The Future of Responsible Sub-prime Lending and Financial Literacy
Remarks given by John Hope Bryant
Before the FDIC Forum on Mortgage Lending for Low and Moderate-Income Households
Tuesday, July 8, 2008
FDIC Seidman Center
I am honored to be here today with the likes of U.S. Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke, FDIC Chairwoman Sheila Bair, Comptroller of the Currency John C. Dugan, JP Morgan Chase chairman and CEO Jamie Dimon, and a host of others, gathered around the future of responsible mortgage lending to and for low to moderate income households.
Let me start by saying there is nothing wrong with responsible sub-prime lending. Responsible sub-prime lending has done more to lift the poor out of poverty than almost anything over the past 50 years.
The problem has been predatory sub-prime lending, irresponsible sub-prime lending, fraud-based and investment-speculator-based sub-prime lending, and massive levels of borrower financial illiteracy.
I am here as both the chairman of Operation HOPE, and the vice chairman of the U.S. President’s Council on Financial Literacy, as well as chairman of the Council Committee on the Under-Served. Operation HOPE, founded following the worst civil unrest in U.S. history, is today the only national urban delivery system for financial literacy in the nation, operational in more than 60 low-wealth communities nationwide, having educated more than 300,000 low-wealth youth in financial literacy, dignity and what we call “silver rights” (making free enterprise and capitalism work for the poor), with the help of 6,000 HOPE Corps volunteers from the banking and financial industry, and more than 1,200 low-wealth schools nationwide. Recognizing that many of the communities I serve are significantly under-served, HOPE became the first non-profit in history to build a bank branch, and to sell it to a bank.
As will soon be announced, our HOPE Banking Center based credit and financial counseling services have resulted in an average increase in credit scores for our clients from 580 to 650, or more than 70 points. That is significant.
This mortgage sub-prime crisis is personal to me. Our family lost our home, and my brother, sister and I never realized the benefit of assets and net worth (grown and) shared from generation to generation. Personally, this lack of both assets ownership, and financial literacy knowledge, materialized itself in my literally becoming homeless for six months of my life at age 18. For my community, not even addressing the ravages of irresponsible mortgage subprime lending, today check cashers, payday loan lenders and other forms of mostly predatory credit providers have resulted in a more than $8 billion a year industry, or close to the annual M & A (mergers and acquisition) fee income on Wall Street. In the words of former U.S. President Bill Clinton, “there are more check cashers and payday loan lenders in America’s inner-cities today, than there are McDonalds restaurants and Starbucks coffee house locations worldwide.” Today my proud father lives in a new 4-unit building, built by my wife and I, and sitting on the same street of the home we lost.
My dad, an integrity rich man who built and ran a business for more than 53 years, and in the process helping to raise me to be the person I am today, was neither dumb nor stupid. “It was what he didn’t know that he didn’t know” that was harming him.
Simply put, no one taught my dad the language of money, financial literacy, or what we at Operation HOPE call “silver rights,” the basic rules of free enterprise and capitalism, and how to make them work for him. Like anyone else, had my father known better, he would have done better.
In the hurried and seemingly one-sided subprime mortgage lending process experienced by my family in South Central Los Angeles, there was no financial literacy scorecard or questionnaire calling forth “common sense” questions at the start of the process, as well as the potential answers those obvious initial questions begged forth, in turn. There were no simplified disclosure of terms and conditions, in plain English, for my dad. A Ph.D could not understand the papers he was signing. Or even if he had questions, there was not an opportunity for a meaningful break in the process, nor a meaningful resource to turn to, of any kind, for my dad. It was for all intent and purposes, a one-sided, if not wholly predatory transaction. The mortgage broker held all the cards, and seemed to have all the answers too, and my dad and our family held and had little to none, of either. My dad was alone and on his own, as he undertook possibly the most significant single financia l transaction (for family wealth creation) of his lifetime.
It is striking that in the largest economy in the world, no one is teaching our children, yet alone our adults, financial literacy and the language of money. This must change.
