Mortgage Servicing Fraud
occurs post loan origination when mortgage servicers use false statements and book-keeping entries, fabricated assignments, forged signatures and utter counterfeit intangible Notes to take a homeowner's property and equity.
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Nye Lavalle
» Mortgaging the Future

Interest rate deregulation dovetailed neatly with a seemingly unrelated phenomenon: the bidding war for suburban housing. The mortgage industry shook off its interest rate regulations just a few years after the credit card industry. In the new world of unfettered mortgage lending, no longer would the middle-class family be restricted to a conventional 80 percent mortgage. The floodgates were opened, and families could get all the mortgage money they ever dreamed of to bid on that precious home in the suburbs -- even if the price tag was more than they could realistically afford.

Competition for houses in good neighborhoods has always been stiff, and overloading on mortgage debt to purchase a better home has long posed a temptation for young families. A generation ago, however, it simply wasn't possible to give in to that temptation; mortgage lenders didn't allow it. But today the game is different. It has become routine for lenders to issue unmanageable mortgages.

The best evidence comes from the mortgage industry itself. Fannie Mae, the quasi-governmental agency that underwrites a huge fraction of home mortgage lending in the United States, advises families that "monthly housing expenses should not represent more than 25 to 28 percent of gross monthly income." Accordingly, anyone whose housing costs exceed 40 percent of their earnings would be considered "house poor," spending so much on housing that they jeopardize their overall financial security. But the label is misleading. Many of the "house poor" are not poor at all. They are middle-class families that overextended themselves in a desperate effort to find a home in the midst of a fearsome bidding war. Over the past generation, at the same time that millions of households sent a second earner into the workforce, the proportion of middle-class families that would be classified as house poor or near-poor has quadrupled.

The down payment -- once a critical device for screening potential borrowers -- has virtually disappeared. In the mid-1970s, first-time home buyers put down, on average, 18 percent of the purchase price in order to get a mortgage. Today, that figure has shrunk to just 3 percent. While a small down payment may sound appealing to those of us who remember scrimping and saving before we could purchase our first home, it has a more ominous side. The family that can't come up with a down payment pays higher points and fees, and many are forced by their lenders to purchase additional credit insurance. These families get mortgages they couldn't have gotten a generation ago, but they pay a lot more for them. More important, families that don't make a down payment are more likely to lose their homes, which is why traditional lenders required the 20 percent down payment in the first place.

According to one study, families that make a down payment of less than 5 percent of the purchase price are fifteen to twenty times more likely to default than those who put down 20 percent or more. The obvious solution would be to reimpose some standards in the mortgage market, but deregulation continues to reign supreme. Even as defaults are rising, President Bush argues that the federal government should work to reduce families' down payments even further -- with no thought about how those low down payments may cost millions of families their chance at staying in their homes.

As regulatory control over interest rates collapsed, a new industry was born: the "subprime" mortgage lender. Subprime lenders specialize in issuing high-interest mortgages to families with spotty credit who are unlikely to qualify for traditional, low-cost "prime" mortgages. In the early days of deregulation, subprime mortgage lending was unheard of. But by the mid-1990s, banking giants such as Chase Manhattan and Citibank, fat with profits from credit card lending, were looking for new markets to tap. They applied the same principles to home mortgage lending that had profited their credit card divisions so handsomely: Charge high interest rates and sell, sell, sell.

To give a sense of just how expensive subprime mortgages are, consider this: In 2001, when standard mortgage loans were in the 6.5 percent range, Citibank's average mortgage rate (which included both subprime and traditional mortgages) was 15.6 percent. To put that in perspective, a family buying a $175,000 home with a subprime loan at 15.6 percent would pay an extra $420,000 during the 30-year life of the mortgage -- that is, over and above the payments due on a prime mortgage. Had the family gotten a traditional mortgage instead, they would have been able to put two children through college, purchase half a dozen new cars, and put enough aside for a comfortable retirement.

Citibank and other subprime lenders typically defend their business practices by arguing that they are helping more families own their own homes. But this is little more than public relations hot air. In the overwhelming majority of cases, subprime lenders prey on families that already own their own homes, rather than expanding access to new homeowners. Fully 80 percent of subprime mortgages involve refinancing loans for families that already own their homes. For these families, subprime lending does nothing more than increase the family's housing costs, taking resources away from other investments and increasing the chances that the family will lose its home if anything goes wrong.

Subprime lending has an even more pernicious effect. It ensnares people who, in a regulated market, would have had access to lower-cost mortgages. Lenders' own data show that many of the families that end up in the subprime market are middle-class families that would typically qualify for a traditional mortgage. At Citibank, for example, researchers have concluded that at least 40 percent of those who were sold ruinous subprime mortgages would have qualified for prime-rate loans. Nor is Citibank an isolated case: A study by the Department of Housing and Urban Development revealed that one in nine middle-income families (and one in fourteen upper-income families) who refinanced a home mortgage ended up with a high-fee, high-interest subprime mortgage. For many of these families there is no trade-off between access to credit and the cost of credit. They had their pockets picked, plain and simple.

Why would middle-class families take on high-interest mortgages if they could qualify for better deals? The answer, quite simply, is they didn't know they could do any better. Many unsuspecting families are steered to an overpriced mortgage by a broker or some other middleman who represents himself as acting in the borrower's best interests, but who is actually taking big fees and commissions from subprime lenders. In some neighborhoods these brokers go door-to-door, acting as "bird dogs" for lenders, looking for unsuspecting homeowners who might be tempted by the promise of extra cash. Other families get broadsided by extra fees and hidden costs that don't show up until it is too late to go to another lender. One industry expert describes the phenomenon: "Mrs. Jones negotiates an 8 percent loan and the paperwork comes in at 10 percent. And the loan officer or the broker says, 'Don't worry, I'll take care of that, just sign here.'"

