Op-Ed : How to Cool A Meltdown

Legal Times
Monday, November 17, 2008

With the historic “Yes We Can” election now behind us, it’s time to pose a logical follow-up question: How do we manage the nation’s most pressing emergency: the economy? And specifically, how do we ensure this kind of crisis never happens again?

Economists and experts may debate the causes and solutions for years. But today, there is surprising consensus about one simple fix that could actually help prevent another subprime mortgage crisis from brewing. It’s an obscure legal concept called “assignee liability,” but it simply means—accountability.

One of the most important functions of our legal system is deterrence of practices that pose a real risk of harm. But as must seem obvious, deterrence wasn’t working when it came to the subprime mortgage meltdown. Banks and lenders lent hundreds of billions of dollars in home loans with terms that made them incredibly risky. Wall Street, in buying up these loans, encouraged this reckless lending behavior. When homebuyers started defaulting, investors were stuck with potentially worthless mortgage notes, and taxpayers were left holding the “bailout” bag.

Borrowers should be able to pursue legal claims against anyone in possession of a piece of their loan—from the original lender who sold it to them to whatever Wall Street investment bank (i.e., “assignee”) purchased it—should the transaction be found to involve illegal actions or abusive terms. But while the commercial banks and original lenders can be on the hook for predatory lending, it turns out that the Wall Street firms that pressured lenders to make these risky loans aren’t—and they knew it at the time.

Had those who profited from these risky loans been liable, through the legal doctrine of assignee liability, many experts now believe that these big financial firms would have been far less likely to have encouraged this type of lending, possibly preventing the entire crisis in the first place.

“The whole world suffered because there was too little accountability in the system,” says Kathleen Keest, a former assistant attorney general in Iowa who now works for the Center for Responsible Lending, a nonprofit based in Durham, N.C. According to Keest, assignee liability would be a way of bringing more balance and discipline to the market.


So what happened?

In 1994, Congress passed the Home Ownership and Equity Protection Act that included an assignee liability provision. Unfortunately, the law applied to just a tiny portion of high-priced loans and did not adequately address the myriad of deceptive strategies that loan originators would utilize in later years. In the meantime, Wall Street went on an unprecedented buying frenzy—increasing its acquisitions of subprime mortgages as much as eightfold from 2001 to 2006, a market phenomenon the 1994 Congress never anticipated when HOEPA was passed.

Meanwhile, states that sought to bolster HOEPA with their own liability laws were aggressively fought by first the Clinton and then the Bush-controlled Office of the Comptroller of the Currency, which rendered the state laws inapplicable to federally chartered banks. That’s about 1,700 financial institutions, which control nearly two-thirds of U.S. commercial bank assets.

The state of Georgia is largely emblematic of how this process played out among the states. In 2002, the state passed the Georgia Fair Lending Act, imposing liability on assignees of some Georgia-based loans for violations by the original brokers and lenders. Wall Street firms opposed the law for fear that it would ruin the market for repackaged mortgages. Major ratings agencies such as Standard and Poor’s had similar worries and threatened to stop evaluating many of the bonds connected to Georgia mortgages, a move that would have caused mainstream investors such as insurance companies and mutual funds to avoid buying investment products drawn from pools that originated in Georgia.

The OCC then issued an administrative ruling in 2003 saying that Georgia law didn’t apply to national banks or their subsidiaries. In 2004, the OCC went even further, proclaiming that state-chartered mortgage brokers and lenders were exempt from Georgia law, so long as the loans they handled were funded at closing by a national bank or its subsidiary.

In the end, the Georgia Legislature succumbed to all the pressure, replacing its law with a considerably watered-down version (though only after first securing the blessing of Standard and Poor’s).

The end result? Georgia now has the sixth-highest foreclosure rate in the country.


Similar clashes have wound up in the courts, most famously in the U.S. Supreme Court between the OCC and regulators in Michigan.

In that case, Waters v. Wachovia Bank (2007), Michigan regulators wanted to continue overseeing a Wachovia-owned mortgage business that had recently become a wholly owned subsidiary of the nationally chartered bank, Wachovia. The parent bank sued, arguing that “states are not at liberty to obstruct, impair, or condition the exercise of national bank powers, including those powers exercised through an operating subsidiary.”

The Supreme Court agreed. In a 5-3 majority opinion written by Justice Ruth Bader Ginsburg, the high court said, “Just as duplicative state inspection and supervision would significantly burden mortgage lending by national banks, so too those state controls would interfere with that same activity when conducted by a national bank’s operating subsidiary.”

In dissent, Justice John Paul Stevens lamented that it was “especially troubling that the court so blithely preempt[ed] Michigan laws designed to protect consumers.”


Historically, one of the main arguments offered by opponents of assignee liability (such as disgraced congressman Bob Ney (R-Ohio)) was that such liability would have made fewer subprime and other risky loans possible for “the little guy.”

But now we know, that’s exactly what was needed. For too long, Wall Street entities were tripping over themselves to profit from the “little guy’s” most toxic and unreliable loans—and 1.2 million subprime foreclosures have been the result, with an additional 2.2 million expected by the end of next year.

Without proper oversight and accountability, even life-long “free-marketers” such as former Federal Reserve Chairman Alan Greenspan have been forced to concede that the market should not have been trusted to police itself.

Every indication is that the new Congress will try to pass tough new legislation to hold Wall Street financiers liable for trading in deceptive or unlawful mortgage loans. Before the election, Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, predicted that the new Congress would pass some form of assignee liability legislation next year. Two proposals for such laws, one sponsored by Frank and another by Sen. Chris Dodd (D-Conn.) are currently in Senate committee limbo.

Ultimately, borrowers want homes they can afford and loans that are not designed to trip them up—and investors want loan portfolios they can rely upon.

If Frank is right, and the incoming Congress has the wherewithal to enact meaningful legislation that would hold Wall Street firms financially accountable, the tale of the “subprime mortgage meltdown” may not end so tragically after all. At least for the future, we know we can prevent it from happening again.

Andy Hoffman is a lawyer and policy analyst with the Center for Justice & Democracy in New York.

Reprinted with permission from Legal Times. © 2008 ALM Properties, Inc. All rights reserved. Further duplication without permission is prohibited.  For information, call (800) 933-4317 or [email protected]. ALM is now Incisive Media, www.incisivemedia.com.

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