How to solve the subprime mess.

The law, lawyers, and the court.
Nov. 24 2008 6:32 AM

Eat the Loan Sharks!

Let's solve the subprime mess by going after lawbreaking lenders.

A sign in front of a foreclosed home.
A sign in front of a foreclosed home

In early October, Bank of America quietly entered into the largest settlement in history to make amends for predatory lending, putting up more than $8 billion to rescue borrowers with faulty loans from Countrywide Financial, a notorious subprime lender recently purchased by the bank. As politicians and regulators haggle over the best approach to modify perilous mortgages and as millions of Americans fall deeper into delinquency, the Bank of America settlement offers a clear path out of the broader problem: Chuck the illegal loans and start over again, making the lawless lenders foot the bill.

Part of the backdrop here is dismayingly familiar. Explosive growth of subprime lending created perverse incentives that led to fraudulently inflated loan terms. What's less known is that some of these loans were priced higher based on the race of the borrower, with African-Americans and Latinos paying more, in secret, behind-the-scenes deals. Some of this activity will even turn out to have been criminal. There are more than 1,500 open FBI investigations into mortgage fraud, much of it concentrated in the subprime market.

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At the same time, many delinquent borrowers don't know that the terms of their home mortgages may have been the byproduct of fraudulent, discriminatory, or criminal behavior by mortgage brokers and lenders. Before we end up spending billions to rescue subprime borrowers, we should figure out which loans were the products of illegal behavior, rescind them, and rewrite them on terms that are fair and legal. If there is a cost associated with this process, let lenders pick up the tab, which is precisely what Bank of America is doing. This would save taxpayer money by reducing the number of loans that the government would pay to modify. It would also help to stabilize the housing market and lay the blame for much of the subprime crisis at the feet of those most responsible: the lenders who acted like predators.

What's the evidence that African-Americans and Latinos paid more for loans in a way that's illegal? A study of lending data from 2006 by the Federal Reserve estimates that roughly 18 percent of the loans made to white borrowers in that year were subprime loans, compared with roughly half the loans made to African-Americans and Latinos during that time. When the study assessed borrowers of similar incomes, 30 percent of African-American borrowers received subprime loans, compared with 18 percent of whites and 26 percent of Latinos. These discrepancies aren't absolute proof, but they suggest that discriminatory steering took place in which otherwise qualified borrowers of color were directed to subprime, and substandard, loans. Federal law makes it illegal to discriminate based on race in the terms and conditions of a home mortgage loan. It would appear that this is exactly what happened.

This discrimination is at the core of a number of lawsuits advocates have filed across the country over the last year. Several of the cases focus on a particularly devious practice: Without borrower knowledge, many mortgage brokers received a commission from the lender for persuading a borrower to accept a higher loan interest rate than what the bank was otherwise willing to offer. The lawsuits claim that such commissions were paid more often in loans to African-Americans and Latinos than in loans to whites, revealing, again, that lenders often charged borrowers of color more than their white counterparts. As these suits progress, and the groups suing gain access to lenders' and brokers' records—e-mails, internal memoranda, training materials, and other documents—we are likely to learn more about the practices of the lenders who are the defendants and about the industry in general.