritize, I gave you my 22 five: prepayment penalty, credit life, yield spread 23 premium in the fees, making sure that the first 24 purchase, the broker actions are accountable to the 25 first lender -- something else I left out -- FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 157 1 flipping. So if you're going to waste or use one of 2 Paul Stock's five possible disclosures, I probably 3 wouldn't do it on the balloon feature. In the world 4 of abuses I think that that one is not in the top; 5 it's not on Letterman's top ten list, or top five 6 list, anyway. 7 MR. LONEY: It sounds like, though, 8 Mr. Maynard's clients might not agree with that. 9 MR. MAYNARD: I agree with both of these 10 gentlemen in almost every respect. I think that 11 there is a particular need for protection with 12 respect to manufactured housing because of the 13 tendency for manufactured housing to depreciate over 14 time. 15 MR. COUDRIET: I also find myself, 16 shockingly, agreeing with Mr. Eakes this time. The 17 one proviso would be that we don't change the 18 triggers. Because, once again, if you take the 19 triggers down and scoop up a lot more transactions 20 into high-cost loans, you're once again taking away 21 from the flexibility that a lender has to solve a 22 family's restructuring needs. 23 MR. LONEY: Let me ask just one more item 24 in the Board's notice, and that has to do with 25 whether the Board ought to do something by way of FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 158 1 requiring a notice of the availability of credit 2 counseling services. Would that be of any use, 3 would it be -- no? 4 MR. EAKES: It's a sham. It's one more 5 piece of paper. All it is -- 6 MR. LONEY: Are you objecting to the notice 7 or to credit counseling? 8 MR. EAKES: I'm just saying that putting -- 9 if it's not required credit counseling, it's not a 10 substantive provision, it's simply a disclosure 11 notice, then I think it's one more piece of paper 12 out of 30. It makes no difference, not worth -- it 13 makes it appear that we've done something when we 14 really haven't. 15 MR. LAMPE: It seems like the answer to the 16 question may come in the afternoon, that Mr. Eakes 17 might agree that community outreach and education 18 may be better on a macro basis anyway than another 19 piece of paper disclosure that can be ignored in 20 connection with a particular transaction. 21 MS. CRAWFORD: I thought about this for a 22 long time, but I think that one of the reasons that 23 HOEPA and the subprime market is in existence 24 naturally is because people have impaired credit, 25 and we are not teaching our children in the school FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 159 1 systems about credit. We teach them about 2 everything else in the school systems and I think 3 there should be -- if they still have social studies 4 class, I think this should be a required course on 5 how to handle credit and what credit does for you. 6 I think that we wouldn't be here today talking about 7 HOEPA if we took more care with our children from 8 day one and talk about credit. It's not necessarily 9 the parents' responsibility to do that but we need 10 to bring it into the school system. They need to be 11 educated, and the earlier they learn the less 12 problems they will have later on in life. 13 MR. LONEY: Would you have the same view 14 about the usefulness or lack thereof of a disclosure 15 about foreclosure rates? That was another issue 16 that was raised about whether we ought to have a 17 federal foreclosure rate notice dealing with the 18 procedures and the legal rights the customer has, 19 the specific amount that if paid will terminate the 20 foreclosure -- or is that just another piece of 21 paper stuck in there? 22 MR. BOST: Personally I think that a lot -- 23 and Ms. Morales can probably answer this, but I 24 think under Fannie Mae loan documents that's 25 required as a condition of foreclosure on a lot of FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 160 1 transactions anyway. And secondly, I think we need 2 to be careful -- foreclosing on a loan, especially 3 now in North Carolina, is a very cumbersome process 4 to start with. If this disclosure is in lieu of a 5 state disclosure or state notice, that's one thing, 6 but in addition to a state notice might create road 7 blocks to foreclosure that are undesirable. 8 MR. MICHAELS: I think we were saying it's 9 also a potential set of standards, minimum 10 standards, for the state-required notice, so there 11 wouldn't be necessarily an additional notice. 12 MR. BOST: I think that it's always 13 important to provide borrowers at least one last 14 chance. It helps the foreclosure process go a 15 little bit quicker, so I don't object to that. 16 MR. LONEY: That's a disclosure probably 17 that would take place, I don't know, maybe at 18 closing. 