An Open Letter to Governor Schwarzenegger: $4 Billion of California’s Budget Deficit is Due to Foreclosure Crisis—Please Sign AB 1830 to Reform Systemic Failures in Subprime Mortgage Meltdown

AB 1830 is also strongly supported by numerous consumer and community organizations, such as Consumer's Union, CALPIRG, ACORN, the Greenlining Institute, and Operation Hope just to name a few.

The industry did not get everything they wanted, and the consumer groups did not get everything they wanted. This bill is a carefully balanced compromise that is supported by the overwhelming majority in industry and the overwhelming majority of consumer groups. Please do not let the small minority of industry groups that choose to remain in their ideological comers to torpedo this bill. This bill is exactly in the spirit of post-partisanship that you have so strenuously advocated, where we come together to help the people of California and not just a small minority of special interest groups.

Newspapers across this state have all editorialized in favor of AB 1830, such as the Los Angeles Times, Modesto Bee, Sacramento Bee, and San Francisco Chronicle. Several of the papers have editorialized repeatedly on multiple occasions about the importance of this bill.

Signing AB 1830 would build upon your strong legacy of reforming systemic problems, and of bringing people together in a post-partisanship manner to help all the citizens of California. Your signature would help prevent a future foreclosure crisis, restore confidence in the California mortgage market, and ensure future state budgets are not devastated by another mortgage meltdown.

II. The Need For More Effective Subprime Mortgage Regulation

On November 1, 2007, the Assembly Banking and Finance Committee conducted an extensive informational hearing titled the "Subprime Mortgage Crisis in California, A Community Hearing to Examine Solutions and Mitigation Efforts," that examined the mortgage crisis through the testimony of consumer advocates, community leaders, and industry experts.

At the time of that hearing it was clear the subprime mortgage crisis would go on to shake up capital markets worldwide. The collapse of the subprime market sent shockwaves through the financial markets, affecting everything from student loans to auction rate securities to mortgage-backed securities. The resulting foreclosure crisis spread a contagion through the markets that has resulted in devastation in California, on Wall Street, and internationally.

The collapse of financial giants Ameriquest, Indy Mac, New Century Financial, and Lehman Brothers; the taxpayer bailouts of Bear Stearns, Fannie Mae, Freddie Mac, and AIG; the impending implosion of Washington Mutual; and the fire sale of the venerable Merrill Lynch all have at their core a single, unifying thread: predatory practices and the making of unsuitable loans to homeowners that have resulted in a mass wave of foreclosures. AB 1830 enacts common-sense reforms to eliminate the worst of the worst predatory practices and unsuitable product features that directly contributed to the subprime meltdown.

The state of California has a vital role to play in providing mortgage reform that offers balance and consumer protection. John Dugan, Director of the Office of the Comptroller of Currency, has even recognized this vital role for states to regulate mortgage lending practices. In a letter published by the Washington Post, March 6, 2008, Mr. Dugan said the following:

"The overwhelming majority of the subprime loans causing so many problems today, including the most predatory loans, were originated by state-regulated mortgage brokers and lenders ...

"The abuses that consumers complain about most --such as loan-flipping and equity-stripping --are not tolerated in the national banking system; nor are the looser lending practices of the subprime market.

"Effective regulation of subprime mortgage lending is a job for both federal and state agencies. But the most urgent need today is for the states to use the authority they already have to effectively regulate the institutions that caused most of the problems."

III. AB 1830 Enacts Common-Sense Systemic Reforms

AB 1830 provides consumer protections for subprime loans while maintaining access to credit and homeownership. This carefully crafted bill is the product of dozens and dozens of meetings and discussions with industry and consumer groups over an eight month period. Through our efforts to craft a balanced approach the leading organizations in the financial and banking industry have gone neutral on this bill. Although a minority of groups still oppose, such as the mortgage brokers and realtors, we have taken several of their suggestions and have worked hard to try to accommodate their concerns.

While AB 1830 was in the legislative process the Federal Reserve finalized changes to Federal Regulation Z which enacts TILA (Part 226 of Title 12 of the Code of Federal Regulations). AB 1830 was amended to match the APR triggers for higher priced loans and to respond to specific areas where California is in need of stronger regulations.

Specifically, AB 1830 does the following to protect California consumers:

1. Enacts Strong Fiduciary Duty Standard:

AB 1830 is the first bill in the nation to codify a fiduciary duty standard for mortgage brokers across all loan products. A violation of this duty will make a broker subject to a violation of their license as well as strong civil liability and penalties.

