Mortgages and Misdemeanors: Criminal Enforcement of State Mortgage Lending License Requirements and Homeowner Protection

Steelman, Christopher N., American Criminal Law Review

INTRODUCTION
  I. FIRST AND SECOND LIEN MORTGAGE LENDING--RESIDENTIAL
     REAL ESTATE
     A. Scope of State Licensing Statutes
     B. Comparison of State Licensing Requirements
 IX. CRIMINAL SANCTIONS
     A. Costs and Benefits of Criminal Enforcement
        1. Direct and Indirect Costs
        2. Other Procedures in Conjunction with Criminal
           Sanction
     B. Consumer Protection by the State
III. CRIMINAL ENFORCEMENT COMPARED TO OTHER METHODS
     A. Civil, Administrative, Regulatory and Other Actions
     B. Costs of Lender Misconduct Compared to Enforcement
        Methods
 IV. CONCLUSION
APPENDIX A: REPRESENTATIVE ENFORCEMENT STATUTES FOR FIRST AND
SECOND LIEN RESIDENTIAL MORTGAGE LENDERS

INTRODUCTION

During the past year the United States economy has faced a serious decline in the housing market--the proverbial "popping" of the "housing bubble." State and federal lawmakers have reacted, passing new legislation attempting to remedy the situation and to prevent future mishaps. However, it is clear that state regulation of non-depository mortgage lending institution conduct has existed in some form for decades. What is somewhat less clear, however, is the manner in which then-existing legislative and regulatory schemes dealt with the factors contributing to this problem. More importantly, the question arises as to whether these conduct-regulating schemes at the state level, which contained criminal penalties for lender misconduct, adequately protected consumers.

Home foreclosure rates are at unprecedented levels, spurred by mortgage interest rate resets and lower home values. (1) In addressing the situation, Congress has noted that "[m]any American families are facing or are at risk of foreclosure." (2) More and more legislation is being introduced and regulations promulgated at the state and federal levels to attempt to address the rising foreclosure rates as well as related issues such as subprime and predatory lending. (3) This additional legislation and regulation of the mortgage lending industry, and particularly the consumer or residential mortgage lending industry, is being made against the backdrop of the recent collapse of the private equity market--including the inability of lenders to engage in the securitization of mortgage loans--and the subprime mortgage lending crisis.

Some see the decline of the private equity market and the subprime mortgage lending crisis as proceeding hand in hand, and some suggest that lenders were willing and able to engage in subprime lending due in part to their ability to quickly and easily securitize these mortgage loans in the private equity market, thereby reducing their own exposure to the increased credit risk associated with subprime borrowers. (4) Additionally, hybrid mortgage products such as "2/28" or "3/27" Adjustable Rate Mortgages ("ARM" or "ARMs") have greatly inflated this problem by offering homeowners the opportunity to refinance their homes with a "teaser" or introductory rate that is set at a fixed percentage, (5) followed by a "reset" period in which the borrower will pay a variable rate pegged to a market rate, for example, the London Interbank Offered Rate ("LIBOR") plus some preset fixed percentage rate. (6)

Although many of the mortgage lending practices developed over the past decade are coming under increased scrutiny, (7) many lenders engaged in such conduct in literal compliance with the statutes as they existed. As a result of this incongruity, states have recently begun adding increased compliance standards to their licensing statute schemes requiring, among other things, that lenders not "[k]nowingly or intentionally make a home loan ... to a borrower, including ... a low-document home loan, no-document home loan or stated-document home loan, without determining, using any commercially reasonable means or mechanism, that the borrower has the ability to repay the home loan." (8) Preambles to congressional bills recently introduced, such as the Mortgage Reform and Anti-Predatory Lending Act of 2007 in the House of Representatives, state that Congress is attempting to establish a uniform national duty of care for mortgage originators, establish a national "licensing and registration regime for loan originators" and set "minimum standards for mortgages requiring that consumers must have a reasonable ability to repay at the time the mortgage is consummated and that the mortgage must provide a net tangible benefit to the consumer." (9)

The regulation of mortgage lenders, through licensing and registration requirements as well as the imposition of restrictions on lender conduct and activities, has existed for some time at the state level. There are two constant purposes behind the statutes regulating mortgage lending. First, the statutes provide a level of homeowner or consumer protection. Second, they create the framework necessary to regulate the mortgage lender activity and enforce the prohibitions on lender conduct needed to protect consumers. (10) Many of these regulatory regimes create enforcement mechanisms using either (1) specialized regulatory agencies; (2) private causes of action; (3) state attorneys general bringing civil or criminal actions; (4) administrative procedures for the removal of the licensee's status, effectively eliminating the lender's ability to engage in mortgage lending in that particular state; or (5) some combination of the foregoing.

In order to more accurately compare the enforcement schemes utilized by the states, this Note makes several simplifying assumptions, set forth more fully below. This paper also makes two general assumptions. First, for purposes of this paper, the terms "consumer" and "homeowner" are used interchangeably, inasmuch as a homeowner is deemed a consumer of mortgage lending services and products. As such, any state or federal legislation aimed at protecting homeowners will be considered a consumer protection device. (11) Second, for purposes of this Note, "mortgage lenders" refers generically to non-depository financial institutions engaged in residential lending. As discussed in Part I.A, this eliminates from the scope of this Note state and nationally-charted banks, savings and loan associations, thrifts, mutual companies, credit unions and other state and federally regulated depository institutions. Additionally, any lender regulated by the United Stated Department of Housing and Urban Development ("HUD") is routinely exempted from state licensing requirements. The underlying rationale for these exclusions is that state and federal rules and regulations promulgated by regulators such as HUD will provide the same level of consumer protection and promote the same goals as the requirements imposed by mortgage-specific laws and regulations.