19 MR. BOST: You're talking about at 20 closing. I thought you meant before you actually 21 went into foreclosure. That's what I wanted to 22 address. 23 MR. LONEY: Could be. Anybody over here 24 have any -- Mr. Creekman? 25 MR. CREEKMAN: I'm sorry, but I think FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 161 1 that's just another useless disclosure. A closing 2 attorney isn't going to spend a whole lot of time 3 telling a person what happens and the procedures 4 that are going to be followed when they don't pay. 5 I tell you when I was in private practice I handed 6 the note to the customer and I said, This is the 7 promise to pay. Then I handed the deed of trust and 8 I said, That's the "or else", and they got the idea. 9 MR. LONEY: I'll bet they did. 10 MR. COUDRIET: I think after closing and at 11 the time where foreclosure might have to be 12 contemplated that the responsible servicer -- and 13 that's what we're talking about, people who service 14 loans; there's only a couple or three of us in the 15 room -- always will make a series of contacts or 16 attempted contacts and then return receipt requested 17 certified mail to send a disclosure. That's in our 18 own interest. It would be easy for us to comply 19 with any legislation. We actually send out a video 20 to those folks that explains the problem to them in 21 case they don't want to read something. 22 As a part of our attempt to participate in 23 mortgage reform, several of the associations in 24 Washington came up with a draft bill called the Home 25 Equity Recovery Act that dealt with foreclosure. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 162 1 We'll be glad to provide you with that to let you 2 see what those stipulations were, because, you know, 3 it's the kind of things that a responsible servicer 4 already does and we feel ought to be a part of the 5 process. 6 MR. LONEY: I think we'd like to see that, 7 yes. Mr. Lampe? 8 MR. LAMPE: I believe from a disclosure 9 viewpoint, at least at closing, I think the standard 10 Fannie Mae, Freddie Mac uniform instruments do a 11 pretty good job at closing if the consumer wishes to 12 read them they're in bold print; I won't say they're 13 in plain English. But I would not want to take the 14 borrower's responsibility away from them completely 15 to understand what they're getting into. Back when 16 I used to do residential closings, which has been 17 years ago -- this is a takeoff on what Mr. Creekman 18 said -- perhaps a suggested form of disclosure, but 19 I would say, If you pay, you stay; if you don't, you 20 won't. And if the Board wishes to promulgate a 21 plain English standard I would suggest that as a 22 starting point. 23 MR. LONEY: I can just about guarantee you 24 the Board won't do that. 25 MR. MICHAELS: This comes up because we've FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 163 1 heard legal aid attorneys tell us that in some 2 states it's still a practice to have foreclosure by 3 publication rather than foreclosure by actual 4 notice. So the question would be, is there any harm 5 in having a HOEPA rule that says it is deemed to be 6 an unfair practice not to meet these minimum 7 standards and one of the minimum standards is 8 foreclosure by actual notice and here's the contents 9 of that minimum notice; is there any downside to 10 that? 11 MR. CREEKMAN: Absent the guy who's bolted. 12 MR. MICHAELS: I think we're talking about 13 the duty on the lender to send the notice. If the 14 person has bolted -- I assume under even state laws 15 that requires actual notice -- 16 MR. CREEKMAN: North Carolina requires 17 actual notice. In the absence of actual notice, you 18 post and you publish. And you're right, in some 19 states it's just publish in the newspaper and 20 foreclose. But is that -- I guess my question is -- 21 what we're concerned about is making sure folks get 22 credit. Are you really aiming at the consequences 23 of default? 24 MR. MICHAELS: Here's how the issue has 25 come up. It's been presented to us in situations FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 164 1 where consumers have been abused or subject to 2 predatory practices and it results in foreclosure, 3 they need at least ample opportunity to prevent that 4 foreclosure on that ground so they have a chance to 5 present -- 6 MR. CREEKMAN: Then treat that as a 7 consequence of having a high-cost home loan. Don't 8 make that a standard which is applicable across the 9 board. Make that, again, one of the criteria that 10 must be satisfied if you have a high-cost home 11 loan. 12 MS. EGGERS: In this instance we would not 13 be looking for the Board's involvement in all of the 14 state foreclosure regulations that we already deal 15 with. We've really addressed the problem and the 16 issue in connection with the consumer earlier in the 17 process in the creation of a lost mitigation effort, 18 which is very contact-intensive with the customer; 19 it's solution-oriented. We don't want to go to 20 foreclosure; it's a lose-lose proposition. 