Discriminating lenders were not the only problem with the housing market that courts should now address. Mortgage brokers rushed into poor communities with exotic subprime loans during the early part of this decade, because these communities were underserved by traditional banks. During the height of the market, nearly half of all subprime loans went through a broker, compared with only 28 percent of prime loans. Brokers also dominated loans made to borrowers of color: 64 percent of African-American borrowers used a broker, compared with only 38 percent of white borrowers.
The problem with this wasn't the mortgage brokers per se. It was that many prospective borrowers wrongly assumed that the brokers were working in the borrower's best interest. But in most states, mortgage brokers do not owe any duty to the borrower to find the best possible deal. Many brokers relied on borrowers' ignorance of the mortgage market to pursue higher commissions and other financial perks for themselves. In much of the country, there's no legal remedy for this. But a few states require that brokers avoid conflicts of interest and pursue the best deal for the borrower. These states include California, home to about one-quarter of the mortgages in the United States that are in some stage of foreclosure. The Department of Justice, the state attorney general, legal-services attorneys, volunteer lawyers, and law students should all be poring over California loan documents to smoke out the brokers who violated their legally mandated duties to their clients. If a significant number of loans in California alone could be altered, consistent with the borrowers' abilities to pay, either through litigation or its threat, the federal government wouldn't have to pay as much for a national bailout.
To date, none of the proposed homeowner-rescue plans acknowledges that a significant number of the homeowners who are in distress were the victims of predatory and illegal practices. Opponents of the plans currently on the table raise three serious objections: First, any massive loan rescue would be costly; second, borrowers in good standing might intentionally default on their mortgages to benefit from a bailout; and third, investors holding securities backed by subprime loans will balk at loan modifications that diminish their already depreciated investments and will sue to stop such efforts.
Going after the lawbreakers helps to address these concerns. It would not only lower the cost of the rescue plan by reducing the number of borrowers needing help, it would also direct assistance only to those people who were victims of illegal conduct and insulate the loan modifications from litigation by investors looking to preserve their investments. Investors won't challenge loan restructuring when the underlying loans were made on illegal terms. You don't lend your horse to Jesse James and then sue the stagecoach he robbed to get it back. Investors will have to redirect their fire from the borrowers to the brokers and lenders who did the fancy loan footwork—and perhaps the ratings agencies that blessed it.
Some investors will have to line up in bankruptcy court, since more than 40 subprime lenders have gone belly up in the last two years. But there are some still standing, like Wells Fargo (already facing a discrimination lawsuit brought by elected officials in Baltimore). And where federal and state investigations have already netted criminal indictments in cases of broker and lender fraud, civil liability should follow. Lax enforcement of the laws is clearly one of the many reasons we find ourselves in the current mess. Strict enforcement of those laws would help get us out of it.