To begin, this Note provides a brief baseline of first and second lien mortgage lending and surveys state enforcement statutes. Part I addresses what can best be described as a generic or typical licensing requirement for first and second lien mortgage lenders. This Part will discuss the scope of the licensing statutes, including the conduct in which they prohibit lenders from engaging. This discussion will primarily revolve around what aspects of lender conduct would be most pivotal in curtailing the current foreclosure rates. It should be noted, however, that this survey of the licensing statutes--although referencing other laws, including unfair and deceptive trade practices, unfair lending laws, and criminal and civil usury statutes--focuses solely on the lender conduct and activities specifically regulated in the licensing statute.

Part II of this Note addresses those states that provide for some form of criminal sanction in order to enforce lender compliance. This Part will discuss the costs and benefits of bringing the full authority of the state to bear on first and second lien mortgage lenders. The theories justifying the use of criminal sanctions will be addressed, with the theory of general deterrence being chiefly discussed. (12) Additionally, this Part will give a brief discussion of the limited number of cases actually brought under these criminal statutes, with the inference that either state prosecutors did not originally perceive that lenders were engaged in conduct that was in violation of the licensing statute, or that states are hesitant to criminally charge mortgage lenders and would prefer to use other enforcement methods. Other methods at their disposal include revocation or suspension of a license, civil or regulatory fines, and other administrative remedies.

This line of discussion segues into Part III, where the discussion centers on the efficacy of other methods of enforcement in promoting consumer or homeowner protection. This Part will then compare the use of the criminal sanction against these other methods. Against the backdrop of the current mortgage crisis, the efficacy of all methods of reasonably restricting first and second lien mortgage lender conduct will be discussed. Based on this discussion, this Note will suggest that the general deterrence mechanism of the criminal sanction, while a laudable goal, does not provide consumers with sufficient protection, but rather that specialized regulatory oversight of the mortgage lending industry is more responsive and efficient in protecting consumers.

Part IV concludes that, although criminal sanctions are a valuable enforcement tool for lender conduct--including fraud and other egregious acts--administrative and regulatory agency enforcement of lender prohibitions are much more efficient methods of enforcement. This conclusion is driven by two considerations. First, many states have not utilized the criminal statutes against mortgage lenders within their state on a scale that would be expected if lender misconduct truly was a factor contributing to the current home foreclosure rate. Second, specialized regulatory and administrative bodies bring their expertise to bear, making them much more efficient and flexible in defining and curtailing lender misconduct.

I. FIRST AND SECOND LIEN MORTGAGE LENDING--RESIDENTIAL REAL ESTATE

"Mortgage lending has undergone greater changes during the past thirty years than in the preceding three centuries." (13) The residential real estate mortgage lending market is currently beset on all sides by claims and allegations of predatory lending, high-cost home lending, and refinancing without considering ability of the consumer to repay. (14) Consumer advocacy groups, state attorneys general, and borrowers are challenging lender conduct in court and with additional legislation and regulation. With respect to first and second lien residential mortgage lending, however, most states currently have in place legislative and regulatory schemes to address lender conduct. (15) Thus, two suppositions may be drawn given from the condition of the lending market, either of which is equally applicable. First, the statutes did not prohibit the conduct that lenders have engaged in to give rise to the current foreclosure crisis. Second, the enforcement mechanisms by which states have chosen to regulate lender activity have not been effective. With respect to this latter assumption, then, certain states have not benefited from the general deterrence effects associated with the use of the criminal sanction in preventing the conduct giving rise to, or mitigating the effects of, the current mortgage crisis. Inasmuch as those states have chosen to use the criminal law to enforce prohibitions on lender conduct and such conduct is related to the current mortgage situation, perhaps even tangentially so, then the disuse of the criminal enforcement mechanism creates social waste through the misallocation of public resources.

The residential real estate mortgage process is a complicated and nuanced field, with various actors, which may or may not be affiliated with each other, playing key roles. For purposes of simplicity, this paper focuses solely on licensing requirements for "mortgage originators"--the party actually engaged in funding the loan--and does not deal with mortgage brokers or mortgage servicing. Some states, however, require an originator to be licensed under a "mortgage broker," "real estate lender," or "supervised lender" licensing statute, due solely to the fact that the definition of those activities encompasses activities generally considered a mortgage origination activity, and as such, enforcement mechanisms for those schemes will be addressed as applied to the conduct of mortgage origination. (16) Also for simplicity, this paper deals only with first and second lien mortgage lenders. Implicitly, when non-traditional mortgage products, such as home equity lines of credit, home equity loans, reverse mortgages, and home equity conversion mortgages, create first and second liens on residential real estate, lenders must comply with the licensing requirements applicable to the creation of these liens.

This Note also makes reference to "licensing" and "registration" requirements for residential mortgage lenders. There appears to be no substantive difference between those states requiring a license and those requiring registration; the application process is similar as are …

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Publication information: Article title: Mortgages and Misdemeanors: Criminal Enforcement of State Mortgage Lending License Requirements and Homeowner Protection. Contributors: Steelman, Christopher N. - Author. Journal title: American Criminal Law Review. Volume: 45. Issue: 4 Publication date: Fall 2008. Page number: 1439+. © 1994 Georgetown University Law Center. COPYRIGHT 2008 Gale Group.

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