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From CQ Weekly, PETER HARKNESS Interstate Frustration With slack federal regulation, states struggle to help borrowers and lenders caught in the subprime chaos 
It seems almost axiomatic that every decade or so the financial and securities industries — known collectively as "Wall Street" — get themselves into serious trouble. Remember the junk bonds meltdown, or the savings and loan fiasco of the past two decades? Both times, lax regulation helped create the mess, and decisive government intrusion helped contain it. Now it's the subprime mortgage catastrophe, which may prove to be the most difficult and expensive such bailout yet because of its complexity and deep penetration throughout the financial system. So how did this happen? In part it's because the regulatory system governing the home mortgage business has become so murky, especially because state officials may not regulate outof- state lenders. And in part it's because of changes in the home mortgage market — which, an International Monetary Fund analysis recently noted, "has changed radically from one in which local depository interests make loans to one that is centered in the major Wall Street banks and securities firms."
In other words, a very lightly regulated mortgage industry generated the loans and then sold them to big banks and securities firms, which bundled them and repackaged them into securities that were sold to investors around the world seeking higher yields. Who is supposed to regulate what has been increasingly unclear. The federal government and the states have been squabbling over that question for years. In 2004, the Bush administration pre-empted laws in four states — Georgia, New York, New Jersey and New Mexico — that exposed national and state banks that purchased subprime mortgages to fines if that lending was later judged to be predatory. John D. Hawke Jr., the comptroller of the currency at the time, told the conservative Federalist Society that such laws stifle those "who provide access to legitimate subprime credit." The Supreme Court finally settled the ensuing regulatory turf battle last April — in favor of the feds. (So, for instance, a state such as Iowa, which has a law banning prepayment penalties, may not enforce it against national banks or their subsidiaries.) The mortgage industry was pleased because the decision ended confusion over who would be setting the rules. All 50 states argued in a joint brief that federal regulation of predatory lending, an important aspect of the subprime mess, was far more lax than that of most of the states — a situation that will probably persist, given that Congress has made no move to take action on lending standards. Now, waves of foreclosures are washing across the country. The Mortgage Bankers Association reports that 1.5 million homes went into foreclosure last year, and that number will be exceeded this year. In the next two years, millions of subprime adjustable loans are scheduled to reset their interest rates to much higher levels, prompting even a greater washout. ACTING LOCALLY Washington may be under election-year pressure to worry about the impact on our financial system. But out in the country, it will be the states and their localities that must clean up the mess. States are using various techniques to get homeowners behind in their payments — and their lenders — to work out new, more affordable loans. Some governors are running public service ads. Six states have established hotlines with credit counselors to offer advice on how to avoid foreclosure. Thousands of people are calling, which is heartening because one of the most serious problems has been that homeowners are afraid to communicate with their mortgage holders. The lenders, in turn, don't want the houses. So there is plenty of incentive on both sides to work out deals. By the end of next year, more than two-thirds of the states are expected to be participating in a National Mortgage Licensing System that will track the behavior of firms operating in multiple states — so that infractions in one state will be known by all. It's an arrangement the states themselves, not Washington, has come up with. Some cities are being more aggressive. Last month, Baltimore sued Wells Fargo & Co., alleging "a pattern of practice of unfair, deceptive and discriminatory lending activity in Baltimore's minority neighborhoods that [has] the effect and purpose of placing inexperienced and undeserved borrowers in loans they cannot afford." Cleveland has done the same, seeking damages against 21 lenders. Local courts are fining national banks that aren't keeping the houses on which they have foreclosed in decent repair. If the locals seem more punitive, there is a reason. They had precious little to do with the regulatory failure that led to this disaster, and yet they are the ones holding the bag of declining home values eroding their tax base as they try to maintain whole neighborhoods blighted by the plague of foreclosures. On Wall Street at the end of last year, annual bonuses rose 14 percent — to almost $30 billion for just the four largest investment banks — even though some of those firms had suffered severe losses because of the subprime fiasco. About the same time, about 250 mayors called for massive federal assistance to help them out in cleaning up the mess. It's a safe bet Congress won't act on that, either. Recent columns: © 2008, Congressional Quarterly, Inc. Reproduction in any form without the written permission of the publisher is prohibited. Governing, City & State and Governing.com are registered trademarks of Congressional Quarterly, Inc. |
THE STATES AND LOCALITIES