Every now and then a case comes to the forefront that is particularly egregious. Citibank was recently caught in one of those cases. In 2002, Citibank's subprime lending subsidiary was prosecuted for deceptive marketing practices, and the company paid $240 million to settle the case (at the time, the largest settlement of its kind). A former loan officer testified about how she marketed the mortgages: "If someone appeared uneducated, inarticulate, was a minority, or was particularly old or young, I would try to include all the [additional costs] CitiFinancial offered." In other words, lending agents routinely steered families to higher-cost loans whenever they thought there was a chance they could get away with it.

Such steering hits minority homeowners with particular force. Several researchers have shown that minority families are far more likely than white families to get stuck with subprime mortgages, even when the data are controlled for income and credit rating. According to one study, African-American borrowers are 450 percent more likely than whites to end up with a subprime instead of a prime mortgage. In fact, residents in high-income, predominantly black neighborhoods are actually more likely to get a subprime mortgage than residents in low-income white neighborhoods-more than twice as likely.

In many cases, these lenders don't just want families' money; they also want to take people's homes. Banks have been caught deliberately issuing mortgages to families that could not afford them, with the ultimate aim of foreclosing on these homes. This practice is so common it has its own name in the industry: "Loan to Own." These lenders have found that foreclosing can be more profitable than just simply collecting a mortgage payment every month, because the property can then be resold for more than the outstanding loan amount. So the lender rakes in fees at closing and high monthly payments for a few years, then waits for the family to fall behind and sweeps in to take the property. The lender wins every possible way -- high profits if the family manages to make all its payments, and higher profits if the family does not.

The results are in. After two decades of mortgage deregulation, today's homeowners are three and a half times more likely to lose their homes to foreclosure than their counterparts a generation ago. This defies the economists' expectations. Today's record low interest rates and rising home prices should have translated into a falling rate of home foreclosure, not a rising one. The only explanation is a lending industry run amok. The rise in "loan-to-own" lending, the disappearance of the down payment, and the explosion in high-interest, subprime refinances have taken their toll, as a growing number of families learn the painful consequences of getting trapped by a mortgage industry that has been allowed to make up its own rules.

And so it was that family spending was transformed in a single generation. In the late 1970s and early 1980s, consumer lending was deregulated, launching a complicated, potentially dangerous product on an unsuspecting public. The timing could not have been worse. Just as corporations were downsizing across America, just when a bidding war for decent family housing was heating up, and just when families lost the all-purpose safety net once provided by the stay-at-home mother, easy credit flooded in, looking just like a life raft to the family that was drowning.


» Where the Money Is

"Why do you rob banks?" The question was put to Willie Sutton, famed bank robber of the 1940s. He replied, "Because that's where the money is." That's how most businesses work: They make profits by dealing with customers who have money. And that is how the lending business used to work: Companies made loans to people who had the money (or soon would have the money) to repay them.

Much has been made about the changing nature of America's debtors. Americans don't have the same work ethic that they once did, people don't work hard to pay their bills as they once did, and on and on. Even my [Elizabeth's] elderly father agreed, telling me quiet stories of destitute families that labored for years to pay bills they had run up during the Great Depression. My father used to talk about Herring Hardware, a farm supply store that my grandfather had run in rural Oklahoma beginning back in 1904. When the Dust Bowl hit in the 1930s and families could no longer scratch a living out of their modest farms, many packed up and headed west, an exodus etched in the national memory by John Steinbeck's Grapes of Wrath.

Some of those families never forgot the debts they left behind. Twenty years later, my grandfather would still get an occasional envelope with a few twenty-dollar bills and a handwritten note: "Grant, we finally got ahead a little. Put this on my account, and let me know if I owe you more. Aileen sends her best to Ethel." My father would lean back at the end of one of these stories and remark that these were "good people, good people who followed through on what they owed." Then he would pause and draw his mouth into a hard line. "Folks just aren't like that anymore."

But my father -- and everyone else who talks about changing values -- overlooks one very important fact: Borrowers aren't the only ones who changed. Lenders changed too, arguably far more than the people to whom they were lending. Most Americans guard their credit ratings jealously, living with a slightly prickly sensation that they could be cut off if they fell behind or forgot to pay a bill. What they don't realize is that when a borrower makes a partial payment, when he misses a bill, and when his credit rating drops, he actually gets more offers for credit. He is not just down on his luck, behind on his bills, and short on cash; he has now joined the ranks of an elite group -- The Lending Industry's Most Profitable Customers.

Consider the example set by Citibank, America's largest credit card issuer. In 1990, I [Elizabeth] was hired as a one-day consultant by Citibank to address a gathering of some forty senior lending executives. The task: use my research to suggest policies that would help Citibank cut its losses from cardholders in financial trouble. I arrived at Citibank's New York headquarters with dozens of graphs and charts tucked in my file folders. I was ushered into a large, brightly lit conference room where each chair was filled by someone outfitted in a starched shirt, silk tie, and dark suit. The executives stayed with me all day, eating lunch at the conference tables as we continued our discussions about the effects of unemployment on loan defaults and the rising number of bankruptcies among two-earner families.

As the afternoon came to a close, I summarized my recommendations. The short version could be boiled down to a single, not very startling, idea: Stop lending money to families that are already in obvious financial trouble. This would have been quite easy to implement. Citibank had reams of data on most of its borrowers, particularly those who had black marks on their credit reports. I suggested that the policy could be put in place within a few short months, potentially cutting Citibank's bankruptcy-related losses by as much as 50 percent.

