Corporate & Securities Law

--INTRODUCTION 

Precisely one decade before JP Morgan announced an agreement to buy Bear Stearns for $2 per share (later increased to $10 per share), the FTC heard and adopted testimony on abusive subprime lending practices.  

That's right, 10 years to the day before Bear Stearns formally collapsed, the FTC outlined specific and (the FTC believed) serious problems in the subprime lending industry.

• 1990's SUBPRIME LENDERS FREQUENTLY BASED UNDERWRITING DECISIONS ON HOME EQUITY RATHER THAN ABILITY TO REPAY

• SUBPRIME LENDERS IN THE 1990'S OFTEN CONVINCED BORROWERS TO REFINANCE (OFTEN SEVERAL TIMES). 

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--MARCH 16, 1998 FTC PRESS RELEASE ON ABUSIVE PRACTICES                                 IN SUBPRIME LENDING

(Excerpted and reprinted from http://www.ftc.gov; highlighted by Wall Street Law Blog)

Predatory practices in the subprime mortgage lending market such as "equity stripping," "packing," and "flipping" and the threat these practices pose to vulnerable homeowners were the subjects of testimony delivered today by Jodie Bernstein, Director of the Federal Trade Commission's Bureau of Consumer Protection...

Subprime lending refers to the extension of high interest rates or higher fee loans to higher risk borrowers. 

This segment of the lending industry has grown substantially since the early 1990s. In 1997 alone, subprime lenders originated over $125 billion in home equity loans. 

In addition to an expansion in the number of loans, the Commission's testimony notes that the composition of the industry is changing. One of the most dramatic changes has been the growth in subprime mortgage lending by large corporations that operate nationwide...

...Bernstein addressed three of the abusive practices that reportedly are occurring with some lenders in the industry and that concern the Commission -- equity stripping, packing, and flipping.

Equity stripping occurs when a loan is made based on the equity in a property rather than on a borrower's ability to repay the loan. 

As a general rule, loans made to individuals who do not have the income to repay such loans usually are designed to fail. They frequently result in the lender acquiring the borrower's home and any equity the borrower had in the home.  (Wall Street Law Blog: Remember, this is from 1998!  Wall Street CEOs claimed to be shocked by lending practices during the recent subprime crash...)

Packing is the practice of adding credit insurance or other "extras" to increase the lender's profit on a loan. Lenders often stand to make significant profits from credit insurance and, therefore, have strong incentives to induce consumers to buy it as part of a loan.  

Flipping occurs when a lender induces a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time...

Bernstein outlined for the Committee the allegations the [FTC] made in a January 1998 complaint filed... [against a subprime lender]. The FTC alleged that the [lender] violated Section 5 of the FTC Act which prohibits unfair and deceptive practices... [The FTC also] alleged that the company violated three credit laws enforced by the Commission: the Truth in Lending Act, the Fair Debt Collection Practices Act, and the Equal Credit Opportunity Act.

-END OF FTC RELEASE-

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Brett Sherman, The Sherman Law Firm