California Legislature Reaches Compromise on Subprime Reform Bill

The L.A. Times reports that the California has reached a compromise with consumer and lending groups on a bill that would guard against some of the practices that contributed to the subprime crisis. The bill, an amended version of AB 1830 introduced by Assemblyman Ted Lieu (D-Torrance), contains measures that would bar pick-a-payment loans to subprime borrowers, limit the size and duration of prepayment penalties on subprime loans and prohibit brokers from steering subprime borrowers into costlier loans than they qualified for. The bill would also forbid lenders from paying brokers more when they persuaded people to take loans with prepayment penalties or higher interest rates, an issue that has come up in state suits against Countrywide, among others. The measure also increases access to the courts for victims of predatory lending by allowing California regulators to enforce both federal lending laws and state rules.

While the bill does address some of the abusive practices that encouraged volume lending and lax underwriting, there is still much work to be done. For one, while the bill includes a provision that would require mortgage brokers to place their customers’ financial interests ahead of their own for all lending, the bill focuses primarily on subprime loans. While this category of loans has received the most attention in the media as the harbinger of the current credit crisis, the problems by no means are limited to these loans. As we have seen, the delinquency and foreclosure rates among so-called Alt-A loans have skyrocketed (for reports regarding this category of loans, see here and here), and I expect to see major problems with this and other categories of non-subprime loans down the road.

Moreover, there is good reason to think that these abusive lending practices have not been limited to residential home mortgages alone. In an interesting profile by the New York Times of Nouriel Roubini, who predicted the current subprime crises back in 2006, Roubini opines that:

“Reckless people have deluded themselves that this was a subprime crisis… But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”

Though Roubini has been criticized as an eternal pessimist, he has been largely vindicated by his numerous accurate predictions regarding the U.S. housing and financial markets. Plus, his reasoning makes sense: given an environment where lax underwriting was encouraged and responsibility was passed off to the next buyer in a securitization chain, there’s no reason to think that lenders were incentivized to care whether borrowers were actually capable of repaying their loans. And by no means are the abuses limited to lenders or banks; the borrowers themselves have been responsible for a significant amount of reckless or fraudulent borrowing which must be curtailed through improved financial education and legal reform. Though AB 1830 is a good start, it will take a much broader overhaul of the entire credit system to address the fact that Americans as a whole are staggering under the weight of their debts.

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