The biggest governmental threat faced by the mortgage banking business isn't a
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
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,
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.
"It's the lending industry's equivalent of the Superfund, because the liability risk runs with the loan," said Laurence Platt, a Washington lawyer, referring to the federal law that requires companies to clean up polluted sites they own, even if they weren't the ones that polluted it.
Platt, a partner with Kirkpatrick & Lockhart who represents many mortgage bankers, said the problem with the Georgia law is that an investor who buys a bundled package of mortgages, or a mortgage-backed security, could be purchasing a ticking time bomb, if some of the borrowers decide to sue at a later date.
"Someone could buy a loan for $100,000 and later find out he not only has to give back the $100,000, but pay millions of dollars in punitive damages when they didn't do anything wrong," said Platt.
Credit agencies, so far, are taking a dim view of the Georgia law. Standard & Poor's and Moody's Investor Services say they will no longer issue rating for mortgage trusts that include home loans written in Georgia.
Supporters of the Georgia law dismiss the complaints of the industry as needless scare tactics. They contend the new state laws are needed to crack down on abusive practices like mandatory arbitration clauses and prepayment penalties, which current federal home lending laws largely ignore.
"If Congress were to put serious protections in place for borrowers, the need for
state pre-emption wouldn't exist," said David Swanson, a spokesman for ACORN, a housing advocacy group.
Indeed, the debate over the Georgia bill comes at a time that some state regulators are taking a more aggressive stance against home lenders -- even in the absence of new legislation.
California officials, for instance, are threatening to strip Wells Fargo of its license to write mortgages in the Golden State, claiming the nation's fourth-largest bank has failed to reimburse mortgage holders for improper fees and interest charges. San Francisco-based Wells Fargo, however, is challenging the state's authority in federal court, contending existing federal housing laws prohibit it from regulating its lending practices.
Meanwhile, Washington observers say that even in a Republican-controlled Congress, the Ney bill will have a tough time gaining sufficient support.