21 So, you know, I think it's how big is that 22 problem you're hearing about versus just more paper, 23 more process, and starting to put the Board into the 24 state foreclosure process. Those would be the 25 trade-offs. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 165 1 MR. EAKES: The point I would make is, if 2 you really want to help borrowers who are in the 3 foreclosure process, have more loans covered by 4 HOEPA. Because then at least if there was abusive 5 actions at the time of origination they at least 6 will have some defense that normally they don't have 7 now because they don't have pass-through liability. 8 MS. HURT: I'd like to ask one question, 9 and it moves away from disclosure; it's back to the 10 Board's use of its 129 authority under HOEPA. 11 Suggestions have been made that the Board declare as 12 unfair and deceptive acts that are already illegal 13 under certain laws, so, for example, the Board would 14 say that it's unfair and deceptive to falsify 15 application or to create income -- well, that's 16 fraud. Is there any benefit, do you see, to 17 consumers in trying to get out of predatory loans in 18 having that type of provision in the federal law, or 19 are the current laws dealing with fraud and 20 misrepresentation good enough? Would that help? 21 MR. MAYNARD: Speaking from I guess the 22 viewpoint of private enforcement, if you look at 23 that in the context of individuals looking for 24 attorneys in the midst of foreclosure, what happens 25 in North Carolina, for instance, there are only four FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 166 1 issues that can be raised in a foreclosure: Whether 2 there's a debt, whether it's past due, whether 3 there's been notice, and whether there's a power of 4 sale. It doesn't matter what wrongful conduct has 5 occurred; a borrower is not allowed to raise in a 6 foreclosure proceeding any defense that doesn't 7 relate to those four issues. 8 If they want to raise those defenses, they 9 have got to go to an attorney and file a separate 10 lawsuit. In order to do that, they're probably 11 going to need -- in the area where I practice, 12 they're going to need $5,000 to $10,000 to hire an 13 attorney who's going to file suit asking for 14 injunctive relief to stop the foreclosure, alleging 15 sufficient causes of action to support that 16 injunctive relief. And most people of course who 17 are in the midst of foreclosure, the last thing they 18 have is money to go pay an attorney. 19 The fact that HOEPA might characterize 20 certain practices as unfair and deceptive trade 21 practices might in fact leverage potential attorneys 22 fees so that a borrower could talk to an attorney 23 who, in the face of egregious misconduct by an 24 originator, would in fact see a potential recovery 25 of an attorneys fee if it was characterized as an FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 167 1 unfair and deceptive trade practice. 2 There are many practices that violate 3 contracts, there are many practices that violate law 4 that are not in that heightened category of course 5 of unfair and deceptive trade practices. If in fact 6 the unfair and deceptive trade practices were tied 7 to attorneys fees, it might actually allow some 8 people who were unable to access an attorney and 9 therefore access justice to have access to the 10 courts. So to that extent I would support it. 11 MS. EGGERS: I'm not sure we've come across 12 anyone who has not had access to attorneys in the 13 scheme of things. But I think when we look at this 14 issue -- you know, the first thing that crossed my 15 mind as you were going through the list is those are 16 things that happen to us, the lender, too. So I'm 17 not sure what benefit comes from putting it, you 18 know, in the HOEPA regulation. 19 I think we've absolutely got to enforce the 20 regulation that's out there and, you know, we are 21 working actively not to have to deal with fraudulent 22 issues and problems that exist out in the 23 marketplace as a whole, so we're all for enforcement 24 of everything that reduces those issues. Because 25 we, as a lender, bear the burden of those and we are FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 168 1 committed to making things right for our customers 2 if we unwittingly have been involved in any 3 situation that's of a difficult nature for them, 4 unwittingly. 