Federal consumer protection law

Countrywide Financial

Consumer Protection and Predatory Lending

The Case Against Countrywide Financial

Consumer Protection and Predatory Lending

The Case Against Countrywide Financial

The most recent U.S. housing boom ended dramatically in 2007, with the near collapse of the economy and the sudden loss of trillions of dollars in home equity and stock values. For years before this sudden recession, some domestic mortgage lenders were setting profit records issuing loans to consumers who would never have previously qualified. In fact, several of the most successful of these lenders were actively engaged in a pattern of predatory lending.

The definition of predatory lending turns on who really benefits in the questioned mortgage transaction. The fact that the homeowner does NOT benefit (but the loan broker does) is what turns a legal mortgage into a predatory lending practice that can and should be acted agains, and barred. Because these shady lenders know this field so well, in many cases only a fine line divides actual fraud from an ethical and legal transaction.

Barred by state and federal consumer protection laws, the practice of predatory lending involves or otherwise impacts a host of stakeholders:

1) Borrowers: wherever low-income borrowers or otherwise financially vulnerable groups enter the market, the potential for unethical mortgage companies (or white collar criminals) to profit from unscrupulous behavior threatens. Predatory lending practices can leave victims homeless and defeated, stripped of self-respect and hope, their credit ruined.

2) Loan initiators: clearly the defrauding party is a stakeholder, often the only one to benefit financially in the end,

3) Secondary mortgage market / investors: usually the fraudulent loan is passed on to a bank or other financial institution to carry as an asset during the period of the loan. When it defaults, they lose.

4) Law enforcement and industry watchdogs: while the actions of these companies may not always be flagrantly illegal, the result can be the same. There are consumer protections against the professionals who are predators -- often seeking their prey from the elderly, the sick, and the poor. Another stakeholder class is the institution charged with seeking recovery and making the parties whole, such as attorneys general and federal agencies.

5) The public ( & the whole economy): where the unfair practices become so systemic that the value of all real estate is impacted, all homeowners and the economy at large become collateral damage. In this instance the nation's unemployment rate rose sharply after these losses, and the stock market lost 50% in one year, as the scale of the harm rippled through the economy.

Now, homeowners and government officials are increasingly taking these institutions to court, either individually or as part of class action lawsuits alleging unfair and predatory practices. While many of these actions are still winding their way through the legal system, some banks have already settled for millions of dollars.

"Borrowers are looking to the legal system for help in keeping their houses," says Gary Klein, a partner in Boston-based Roddy Klein & Ryan, which focuses on consumer law. "There are more cases pending than I've ever seen in my 23-year career."

Legal analysis

Countrywide Financial (a Fortune 500 finance company) was among the most egregiously non-compliant with the applicable unfair-lending practices laws. Many banks have been served with such lawsuits for years and have paid millions of dollars in settlements. But the recent housing boom was fueled by questionable and exotic loans that many borrowers had no hope of repaying. Countrywide literally specialized in this market segment.

The key legal issues related to federal consumer protection law are fraud, misrepresentation, failure to disclose and disregard of federal mortgage statutes. Sophisticated loan predation has many forms and practitioners employ a host of different abusive practices when putting together a subprime loan. Countrywide used each of the following techniques:

One is loan flipping, wherein Countrywide reps find a homeowner whom they persuade or coerce into refinancing their mortgage, even though the homeowner gains nothing from the transaction. While the transaction might put a few thousand dollars into the homeowner's bank account temporarily, this amount is easily eaten up by the excessive fees, higher interest rate, and prepayment penalties of the new mortgage. A serious danger with loan flipping occurs when a balloon payment is inserted into the fine print. While the homeowners originally may have had twenty or thirty years to pay on the mortgage, under the loan flipping they might be signing for a two, three, or five-year balloon payment. At the end of that time they need to find a way to refinance the house again or lose it completely. Incredibly, Countrywide then repeats the above!

Excessive Fees: A new or refinanced mortgage can be packed with excessive fees and/or unnecessary fees. A regular mortgage usually will have loan fees below 1% of the total loan amount. Countrywide's predatory mortgages carried loan fees in excess of 5%, tucked into the loan amount to disguise them. These charges are within the definition of predatory lending.

Steering & Coercing: Countrywide's known targets for these practices were the elderly, low-income, or minority homeowners who, in many cases, would actually have qualified for a regular prime loan. Fannie Mae estimates that up to 50% of the subprime refinanced loans could have been written as standard, safe prime loans -- saving the borrowers thousands of dollars in fees and interest rates. The abuse of subprime loans in minority neighborhoods is evidenced by a government study in an African-American neighborhood showing over 51% of the refinanced mortgages being subprime, compared to only 9% in predominantly white neighborhoods. Borrowers were often subjected to very aggressive Countrywide sales tactics to steer them or coerce them into a new loan when it isn't in their best interest. Inexplicably, many states are still attempting to set up predatory lending laws to avert this type of activity.

