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Originally published October 30, 2009 at 2:38 PM | Page modified October 30, 2009 at 4:46 PM

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Washington Mutual's failure is a road map for how to protect consumers

Washington Mutual's implosion gave Seattle a front-row seat to the perils of exploitative mortgage-lending practices that became common among the nation's banks. The lesson, writes guest columnist Helen P. Howell, is tighter federal rules but also giving states more regulatory authority.

Special to The Times

SINCE the failure of Washington Mutual last year, we've learned a lot about the exploitative mortgage-lending practices of the nation's largest thrift, a corporation headquartered in Seattle, one of our community's leading employers, and a favorite investment of many locals.

The sting of the financial crisis that resulted from the meltdown of the home-mortgage market and the market for mortgage-backed securities, as well as the credit crisis and recession that followed, is very real for Seattleites. In addition, our trust was violated by one of our own.

Although some protections against predatory lending exist in federal law — under the Federal Trade Commission Act and the Home Ownership and Equity Protection Act — federal banking regulators rarely bring enforcement actions.

The Obama administration's proposal to create a Consumer Financial Protection Agency (CFPA) to regulate financial products and protect consumers from deceptive practices makes sense.

Most traditional banks have escaped scrutiny for predatory practices for three reasons: 1) lack of a national, anti-predatory lending law combined with pre-emption rules by national bank regulators; 2) reliance by state banking departments on the FDIC to police compliance by state-chartered banks with federal consumer-protection and fair-lending laws; and, 3) the fact that federal regulators — including the FDIC, Office of the Comptroller of the Currency, Federal Reserve, and the Office of Thrift Supervision — generally do not drill down to the individual-transaction level when they conduct examinations.

Instead, they focus at the portfolio level on enterprise risk management, the economic viability of the institution, its earnings, etc. And, when they do sample individual loan files, they concentrate on disclosures.

The inadequacy of regulating disclosures alone has become clear, and is one of the reasons the Obama administration has proposed creating a federal agency to regulate financial products. Such regulation is crucial, especially when some mortgage products are inherently susceptible to fraud.

Besides ensuring the safety of consumer financial products, the proposed CFPA would ban deceptive practices and promote transparency, fairness and accountability. The agency would be responsible for federal consumer-protection and unfair-lending laws and empowered with broad rule-making, examination and enforcement authority, as well as adequate resources.

However, the CFPA law should provide a floor — a base level of consumer protection — rather than a ceiling. The states have been far more vigilant in establishing legal protections for consumers of financial services and enforcing those consumer-protection laws.

While nearly 8,000 state mortgage enforcement actions were brought in 2008, federal regulators' consumer-protection enforcement record is dismal in comparison. For example, between 2000 and 2008, the Office of the Comptroller of the Currency took only two public enforcement actions against banks for unfair and deceptive practices in mortgage lending, although the agency claims to ensure consumer protection through "behind-the-scenes" supervision.

In addition, the regulators of national banks have aggressively pre-empted state law and prevented state attorneys general from enforcing state consumer-protection laws against national banks, their subsidiaries and affiliates.

The irony of federal banking regulators asserting pre-emptive enforcement authority, and then abdicating their consumer-protection law enforcement responsibilities must not remain. The consumer-protection role of state banking regulators and state attorneys general in the financial-services arena should be augmented, not diminished.

Next, in addition to the regulation of financial products, a national, industrywide, legal standard should be applied to the sale of mortgage loans — a reasonableness standard similar to the "suitability" rule applied in the securities context to prevent fraud.

When recommending a securities investment, a broker must consider the financial condition of her client. She must have reasonable grounds for making a recommendation, and can be held accountable.

The application of a similar standard in the mortgage-lending context is urgently needed, and should be enforceable against everyone selling mortgage products. It would generate more transparency in the industry, and lead to more responsible behavior by independent mortgage brokers and in-house loan officers.

Perhaps as important, lenders could then be held accountable for the incentives they provide mortgage brokers in the form of yield-spread premiums, and loan officers in the form of commissions.

Regulators would be on the lookout for inappropriate incentives that reward practices such as locking prepayment penalties into mortgage loans, placing borrowers qualified based on teaser rates into high-risk loans, and/or adding points to the annualized percentage rate for which the borrower qualifies without providing the borrower any benefit.

Finally, in addition to the proper regulation of the sale of mortgage products, and a national, industrywide standard for mortgage lending in federal law, financial institutions need to embrace their moral, ethical and corporate governance responsibilities with regard to mortgage lending.

Banks have demonstrated tremendous sophistication in generating income. It's time for them to show us that they're able to apply that same ingenuity to rebuilding consumer trust.

Clearly, they can offer consumers a range of appropriate products, provide clear explanations of their offerings, and still earn a profit.

They just may not produce earnings similar to those generated during the boom years of predatory lending — when high-risk, specialty products were sold broadly and recklessly by WaMu and others.

Helen P. Howell, a Seattle attorney and consultant, previously served as director of the Washington State Department of Financial Institutions.

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atlatl? You evidently need to review, a few short years, of American History. Woodrow Wilson(D) would be a great place to start! His...  Posted on October 31, 2009 at 12:58 PM by Liberty Bell. Jump to comment
Ummm...Helen? Wanna guess which investment bank created and marketed the first mortgage-backed security (the instrument that ultimately...  Posted on October 30, 2009 at 5:53 PM by right wing nutjob. Jump to comment
the second i saw that this was written by an attorney i knew how it would lean. guess who gets to make money if this comes to fruition?...  Posted on October 31, 2009 at 10:59 AM by davidfelder. Jump to comment


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