There were interested murmurs around the room, and several hands eagerly shot up. But before I could call on anyone, one slightly older man spoke up. He had been silent throughout the long day, leaning back in his chair and giving me a faintly bemused smile. "Professor Warren," he began. The room hushed immediately, and I suddenly realized that I had been oblivious to the corporate pecking order; this was the guy who outranked everyone else in the room. "We appreciate your presentation. We really do. But we have no interest in cutting back on our lending to these people. They are the ones who provide most of our profits." With that, he got up, and the meeting was over. I was ushered out, and I never heard from Citibank again -- except to get my monthly credit card bills.

Citibank understood the new economics of consumer credit. Credit card issuers make their profits from lending lots of money and charging hefty fees to families that are financially strapped. More than 75 percent of credit card profits come from people who make those low, minimum monthly payments. And who makes minimum monthly payments at 26 percent interest? Who pays late fees, overbalance charges, and cash advance premiums? Families that can barely make ends meet, households precariously balanced between financial survival and complete collapse. These are the families that are singled out by the lending industry, barraged with special offers, personalized advertisements, and home phone calls, all with one objective in mind: get them to borrow more money.

After he suffered a heart attack, missed several months' work, and fell behind on his mortgage, Jamal Dupree (from chapter 4) got the hard sell from his mortgage lender. When Jamal missed a payment, the mortgage company sent him dozens of personalized letters with a single goal -- to persuade him to take out yet another mortgage. "They'd send out a notice, saying 'you need a vacation, take out this thousand dollars and pay it back in ninety days.' If you didn't pay it back in ninety days, they charged you 22 percent interest." When he didn't respond to the mailers, the mortgage company started calling Jamal at home, as often as four times a week. Again, the company wasn't calling to collect the payments he had already missed; it was calling to sign him up for even more debt. Jamal resisted, but his mortgage lender didn't let up. "When I turned them down, they called my wife [at work], trying to get her to talk me into it."

The strategy used by today's lenders exactly reverses the approach bankers used a generation ago when their main goal was to be repaid on time, not to string along the payments for as long as possible. Herring Hardware may have collected most of its debts -- even during the Great Depression -- but its lending policies were radically different from those embraced by today's major lenders. Unlike today's megabanks, Herring Hardware stopped making loans when a family got in trouble. Grandfather Herring would never have dreamed of sending a flyer in the mail cheerfully suggesting, "Fred, you're behind on your payments for the fertilizer. Can we lend you the money for a new cookstove?" Nor would the local bank have suggested a second mortgage to the family that had just missed a payment on its first mortgage.

There is another important difference. When families arranged credit in my grandfather's store, he charged them a simple 1 percent per month. Neither he nor the bank had any penalty fees or shifting rates of interest. When someone missed a payment, the rate was still 1 percent a month. Today, that practice has disappeared. Like Jamal's mortgage lender, many banks routinely double or even triple the interest rate the moment someone is a few days late with a payment. Then there are the fees. This year credit card companies will charge more than $7 billion in late fees (quadruple what they charged less than ten years ago) -- a penalty unheard of in my grandfather's day. Moreover, when my grandfather got a check in the mail, he applied it to the principal balance on the loan; he wouldn't have dreamed of telling those families that with compounded interest at the new rates and special overbalance fees and late-payment penalties, they now owed $4,000 for their original $800 purchase.


» Repo Man in the Suburbs

In an era when lenders routinely target the almost-bankrupt for extra loans, how do they ensure that they will get their money back? Corporate lenders don't have "Jimmy the finger-breaker" on retainer, but they do have thousands of trained professionals who do nothing but hound families for money. Most of the time, these agents make their living by calling families at home, reminding them that they are late on their bills and pressing them to make a payment. (Or, in the case of Jamal Dupree, urging them to take on a second loan to pay off the first.) But when a simple request isn't enough, they, too, use tougher tactics.

Sears, America's fourth-largest retail chain, got caught threatening to nab a battery from a Massachusetts family's car unless the family promised to send Sears some money-money that the family no longer owed. This was in clear violation of the law. The family had filed for bankruptcy protection, so Sears was legally barred from further collection efforts. Aside from that, it is reasonable to wonder: What could Sears possibly want with a used car battery? Or with the used dehumidifiers, mattresses, and Walkmans the company had threatened to take back from thousands of other families? Sears was not in the business of selling used household goods. And it would have cost the company several hundred dollars to hire a repo man and send a truck to someone's door-far more than a used Walkman or car battery would be worth.

Sears almost certainly didn't want those goods; the company wanted the money people would pay to keep the Sears repo man away. The company probably hoped that some families were unaware of their legal rights, and that if they were frightened enough, they just might keep making payments on old bills, even after those bills had been discharged in bankruptcy. FBI Special Agent in Charge Barry Mawn described the Sears case as an example of "Corporate America blindly [pursuing] profitability over its obligation to treat the consuming public with fairness and honesty."

And Sears was not alone: AT&T, General Electric Credit, Federated Department Stores (owner of Macy's), J.C. Penney, Circuit City, Tandy (owner of Radio Shack), and General Motors also paid multimillion dollar fines for making collection threats against families whose debts had been forgiven in the bankruptcy courts. But these companies were punished for pursuing families that were under the protection of the bankruptcy courts, not for aggressive collection tactics per se. Indeed, many aggressive collection tactics are perfectly legal. For example, Sears, unlike J.C. Penney, issues credit cards that add some special touches in the fine print. Whenever a customer purchases something on a Sears card, the goods become collateral against the loan. That means that Sears is within its legal rights to repossess (or to threaten to repossess) everything the family bought with the card if it falls behind on its bills. Even when those threats are patently absurd.

Consider, for example, a conversation we had with "Sally," a former Sears collection agent in the Boston area. Sally's job was to call families that had fallen behind and to pressure them to pay up. One incident particularly stood out in Sally's memory. When another Sears agent threatened to repossess a mattress from a woman who was delinquent on her payments, the customer in question stuck to her guns. "You will not. It isn't worth anything. Besides, you can't even sell a used mattress. It's not legal." Sally's coworker was quick on her feet. "We'll come and get it because we can. And then, we'll set it on fire and burn it up. It won't give us anything, but you won't have it either." The woman caved in and sent Sears a check for $50. According to Sally, the story was widely told and retold in her department and praised by the department manager as an example of "real initiative." Since we only have Sally's word, we can't confirm the facts of her account, but it is a matter of public record that Sears has threatened to repossess used mattresses from other families.

