Is There a Precedent for Mortgage Investor Liability?

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Media interest in the subprime problem has died down. Subprimes are now in that same zombie category of ongoing problems that are unpleasant and unresolved, like Katrina victims and Iraq turning military service into involuntary servitude.

In poking around, we found an intriguing item that likely won’t get the attention it warrants.

Readers may recall that when the subprime mess was in the press, one proposal floated was to have buyers of mortgages also be liable when the borrowers had been defrauded by the originator. Part of the logic was that some mortgage lenders have modest capital bases relative to the volume of loans they sell onward, so if an organization engaged in large-scale deception, it might not have enough capital to compensate borrowers. From the Financial Times:

….senior figures in Congress hope to force the financiers who buy mortgages and create mortgage-backed securities to share some of the liability – and thus financial cost – that might arise if mortgages were mis-sold to borrowers who proved unable to meet payments.

Of course, investment banks howled, since this would make it much more difficult to sell mortgage paper, and would also likely create greater reporting requirements (you’d need to be able to find out where a mortage wound up, and since they can be repackaged multiple times, the transaction trail could get complex).

It turns out the notion of investor obligation, which is what the investment banks found particularly offensive exists in current law for high-interest subprimes. Home Ownership and Equity Protection Act (HOEPA) defines HOEPA loans according to fees, interest charges, and other terms, and has the effect of including the higher-cost subprimes (which are the ones that got in trouble). From Irv Ackelburg’s “Evaluating Foreclosure Cases Involving Rip-Off Home Equity Loans” from the Consumer Advocate:

Remember that, if you are within a year of the transaction, a HOEPA violation
gets you statutory penalties in addition to the basic TILA penalty of $2,000. See
15 U.S.C. §1640(a)(4); Newton v. United Companies. It also gets you rescission
within three years of the transaction. 15 U.S.C. §1639(j); Reg. Z §226.23, n. 48.
A lesser known, but extremely important, consequence of a transaction being a
HOEPA loan is that all claims and defenses, up the amount of the indebtedness,
that exist against the original lender can be asserted against subsequent holders
of the mortgage. 15 U.S.C. §1639(d).

So the principle of subsequent holders of the mortgage being liable for HOEPA loans is already established. HOEPA loans have higher disclosure requirements than conventional loans. So the only issue about the Congressional proposal should be how many additional mortgages it might encompass by using the concept of “mis-selling” (how is that any different from fraud? Presumably the new term is meant to set a lower bar) and whether the standards will go beyond HOEPA borrowers to include all subprime borrowers.

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