As you may know, I'm opposed to any type of taxpayer bailout of subprime
mortgage borrowers or lenders. Yet I believe our state regulators and
law-enforcement agencies should be doing much more to pressure lenders and
brokers to clean up the mortgage mess they helped create. They could compel
lenders to restructure loans where borrowers were deliberately misled or waive
the painful prepayment penalties that keep people trapped in mortgages they
can't afford.
The goal is not to keep every struggling borrower in a house, but to let
those who could afford to own with a more-conventional mortgage work out a
deal.
Given that 7 of the 10 largest subprime mortgages lenders are based in
California, and that our state is the largest market for subprime loans, this
is fertile territory for an enterprising law-enforcement official who wants to
stand out.
Think of former New York Attorney General Eliot Spitzer, who propelled
himself into the governor's office by taking on Wall Street giants, or his
successor Andrew Cuomo, who in less than four months in office has shaken up
the student-lending industry. Without filing a lawsuit, Cuomo has coerced
colleges into returning money to student borrowers and adopting his code of
conduct. His work has spawned congressional investigations into the U.S.
Education Department and some of the nation's biggest lenders.
California Attorney General Jerry Brown says he is investigating the
subprime industry, but his office declines to state whether it has issued any
subpoenas or demand letters. The investigation "is one of his many priorities,"
says Brown spokesman David Kravets.
Michael Pfeifer, a fraud-recovery lawyer who represents lenders and
investors including some in the subprime area, says he has not heard of any
companies being contacted by Brown's office. Pfeifer works in Orange County,
the subprime capital of the nation.
The California real estate and corporations departments, which regulate
most lenders and mortgage brokers in the state except for federally chartered
banks, also could be taking a more-proactive approach. So could local district
attorneys and law enforcement.
In 2004, Section 27388 of the government code was amended to give
California counties the option of adding a $2 surcharge to fees for recording
most real estate documents. The money must go into a real estate fraud
protection trust fund to "enhance the capacity of local police and prosecutors
to deter, investigate and prosecute real estate fraud crimes." Many counties,
including San Francisco, have adopted this.
Foreclosure activity is rising almost everywhere in the state. If left
untreated, it could threaten the state's economy.
While the problem is usually blamed on an explosion in loans to borrowers
with subprime credit, the real problem "is the way these loans were structured
and sold," says Jeffrey Berns, a Tarzana (Los Angeles County) lawyer who is
preparing to file suits on behalf of hundreds of borrowers who took out option
ARMs.
An option ARM is an adjustable-rate mortgage that gives the borrower
several payment options. The lowest payment covers no principal and less than
100 percent of the interest. The unpaid interest is added to the loan balance.
This negative amortization is disclosed in legalese in the loan documents, but
many brokers glossed over or failed to mention it.
"The (broker) would say, 'I'm going to give you a 1.5 percent teaser
rate.' Then they are shown a payment schedule with these low payments for the
first five years," Berns says
The schedule might show a payment of $2,000 a month for five years,
followed by $6,000 a month for 25 years. However, the broker tells the
borrower, "We will refinance you before the payment goes up," Berns says.
What they are not told is that the teaser rate is good not for five years,
but often for 30 days. Then the rate shoots up and the escalating interest
payments are added to the balance.
"This is disclosed in the note, but the way they describe it, it's almost
impossible to figure out," says Berns. "They say if your payments are not
sufficient you may have interest added to principal."
Many borrowers don't discover that they've made an awful mistake until
they notice that their balance is ballooning. To get out of the loan, they
usually have to pay a prepayment penalty. A typical option ARM penalty is 3
percent during the first three years, which is $15,000 on a $500,000 loan.
Bob Bishop got an option ARM from IndyMac Bank when he refinanced his
condo in San Rafael last year. He says his loan broker, Paul Mikhail of Nation
Mortgage, told him that he would get a 2 percent rate and that his payment
would be fixed for five years. Mikhail warned him that interest could be added
to his principal, but "He said the most this is going to increase would be
about $10,000 over five years," Bishop says.
In fact, Bishop says, his principal is increasing at a rate of about
$10,000 per year.
When he called Mikhail to find out why, "He apologized and said this is
what we were told by the lenders," Bishop says.
Mikhail says he can't talk about an individual client or loan but, "In a
nutshell, (borrowers) get disclosures from us and from the lender prior to
closing. If they don't understand it, they can ask us questions" or hire an
attorney. Even after closing, a consumer has three days to rescind a refinance
loan (but not a purchase loan).
Berns, who is not representing Bishop, says it was not uncommon for
brokers to misunderstand the complex loans they were selling. "Some brokers had
no idea what the terms were. They just saw the lenders were giving them extra
to write this loan," he says.
Berns says he will not represent people who took out option ARMs to buy
investment property. While many of his clients are financially unsophisticated,
some are not, including a judge. Nor are they all subprime borrowers.
"I have examples of clients who had fixed 5.5 percent loans. Their FICO
scores were over 750. They were refinanced out of that loan because they were
told this (option ARM) was better. After the first month, their interest rate
was 8 percent variable."
Berns says he is going to file cases in state court alleging violations of
federal truth-in-lending laws as well as deceptive practices, fraud and
negligent or intentional misrepresentation.
Berns, who is working on a contingency basis, says many lawyers are not
willing to take on these cases. They can be difficult to win because "the
disclosures are there, they're just buried in more than 100 pages of
documents."
However, a state judge in Wisconsin recently ruled in favor of borrowers
who had taken out option ARMs offered by Chevy Chase Bank. The judge ruled that
the loan violated three provisions of the federal Truth in Lending Act, says
Kevin Demet, a Milwaukee attorney who represented the plaintiffs.
The case was filed on behalf of a couple named Andrews, but the same judge
later certified it as a class action. Demet says the class could include 7,000
to 8,000 people nationwide who took out the Chevy Chase option ARM in the year
leading up to April 2005.
The judge ordered these loans to be rescinded, which essentially puts the
borrower and lender back where they were before the loan was made. Chevy Chase
is appealing the decision.
Other types of borrowers who might have a fraud claim include those who
borrowed more than their home was worth based on an inflated appraisal or those
who borrowed more than they ever had any way of repaying.
"I would argue that if there was no apparent way for repayment down the
road after these things started adjusting and it was readily apparent to
someone who ought to know, we would investigate, get all the sides. Unless
there was some sort of reasonable explanation (as to how the borrower would pay
off the loan), I think that's an actionable offense," says Tom Pool, spokesman
for the California Department of Real Estate.
"State courts have found that mortgage brokers are fiduciaries in these
types of transactions," Pool adds.
The state real estate and corporations departments can suspend or revoke
licenses, but they can't provide remedies to borrowers. For that, consumers
must rely on attorneys or law enforcement.
Borrowers who are in trouble should first talk to their lenders.
"My hope is the lenders will come to their senses, say it's time to step
up, we'll rewrite the terms of the loans. There are many opportunities prior to
going to court," Berns says.
He also would like to see federal and state regulators take a larger role.
But "they never do anything until after lawsuits are filed and won," Berns
says. "Once the lenders are hit a few times, the regulators will say we have
proof now. Somebody else did their homework for them."
Net Worth runs Tuesdays, Thursdays and Sundays. E-mail Kathleen Pender at kpender@sfchronicle.com.