AB 1830 provides that anyone providing mortgage brokerage services owes a borrower, regardless of loan type, a fiduciary duty. This duty expressly includes a requirement that a mortgage broker must place the economic interest of the borrower ahead of the broker's own economic interest.

Wyatt v. Union Mortgage Co., (924 Cal. 3d 773,598 P.2d 45,157 Cal. Rptr. 392 (1979)) is the main case that establishes the common law fiduciary duty in California. The court analogized the obligation of the mortgage brokers to that of insurance agents noting that individuals justifiably rely on agents' advice because of the volume and technical nature of the documents. The court concluded:

"There is a second reason why appellants breached their fiduciary obligations toward respondents. [T]he broker's failure to disclosure orally the true rate of interest, the penalty for late payment of the swollen size of the balloon payment clearly consisted of a breach of broker's fiduciary obligations."

2. Eliminates Compensation Incentives That Led To Riskier Loans:

The subprime marketplace has incentives, including yield spread premiums, that entice brokers to put borrowers into costlier loans without the knowledge of the borrower. The current structure of compensation provides a perverse incentive to steer borrowers to a riskier loan in order to increase the broker's compensation. AB 1830 eliminates this incentive by requiring that regardless of who pays the broker (borrower, lender or third party), the compensation must be the same. This will ensure that a broker can receive no more from a lender than the borrower would pay to the broker in up-front costs.

This removes the incentive to steer borrowers while ensuring that consumers can make informed choices about how to pay for their loan costs. For instance, a broker cannot make more in compensation from a loan with a yield spread premium than the same loan without a yield spread premium.

3. Directly Prohibits Steering:

An article from the Wall Street Journal, Subprime Debacle Traps Even Very Credit Worthy, December 3, 2007, reported that two independent studies found that 55-61 % of borrowers who received subprime loans had credit scores that made them eligible for traditional, fixed-rate prime products. One of the reasons this happens is a practice known as steering.

AB 1830 directly prohibits a broker from steering borrowers to accept a loan at a higher cost than that for which the consumer could otherwise qualify. Additionally, a mortgage broker that only originates subprime loans must disclose that fact to a borrower prior to offering services. AB 1830 seeks to eliminate the practices that put borrowers into loans that are costlier and higher-risk than those for which they qualify.

4. Directly Prohibits Deceptive Statements:

AB 1830 contains a common-sense prohibition against brokers and lenders making false or deceptive statements connected with a subprime loan. This will require lenders and brokers to be upfront and honest in subprime loan transactions and ensure that borrowers are not misled with false statements about their loan.

5. Puts Caps On Prepayment Penalties:

Prepayment penalties have been a constant feature in the subprime marketplace. They have made it possible for subprime borrowers to get into a home even though they have increased credit risks. When used correctly, prepayment penalties benefit the borrower. Prepayment penalties, however, have also been abused in the subprime market and it is the abuse that AB 1830 seeks to eliminate.

AB 1830 establishes clear regulations for prepayment penalties without stifling the subprime market. In addition to the restrictions put in place by recent amendments to Regulation Z, AB 1830 caps the amount of the penalty to no more than 2% of the principle balance in year one of the loan and no more than 1% of the principle balance in subsequent years.

AB 1830 also prohibits anyone who arranges a subprime loan from receiving increased compensation for originating a loan that includes a prepayment penalty.

6. Bans Negative Amortization Loans:

Many option ARM loans included scheduled payments that would lead the borrower to owe more on the loan than its original balance. Once this happens, the borrower is subject to an extreme payment shock to make the adjustment or a balloon payment to cover the difference. AB 1830 prohibits any subprime loan that could lead to negative amortization. Borrowers in the subprime market, by definition, are already at greater risk than prime borrowers. Allowing an extremely risky product such as a negative amortization loan to be offered to this pool is not sound policy.

7. AB 1830 establishes strong penalties and enforcement mechanisms to prevent abusive subprime lending.

• Provides for a civil penalty of $1 0,000 per violation.

• Provides borrowers with a private right of action and the ability to recover attorney's fees.

• Provides that a licensing agency may prohibit licensees from engaging in acts or practices in connection with subprime loans that the agency finds to be unfair, deceptive, or designed to evade the laws.

