Federal action to exempt national banks from state anti-predatory lending laws resulted in more defaults and riskier lending compared to other banks, a study funded by the National State Attorneys General Program at Columbia Law School found. At the same time, the study found anti-predatory lending laws enacted by some to protect consumers from abusive and unfair mortgage practices saved many people from losing their homes to foreclosure.
"The implications of these results are extraordinarily important," said James Tierney, director of the National State Attorneys General Program. "This report proves that that vigorous state consumer protection laws make a positive difference for consumers throughout the country. The federal government must respect that clear fact."
The study, “The Preemption Effect: The Impact of Federal Preemption of State Anti-Predatory Lending Laws on the Foreclosure Crisis,” was conducted by researchers at the UNC Center for Community Capital. It found foreclosures and risky lending increased as a direct result of the preemption order enacted by the Office of the Comptroller of the Currency (OCC) in 2004.
“Our research confirms that state consumer protection laws worked, but that when one group of lenders is handed a regulatory free pass, they are going to take advantage of it,” says Center for Community Capital Director Roberto G. Quercia. “In this scenario, unfortunately, we see preemption shifting the activities of federally insured banks to riskier activities than they would otherwise have pursued.”
The research findings are the result of two companion reports that offer the first comprehensive look at loan quality and performance following the federal preemption of state laws in states with and without strong anti-predatory lending laws.
"This research shows the need for strong, consistent mortgage laws in North Carolina and across the country," said North Carolina Attorney General Roy Cooper, who wrote the nation's first comprehensive state law combating predatory lending as a state senator. "While our laws kept more homeowners from risky loans than other states', our communities are still suffering from too many foreclosures. Washington needs to let states set high standards and hold unfair lenders accountable."
The order exempted nationally chartered banks and their subsidiaries from most state laws regulating mortgage lending, including stricter laws that had been passed by some states to curb abusive, “predatory” mortgage lending.
The center analyzed data from 2.5 million mortgages before and after federal preemption in states with and without anti-predatory lending laws. It found that:
► Mortgage defaults increased among OCC-regulated banks as a result of preemption. Default rates of fixed-rate refinance mortgages by exempt lenders made in 2004 were 41 percent more likely to default and fixed-rate purchase mortgages seven percent more likely to default than before preemption. Second, mortgage default rates for exempt lenders increased faster in those states after preemption than those made by independent mortgage companies that remained subject to state laws.
► Risky lending increased because of preemption. Before preemption, 11 percent of the fixed-rate refinance loans made by OCC lenders in states with anti-predatory lending laws had at least one risky feature. After preemption, in 2005-2006, that number ballooned to 29 percent. Risky features include prepayment penalties, balloon payments, and interest-only loans, characteristics that research shows contribute to higher defaults rates.
Further, the share of loans with risky features not only increased for OCC lenders in states with anti-predatory lending laws, it also increased relative to OCC lenders in other states in every category and to independent mortgage companies in other states in every category except fixed-rate purchase mortgages.
The preemption effect was most visible and significant in the refinance market, likely because most state anti-predatory lending laws placed greater restrictions on such loans, researchers said.
The second report, “The APL Effect: The Impacts of State Anti-Predatory Lending Laws on Foreclosures,” examined the quality of loans in states with and without these laws. It found:
► States with strong anti-predatory lending laws exhibited significantly lower foreclosure risk than other states. A typical state law reduced neighborhood default rates as much as 18 percent.
► Loans made by lenders covered by tougher state laws had fewer risky features and better underwriting to ensure that borrowers could repay. For instance, borrowers in states with strong anti-predatory lending laws were 13 percent less likely to receive loans with prepayment penalties than borrowers elsewhere.
“We believe these results provide strong support for policy proposals that will prevent regulatory loopholes, so that borrowers can rely on the full protection that state laws afford them,” said Quercia.
The mortgages examined were issued from 2002-06, and represent about 30 percent of U.S. mortgages rated sub-prime or “Alt-A” (loans considered to be prime, but that have some risky characteristic) and about five percent of all U.S. mortgages during the period.
The full report is available at www.ccc.unc.edu/preemptioneffect.