Sally's real expertise wasn't collecting from the living. She spent most of her days collecting from the dead -- or at least the family members of the dead. When a person dies, only a cosigner on the account is liable for the bill. If no one has cosigned, the store can repossess the goods (if the original contract permitted this) or collect from the estate of the deceased, but they cannot hold other family members liable for the debt. The company is not, however, prohibited from trying to collect from the family. So Sally's job was to call the adult children or grieving widows of customers who had died leaving an outstanding bill. She typically started a call with something gentle and confidential. "Mabel was a longtime member of the Sears family, and we're sure she would have wanted her bills to be paid." Sally then read from a list of purchases Mabel had made on her Sears card, inserting some personal comments. "I see she bought eyeglasses. And some baby clothes-I love those sweet little sweaters and matching caps, don't you?" If the soft sell didn't work, Sally would turn up the heat, threatening to send a collection agent who would plow through the deceased's closets and drawers and "take back what belonged to Sears." If that wasn't enough, there was a final warning that must have sent many families running for the checkbook: She threatened to reclaim every gift ever purchased on the Sears card. Again, the claim seems ridiculous; how would a Sears agent ever figure out that Mabel had given the frilly dress to her grandniece in Detroit, while the Walkman had gone to a great-grandson in Denver? But these threats were put to grieving family members who had just lost a loved one, not to battle-hardened debt-dodgers who were primed to defend themselves. Not surprisingly, Sally said that most families paid.

We remind the reader that we have only Sally's word to go on. It is possible that she wasn't telling the whole truth or that she had an ax to grind. But a statement by former Sears CEO Arthur C. Martinez is certainly in keeping with Sally's story. He explained the company's aggressive debt collection practices this way: "We have an old-fashioned view. People should pay for what they take." As he touted that "old-fashioned view" of debt, Mr. Martinez seemed oddly blind to the fact that Sears is no longer an "old-fashioned" merchant. At the time Mr. Martinez made his statement, Sears reportedly earned more money from the interest and late fees the company charged its credit cardholders than it earned from selling merchandise. In other words, Sears kept all those stores open and sold all those Lady Kenmore washing machines and Craftsman tools in the hope that its customers would buy on credit and pay over time. Merchants like my grandfather used to offer credit as a way to increase store purchases. For stores like Sears, that formula has been turned upside-down: Store purchases have become a way to increase credit card debt. That's not "old-fashioned" at all; indeed, it is possible only in the new world of uncapped interest rates and deregulated lending.


» A Problem That Can Be Solved

The problems posed by families deep in debt may seem intractable, or at least so deeply embedded that only a complex, expensive array of regulations and laws could turn things around. But this is one problem that isn't so hard to solve. The consumer-credit monster could be beaten back if Congress would enact a simple provision into law -- a provision that wouldn't require the creation of vast new oversight committees or contentious battles in the Supreme Court. Congress could simply revive the usury laws that served this country since the American Revolution. Federal law could be amended to close the loopholes that let one state override the lending rules of another. Alternatively, Congress could impose a uniform rate to apply across the country. Such a provision would enable the states or the federal government to reimpose meaningful limits on interest rates.

Consumer lenders balk at the notion of reregulation, immediately claiming that tighter limits on interest rates would put America at risk for another banking disaster like the Savings and Loan (S&L) crisis of the late 1970s. Hemmed in by high inflation rates and low limits on interest rates, the S&Ls (which issued most home mortgages) found themselves hemorrhaging money. But the real problem was inflation, not usury rates per se, which had worked reasonably well for centuries. At the time, usury limits in most states were fixed at a specific number, and they hadn't been written with double-digit inflation in mind. But that would be an easy problem to solve.

To avoid a repeat of the S&L crisis, all that is needed is to tie the limit on interest rates to the inflation rate or the prime rate (which changes with inflation) so that the two never get too far out of sync. (To keep a check on fees, points, and all the other hidden charges, these costs should be included in the interest calculations up front.) That way, mortgage and credit card interest rates would be higher when inflation is rampant, but they would come right back down when the inflation monster is tamed. The ceiling on interest rates would float up and down, but it would always be tethered to the lender's cost of funds. That way, banks would always be able to lend profitably, and consumers would always be protected from unreasonable rates.

The beauty of this approach is that it would help families get out of debt without costing taxpayers a dime. How would it work? By harnessing the energy of the marketplace. Lenders themselves would transform mortgage and credit card practices just by acting in their own best interest. Since they would no longer be allowed to charge exorbitant interest rates to families with marginal credit records, it would become unprofitable for lenders to pursue families in financial trouble. Instead, banks would once again have a reason to screen potential borrowers carefully, making loans only to those who really can afford to repay.

We hear the antiregulation camp clear their throats, ready to explain why regulating the credit industry (or any other industry, for that matter) is a bad idea. On the surface, their logic sounds convincing. A deregulated market reduces costs and provides more choices for home buyers and credit card holders, so consumers should win out-eventually. Besides, as federal judge Edith Jones wrote, "Nobody is holding a gun to consumers' heads and forcing them to send in credit card applications." People always have the option of walking away from an overpriced mortgage offer or an outrageous credit card offer.

