Lawmakers and lending

The state Assembly’s response to the sub-prime mortgage catastrophe experienced its own meltdown in the Senate Banking, Finance and Insurance Committee last week. In a twist on the cliche, only the weak bills survived. The most ambitious Assembly bill, AB 1830, was tamed in advance by sponsor Ted Lieu (D-Torrance) to answer some of the industry’s objections, yet even the less-restrictive version was gutted by the committee.

Granted, not every problem requires a response from government -- especially when the problem is in a competitive marketplace. But in the case of the mortgage crisis, there’s much for lawmakers at the national and state levels to do. The credit doldrums sinking our economy resulted in no small part from incentives among brokers, lenders, rating firms and investors to push high-priced loans into borrowers’ hands regardless of their ability to repay. To avoid another crisis the next time housing prices shoot up, those incentives have to be removed. Fortunately, the Senate Judiciary Committee is poised to take up Lieu’s bill as early as this week. It has the chance to undo the damage inflicted by the banking panel, and it shouldn’t hesitate to do so.

The Assembly-passed bill would have, for sub-prime loans, banned prepayment penalties, which can lock borrowers into bad loans, and “yield spread premiums,” which reward mortgage brokers who persuade customers to accept higher interest rates. It also would have barred some exotic loans for sub-prime borrowers, including “liar loans” that are granted without verifying the borrower’s ability to repay. Finally, it would have prohibited lenders from refinancing loans unless there were tangible benefits for borrowers. These restrictions, aimed at widespread predatory lending practices, are already law in some states, and the Federal Deposit Insurance Corp. has called for similar strictures in new federal “truth in lending” rules.

We would prefer retaining some freedom for borrowers and lenders to agree to loans with prepayment penalties and higher interest rates, as long as there are better protections in place for borrowers. Lieu offered a compromise along those lines to the Senate Banking Committee. Such alternatives, which can offer lower upfront costs but higher payments over the long term, can make sense for savvy short-term borrowers. There’s enough evidence of borrowers being harmed by prepayment penalties and yield-spread premiums, however, to justify banning them. Either way is far better than the hamstrung version of AB 1830 that the banking committee approved, which would merely give state regulators the power to help enforce federal lending rules. That’s not a bad addition to the Assembly-passed version of AB 1830, but it’s not an acceptable substitute.