Predators Turn Prey in Lending Laws

The biggest governmental threat faced by the mortgage banking business isn't a Federal Reserve rate hike. Rather, it's state legislatures that suddenly are hellbent on cleaning up the aggressive lending practices of a few bad apples.

The mortgage industry has been abuzz for weeks about a new Georgia law that makes it easier for borrowers to sue lenders who engage in so-called predatory practices by charging excessive fees or interest rates on home loans.

Mortgage lenders -- especially those that cater to subprime borrowers -- fear the Georgia law and others like it could spark a wave of costly litigation. And that's prompting lenders such as Countrywide Financial(CFC Quote - Cramer on CFC - Stock Picks) to stop making loans to Georgia residents with shaky credit histories.

The industry is responding by backing a bill introduced last week by a Republican congressman, which effectively would render moot any new state predatory lending laws, including the Georgia measure. Rep. Robert Ney's (R., Ohio) bill would pre-empt states from trying to regulate the mortgage lending business and impose less Draconian penalties than the Georgia law for predatory tactics.

The outcome could have implications for more than just lenders that do business with the elderly or poor. It has big ramifications for financial institutions and investors that buy home mortgages in the secondary market, or purchase mortgage-backed securities. That's because the Georgia law allows borrowers to also sue secondary mortgage buyers.

The fear is that if aggressive laws like the one in Georgia are allowed to stand, the market for buying and selling mortgages will dry up. The law could also spell trouble for lenders with large mortgage-servicing portfolios, such as Countrywide, Wells Fargo(WFC Quote - Cramer on WFC - Stock Picks) and Washington Mutual(WM Quote - Cramer on WM - Stock Picks).

Also facing a potential squeeze are mortgage lenders that raise capital by forming special trusts and using them to package loans as bonds, which they sell to investors. It also could hurt the Wall Street firms that help arrange these securitizations and sell shares in the loan trusts to investors.

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