But this argument rests on one very important supposition -- a well-functioning market for credit. Any honest economist will explain that markets work efficiently only when there is a level playing field, when consumers have full information about the costs and risks associated with whatever they are purchasing. The evidence is strong that the lending playing field is anything but level. After all, if the market were working properly, how could Citibank sell 40 percent of its high-priced subprime mortgages to families with good credit who would have qualified for low-cost mortgages? How could the company's loan officers get away with charging extra fees to anyone who "appeared uneducated"? And why would low-income whites get better terms on their mortgages than high-income African Americans? A perfect market free to operate without government interference certainly sounds good, but it is little more than a fantasy held up to distract policymakers while lenders rake in profits from those who never quite figure out the terms in fine print.

The argument for reregulation of consumer lending is a lot like the argument for regulating any other useful but potentially dangerous product. Consider the toaster. People buy toasters for home use. No one makes them buy toasters, and they could live without toasters. If they understood electrical engineering, they could evaluate the safety of each toaster under every possible scenario. But toasters are regulated. No toaster manufacturer may peddle toasters that have even a 1 percent chance of catching fire. Toaster makers (and conservative economists) could point out that riskier toasters could be made more cheaply, and that permitting their sale would expand the number of toaster owners in the country. Companies might put special disclaimers and instructions on their toasters, telling customers how to extinguish the fires themselves. But as a nation, we have collectively decided that the risks posed by an unregulated toaster industry are not acceptable.

The government regulates the sale of millions of products -- everything from children's pajamas to aspirin to automobiles -- to protect consumers from the risks of substantial injury. For most of America's history, loans to consumers fell squarely within that definition. Interest rates and other terms were carefully limited by state legislatures and patrolled, when necessary, by state attorneys general. Predatory loans may not set houses on fire the way a faulty toaster might, but they steal people's homes all the same. America has had more than twenty years to observe the effects of a deregulated lending industry, and the evidence is overwhelming. It is time to call the experiment a failure.

Re-regulation would help solve a litany of evils. The most important is worth its own headline: Limiting interest rates would halt the rapid rise in home foreclosures. With a lower ceiling on interest rates, lenders would lead the charge to reestablish an appropriate match between family income and mortgage size, which would have the effect of reducing the mass of families that are sucked into mortgages they have no hope of paying. Minority communities would no longer find themselves stripped of wealth by predatory subprime lenders. And homeowners would no longer be suckered into second and third mortgages that promise to lower their monthly bills but that actually rob them of the family home.

Interest rate regulation would also take the ammunition out of the middle-class bidding war, helping to save families from the Two-Income Trap. Competition for the best neighborhoods would continue, but if no one could get a mortgage that ate up 40 or 50 percent of the family's entire income, then home prices would begin to settle down to Earth. To many economists, this is a scandalous notion, involving a reduction in Americans' "net worth." But that net worth isn't worth anything unless a family plans to sell its home and live in a cave, because the next house the family buys would carry a similarly outrageous price tag. Some families with weaker credit histories or more modest incomes might find themselves limited to smaller houses, but they would also be far less likely to end up in a home that drove them into the bankruptcy courts. Moreover, as housing prices leveled off, more families would be able to afford a home without having to resort to a subprime mortgage. Reregulation of interest rates would bring relief to all families, not just those already in serious trouble.

Families would also be far less likely to get into trouble with their credit cards. With appropriate limits on interest rates, banks would still be able to issue credit cards profitably, and consumers would still have access to those convenient plastic cards. But banks would have far greater incentive to screen cardholders, offering only as much credit as each family could repay. Moreover, there would be no incentive to single out families in financial trouble, tempting them at the moment when they are most vulnerable with special offers of extra credit at exorbitant rates. Banks would have no reason to scour credit records looking for homeowners in trouble, offering to "solve" their credit problems by putting their homes at risk through second or third mortgages.

Limits on interest rates would reverse another disturbing trend -- the transfer of wealth away from lower- and middle-income families. Since 1970, banking profits (inflation-adjusted) have more than tripled, growing by more than $50 billion. Those profits weren't the rewards for important innovations. Lenders didn't invent a faster computer, design a better car, or make a great new movie that everyone wanted to see. (Indeed, many would argue that the quality of banking service actually declined during this period.) No, they sold pretty much the same thing they always had-debt. The difference was that they sold more of it, and they charged higher prices.

A modest example illustrates what is happening to American families. Credit card companies basically have three costs: marketing costs, collection costs, and the cost to borrow the money they will re-lend to consumers. The Federal Reserve lowered interest rates nine times in 2001, which meant that credit card companies' cost of borrowing fell considerably. Even so, they held steady the rates they charged most of their cardholders. The result? A $10 billion windfall for credit card companies. Nothing had changed in the way these companies did business; their marketing costs stayed the same, their collection costs stayed the same, and their products stayed the same. The only difference was that their already-high profits jumped by an additional $10 billion. That $10 billion was paid by families across the country -- $10 billion that might have paid for medical bills or college tuition, school shoes or car repairs--or even paid down the balances on outstanding loans. In a single year, 10 billion extra dollars disappeared from families' wallets and reappeared on the balance sheets of a handful of corporate lenders. Families got nothing in return; they paid out dollars that, if interest rates had been regulated, would have belonged to them.

Regulation would also eliminate the worst abuses of a lending industry run amok. Payday lenders would no longer target minority neighborhoods with short-term loans at interest rates of 100, 500, and even 1,000 percent-rates that would make any mobster drool. The more subtle forms of loan sharking would also disappear, so that when families managed to get into trouble with credit card debt, lenders would no longer be able to prey on their desperation by doubling the interest rates and piling on the late fees that turn their debts into financial quicksand.

What about families' access to credit? Deregulation of the mortgage lending industry was not a right-wing conspiracy; it was actually supported by most Democrats as well. Many liberals got behind the move for traditionally liberal reasons: They wanted to defend lower-income families. They had been persuaded that the risks posed by overaggressive lenders might not be as dangerous as once was thought. A deregulated lending market could even prove to be a critical tool to help low-income and disadvantaged groups improve their lot. After all, working-class families needed credit to start businesses, to build homes, and to send their kids to college -- things that upper-income families had long had plenty of opportunities to do.

