Every now and again, a potentially significant story manages to slip through the cracks, barely noticed by anyone. A recent Dow Jones article by Jilian Mincer -- "Mtge Lawsuits Could Bail Out Some Borrowers" -- is just such an article. The only reason I even knew about it was because I spoke with the reporter and was quoted in it.
It is a fascinating tale that I suspect won't be ignored for long. For those few people familiar with the Federal Truth-in-Lending Act [TILA], this won't be much of a surprise. To everyone else, read on.
What happens if a lender fails to comply with the TILA rules? The borrowers are allowed to RESCIND THE LOANS AND VOID THE MORTGAGES ON THEIR HOMES. The mortgage lender is then just another unsecured creditor, who must get in line behind everyone else who may have filed a lien on the property. Whoever files first (Credit card, auto finance, doctors, etc.) has first priority.
That makes the mortgage loan itself unsecuritized -- and worth a lot less -- due to the increased risk of loss of collateral:
"Some consumers burdened by escalating subprime mortgage payments are finding a way out. A growing number are suing lenders over inaccurate disclosure papers, and if they win they get to rescind the loans.
While that's good news for individuals, it's a potential problem for investors exposed to subprime mortgages. These investors, already buffeted by the subprime mortgage meltdown, are facing a new risk - the mortgages supporting some of their investments may not be enforceable because of violations of state and federal consumer protection laws.
It's not clear yet how widespread or successful these lawsuits may become. "Depending on how widespread, this could be a minor bump in the road or this could be a very significant factor," says Barry Ritholtz, chief market strategist at Ritholtz Research & Analytics.
The subprime market has been known for its lax standards in documentation and the proliferation of these loans in recent years is now fueling significantly more complaints. The subprime share of first mortgages rose to 13.4% in the first quarter of 2007 from 10.9% in the first quarter of 2004."
Let me put on my lawyer hat for a moment: The Truth-in-Lending Act requires "clear and conspicuous" disclosure to borrowers of the key provisions of their mortgages. This includes such details as the eventually reset interest rate, specific loan terms, and the total dollar amount the mortgage will cost over time:
§ 129. Requirements for certain mortgages
(1) SPECIFIC DISCLOSURES.--In addition to other disclosures required under this title, for each mortgage referred to in section 103(aa), the creditor shall provide the following disclosures in conspicuous type size:
(2) ANNUAL PERCENTAGE RATE.--In addition to the disclosures required under paragraph (1), the creditor shall disclose
(NYSE:A) in the case of a credit transaction with a fixed rate of interest, the annual percentage rate and the amount of the regular monthly payment; or
(NYSE:B) in the case of any other credit transaction, the annual percentage rate of the loan, the amount of the regular monthly payment, a statement that the interest rate and monthly payment may increase, and the amount of the maximum monthly payment, based on the maximum interest rate allowed pursuant to section 1204 of the Competitive Equality Banking Act of 1987.
This seems to be where many of the subprime 2/28 ARMs ran afoul: They failed to meet the disclosure laws regarding actual interest amounts and payments.
Who has gotten tagged with these cases so far? Subprime lender NovaStar Financial Inc. (NFI) in Kansas City settled a class action suit for $5.1 million. And, consumers in Wisconsin recently won a class-action TILA suit (its under appeal).
Between 1998 and 2006, approximately 2.2 million (nominal) home owners with subprime loans are expected to lose their homes, according to the Center for Responsible Lending. The consumers in this group who a) could not afford those loans and b) did not receive the proper disclosures are "talking with lawyers in an effort to prevent foreclosures."
Anyone who has worked in a corporate environment has used or heard the phrase "Send it to Legal," or "What did Legal say about that?" Of course, "Legal" being the internal corporate legal department.
Didn't the legal departments of the mortgage underwriters prepare these loan forms? Aren't these standardized? WTF did the various legal departments involved actually do, other than go to lunch and wear ugly ties ?
And, here's the real rub: This kinda makes you wonder what sort of due diligence the secondary market actually did on these basic non-compliant loan errors in the sub-prime market. How about the CDO banking underwriters -- didn't their Legal review these docs for compliance with existing laws prior to purchasing trillions of dollars worth of the stuff? Was their fraud involved, or did these guys just miss it?
This is basic stuff, and it's amazing that in the headlong rush to write these garbage loans, no one caught very basic, banking 101 type rule. It just shows how little oversight by the regulators there was in this space. Hard to imagine, but the Central Bankers either never reviewed these loan documents, or never caught these basic disclosure errors.
And yes, I place some of the blame on the Greenspan Federal Reserve -- they were the regulatory authority in charge of bank mortgage lending when these junk mortgages were written . . .
Mtge Lawsuits Could Bail Out Some Borrowers
Dow Jones Newswires Column, 7/16/2007 7:31 AM
CONSUMER CREDIT PROTECTION ACT
15 U.S.C. 1601 note]
May 29, 1968 (Pub. L. No. 90--321; 82 Stat. 146)