Abusive and Abnormal Prepayment Penalties: The prepayment penalty is a fee due only if the borrower retired the mortgage loan early (or sold the property). Only about 2% of normal conventional mortgages have a prepayment penalty that might be difficult to meet. By contrast, up to 80% of Countrywide's subprime mortgages contained an abusive prepayment penalty. Why? This is one more way they gouged an unsuspecting borrowers with less-than-perfect credit, using this penalty is hidden in the fine print. It has been determined that Countrywide actually gave kickbacks to mortgage brokers who included the high prepayment penalty in the mortgage.

It is now clear that Countrywide's aggressive sales practices were motivated out of pure greed. They resold all of these questionable loans (for billions of dollars) to investment bankers who then "securitized them" for sale on the stock market. That unregulated practice led to a whole new layer of economic disaster, bank bailouts and loss of consumer and investor wealth.

Ethical analysis

Countrywide Financial Corp. said Friday that it fired a mid-level executive at one of its mortgage units after he encouraged loan officers in a memo to downgrade borrowers' credit ratings in order to steer them into more expensive loans.

"We are fortunate that one of our conscientious employees made us aware of inappropriate conduct by one of our managers," said the company's chief ethics officer, Richard Wentz. He said Countrywide had "no tolerance" for such actions, adding that "we are committed to responsible lending practices." Annette Haddad, Times Staff Writer, Countrywide Fires Manager, Citing Ethics, Los Angeles Times, (November 20, 2004)

Years before the crises broke, Countrywide acknowledged its improper practices, resolving the entire issue with a single firing -- an "ethical" resolution, no? Now it is known that they misrepresented, misled, and worked against their own clients' interests. A partial list of the ethical issues raised by this case includes:

Full disclosure -- has the lender advised the borrower of all the terms and conditions of the loan?

Incomplete, irregular forms -- was the borrower asked to sign paperwork not completely filled out? Unethical lenders will inflate reported income, making changes to W-2 documentation. Changes might be made to the debt to income ratio to mislead the loan processor.

Pre-qualification -- A lender should only secure a mortgage for a client that they are financially suited to. Even though the mortgage broker knows a borrower cannot qualify for the loan, he will make every attempt to push it through

Misrepresentation -- Client is promised a fixed rate loan without pre-payment penalties; at the closing this becomes an adjustable rate mortgage with pre-payment penalty.

Fees -- was there a Good Faith Estimate, listing all fees and charges in advance?

An ethical lender works in a timely manner, and does his best to close the loan quickly.

Timeliness -- did the matter close on time and as indicated?

The ethical issues presented by Countrywide's case are so plentiful that under at least three of the established theories of ethical perspective, Countrywide's conduct falls grievously short.

Under a deontological perspective, Countrywide absolutely failed to "Do unto others as you would have them do unto you." In the 1800's Immanuel Kant argued that the basis of ethics is the obligation, or the duty, to do what is "right," an idealized notion of what a better world ought to be. He defined the ideals that people share about how people ought to behave a "categorical imperative" - a transcendent concept of "rightness of action." No one would want to be taken advantage of the way Countrywide did, and under no circumstances did they themselves believe their actions were "right."

Egoism or self-interest ethics may explain the Countrywide rationale, after all, they were acting to advance own interests, over all else. Although some conduct is "right" when it advances personal interests, Countrywide's motive was actual "greed" because greed includes "excess" -- demanding more than one is entitled to. Egoism assumes that there is no "entitlement," others also have interests, and interests can and should compete. No one is "more deserving" than another. This also is Adam Smith's view of the market: buyers and suppliers with opposing interests (buyers want the lowest price and suppliers want the highest price) seek a transaction, to buy or to sell. Countrywide so skewed the negotiations in their own best interests that Mr. Smith would have been appalled.

Pursuant to the ethics of social group relativism, we assess Countrywide's conduct by understanding what our social group expects of us. While the term "relativism" has been misunderstood to imply that "anything goes," here the term simply means that standards of conduct in business are governed by the expectations of others on our behavior. "We conform." Countrywide obviously did not.

Each of these categories identifies a different kind of standard for making choices, and refers to some interest that is valued or preferred. We may not share the same interest or preference, but this is not an argument for what some call "situational" ethics -- ethical behavior that may, or may not, differ with circumstances.

Questions

What aspects of the situation (actions by any stakeholder) demonstrate ethically sound behavior and which illustrate unethical behavior?

Sadly, until the Attorneys General pursued Countrywide for consumer fraud, securing an $8.68 Billion settlement for defrauded borrowers, no one acted ethically. Not Countrywide, and in some instances, not the homeowners either, where they acquiesced in the lies.

Analyze how the company's corporate culture that may have helped to minimize the unethical behavior or actually contributed to/caused the unethical behavior.

The corporate culture at Countrywide included a "Friends of Angelo" scheme that gave low interest loans to members of congress. The order of the day was profit, from any action, and the profits were divvied up in the billions.

Analyze how the company's corporate governance (overall guidelines, strategic decisions/actions) may have helped to minimize the unethical behavior or actually contributed to/caused the unethical behavior.