Let me also say that this is not an issue of the poor.
This current crisis is principally a crisis of the middle class, not the poor. Individuals who asked “what’s the payment,” and not “what’s the interest rate.” Individuals who purchased a home, like many of us purchase automobiles, and you shouldn’t purchase an automobile that way.
If you purchase an iPod, and place it on a credit card and make minimum payments over time, it will cost you $4,000
.00. Now, apply this analogy to a six-figure home purchase and you have an economic tsunami on your hands.
Let me thank my friend and colleague FDIC Chair Sheila Bair, in calling for this important and forward-looking forum on (the future of) low and moderate income mortgage lending. This is a vitally important meeting, at a vitally important time in our nation’s history. The still-unfolding magnitude of and fallout from this mortgage sub-prime crisis, has not been seen in my or my father’s lifetime.
I see this crisis in three primary buckets; (1) make sure it never happens again, (2) make sure that individuals have reasonable continued access to credit, post crisis, and (3) make sure that folks in the economic soup (of foreclosure) get as much help as can be reasonably provided (without rewarding investors, speculators and providers of capital).
The U.S. President’s Advisory Council on Financial Literacy was created by Executive Order by U.S. President George W. Bush, on January 22nd, 2008, in the midst of this mortgage sub-prime crisis, and the President’s very words on that day articulated his own desire for this group, saying, “one of the issues that many of our folks are facing now are these sub-prime mortgages. I just wonder how many people, when they bought a sub-prime mortgage, knew what they were getting into. The low interest rates sounded very attractive, and all of a sudden, that contract kicks in and people are paying high interest rates. One of the missions (of the Council) is to make sure that when somebody gets a financial instrument they know what they’re getting into, they know what they’re buying, they understand.”
I certainly saw that we, the Council, could and should do all that we could to ensure this sort of crisis never happens again (with respect to future generations), and that going forward, reasonable access to credit and the financial markets should continue for those qualified but under-served and/or low-wealth in our great nation.
Operation HOPE’s Mortgage HOPE Crisis Hotline is doing its part in California, and HOPE Now and others are doing their part nationwide. Operation HOPE’s crisis hotline received more than 25,000 calls in the first 60 days, in Los Angeles alone. To the extent that there has been a Washington, (D.C.) response to the current economic crisis, including the innovative proposal by Chairwoman Sheila Bair, it has understandably been with respect to stemming the pain of those in foreclosure.
This said, I remain very concerned that lending to the poor, the working class, and even America’s middle class, will effectively “dry-up” post mortgage sub-prime crisis. Some would say that credit access has already dried up in the non-government market.
I first communicated my concern to the chairwoman on a Saturday morning in March; a concern that unless you had a credit score of 800 and 25% down payment, you were not going to be able to obtain a loan from a mainstream lender. I offered that, in my view, this would not be good for America.
I didn’t expect her to respond immediately. Privately, while I hold Chairwoman Bair in very high regard, I didn’t expect her to even share my depth of concern, nor my passion for the issue. It was I, after all, who grew up in an inner-city community; who saw the ravages of communities and individuals, whose only sin was that they were hard working yet financially illiterate, and forced by circumstances of life to make sometimes major financial decisions, daily, yet without the knowledge and tools to do so.
This was my problem I thought. Chairwoman Bair’s response to me was instantaneous.
I had barely finished my message to her, and there was her response – this was indeed a problem, but not just a problem of the poor (Operation HOPE’s mandated target audience), it was a problem for the country, and she wanted the FDIC to be a part of the solution. What I didn’t know was that Chairwoman Bair was in fact, ahead of me.
Chairwoman Bair shared with me her vision for this “forum on the future of LMI lending,” and likewise she vowed to work with me in my new role, both as vice chairman of the U.S. President’s Advisory Council on Financial Literacy as well as the Council’s chairman of its Committee on the Under-Served.
