State's Subprime Bill Leaves Borrowers Bamboozled, Broke
During the spring of 2007, when the subprime mortgage crisis was just beginning to rear its ugly, complicated, deeply entrenched head, the New York Assembly held an all-day hearing in search of a solution. The Assembly listened to testimony from consumer groups, mortgage brokers, members of the banking department, and housing agencies -- all debating the myriad causes of the emerging economic black hole.
Several witnesses raised the specter of secret payments, made by lenders to mortgage brokers in 90 percent of the subprime deals here and across the country. The payments -- known as yield spread premiums, or YSPs -- are mostly a secret to borrowers, who mistakenly believe that the brokers are representing them in obtaining the cheapest possible mortgage. And most of the front-page and television coverage of the crisis does nothing to enlighten them, though YSPs cost them an estimated $3 billion a year.
The watered-down version of the Responsible Lending Act that Gov. Paterson signed this past Tuesday does little to curb their potential future damage.
YSPs are called spread premiums because they’re based on the spread between what a borrower would ordinarily pay for a loan and the higher interest rate the broker convinces the borrower to pay. YSPs are a cash bonus that have been branded “kickbacks” by at least one federal judge and are generally understood (well, aside from the brokers who profit from them) to have pushed millions of people who are qualified for a lower interest rate into a higher one without any advantage to borrowers.
Senator Chris Dodd, the chair of the banking committee, has tried repeatedly to ban them, as Wayne Barrett noted in his recent piece for the Voice. When, in July, the Federal Reserve considered barring them and then backed off, a New York Times editorial claimed that it had "balked on banning the practice whereby brokers maximize their commissions by signing up borrowers for the most expensive loan possible, even when the borrower qualifies for a cheaper."
More than a dozen states, including New York, Connecticut and North Carolina, have passed strong legislation in recent months to curb abuses in the subprime market. All three states have banned all subprime prepayment penalties, while Maryland recently joined the list of states that bans prepayment penalties for all loans. And the North Carolina General Assembly just became the first in the nation to completely prohibit yield spread premiums.
New York, though, has taken a step backward with its legislative flip-flopping on the issue.
It’s enough to raise an eyebrow or two that Paterson signed Bill A. 10817, a compromise of the New York State Responsible Lending Act of 2008 that passed in the Assembly in May. The Assembly’s plan completely outlawed YSPs, but the Senate has insisted on allowing them.
The bill Paterson signed allows YSPs only as a form of compensating brokers for (legislatively undefined) “up front costs.” Yield spread premium fees earned by a broker in an amount greater than the borrower’s up-front costs, however, must be reimbursed to the borrower.
A spokesperson for Paterson told The Voice that the governor does not believe all compensation of brokers is necessarily detrimental, and that when brokers work in the best interest of borrowers, they deserve to be compensated, either by the borrower, the lender, or a combination of the two.
But Queens assemblyman and strong anti-YSP proponent Rory Lancman, who drafted the “Fairness in Lending Act” that specifically banned YSPs, said that the new bill allows too much financial-wiggle room. And it perpetuates what has been going on all along in this economic mess -- borrowers usually don’t understand the financial transaction they’re engaging in.
That confusion, Lancman said, is at the core of the whole crisis: “I compare it to the system we have in securities markets. Buying and selling stocks is a complicated transaction, and most people don’t understand [the process]. They rely on a stockbroker to give them accurate and honest advice and to put them in transactions that are appropriate for them. That relationship -- broker-customer -- is etched in law. There is a legal obligation to act in the customer’s best interest.”
But there is no similar obligation in the borrower-lender relationship; and that lack of responsibility has been the Achilles’ heel of the entire subprime mortgage system.
Peter Edman, who coordinates the Senate Banking committee for the bill’s sponsor, Senator Hugh Farley, told the Voice that allowing YSPs is about giving consumers the ability to choose.
“It’s hard to simply ban them,” he said. “Because if I go into a lender, I might be willing to pay lower up front to get a lower interest rate, and I want to have that choice. The question was how to target the problem without taking away choice. People view [YSPs] as equivalent to broker compensation, but it’s broader than that.”
In a proposal to address the subprime crisis within the state, the New York Association of Mortgage Brokers (who have, in the past, contributed to Farley’s campaign) takes a strikingly similar stance. Instead of banning YSPs, it suggests changing the term to “upselling” and leaving the broker with the ability to employ this tactic to offset the borrower’s closing costs.
If the Senate, the Governor and the NYAMB want to give New Yorkers the option to pay inflated amounts over the lives of their loans, so be it. But do consumers really need a "choice" that encourages them to spend (in the long run) an exorbitantly larger amount of money in favor of instant gratification? To us, that looks more like a booby-trap than a real alternative.
Edman said some people might think so, even though the issue was debated heavily within the Senate. And Farley, who has collected over $40,000 from mortgage corporations and New York banks throughout his campaign, doesn’t want to limit people’s options, Edman said. And so YSPs have found a way to survive.
The Voice reported last week that Attorney General Andrew Cuomo -- although he made several muddied steps early on in his career that contributed to the subprime crisis -- once proposed reform to YSPs that promised more disclosure. In his first year as HUD secretary, he said: "Too often consumers think the brokers are working for them. In reality, they are working against them."
Cuomo's proposal that year did not prohibit YSPs, but they did require a written contract between the brokers and the borrowers. The brokers had to check one of three boxes, revealing whether they represented borrowers only or were receiving lender fees. Then they had to fully disclose the amount of the fees, which usually far exceeded what the borrowers were paying.
But Lancman -- although he concedes that, for the most part, the bill’s intentions are good -- said that the issue of full disclosure for the consumer is still waiting to be resolved. Superintendent of Banking Marjorie Gross will be charged with deciding how and if this disclosure will be regulated.
At the end of July, as the bill was awaiting Paterson’s signature, Lancman e-mailed a list of suggestions to Gross on how to ensure consumers are protected. He proposed a tentative “Yield Spread Premium Notice,” something borrowers would sign before giving their lenders the opportunity to get a kickback.
Lancman’s proposed notice would ask borrowers to explicitly recognize or reject that they are accepting a loan at an interest rate higher than the one they qualify for. Even more, they would have to accept or reject that their broker will receive however much more in compensation from the lender, in order to compensate the broker for up front costs. The notice would clearly map out how much more the borrower would be paying for the life of the loan, and would juxtapose the amounts with and without employing a YSP.
Plain and simple. And if such disclosure were required of YSPs, surely fewer borrowers would agree to them. If this kind of disclosure had been required all along, who knows if the subprime mortgage crisis would even have come to such a catastrophic result?
Lancman hasn’t heard a final decision from the superintendent yet, but he’s hopeful that the task of finalizing the disclosure details will fall in the hands of “the good guys.” If not, he said, he plans to make his voice heard:
“We didn’t come this far -- a year and a half of negotiations -- after changing the way subprime mortgages are marketed, only to drop the ball on what has been the posterchild for the subprime mortgage crisis.”