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Securitization and Predatory Lending


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Patricia A. McCoy's presentation for the Penn IUR conference:


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Securitization and Predatory Lending

  1. 1. Securitization and Predatory Lending Patricia A. McCoy University of Connecticut School of Law
  2. 2. The Ostrich Phenomenon <ul><li>An excerpt from the offering circular for the Terwin Subprime Pool 2004-5HE (emphasis added) : </li></ul><ul><li>“ UNDERWRITING CRITERIA </li></ul><ul><li>With the exception of approximately 20.82% of the mortgage loans in the statistical mortgage pool that were underwritten in accordance with the underwriting criteria of The Winter Group, underwriting criteria are generally not available with respect to the mortgage loans . In many instances the mortgage loans in the statistical mortgage pool were acquired by Terwin Advisors LLC from sources , including mortgage brokers and other non-originators, that could not provide detailed information regarding the underwriting guidelines of the originators .” </li></ul>
  3. 3. Predatory Practices <ul><li>Loans that Violate Common Loan Underwriting Conventions to the Detriment of Borrowers </li></ul><ul><li>Loans that Result in No Net Benefit to the Borrowers </li></ul><ul><li>Loan Terms Designed to Earn Oligopoly Profits </li></ul><ul><li>Loans Involving Fraud or Deceptive Practices </li></ul><ul><li>Loans Involving Other Misleading Nondisclosures that are Legal </li></ul><ul><li>Loans that Require Borrowers to Waive Meaningful Legal Redress </li></ul><ul><li>Servicing Abuses </li></ul>
  4. 4. Impact of Predatory Lending <ul><li>Predatory Lending : </li></ul><ul><li>-- Is most prevalent in the subprime refinance market. </li></ul><ul><li>-- Often involves targeting by race, ethnicity, census tract, or age. </li></ul>
  5. 5. Credit Risk and Lemons Problem <ul><li>Subprime loans have elevated default rates </li></ul><ul><li>Unbundling of mortgage market functions </li></ul><ul><li>Result is a “lemons” problem </li></ul><ul><li>Examination of individual loan files impractical </li></ul><ul><li>So outside investors demand risk premium </li></ul><ul><li>Oligopoly pricing permits passing risk premium on to borrowers </li></ul>
  6. 6. How Securitization Manages Credit Risk <ul><li>Through structured finance and pricing, not filtering </li></ul><ul><li>-- Credit enhancements </li></ul><ul><li>Due diligence: limited and often ineffective </li></ul><ul><li>Federal securities law permits private offerings with very limited disclosures about the quality of the loan pool </li></ul>
  7. 7. Is Legal Intervention Needed? <ul><li>Ability to sue or to defend against foreclosure depends on whether loans are securitized </li></ul><ul><li>Severity of predatory lending injuries </li></ul><ul><li>Current absence of market discipline </li></ul><ul><li>As things stand, securitization now exacerbates predatory lending by supplying capital </li></ul>
  8. 8. Proposal <ul><li>Federal legislation imposing assignee liability under certain circumstances </li></ul><ul><li>Damages cap for effective screening: </li></ul><ul><li>-- Capture relevant fields on data tapes </li></ul><ul><li>-- Random sampling where necessary </li></ul><ul><li>No damages cap for failure to conduct minimum screening </li></ul>