On May 28th, 2008, as my Committee gathered together experts from a range of disciplines, from banking, to mortgage lending, to state and federal regulatory agencies, to community leaders, and leaders from Wall Street and the secondary market, many individuals in this room today, on “the future of responsible sub-prime mortgage lending” in the Cash Room at the U.S. Department of the Treasury, the FDIC was with us. Led by Robert Mooney, director of consumer affairs for the FDIC, the four substantive half-day Committee work sessions, encompassing products, disclosures, intermediaries and of course financial literacy, were even moderated by FDIC personnel.
My participation in today’s FDIC Forum on (the future of) LMI Mortgage Lending represents an important benchmark in my commitment both to Chair Bair and the under-served communities we serve.
Joining the likes of Treasury Under-Secretary Steel, Comptroller of the Currency John Dugan, Deputy Comptroller Barry Wides, SEC Commissioner Paul Atkins, and representatives from all of the federal regulatory agencies, as well as the New York Banking superintendent and Washington, D.C. Banking Commissioner, here today, were banks including Wells Fargo, Bank of America, Washington Mutual, Bank of the West, Goldman Sachs, the Financial Services Roundtable, and many others. 60 leading experts, to be exact.
I know that James Lockhart is here today, director of the Office of Federal Housing Enterprise Oversight, which regulates Fannie Mae and Freddie Mac, and who was an active participant in our Committee discussions on May 28th.
The goals of the meeting were to:
1. identify and differentiate between responsible and irresponsible sub-prime mortgage lending;
p; outline the principles that should govern future development of sub-prime mortgage products; and
3. identify what financial literacy initiatives would be needed to address the massive level of financial illiteracy that has been a key contributor to the recent crisis.
After a half day session at Treasury on May 28th with 60 leaders, and a 4-hour follow up meeting with lead participants from May 28th, the Committee was able to finalize and issue a report, entitled “the future of responsible mortgage sub-prime lending,” and the Committee-approved version is available on the Treasury website here .
Here is a summary of some of our key recommendations from the report:
- A fixed rate, fully amortizing mortgage with a term of up to 40 years.
- Minimum one month PITI (principal, interest, tax, insurance) in required borrower cash reserves at closing (borrower’s own funds).
- Standard verification of income and assets.
- Minimum down payment required by borrower.
- A Life Event Clause. For borrowers with good payment performance, under certain circumstances borrowers would be allowed to skip a payment (or payments) for certain specified “life event” reasons, with the amount of missed payments added to loan principal. One approach would be to provide one “payment holiday” for every specified period of months with good payment history. So, after 10 years of consistent and timely payments, a borrower could request as much as a 6 month “life event” payment deferral, with principal and interest here moved to the rear of the loan. Everyone wins.
- Determination of the borrower’s ability to repay. Appropriate underwriting parameters are critical for borrowers with an established, but blemished, credit history. The risk factors should be carefully balanced and include the borrower’s credit score, debt payment capacity (debt-to-income ratios), post-close liquidity, etc.
- Non-traditional credit history. Borrowers with thin credit files and/or non-traditional credit history should be underwritten in a manner that takes into account a borrower’s non-traditional payment history profile – that is, their fixed or regular payment obligations that are not reported to the credit bureaus (e.g. rent or utilities, as well as other periodic payment obligations, e.g. alimony, child support, or remittances).
- A simplified disclosure of terms delivered to borrower early in the process. Possibly, a one to, maximum, four page, easy to understand form at the loan shopping stage, with the most pertinent information summarized on page one.
- No prepayment penalty.
- Pre- and post-purchase counseling options to be made available, but are not required for this loan product.
- Ongoing best practices to maintain payment discipline. The ongoing best practices should include, for example, providing periodic free credit reports to help manage credit, with access to credit education specialists that can answer questions about the reports. In addition, education should be provided about banking products that can make money management routine and effective for the borrower.