• Provides explicit authority for California regulators (DRE, DOC & DFI) to enforce provisions of federal lending laws against their licensees and furthermore provides that violations of federal lending laws is also a violation of that person's license.

• Voids any prepayment penalty in violation of Reg Z or AB 1830.

IV. Arguments Against AD 1830 Are Weak And Misplaced

The minority of groups that still remain opposed to AB 1830 are concerned about the private right of action and attorney's fees provision. Their concerns are misplaced for at least five reasons. First, the ability of consumers to seek civil remedies is not a new or unique idea. The ability to bring civil actions to enforce statutory rights for consumers who have suffered direct and actual harm is a cornerstone of the legal system and of consumer protection measures. This is especially true in the mortgage industry and existing laws already contain such provisions.

The existing federal TILA and the Homeownership Equity Protection Act (HOEPA), 15 U.S.C. § 1640(a) provides for a private right of action and the ability to recover costs associated with the action. California's own Covered Loan Law, Financial Code Section §4978, also provides for civil actions and recoverable attorney's fees and costs. Both the federal and state governments have recognized that a private right of action and attorney's fees are necessary in the mortgage field because the transactions are unique, individual transactions between a homeowner and a particular industry participant. Indeed, it would be odd and incongruent with existing law if AB 1830 did not contain a private right of action and attorney's fees.

Second, such provisions reduce regulatory burdens by allowing consumers to enforce their rights. With limited governmental budgets, it is important not to subject regulators to increased financial and time burdens that result from administrative or civil actions.

Third, you have previously identified the importance of privately enforceable civil remedies for consumers by signing bills such as SB 355 (Murray) Chapter 437, Statutes of 2005 which provides consumers with access to civil relief and attorneys fees when they have been a victim of phishing scams; and SB 61 (Battin) Chapter 450, Statutes of 2005 dealing with common interest developments.

Fourth, existing California law contains numerous provisions that provide consumers with the ability to bring civil actions. For example, the following code sections provide such rights:

• Cal. Bus. & Prof. Code § 10246--Excess Charges re Real Property Loans.
• Cal.. Bus. & Prof. Code § 10248.2--Real Property Loans.
• Cal. Civ. Code § 2954.6--Mortgage Insurance.
• Cal. Civ. Code § 2955.5--Hazard Insurance.
• Cal. Civ. Code § 2945.6--Mortgage Foreclosure Consultants.
• Cal. Civ. Code § 1799.100--Taking of security interest in household goods
• Cal. Bus. & Prof. Code § 10238.7 Regulations re Real Property Securities Dealers.
• Cal. Civ. Code § 1785.31--Consumer Credit Reporting Agencies Act.
• Cal. Bus. & Prof. Code § 16750--Combinations in Restraint ofTrade.
• Cal. Bus. & Prof. Code § 17082--Unfair Trade Practices.
• Cal. Bus. & Prof. Code § 21140.4--Franchise Dealers Fair Practices.
• Cal. Bus. & Prof. Code § 21202--Unfair Practices re distribution and sales ofmotor vehicle fuels and oils.
• Cal. Bus. & Prof. Code § 22257--Tax Preparers.
• Cal. Bus. & Prof. Code § 4381--Unfair Trade Practices/Pharmacy.
• Cal. Bus. & Prof. Code §22948.3-Anti-Phishing Act of 2005

Fifth, AB 1830 provides those subject to its regulation with the right to cure if the compliance failure was not willful. This provision is in proposed Financial Code §4995.2(h) and exhibits detailed steps for a licensed person to avoid a violation, even• after a violation may have occurred.

Based on the above, the arguments against AB 1830 are meritless. Now is not the time to continue backing the small minority in industry and Wall Street that believe nothing should be done to reform a broken system. Now is not the time to be captured by ideological positions when so much is at stake and a compromise is at hand.

V. Conclusion

AB 1830 is a measured and carefully crafted bill that will provide effective consumer protections while ensuring access to homeownership. AB 1830 is consistent with, and builds upon, your leadership in fixing systems that have caused real harm to Californians. A subprime meltdown of this magnitude must not happen again. Enough is enough. We urge your signature on this vital piece of legislation.

Signed
Assemblymember Karen Bass Assembly Speaker
Assemblymember Ted W. Lieu Chair, Assembly Rules Committee
Assemblymember Pedro Nava Chair, Assembly Banking & Finance Committee

Assemblymember Lois Wolk, 8th Assembly District