Moreover, there was a growing body of evidence that even though it was illegal, overt discrimination and "redlining" -- the practice by which mortgage lenders refused to lend in certain neighborhoods -- was crippling housing markets in minority neighborhoods and denying low- and moderate-income families the chance to build wealth through home ownership. The new solution was to "democratize credit" -- make credit available to anyone and everyone, no matter how poor. The prediction was for a more perfect world in which home ownership rates would go up, a sluggish economy would begin to boom, and cities would blossom -- all thanks to the free flow of credit.

Obviously, that perfect world didn't come to pass. But politicians may still worry: If America turns back the clock on lending regulation, what will happen to the home-ownership rate? Every time anyone talks about putting restrictions on interest rates, the lending industry puts up one of those heart-warming advertisements that show a family with two kids and a dog moving into their first home. But the hard numbers belie those happy ads. Reregulation of interest rates would have very little effect on home-ownership rates. Since the mortgage industry was deregulated in 1980, the proportion of families owning their own homes has increased by less than 3 percentage points. Plenty of factors have contributed to these modest overall gains, such as a long-running economic boom, the aging of the population, and a falling inflation rate -- and those factors won't be affected by changes to mortgage regulations. Moreover, since most high-interest subprime mortgages are used for refinancing, not for families trying to buy their first homes, outlawing those mortgages should have little effect on the number of first-time home buyers. In fact, if fewer families were pushed out of their homes by creditors intent on raking in profits through loan-to-own scams and predatory practices, the overall number of homeowners in America might be higher.

What about the "democratization of credit" for which activists fought so hard? If interest rates are regulated once again, will credit become undemocratic, available only to those with realistic prospects for repayment? To answer this, it is time to step back a moment. The original intent of the credit democratization movement was for credit to help more families become financially independent. Credit was not supposed to be an end in itself. But it seems that the original intent has been forgotten. Consider, for example, the motto of one prominent advocacy group: "Access to credit and capital is a basic civil right." Is it a civil right to pay interest on a credit card balance for the rest of a person's natural life? A family that finances its home with a subprime mortgage can end up paying twice as much for that home as a family that gets the market rate. Is it really a basic civil right to pay double for a home? And foreclosure rates are skyrocketing. Is it a civil right to lose that home in a sheriff's auction? The dream of democratization of credit was to use credit as a vehicle to expand home ownership, to launch businesses, and ultimately to help build wealth in neighborhoods that are short on it. The point was not to bombard families with more credit than they could possibly afford or to flood the market with complicated loans that only a CPA could understand.

But the mantra of expanding access to credit has been hard for consumer activists and politicians to abandon. As a result, reform efforts have fragmented into a patchwork of measures intended to curb "predatory" lending practices. The problem is that no one can agree on how to define "predatory" lending. As The Economist dryly observes: "As with pornography, consumer activists and legislators say they know predatory lending when they see it." The National Housing Institute defines predatory lending as "any unfair credit practice that harms the borrower or supports a credit system that promotes inequality and poverty." But what constitutes "unfair"? And who decides whether a system is promoting inequality or poverty?

Attempting to stamp out "predatory" and "unfair" practices is certainly better than ignoring them, but it puts legislators in the position of trying to uncover the latest shenanigans and redefine abuses, always two steps behind the lenders who keep changing their products to sidestep regulations. It also gives far too much room for lenders to circumvent the intent of the law. For example, the New York State Banking Department recently banned "unaffordable loans," except "under compelling circumstances." We suspect that any crafty loan marketer could dream up some "compelling circumstances" that would permit a lender to sell overpriced loans. The only way to stop predatory lending once and for all is to go directly to the heart of the loan -- the interest rate. Limiting the amount of interest that creditors can charge avoids the hide-and-seek game over what is and what is not "predatory," offering instead a simple, effective means of regulation.

In order to achieve the real dream of "credit democratization," it is time to recognize, once and for all, that families are not better off getting credit at double, triple, or even ten times the market rate. If a family does not have the income to qualify for a loan at a reasonable rate, then they should not get that loan. It does no one any favors to impose a modern-day debtor's prison on hard-working families. They would be better off renting an apartment and putting whatever extra money they have into savings accounts rather than paying double the market rate for a mortgage. If the private market cannot meet the needs of all communities, then it may be necessary for the government to step in to provide alternative sources of credit. The point worth emphasizing is that overpriced credit is no solution. Getting robbed to buy a home or to get a cash advance is still getting robbed, and it should be illegal.


» Deafening Silence

If America's crippling addiction to debt could be shaken off with a simple regulatory change, what are the politicians doing about it? The answer, quite simply, is nothing.

As the number of mortgage foreclosures skyrockets, as credit card debt soars, as the lines at the bankruptcy courthouse stretch out into the street and around the block, all we hear from Washington is the sound of silence. There has been no serious progress on any proposal to rein in predatory lending: no measure to control credit card fees, no proposal to ban creditors from trying to collect from a dead person's brothers and sisters, and certainly no bill to bring back meaningful limits on interest rates. The national political parties have found time to take positions on the speed of the Internet, ergonomic standards in the workplace, and regional restrictions on dairy products, but they have claimed no position on the financial issues that profoundly affect millions of middle-class families.

There is, however, one notable exception to all that inaction. Congress has paid attention to one troubling statistic -- the rapidly growing number of families filing for bankruptcy. High interest rates and aggressive marketing of complicated debt products echo through the bankruptcy statistics, as record numbers of families seek refuge in the bankruptcy courts after getting in over their heads with too much easy credit at exorbitant interest rates. In 1994, Congress created a bipartisan commission to study the issue. The group's charter was relatively straightforward: to investigate why so many families were in trouble and to develop recommendations to improve the situation. I [Elizabeth] was named senior adviser to the National Bankruptcy Review Commission.

