WASHINGTON — A bill proposed by three Senate Banking Committee members last week would dramatically change the face of the mortgage market, several banking lawyers, analysts, and other observers said Monday.
When Sen. Charles Schumer, D-N.Y., proposed the bill, some saw it as a relatively benign measure to force mortgage brokers to take more responsibility for loans they originate. But upon closer inspection, the legislation alarmed many industry participants, who said it would end commonplace practices, force bankers to stop doing business with brokers, and create rigid underwriting requirements.
"On a ranking of 1 to 10, where 1 is bad and 10 is good, this is probably a minus-1," said Gil Schwartz, a partner with the Washington law firm Schwartz & Ballen LLP.
The Borrowers' Protection Act, which is cosponsored by Sens. Robert Casey, D-Pa., and Sherrod Brown D-Ohio, is the first broad bill introduced this year on subprime mortgage lending.
Though the bill has garnered support from several consumer groups, the one thing in which banking industry representatives said they find solace is that it faces long odds against enactment. Senate Banking Chairman Chris Dodd, D-Conn., has signaled he is not ready to pursue a bill and has not endorsed Sen. Schumer's approach.
But Charles Gabriel, a senior vice president at Prudential Equity Group, said that whether the industry likes it or not, the Schumer bill will have an effect.
"You have an important open debate on this, and what Sen. Schumer does will help to frame that debate," he said. "Just because legislation doesn't move towards enactment doesn't mean that it hasn't had an impact... The Democratic Congress is going to continue to beat the drum about these problems."
Industry participants said they were particularly concerned about a provision that would hold lenders liable for any wrongdoing by brokers in their employ. Though the provision appears to be limited to subprime loans, industry representatives said it could force banks to stop doing business with brokers altogether.
"If you were liable for every action of a broker, you would totally revamp your relationship with the broker and might just use loan officers. … You can't have a casual, arm's-length relationship with that person," said Erick Gustafson, a lobbyist for the Mortgage Bankers Association.
Roy DeLoach, the executive vice president of the National Association of Mortgage Brokers, said such liability could hurt brokers' relationships with banks.
"The way the mortgage broker's business model is, we have a contractual relationship with many lenders," he said. "That provision would change the relationships of all the parties in the mortgage system today."
One of the banking industry's top concerns this year has been whether lawmakers will impose a suitability standard that would holds lenders accountable for ensuring borrowers receive loans that are suitable for them. Bankers argue that such a provision would be a lawsuit in the making, because they would be at risk any time a lawyer finds a way to argue that a loan was not suitable.
Several industry sources said Sen. Schumer's bill would create such a standard by stipulating that a "mortgage originator may not steer, counsel, or direct a consumer to rates, charges, principal amount, or prepayment terms that are not reasonably advantageous to the consumer."
The steering provision "is essentially where you get into suitability," said Wright Andrews, the executive director for the Coalition for Fair and Affordable Lending. "A loan that's not 'reasonably advantageous' in light of all the circumstances. … What does that mean? I don't think you really have a definition of what's reasonably advantageous. It just opens up an issue that would have to be litigated."
Mr. Schwartz said another potential liability in the bill is a provision that says borrowers must have an ability to repay the loan.
"It imposes a higher standard of care for mortgage originators in that they have to act with reasonable skill, care, and diligence and act in good faith and fair dealing," he said.
Though regulators already are telling lenders through guidance to ensure borrowers can repay their loans, "by putting it into statute, what you are doing is exposing the mortgage originator to private rights of actions by consumers, who would say lenders didn't do their job accurately — that they didn't verify with reasonableness that I was able to repay the loan," Mr. Schwartz said.
The bill also would require lenders to underwrite any variable-rate mortgage in a way that ensures the borrower would be able to make the highest possible monthly payment during the first seven years. Observers said the requirement would go beyond trying to correct problems with subprime hybrid adjustable rate mortgages in which borrowers have difficulty repaying the loan after it resets.
"The problem with the subprime hybrid ARMs is that they involve payment shocks as consumers adjust from the introductory rate to the adjustable rate. Traditional 7/23 ARMs don't have teaser rates, and the adjustments are simply designed to reflect broader changes in the interest rate environment," said Jaret Seiberg, an analyst with Stanford Washington Research Group. "This legislation is going to make it harder for consumers to qualify for adjustable-rate mortgages and push most borrowers into fixed-rate mortgages."
Another provision in the bill would require lenders to verify income through specific forms of documentation, such as "tax returns, payroll receipts, bank records, or other similarly reliable documents." Observers said the provision not only would eliminate no-documentation loans, but also could upend low-documentation ones.
"It would sharply curtail, if not eliminate, the ability to do low-doc loans," Mr. Seiberg said.
The bill "is going to make it more difficult for lenders to provide consumers with the type of mortgage products they want," he said. "It doesn't mean that everything in here is bad. It just means that many of the provisions in here go one step too far."