- A Financial Literacy Scorecard review would be required for this loan product; helping to ensure that borrowers understand the basic terms of the transaction, including a clear differentiation of and between “payment” vs. “interest rate.” Borrowers who are not clear at that point would be encouraged
to stop the process, and to call a designated 1-800 number.
- No negative amortization or pay option features allowed.
And while I will not get into details around what crafters referred to as “Product B,” also outlined in the Committee report, let me provide a clarification here:
- Product B is a variable rate product with 1) affordable rate and payment caps;
- 2) does not limit rate and payment discounts for borrowers;
- 3) with underwriting based on one’s ability to repay the “fully indexed” rate and amortizing payments.
We will clarify this more formally in a future report revision.
Other good ideas included:
- The overarching goal is to move consumers from sub-prime borrowing to become a prime borrower. Every participant in the mortgage process should be held accountable in making this happen. By establishing compensation based on the demonstrated performance in making loan payments, the originators or brokers and servicing representatives would be encouraged to follow best practices.
- Therefore, we recommend that these incentives should be implemented: 1) withholding a portion of originator sales commission until payment performance has occurred, 2) reduction in GSE guarantee fees for loans where the borrower has received certified financial education, 3) reduction in fees/rate for borrowers who have received certified financial education, and 4) GSE/investor compensation to servicers for financial education and servicer prompting of borrowers to make payments to help establish good payment practices.
- Financial education should be done face-to-face, over the telephone, and financial education resources and contacts should be listed and provided at all points of the mortgage process and in all mortgage materials.
Finally and in conclusion, I am proud to announce today that today the following endorsements and statements of support for the Committee’s work have been released publicly:
- This morning, Wells Fargo issued a full endorsement of the Committee-approved report, stating “we support the Council on Financial Literacy and the Committee’s recommendations noted in “the future of responsible sub-prime lending.” Their statement continued, “we agree with the Council that financial literacy should serve as a foundation to all responsible sub-prime lending and understand the Council is continuing its discussions. We look forward to their final determination.”
- Cara Heiden, co-president of Wells Fargo Mortgage deserves special leadership credit. As far back as 2003 she risked her career by stopping practices she thought inappropriate but which unreasonably benefited the broker community. She went on to require her bank to send a letter to every approved sub-prime borrower who qualified for better rates and terms, copying their broker, offering them a prime loan instead. Oddly enough, I recently received a call from their home equity division, noting my good payment record but offering me assistance around restructuring “during these times,” should I need it. I didn’t need it, but I sure appreciated the offer.
• Banco Popular today endorsed the Committee-approved report, and we have heard from its CEO here today. Honored to be associated.
- The Housing Policy Council of the Financial Services Roundtable issued a statement of support, saying “HPC supports the mission of the Committee which is to ensure that responsible sub-prime lending continues in the future.” HPC continued “we applaud the efforts of the Committee to reinvigorate the sub-prime market through responsible lending practices and improved financial education for consumers.”
- John Reich, director of the Office of Thrift Supervision, issued a statement of support, saying “the OTS strongly supports initiatives and policies that foster financial literacy, informed consumers and high standards of business conduct throughout the financial services industry. Consistent with these objectives, I strongly support the efforts of the President’s Advisory Council on Financial Literacy and the Committee on the Under-Served to develop a range of practices and policy recommendations for responsible sub-prime lending. The OTS is committed to lending our sup
port to this important work. Senior members of my staff have participated in discussions, including the May 28th meeting of the Committee on the Under-Served. We remain available for additional discussions and assistance as needed.”
And while these are surely very encouraging developments with respect to the now public Committee-approved report, and fairly early on in the process, and we encourage others to take whatever good ideas they find might be useful to them “in the market,” Council Chairman Schwab and I are already looking at what I refer to as “phase II,” of the process.
The next step, which is now underway, involves the full Council review and consideration of a broader, related series of “guiding principles” (policy recommendations) around “the future of responsible mortgage sub-prime lending,” which build off of the Committee report.
This final series of “guiding principles” will be brought before the full Council in the very near future.