Three years later, the commission delivered its report to Congress. The 1,100-page document detailed why so many families were in trouble (job losses, medical problems, and divorce) and identified certain lending practices that put families at particular risk. More important, it reaffirmed that the bankruptcy laws were, for the most part, working as Congress had originally intended: to offer families a fresh start in the wake of financial and personal disaster. It concluded with recommendations for modest legislative changes that were designed to curb abuses by both borrowers and lenders.

But the Congressional bankruptcy commission was not to have the final world. While the commission was busy gathering facts, holding hearings, and analyzing current practices, another group also went to work, advancing a very different perspective. The "National Consumer Bankruptcy Coalition" (NCBC), the clever moniker of the banking industry lobby, was pushing its own agenda. The major banks had hit on a new strategy to reduce their bankruptcy losses. Rather than stop lending to families in financial trouble (as Elizabeth had counseled Citibank), they had a simpler and more profitable solution -- restrict the rights of consumers to file for bankruptcy.

If fewer people could turn to bankruptcy for relief, more families would be subject to collection efforts from banks -- and every other creditor -- forever. Those families might never pay off their bills in full, but they would continue to rack up the interest and penalties, and at least a few would make some small payment every month, effectively becoming lifelong profit wells for their creditors. For the rest -- those who simply could not come up with the money, no matter how hard they were squeezed -- the lenders might eventually write off some of those loans voluntarily. (Although one wouldn't guess it from all the fiery rhetoric, bankruptcy filings account for just a fraction of lending industry losses; in the large majority of cases, the bank simply gets tired of trying to collect.) But if a family were not permitted to file for bankruptcy, it would be the lender, not the family in trouble, that would decide when the collection calls should stop.

And so the banking lobby drafted a new bankruptcy law. To get all the lenders on board, the coalition added changes that would give better deals for car lenders, mortgage lenders, education loan servicers, landlords, credit unions -- in short, better deals for everyone except families in trouble. The credit industry moved fast, persuading two friendly congressmen to introduce their bill in September 1997, a month before the official Bankruptcy Commission was scheduled to release its report. From then on, all eyes were on what Hillary Clinton would eventually dub "that awful bill."

The "awful bill" was long and complex, couched in virtually unreadable prose. But to a trained bankruptcy lawyer, the intent was unmistakable: to undercut virtually every protection in the bankruptcy laws. Under the proposed legislation, child support payments would no longer take precedence over all credit card debt. As a result, more single mothers would be forced to compete with professional collection agents when they needed money from their bankrupt ex-husbands. Homeowners who had fallen behind on their mortgages would be prevented from catching up on past-due house payments until they had also paid off their credit card debts, increasing the likelihood of foreclosure. Families would no longer be able to free themselves from certain unsecured debts, so they would be required to make payments (plus penalties, late fees, and interest) on some of those bills for the rest of their natural lives-even if those payments took up 100 percent of their paychecks.

To win over legislators, credit industry executives lobbied extensively and donated more than $60 million in political contributions. This was followed by a public relations strategy that would make any spin doctor proud. Instead of telling the public that the bankruptcy reform bill would improve profits for credit card companies and giant banks (not exactly the most sympathetic group), the NCBC and its supporters in Congress announced that the bill would help the American family. To quote Democratic Representative Rick Boucher: "The typical American family pays a hidden tax of $550 each year because of . . . bankruptcies of mere convenience." The implied promise, repeated so often that it has become an article of faith, was that changing the laws would put $550 a year in the pocket of every bill-paying American family.

Well that certainly sounds good; after all, who wouldn't want some extra cash? But there are a few serious problems with this claim. First, the figure is a gross exaggeration. According to the NCBC, the same banking lobby group that generated the $550 promise, only 100,000 of the 1.5 million families who file for bankruptcy each year could afford to repay some of their debts. In other words, under the proposed bill, those 100,000 bankrupt families would be expected to generate $550 for every household in America, since the other 1.4 million are already tapped out. So we did the math. Suppose the laws were changed, and those 100,000 families could no longer seek protection from the bankruptcy courts, and they were forced to repay as much as they possibly could. In order to return an amount that added up to $550 for every household in America, each one of those bankrupt families would have to repay more than $550,000 in a single year! In our sample of more than 2,000 bankrupt families, not one even owed $550,000, let alone earned enough money to repay that amount. But even if a magic fairy somehow gave all the bankrupt families every dollar they needed to repay their debts in full, what makes anyone think the banks would pass that money on to consumers? Recall that the credit card industry got a $10 billion windfall from falling interest rates in 2001 that they did not pass on to their customers. Why would this supposed $550 per family be any different?

Nevertheless, the combination of intense lobbying and a good cover story had its intended effect. Despite President Clinton's veto, the bankruptcy bill was reintroduced in the next session of Congress. This time, even Senator Hillary Clinton bowed to big business. She had been in office two months when she had her chance to vote on what she had called that "awful bill." Sure, the official Bankruptcy Commission had better credentials than the banking lobby. Yes, her husband had actually appointed the Chairman of the Commission and two of the commissioners. And she clearly understood that families in trouble would be hit hardest by the proposed changes. But the Bankruptcy Commission did not make campaign contributions or have its own lobbyists, and neither do families in financial trouble. Senator Clinton had taken $140,000 in campaign contributions from the banking industry, and she proved willing to overcome her "strong reservations about whether this bill is both balanced and responsible" and voted in favor of "that awful bill."


» Goliath Meets David

We could stop here. We could join the chorus of those who routinely bemoan the political clout of a few big businesses, and we could make the obligatory plea for effective campaign finance reform (which somehow never quite takes hold in a meaningful way, despite the clamor). But if we stopped now, we would be missing the best part of the story -- the part that shows that although the banking industry may be powerful, it isn't the only voice that gets heard in Washington.

