Linda A. Watters has spent the past few years busily suing Wachovia National Bank. Her beef? The bank’s mortgage subsidiary was once a lender regulated by the state of Michigan, a state where Watters is the commissioner of insurance and financial services. However, in 2003 Wachovia said its mortgage subsidiary would make loans under the authority of federal regulators and that Michigan’s rules didn’t apply.
Jim Saccacio, chairman and CEO at RealtyTrac.com, the largest online marketplace for foreclosure properties, says “there’s no question that the federal government has the authority to regulate national banks, a practice which began in 1864 under the National Bank Act. But the question raised by Watters was different: Who regulates national bank subsidiaries — subsidiaries which are often separate corporate entities from the banks — the federal government or the states?”
This debate is important to borrowers because state and federal rules routinely differ over such issues as points, fees, prepayment penalties, single-premium insurance, discrimination penalties and lender compensation. When there’s a conflict between state and federal rules, the feds win under the concept of preemption. With preemption, it’s assumed that federal regulations trump conflicting or contrary state rules.
There is logic to preemption. With federal rules there’s one set of standards nationwide, something which makes for an efficient and low-cost marketplace.
However, while federal standards plainly apply to national banks do they also apply to bank subsidiaries? In Watters V. Wachovia Bank, the Supreme Court said yes and voted 5-3 in favor of Wachovia.
Watters had lost earlier cases and the odds of winning in the highest court were virtually nil. If the Supreme Court said that the federal government did not have preemption in banking, then there would have instantly been challenges to federal law in virtually every field, including such areas as environmental rules, product safety regulations and drug enforcement.
State regulators, if they had the chance, might be expected to enact more pro-borrower rules and regulations because they are appointed by easily-accessible state officials. But state regulators can’t regulate national banks and now they also cannot regulate the mortgage subsidiaries of such institutions.
The current system means that national bank subsidiaries can elect to be regulated by the states or — if they prefer — they can opt to be regulated by the federal government. This is the equivalent of you deciding to pay taxes in the jurisdiction with the lowest costs instead of the state where you actually live.
It would seem as a result of the Watters decision that victory by the national banks is absolute, but this may not be the case. What is it that Congress does? It passes laws, laws which set the standards for federal regulators. After the Watters decision, what’s the fastest and most effective way to change the lending system? Change the federal laws and regulations which impact the biggest players.
For the past few weeks, lenders, regulators, experts and consumer groups have been testifying on Capitol Hill about the recent and massive increase in foreclosures, especially among subprime borrowers. According to RealtyTrac.com, there were more than 1.2 million foreclosure actions in 2006, a 42 percent increase over 2005.
The day the Watters decision was announced, Sen. Chris Dodd, chairman of the Senate Banking, Housing and Urban Affairs Committee, said he planned “to carefully examine today’s Court’s decision and to consider with equal care its impact on the future of bank regulation. In doing so, I intend to look closely at the commitment displayed by federal banking regulators to upholding their safety and soundness duties and their equally important consumer protection and enforcement responsibilities.”
Almost instantaneously, federal regulators declared that “federal bank, thrift and credit union regulatory agencies are encouraging financial institutions to work with homeowners who are unable to make mortgage payments. Prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the financial institution and the borrower. Institutions will not face regulatory penalties if they pursue reasonable workout arrangements with borrowers.”
Reading between the lines, federal regulators are telling their constituency to go easy on endangered borrowers, even if that means reduced revenues and profits. The reason: Inflamed lawmakers may enact far-stricter legislation than anything regulators might contemplate.
The big deal in Washington is now the coming 2008 presidential election. Millions of foreclosures over a period of several years translate into millions of votes. The grim headlines regarding subprime and Alt-A loans as well as failing lenders and discomforted investors all suggest change is in the air.
The Watters decision means Congress can no longer ignore the issue of mortgage reform. Since no one in Congress is realistically disposed to give national banks more power — and since no one wants to dismantle or harm a financial system which generally works with great success — the changes we are about to see will be modest.
For instance, a report from the Senate Joint Economic Subcommittee says “policymakers should investigate whether they should prohibit certain types of harmful loan provisions and practices all together, like pre-payment penalties, stated income or low documentation loans. In addition, lawmakers should consider requiring all subprime loan borrowers to escrow property taxes and hazard insurance.”
“Will there be outright prohibitions of such things as prepayment penalties or stated income loan applications?” asks RealtyTrac’s Saccacio. “No one knows at the moment, but don’t bet against at least some changes in the mortgage system, help for beleaguered homeowners and more balance between lenders and borrowers.”
Columnist Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 100 newspapers.