Lender Liability

Article excerpt

Ten years ago, the legal liability of mortgage lenders was containable and slow moving. Today, legal exposure is growing faster than an outbreak of the plague. As for lenders as predators, many feel more like prey to ubiquitous class-action lawyers, regulators and activists.

LENDERS AS "PREDATORS." This image--of ruthless and powerful carnivores devouring the innocent and defenseless--plays on the deepest fears of the human psyche and is impossible to ignore. Invoked in political debate or in litigation rhetoric, it becomes a potent mantra that shortcuts analysis and preempts explanation. It is an image, however, that is quite inconsistent with the way in which most of the mortgage lending industry views itself and actually conducts business.

And yet, no matter how many task forces are marshaled to purge an outlaw minority or inform the public of the facts; no matter how carefully mortgage lenders police their operations and reduce their already shrinking profits to survive; and despite the noble service of mortgage lending in facilitating homeownership, many mortgage lenders these days feel less like predators and more like prey.

They are overrun by a proliferation of laws and regulations enacted to meet simultaneous revolutions in communications technology, information processing and the availability of "nonpublic" consumer records. They are buried in an avalanche of rules hastily made to accommodate the "parallel universe" of Internet lending and its radical impact on traditional assumptions and practices.

Bombarded by myriad exotic underwriting, documentation and repurchase requirements from a profusion of Wall Street conduits, they also face a torrent of new conditions for participating in the high-profit yet high-risk enterprise of subprime lending.

Threatened at every turn by activist regulators and bureaucrats, aggressive state attorneys general and ubiquitous class-action lawyers looking to make their mark, many mortgage lenders are beginning to believe the risks no longer match the rewards. Some are selling out to those large enough to afford a compliance department or in-house legal staff. Others are exiting the business entirely. And still others have simply given up on any serious compliance program altogether, risking the futures of their companies for quick profits today.

How did we get to this troubling state of affairs? Are these attitudes of mortgage lenders nothing more than paranoid delusions? Or do they reveal something deeper, and more profound, about a change in the nature and extent of legal and regulatory risks facing mortgage banking today? Are those risks any greater now than in the past? And if so, in what ways? And perhaps most important, what, if anything, can be done about it?

There is a genuine need to think deeply about these questions and to make wise decisions about what the answers to them may mean. For those who fail in this endeavor, their future as mortgage bankers in the 21st century may simply be--in the words of political philosopher Thomas Hobbes--"solitary, poor, nasty, brutish and short."

What a difference a decade makes

As recently as 1990, the familiar demons of credit risk and limited capital availability were the greatest threats to the success of any mortgage banking operation. Legal and regulatory exposure to the enterprise itself, as opposed to losses on a single loan or even a pool of loans, was thought to be manageable.

This was particularly so in light of the widespread rejection by courts in the mid-1980s of various "lender liability" theories that had initially threatened to transform the relationship between a lender and borrower into that of a fiduciary and beneficiary. Remembering what was not yet on the scene in mortgage banking in 1990, quickly brings into focus just how much the legal and regulatory landscape has changed.

In 1990, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIR-REA) had just been passed. …

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