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We are at a crossroads. The regulatory landscape of mortgages, through decades of deregulation, crass competition for charters, and aggressive concentration of federal power at the expense of state laws protecting local citizens , failed to curb abuses in the mortgage market in any meaningful way. The subprime crisis was the direct result of not policing the market, resulting in skyrocketing foreclosures, falling homeownership rates, lost municipal tax revenues, vacant buildings, and distress to the economy as a whole. The persistent nature of these problems strongly suggests that proper reregulation of mortgage loans, with a strong federal floor augmented by state regulation, is necessary to stabilize the economy and make homeownership sustainable. In this chapter, we offer a critical analysis of the legal landscape of residential mortgage lending and explain how federal law abdicated regulation of the subprime market.1 In the loan origination market, federal deregulation and preemption of state law combined to produce a system of dual regulation of home The Legal Infrastructure of Subprime and Nontraditional Home Mortgages patricia a. mccoy and elizabeth renuart 4 1. We use the term “subprime” to refer to home mortgage loans that carry higher interest rates, points, or fees when compared with loans extended to the best-qualified borrowers (also known as “prime” borrowers). Although the subprime market was designed for borrowers with impaired credit, lenders also frequently made subprime loans to unsuspecting borrowers who could have qualified for the best-rate prime mortgages. See, for example, Rick Brooks and Ruth Simon, “Subprime Debacle Traps Even Very Credit-Worthy,” Wall Street Journal, December 3, 2007, p. A1. Accordingly, our definition of subprime loans turns on the high-cost nature of those loans, not on the borrowers’ credit profiles. 110 subprime and nontraditional home mortgages 111 mortgages that precipitated a race to the bottom in mortgage-lending standards. In the process, numerous aggrieved borrowers were left with little or no recourse for abusive lending practices. This laissez-faire state of residential mortgage law, the disastrous marketing of faulty mortgages that contain multiple layers of risk, and declining property values combined to produce the worst foreclosure crisis in the United States since the Great Depression. The Evolving Legal Architecture of the Residential Mortgage-Origination Market Today, federal disclosure law forms the main regulatory paradigm for overseeing residential mortgage credit. That was not always the case, however. Until 1980, state and federal laws regulated the substantive terms of mortgage loans. This regulation included maximum caps on interest rates, otherwise known as usury laws, and restrictions on other loan terms and practices. In this section, we chronicle how federal disclosure laws came to displace the extensive former regime of state regulation. Legal Developments Preceding the Emergence of the Subprime Market Modern consumer credit transactions in the United States are regulated (or not) by an overlapping set of state and federal laws, which are riddled with exceptions and undermined by federal banking agency preemption. These complexities and loopholes did not always exist. Indeed, across-the-board usury caps reigned in state law until the twentieth century. In response to a surge in high-cost “salary” lending and loan sharking in the early 1900s, states began to pass “specialty” usury laws, each of which addressed a specific loan product (for example, a small loan, a retail installment sales finance contract, or revolving credit). These laws were exceptions to the states’ general usury caps. They permitted lending at higher rates and fees and regulated some noninterest aspects of the transactions.2 2. Peterson (2003, pp. 843–44, 862–63); Drysdale and Keest (2000, pp. 618–21). The state usury caps were modeled on the Statute of Anne, passed in England in 1713, which set a maximum interest rate of 5 percent per annum. See also Renuart and Keest (2005, sections 2.2.1, 2.2.2). Throughout the twentieth century, states used a variety of techniques to regulate consumer credit, generally for the protection of borrowers. These included limitations on attorneys’ fees, credit insurance premiums, “service charges,” appraisal fees, commitment fees, and other charges that a creditor might impose. Moreover, many of these laws were (and are) unrelated to direct limitations on the interest rate or other charges that can be assessed by a creditor. For example, state credit statutes frequently render unenforceable some particularly one-sided contract clauses such as waivers of a borrower ’s legal rights, confessions of judgment, or wage assignments. Other restrictions make the consumer debt easier to repay. For example, a special usury law...

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