Statement by Richard F. Syron, President, Federal Reserve Bank of Boston, before the Subcommittee on Consumer Credit and Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives February 4, 1993 - Statements to Congress - Transcript

Federal Reserve Bulletin, April, 1993

Thank you for this opportunity to testify on the credit availability problems that have arisen in low-income communities. As you know, this issue has been an important one in the First Federal Reserve District. Accordingly, my prepared statement will focus on what we have learned from second-mortgage abuses in Boston.

Second-mortgage abuses represent one of the most emotional issues facing the Congress, regulators, lenders, and the public. Some homeowners, usually the elderly or disadvantaged, have been literally "conned" out of their homes through abusive second-mortgage practices. Others, who have not lost their homes, have been so burdened by high payments that their lives have been severely disrupted. At the same time, home equity is the major asset of most households; borrowing against this asset is the only way that many homeowners can make needed repairs and improvements and tide themselves over in periods of economic distress. Striking the right balance between protecting homeowners and ensuring widespread access to credit is no easy task.

The problems created by abusive second-mortgage practices in Boston came to light in the spring of 1991, when numerous media accounts appeared of minority homeowners having been victimized by second-mortgage lenders. community activists were effective in bringing these abuses to the attention of the public and to government officials.

The rapid appreciation of house prices in the Boston area in the 1980s resulted in many homeowners accumulating significant wealth in the form of home equity. Middle-and higher-income homeowners frequently took advantage of these gains by borrowing through home equity loans to improve their properties, to send their children to college, or simply to finance higher spending. Low- and moderate-income homeowners should have the same opportunities; but unfortunately, some unsophisticated residents, frequently unaware of the value of their assets, fell prey to unregulated and aggressive loan brokers and home improvement contractors. The end result. of these abuses was to take the equity these people had built, sometimes over a lifetime.

In some cases, unsophisticated homeowners were induced to borrow against their home equity in amounts that were larger than their incomes could comfortably support. When they ran into difficulty, the day of reckoning was postponed with yet larger loans until the potential to refinance was exhausted. At that point, the monthly payments were far beyond their means.

Media stories of elderly and infirm homeowners losing their homes understandably fostered deep anger and outrage and fed speculation that the extent of victimization reached many thousands. To help understand the problem, the Federal Reserve Bank of Boston undertook a study to estimate the number of potentially abusive loans secured by real estate in Boston. I would like to submit this report for the official record.

We found that, out of a total of more than 50,000 nonacquisition mortgages made in the four years 1987 through 1990, 698 carried an initial interest rate of 18 percent or more. Another, 1,630 were estimated to have interest rates in the 15 to 18 percent range. The bulk of the loans with interest rates higher than 18 percent was made by a small group of lenders, identified in the report. No banks were among the lenders with the highest rates or even among the lenders making loans at 15 to 18 percent. However, most of the large banks had provided financing to some high-rate lenders or purchased mortgages from them.

The report by the Federal Reserve bank of Boston is subject to several qualifications. Most important, the report focused on loans at high interest rates, and, therefore, it did not identify as problems those loans with relatively low interest rates but high points ad fees; nor did it uncover instances of shoddy workmanship, high pressure sales tactics, or fraudulent documents. Some people have also noted that the study was limited to loans made in the four years 1987 to 1990, whereas newspaper accounts indicated that some problems dated back to 1985. However, bias in the study may overstate the value of problem mortgages.

The report helped to accomplish the following.

First, identifying the type and the names of the companies that were most active in making potentially abusive loans helped state officials formulated their response. A relatively small number of companies accounted for most of the problems. Legislation was enacted to license mortgage lenders and brokers and also home improvement contractors, and new consumer protection regulations were promulgated by the Massachusetts Attorney General. In addition, the Attorney General initiated several enforcement actions, including litigation against several mortgage and home improvement companies, as well as some individuals. During this process we worked with State officials and made specific suggestions about approaches that could be taken.

Second, the report confirmed that banks did, indeed, bear some responsibility for the problems arising from second mortgages, even though they themselves were not high-rate lenders.