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May-June 2008
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< previous | 1 | 2 | 3 | 4 Legal protection is only a small part of the proliferating verbiage. For those willing to wade through terms like “LIBOR” and “Cash Equivalent Transactions,” lenders have built in enough surprises in some credit contracts that even successful efforts to understand and assess risk will still be erased. For example, after 47 lines of text explaining how interest rates will be calculated, one prominent credit-card company concludes, “We reserve the right to change the terms at any time for any reason.” Evidently, all that convoluted language was there only to obscure the bottom line: The company will charge whatever it wants. In effect, lenders won’t be bound by any term or price that becomes inconvenient for them, but they will expect their customers to be bound by whatever terms the lenders want to enforce—and to have the courts back them up. Even worse, consumers wary of creditor tricks may look for help, only to rush headlong into the waiting arms of someone else who will fleece them—and then hand them over to the creditors for further fleecing. For example, consumers may respond to advertisements for “a friend to help you find the best possible mortgage,” “someone on your side,” and “access to thousands of mortgages with a single phone call—do all your comparison shopping here.” When they call a mortgage broker, they may believe he or she will provide wise advice to guide them through a dangerous thicket—and some brokers do just that. But consumers are just as likely to encounter brokers who are working only for themselves, taking what amounts to a bribe from a mortgage company to steer a family into a high-cost teaser-rate mortgage, for example, rather than a 6.5 percent fixed-rate, 30-year mortgage—because the broker can pocket a fee (a “yield service premium,” or YSP) from the company to place the higher-priced loan. High YSPs helped drive the wild selling that led to the meltdown in the subprime mortgage market. Despite the characterization of YSPs by one Fannie Mae Foundation vice president as “lender kickbacks,” Congress and the regulatory agencies have generally approved of these fees under pressure from the mortgage-broker industry. In fact, mortgage brokers face few regulatory restrictions—a critical problem given that they originate more than half of all mortgage loans, particularly at the low end of the credit market. (YSPs are present in 85 percent to 90 percent of subprime mortgages, implying that brokers needlessly push clients into more expensive products.) The costs are staggering: Fannie Mae estimates that fully 50 percent of those who were sold ruinous subprime mortgages would have qualified for prime-rate loans. A study by the Department of Housing and Urban Development revealed that one in nine middle-income families (and one in 14 upper-income families) who refinanced a mortgage ended up with a high-fee, high-interest, subprime loan. Of course, YSPs are not confined to subprime mortgages. Pushing a family that qualifies for a 6.5 percent loan into a higher-cost loan and pocketing the difference will cost the family tens of thousands of dollars—but it will not show up in anyone’s statistics on subprime lending. Other creditors have their own techniques for fleecing borrowers. Payday lenders offer consumers a friendly hand when they are short of cash. But buried back in a page of disclosures for one lender (rather than on the fee page, where the customer might expect to see it) was the note that the interest rate on the loan was 485.450 percent. In transactions recently documented by the Center on Responsible Lending, a $300 loan cost one family $2,700, while another borrowed $400, paid back $3,000, and was being hounded by the payday lender for $1,200 per month when they gave up and filed for bankruptcy. In total, the cost to American families of payday lending is estimated to be $4.2 billion a year. The Department of Defense identified payday lending as such a serious problem for those in military service that it noted that the industry “impaired military readiness.” Congress has now banned all companies from charging military people more than 36 percent interest, while leaving all other families subject to the same predatory practices. For some, Shakespeare’s injunction “Neither a borrower nor a lender be” seems to be good policy. But no one advocates that people who don’t want their homes burned down should stay away from toasters, or that those who don’t want their fingers and toes cut off should give up mowing the lawn. To say that credit markets should follow a caveat emptor model is to ignore the success of the consumer-goods market—and the pain inflicted by dangerous credit products. Indeed, the pain imposed by a dangerous credit product is even more insidious than that inflicted by a malfunctioning kitchen appliance. Wealthy families can ignore the traps associated with credit-card debt: their savings will protect them from medical expenses that exceed their insurance coverage or the effects of an unexpected car repair. Working- and middle-class families are far less insulated. For those closer to the economic margin, a credit card with an interest rate that unexpectedly escalates to 29.99 percent or misplaced trust in a broker who recommends a high-priced mortgage can trigger a downward economic spiral from which a family may never recover. Insufficient RemediesCredit transactions have in fact been regulated by statute or common law since the founding of the Republic. Traditionally states bore the primary responsibility for protecting their citizens from unscrupulous lenders, imposing usury caps and other credit regulations on all companies doing business locally. Although states still play some role, particularly in the regulation of real-estate transactions, their primary tool—interest-rate regulation—has been effectively destroyed by federal legislation. Today, any lender that gets a federal bank charter can locate its operations in a state with high usury rates (e.g., South Dakota or Delaware) and then export that state’s interest-rate caps (or no caps at all) to customers located all over the country. As a result, and with no public debate, interest rates have been effectively deregulated across the country. In April 2007, the Supreme Court took another step in the same direction in Watters v. Wachovia, giving federal regulators the power to shut down state efforts to regulate mortgage lenders—without providing effective federal regulation in turn. 1 | 2 | 3 | 4 | continued >  
 
 
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