The New York Times
By PETER EAVIS
December 17, 2012
As regulators complete new mortgage rules, banks are about to get a significant advantage: protection against homeowner lawsuits.
The rules are meant to help bolster the housing market. By shielding banks from potential litigation, policy makers contend that the industry will have a powerful incentive to make higher quality home loans.
But some banking and housing specialists worry that borrowers are losing a critical safeguard. Industries rarely get broad protection from consumer lawsuits, and banks would seem unlikely candidates given the range of abuses revealed during the housing bust.
"A lot of bad things are done in the name of expanding access to credit, as we found out," said Sheila C. Bair, former chairwoman of the Federal Deposit Insurance Corporation and now a senior adviser to the Pew Charitable Trusts.
The legal protection stems from the Dodd-Frank Act, the sweeping regulatory overhaul passed in 2010 to help repair the financial system.
The legislation mandated that loans be affordable, but Congress conceded that banks might fear the legal consequences if the mortgages did not comply. So lawmakers created a type of home loan that would have legal protection, called a "qualified mortgage." In practice, the protection will make it harder for borrowers to sue their lenders in the case of foreclosure.
The Consumer Financial Protection Bureau, the fledgling agency that is shaping the rules, faces a crucial but difficult task. Banks are pressing for a strong version of the legal shield. They also want qualified mortgages to be available to a broad range of borrowers, not just those with pristine credit.
Consumer advocates also tend to favor a broad definition for qualified mortgages, to maximize the availability of home loans and increase homeownership. But they argue that banks do not deserve a high degree of protection, citing the problems during the housing crisis.
Big financial institutions have faced an onslaught of litigation since the downturn, although mostly by the government, investors and other companies instead of borrowers. In February, five large mortgage banks reached a $26 billion settlement with government authorities that aimed, in part, to hold banks accountable for foreclosure abuses.
The bureau has some leeway. In writing the proposed rules, the Federal Reserve suggested two approaches, and it is up to the consumer agency to define the safeguard for lenders.
One option, called a "safe harbor," raises the threshold for litigation. In that case, a borrower may win a lawsuit only by showing that the disputed mortgage lacked the precise features required for a qualified mortgage, like a defined amount for points and fees.
A second option would increase borrowers' ability to challenge a mortgage in court. A loan might appear to comply with the requirements for a qualified mortgage, but the borrower might be able to introduce other evidence that shows the underwriting fell short of the standards.
For example, a borrower's payments could fall within the guidelines for the qualified mortgage, based on that person's income at the time the loan was made. But the homeowner might have also told the bank that he was about to lose his job or get a divorce, events that could make it much harder to pay back the loan. Under a looser legal shield, the borrower might be able to cite records of such conversations, and contest the mortgage in court.
The new qualified mortgage rules won't stop borrowers from using other laws to sue banks, like regulations about loan document disclosures.
Moira Vahey, a spokeswoman for the bureau, declined to comment on the specifics of the rule. She added that the bureau should be able to meet the Jan. 21 deadline for completing the rule.
A big question for the bureau is how seriously to take the banks' assertions that they will cut back on lending without a strong legal shield. JPMorgan Chase said last year that weaker protection would lead to fewer loans and higher-cost mortgages. "A large percentage of Americans may arbitrarily be shut out of the residential mortgage market," the bank wrote in a comment letter to regulators.
Some smaller institutions feel the same way. Steven H. Swartout, the general counsel of Canandaigua National Bank and Trust of Canandaigua, N.Y., says the bank will be strongly deterred from making mortgages without a strong legal shield.
"I want a safe harbor, and I want a safe harbor that makes sense," he said. "This is a quantum change in the risk."
But consumer advocates say banks are overstating the risks. They indicate that few borrowers have sued lenders over the recent foreclosure mess. And they note that states with tough consumer lending laws have not experienced large numbers of borrower lawsuits.
"A lot of this, quite frankly, is litigation paranoia," said Michael D. Calhoun, president of the Center for Responsible Lending. "If you ask any of the lawyers in the financial industry, they'll acknowledge there won't be class actions."
The banks may end up tolerating a weaker provision if the characteristics of a qualified mortgage are sufficiently clear and detailed.
That appeared to be the position banks set out in a July letter from the Clearing House Association, a financial industry group. It said its "priority has been and remains the issuance of clear and objective standards to ensure that the vast majority of borrowers have access to safe and affordable loans at reasonable cost." If the standards are expansive and clear, the banks say they will feel more certain that they have met them.
There is another reason that banks may continue to lend even if they end up with a less secure legal shield. They are making big profits in the mortgage market. Wells Fargo, the top mortgage lender, made $399 billion of home loans in the first nine months of this year, up substantially from $237 billion in the same period of 2011. The bank's mortgage banking revenue surged to $8.6 billion in the first nine months of this year, compared with $5.5 billion last year.
Even a more modest legal shield would still favor the banks, says Alys Cohen, a lawyer at the National Consumer Law Center. In legal terms, it "presumes" from the outset that the banks have met the qualified mortgage standards. Borrowers merely get the chance to "rebut" that presumption. "You are still putting the finger on the scale on the side of the lender," she said. "The burden for the borrower is still huge."