One way that lenders and brokers can manipulate the underwriting process

A study by the Federal Reserve System’s Study Group on Disclosure issued in March 2000 focused on improving transparency in bank reporting through disclosures to such stakeholders as regulators, ratings agencies, securities firms, and institutional investors; the study did not mention consumers. The study group reported that while “a wide spectrum of market participants would like to see information on credit exposures broken down by a bank’s internal credit-rating system,” “[s]ome banks argued that the credit-evaluation process that yields internal loan ratings is highly proprietary” or that “internal risk ratings were so subjective that they would not be meaningful if disclosed.”12 If powerful players face such resistance to disclosure regarding how banks analyze credit quality, consumers certainly do not receive adequate information about banks’ “proprietary” underwriting systems.13
Only lenders have access to key information about the interplay of various borrower and loan characteristics that underlie credit decisions. When a lender inputs this information into a “black
12 Study Group on Disclosure of the Federal Reserve System, Improving Public Disclosure on Banking, Staff Study 173 at 22 (Mar. 2000), available at http://www.federalreserve.gov/pubs/staffstudies/2000-present/ss173.pdf (last visited Mar. 13, 2006).
13 Cf. Avery et al., supra note 10, at 366 (“[T]he fact that lenders differ in the factors they consider in setting loan prices makes it difficult to select additional data elements that would allow a complete understanding of the determinants of a particular lender’s pricing method.”).
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Comments of the Center for Responsible Lending Mar. 29, 2006
box” and then offers a loan product to a consumer, it essentially says to the consumer “Based on the information I have, here is a loan that would work for you.” It is unfair and deceptive for a lender, who controls the black box, to rig the underwriting process or underwriting criteria to “get to a yes,” regardless of the consumer’s actual ability to repay the loan without refinancing or selling the home. Underwriting practices that misrepresent a subprime borrower’s ability to repay a loan benefit neither consumers nor the economic stability of financial institutions.
One way that lenders and brokers can manipulate the underwriting process for a nontraditional mortgage loan is to analyze a subprime borrower’s ability to repay the loan at an interest rate that is lower than the fully indexed rate. Another way to rig the process is not to count potential balance increases caused by negative amortization. At a minimum, the Agencies should issue safety and soundness regulations that make clear that the underwriting practices that institutions “should” employ indeed are required. The better course of action, and one that would apply across the board to all lenders, would be for the FRB, the NCUA, the OTS, and the FTC to declare contrary underwriting practices to be unfair and deceptive under the FTC Act.