The United States Senate last month, in an effort to confront the predatory lending practices that have wreaked havoc on the country for a large part of the last two years, voted to pass an amendment to Wall Street Reform legislation banning the use of liar loans. These loans, also known as "no doc" loans or stated income loans, are loans given by mortgage lenders that simply ask for a borrower's income without requiring them to show any proof of said income.
Many blame the use of these loans for the mortgage crisis that sent the housing market upside down. By pressuring lenders to place borrowers in the biggest loans possible, borrowers were unable to keep up with their mortgages once the rate adjusted after the first few years. The new provisions outlined in the bill would add onto Federal Reserve regulations enacted in October that require lenders to verify the income and assets of subprime borrowers.
The larger bill, known generally as Wall Street Reform legislation, addresses many of the issues that are believed to be the causes of the 2008 market meltdown. Toxic mortgage lending, banks taking on too much risk, unreliable credit rating agencies and the collapse of "too big to fail" banks all contributed to the problems that hit Wall Street and the rest of the country, and these are the exact issues that the bill looks to change.
The first part of this bill is the one this amendment addresses. "Toxic" mortgage lending includes giving subprime loans to borrowers who cannot afford them by granting loans without documentation or by giving fraudulent loans altogether. This, combined with the lack of necessary regulation on the federal level, led to the subprime crisis. Under this legislation, a Consumer Financial Protection Bureau would be created which would ban liar loans and more closely monitor the documentation provided to lenders. This should be a win for both sides because consumers know what they are signing up for and banks will be giving loans that are less risky.
A second problem addressed in the legislation is that banks took on too much risk for years leading up to the crisis, buying and packaging problem loans. The new bill would prevent banks from trading derivatives and would introduce stronger capital and liquidity requirements to large financial institutions, essentially grounding some of their assets to ensure reliability.
Previously, credit rating agencies gave top scores to securities that later turned out be to be toxic. An incentive to inflate scores also arose because underwriters could shop around for the best score. The Wall Street Reform bill would create a government agency overseeing credit ranking and would require agencies to disclose their methodology for ranking in an effort to encourage transparency in the credit ranking process.
Lastly, banks that were deemed "too big to fail" wreaked havoc on the economy by monopolizing the market and then bringing it down when they in fact did start to fail. The new provisions would set up a process for unwinding such corporations and would allow the government to break up corporations they believe to be getting too big and threatening to destabilize the system. There would also be available funds in the Federal Reserve to loan to otherwise healthy banks in times of crisis.
The Wall Street Reform bill promises many improvements on the system that created the economic crisis of the past few years, especially liar loans to consumers, but it is far from finished. With another week of debate ahead of them, lawmakers look to meld the House and Senate bills into a comprehensive plan for fixing the problems that directly caused the market meltdown.
-Andrew R. Martignetti, Esq.
Information in the above article is for educational purposes only and does not create an attorney-client relationship. You should not construe this to be a legal opinion on any specific facts or circumstances, and you should not act upon this information without seeking professional counsel.