The cards were certainly stacked in favor of passing the banking industry's version of the bankruptcy bill in 2002. So who stopped the "awful bill" from becoming law? The answer may surprise the reader; it certainly surprised the credit industry and the congressional power brokers. An unlikely group of citizens organized without any help from big business, and they made sure Congress paid attention. Who were these citizens? Women.

What prompted them to organize was not the financial issues in the pro-creditor bankruptcy bill, which were numerous. Nor was it concern over single mothers or women homeowners, who would have been hit particularly hard if the bill had become law. No, the issue that riled up the women's groups was abortion.

What does bankruptcy have to do with abortion? In Washington, a great deal. Over the past several years, pro-choice groups had scored significant court victories against a few prominent abortion clinic protesters by obtaining money judgments against them, only to see those victories turn to dust when the protesters declared bankruptcy and discharged their debts.

In a strange twist of politics, the credit industry's version of the bankruptcy bill had been supported by Senator Charles Schumer, of New York, who had garnered strong support among women's groups for his pro-choice politics. Ever responsive to his constituents, Senator Schumer inserted a provision into the bankruptcy bill that would make it more difficult for abortion clinic protesters to discharge judgments entered against them if they were sued for their protest activities, much in the same way drunk drivers and embezzlers cannot use bankruptcy to discharge judgments against themselves. Eager to appeal to women voters, the Senate had accepted the amendment in 2001. But in 2002, when the bankruptcy bill went back to the House with the abortion amendment in it, a coalition of right-to-life representatives refused to go along. They brought the bill to a standstill.

Desperate to get the bill passed, the banking lobby went back to the Senate, pressuring Senator Schumer to remove the controversial abortion provision. The industry ran attack ads against him in his home state, demanding that he support the bankruptcy bill -- and claiming that he was costing every American family $550 a year. (The attack on Senator Schumer was particularly ironic, since he had received more campaign contributions from the credit industry than any other Senator, just nosing out fellow New Yorker Hillary Clinton.) But by this point, the pro-choice women's groups were also mobilized, and they held firm, supporting Senator Schumer and threatening to withhold support from any elected official who moved to take the provision out of the bankruptcy bill. In one of those rare defining moments, Senator Schumer had to choose between big business and pro-choice women, both of whom had supported his campaign. He chose women, and the amendment remained in the bill.

Ultimately, two strange bedfellows -- a small group of socially conservative Republicans and a handful of progressive Democrats -- gathered enough momentum to defeat the bankruptcy bill against the best-financed lobbying campaign of the 107th Congress.


» Reclaiming the Politics of the Family

The real victors on that strange day were the grassroots groups that successfully flexed their muscles against the most well-funded lobbying group in America, showing the world that even the credit industry can be defeated if key groups can be rallied against them. What was the key to action? It was not simply a matter of putting forth the facts. Congress had already impaneled a Bankruptcy Commission to write 1,100 pages of facts, which few even bothered to read. No, the real key was to match up the politics of financial distress with the interests of the rest of the country. The right-to-life organizations put a face on those who would be affected by the Schumer Amendment, showcasing stories of elderly grandmothers and churchgoing families who protest abortion as a matter of conscience. The pro-choice organizations put their own face on the issue, spotlighting violent abortion protesters who had found a loophole that let them get away with breaking the law.

There is a lesson here. To put sound economic policies on the political agenda, families also need to find a face. So long as they are "debtors" or "bankrupts," their needs can be dismissed. Instead, they need to be seen as members of powerful constituencies, members of groups that command the respect -- and the fear -- of the political elite. Families in financial trouble must be depicted as they really are: "parents of young children," "nonresident fathers paying child support," "suburban homeowners," "African-American middle-class families," "single mothers," "families sending a kid to college," "multigenerational Hispanic families." Most of all, the groups that defend these people need to organize against those who are picking their constituents' pockets.

The case is not hard to make. Consider the circumstances of African Americans. For decades, the National Association for the Advancement of Colored People (NAACP) and other minority rights groups have lobbied to expand African-American home ownership, and they have been at least somewhat successful in their efforts. Now predatory and subprime lenders threaten to unravel those hard-won gains. Every year, more than 300,000 black and Hispanic homeowners file for bankruptcy in a desperate attempt to hold on to their homes. Hispanic homeowners are nearly three times more likely than white homeowners to file for bankruptcy, and black homeowners are more than six times more likely.

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   This was a great explanation of how ideas about debt have changed over
time and the motivations of the lenders. I would add that even a "defaulted"
note has value and these lenders trade them like baseball cards. They buy
them at big discounts and hope to come across a "winner" ie someone whose
luck has changed or who inherited some property they can attach.
   I think of my poor brother and his wife who were given a house free and
clear by my father. They were immediately barraged by credit card offers
in New York. The temptation was too much for them and they ran up $10,000
they defaulted on. In New York, its possible to get someones house over
a $10,000 debt. They filed for bankruptcy but were eventually forced to sell
the house for about 60% of its value to avoid a foreclosure. Naturally, their
marriage broke up and their child ended up being raised without a father,
who had drowned his sorrows in a bottle. It broke my father's heart. But
hey, that's finance capitalism in America, Prey on the Weak so the Strong
can have more! They even give seminars on how to do it! What we really
need is a Social Revolution to put these parasites and corrupt (or frightened)
Judges out of office. What we need are fearless Judges who put the wel-
fare of the country above their own interests (or survival). It takes guts
to be a good Judge, and most of them died along time ago! To all you
spineless Judges out there, I say this, right now you are afraid of the big
corporations but the day is coming when you will fear the wrath of the
commoners instead of the Lords. It has happened before and it could happen
again. If you are gutless, resign and let a braver man or woman take your
Judgeship!
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