5 MR. MAYNARD: Your experience with respect 6 to attorneys is different than mine. I worked in a 7 legal aid office in North Carolina for ten years and 8 one of the things that we did not generally have 9 funding to do was foreclosure defense. We had 10 dozens of clients contact us each month asking for 11 legal assistance with respect to foreclosure defense 12 and there were no attorneys available. We would try 13 very hard to induce attorneys through pro bono 14 efforts to do that, volunteer efforts. It's an area 15 of expertise -- we always wind up with very, very 16 formidable counsel as those who are sitting around 17 this table here as our adversaries when we're suing 18 a bank. 19 MS. EGGERS: We need to invest in the front 20 end of the process though, because we don't want 21 things to go to foreclosure. So the education Kate 22 talks about, the process that gets us into not 23 landing in those kinds of situations -- 24 MR. MAYNARD: That's a good, wholesome 25 approach and I certainly agree with that too, but FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 169 1 the question had to do with the tail end at 2 foreclosure and whether or not HOEPA might address 3 the unfair and deceptive trade practice issues. To 4 that extent -- 5 MR. LONEY: I'm going to have to give you 6 the very last words because we're going to have a 7 break. 8 MR. EAKES: I was going to ask a question 9 as we were starting to run out of time. HOEPA, one 10 of its main goals was to induce self-policing so 11 that the industry would do due diligence itself. 12 Are there ways to use HOEPA regulations so that we 13 don't have other intrusions, that we induce self-due 14 diligence searches? 15 I mean, I heard the attorney general for New 16 York speak at the Leach hearing, very, very 17 eloquently, saying that the very small minority of 18 bad brokers creates a whole lot of the problem 19 that's out there, and yet the lender who takes that 20 first loan can say that was an independent 21 contractor, I don't have any responsibility, nor 22 does this loan, for the bad actions. 23 I think one of the things I saw in North 24 Carolina that was very encouraging is that the 25 brokers association and representatives and the FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 170 1 lenders were really very responsible in helping us 2 work through. Yes, we fought, and yes, we got a 3 compromised bill that none of us really liked by the 4 time it was over, but they stepped forward in a way 5 that no other state -- I think Paul Stock, the 6 bankers association and other folks who said we want 7 to stop the bad guys, how can you help us with that 8 minority of bad guys, make the self-policing -- the 9 same way Fannie Mae and Freddie Mac when they're 10 selecting seller services, they do an extensive due 11 diligence and know that they're not going to get a 12 bad actor; at least not many. How do we induce that 13 same self-policing of the very bad actors? 14 And I think -- you know, I just want to 15 encourage you to think about some way, through the 16 discretionary authority that the Federal Reserve has 17 under HOEPA, to make the first lender unable to deny 18 it. No see, no tell, no liability. 19 MR. BURFEIND: You wanted a response, I 20 think; 30 seconds. I had asked Mr. Eakes to 21 identify the source of his data, and I thought he 22 had to aggregate some data to get there. The part 23 that he's aggregating doesn't go to the question of 24 consumer awareness of the purchase, it goes to the 25 question of the perception of marketing practices. FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 171 1 To get to the number that he gets to he has 2 to aggregate responses from those who did not 3 purchase. Obviously the sales pressure couldn't 4 have been all that persuasive. I would look to the 5 overriding conclusion which they cite, which is, We 6 estimate that marketing/coercion alone accounts for 7 a maximum of 3.4 percent of credit life insurance 8 sales. 9 MR. LONEY: Well, we're going to have to 10 settle that at lunch. 11 First of all, I'd like to thank the members 12 of the panel. This has worked out so much better 13 even than we could have guessed. I appreciate your 14 cooperation and your initial statements, and in your 15 participation in this discussion. It's been 16 largely, I know for me, very informative and very 17 useful. 18 We are going to have to break now; we're 19 going to break for about a half-hour. I have been 20 told to tell the folks in the audience that there 21 are places around here that you can go to eat; 22 someplace called Showmar's, which is behind the 23 bank, there's miscellaneous restaurants uptown. 24 There's a Burger King, Bojangle's, Subway, 25 et cetera, in the food court a block west in the bus FEDERAL RESERVE PUBLIC HEARING JULY 27, 2000 172 1 terminal. So you may be consigned to that, I 2 apologize, but given the constraints on time we're 3 not going to have a lot of time to take this break. 4 So we're going to shoot for about 1:30 to 5 start up again, and again, thank you very much to 6 all the panelists. It was very helpful.
July 27 hearing on home equity lending |
Afternoon session |
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Last update: February 14, 2002