Considerations in Defending State Attorneys General Class Action Lawsuits Against Mortgage Lenders
In response to the unusually high levels of delinquency rates and foreclosure rates for mortgage loans, including subprime mortgage loans, the attorneys general of several states have filed class-action lawsuits against some of the country’s higher profile mortgage lenders. However, the situation may not be as simple as the state attorneys general see it.
Clearly, the unfortunate situation that exists today with regard to subprime and other mortgage loans is a disaster. In addition to upsetting and displacing thousands of families across the country, it is wreaking havoc with the country’s financial institutions and other investors in mortgage loans. People are losing their homes and jobs, associated foreclosures of subdivision lots and supporting commercial facilities are past the point of financial danger, and the overall situation clearly is the major factor causing the entire United States economy to tank. No one likes it, and everyone wishes it would go away.
Several state attorneys general are seeking to gain some relief for the victimized citizens of their states by filing lawsuits against larger mortgage lenders, but there is another side to this situation that needs to be considered.
Criticisms of Lenders
The leitmotif of the complaints filed by the state attorneys general seem to include four basic universal criticisms:
● The lenders made loans to many borrowers who should not have qualified for the mortgage loans and who had no realistic chance of repaying the loans in a reasonable period of time.
● The lenders developed and utilized exotic loan structures that were difficult for borrowers to understand and resulted in loans that were very difficult, if not impossible, for many borrowers to repay.
● The lenders charged high fees and interest that were unfair.
● The lenders sold their mortgage loans to Fannie Mae and Freddie Mac who literally gave their stamp of approval by agreeing to buy these loans that the state attorneys general say should never have been originated in the first place.
It has been my observation that when some catastrophic situation like the present one occurs, the most convenient way for everyone to attempt to avoid responsibility is to start looking for someone to blame. In the instant case, the state attorneys general clearly have sided with those who blame the banks, mortgage lenders and mortgage bankers. However, there is plenty of blame to go around, to wit:
● We, in this country, have as one of our overriding economic principles and beliefs the idea that widespread homeownership is universally desirable since it is the financial foundation of virtually all people. (Note: This is why we shouldn’t get nervous when economists point out that we only save a fraction of what people in most other countries save, and they conveniently overlook the fact that our citizens have substantially more in home equity than do the citizens of almost all other countries.)
● Home building and associated economic activities are the backbone of our national economy.
● Our government encourages homeownership and provides many economic opportunities and tax incentives to encourage it.
● Lenders records are regularly examined by the government to make sure that they are making acceptable levels of loans to a wide range of borrower types.
● Lenders responded to government demands for easier home mortgage credit by developing innovative loan structures that would help more borrowers qualify for a mortgage loan by allowing lower payments up front and higher payments or a balloon payment later on.
● Some of these loan structures carry greater risk, so lenders are justified in charging higher fees and higher interest rates than they would charge for a mortgage loan with less risk.
● While the demands of Congress may have caused mortgage lenders to have varied from their previous underwriting standards, it is also an undisputed truth that many of their mortgage loans that are now in trouble apparently were based upon false information provided to the mortgage lenders by borrowers anxious to become first-time homeowners or to move up to a higher level of housing.
● Fannie Mae and Freddie Mac were pushed by Congress to expand their lending to less credit-worthy borrowers. (see below)
● The development of securitization techniques opened up many huge new sources of funds for investment in mortgage loans, thus facilitating a huge expansion of mortgage lending.
A History and Physics Lesson: Dominoes Will Fall
Let’s look at how we morphed from a mortgage loan industry that made only quality loans to responsible borrowers and that had a reasonable chance of being repaid, to the unraveling fiasco that we have today:
● In 1977, the Community Reinvestment Act (“CRA”) was passed to encourage mortgage lenders to make more loans in geographical areas that had a history of low loan originations, primarily due to the inability of the residents in the area to qualify for traditional mortgage loans. Federal examiners periodically check the records of all lenders to make sure that they conform to the requirements of the CRA. This continues up to the present.
● Another watershed moment in the dumbing-down of mortgage loan underwriting standards occurred in 1992 with the passage of the GSE Act, which is officially known as the Federal Housing Enterprises Financial Safety and Soundness Act, that established requirements for Fannie Mae and Freddie Mac (known as “Government Sponsored Entities” or simply “GSE”s) to provide higher volumes of loans to borrowers who would not otherwise qualify for a mortgage loan under the nationwide lending standards followed by virtually all lenders at the time. The GSE Act went into effect in 1993 and encouraged Fannie and Freddie to overlook some common indicators that lenders had used for years that a borrower was a bad credit risk.
● Unfortunately, at the same time that these lower underwriting standards were being pushed on Fannie and Freddie, there were rumblings of the federal government creating a governmental regulator to oversee both GSEs. One of the chief purposes of the governmental regulator would be to make sure that Fannie and Freddie purchased more loans originated to less credit worthy borrowers; so the actual situation was that whether or not Fannie and Freddie were destined to purchase more loans to less credit worthy borrowers was a Hobson’s choice decided for them; so then Fannie’s and Freddie’s only choice became whether or not to simply implement the lower underwriting standards being forced upon them, or fight the decision and have the new lower underwriting standards forced upon them by a new permanent governmental regulator. Fannie and Freddie acquiesced and accepted the lower underwriting standards that were being forced upon them.
● Fannie’s and Freddie’s forced acceptance of the new lower underwriting standards served as a nationwide imprimatur for all mortgage lenders that originated mortgage loans and sold them to Fannie and Freddie (which includes just about all mortgage lenders) that they could lower their standards to conform with the “new normal” standards that had been forced upon Fannie and Freddie.
● And in true cascading fashion, institutional investors that purchased pools of loans and securitized loan packages accepted these new Fannie- and Freddie-blessed investments as the “new normal” and poured their investment funds into these mortgage-based investments, resulting in even more funds available to originate poor quality mortgage loans.
● More investment funds flowing into the purchase of these mortgage loan investments created more demand for housing, which, of course, created more demand for subdivision lots and supporting commercial facilities, resulting in our current glut of all of the above.
The clear 30,000-foot view of this situation is that the nationwide mortgage lending industry’s transition from sensible lending to irrational lending had its roots in the various above-described changes that emanated from Congressional actions and threats, and not from actions or changes initiated by the country’s mortgage lenders. It appears that Congress had in mind the admirable goal of expanding homeownership; but, in my professional opinion, they went about implementing their goal in an imprudent manner that basically allowed uncreditworthy borrowers, in effect, to cut in line and obtain mortgage financing before they were financially capable of repaying it.
Considering all of these factors, it is my professional opinion that it is illogical and unreasonable to place blame for the current nationwide mortgage loan situation with the country’s mortgage lenders.
ABOUT THE AUTHOR: Don Coker
Expert witness and consulting services. Over 400 cases for plaintiffs & defendants nationwide, over 100 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ.
Clients have included numerous individuals, 60+ banks, and governmental clients such as the IRS, FDIC.
Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator.
B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School.
Called on by clients in 27 countries for work involving 56 countries. Widely published, often called on by the media.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.