It hardly seems unfair. Aren’t borrowers responsible for the loans they take out? It’s not like someone is held at gunpoint and forced to accept the worst loan lenders can concoct.
That’s the thinking of a considerable segment of the population, a segment represented in some of the email I receive as well as in the ethics classes I teach for real estate brokers.
Borrowers, according to such logic, should not be bailed out. They signed up for a loan and if it had woeful terms it was the borrower’s job to know better. Let the market take its course; if people fail they’ll know better the next time. Besides, individual responsibility counts.
It’s not up the government to rescue people who made bad financial decisions goes such thinking, especially real estate investors. As President Bush said in August 2007, “it’s not the government’s job to bail out speculators, or those who made the decision to buy a home they knew they could never afford.”
There’s much regarding the borrower-is-responsible view which is attractive, including simplicity. That said, borrower responsibility should be seen as a nuanced concept, one which requires a look at both principle and circumstances. Here’s why:
Mortgage Theory Versus Reality
Personal responsibility is a great theory, but when used on an absolutist basis it denies the reality of modern life, the fact that we are each dependent on one another because no one knows everything.
For instance, when you get dental work do you check to see that the dentist properly sterilized his instruments? Why not? Dirty dental tools can lead to massive infections that can disfigure your face, cause you to go blind and lead to brain injuries and death.
The truth is you don’t check the dentist’s instruments for the same reason you don’t ask a chef when he last washed his hands or the brake repair guy if he tightened all the bolts. Instead, you expect that even the most mundane activities have standards, protections and social norms which make your dealings safe and predictable.
Unfortunately, when it comes to mortgage lending virtually no one understands the paperwork they sign at closing and thus the full content of the loans they take out.
Don’t believe it? Let’s get some testimony from people who should be supremely adept at mortgage matters, real estate attorneys with nationally-recognized expertise and credentials.
Unread Mortgage Paperwork
First up we have Mel Martinez, previously a secretary of the Department of Housing and Urban Development and a former United States senator from Florida. As Mr. Martinez told The Washington Post, “you know if I’m a lawyer and the secretary of HUD and I’m not reading this junk, you know there’s work’ to be done fixing the system.” (See: HUD Chief Seeks Simpler Sale Closings, June 2, 2001)
Next we have former HUD Secretary Alphonso Jackson. According to The Washington Times, “Jackson says he knows just how borrowers must feel when they’re caught off-guard by sudden surges in their monthly payments because they didn’t read the fine print in their contracts.
“‘I’m an attorney and I’ve had eight houses and I didn’t read all that mess. If I didn’t read it — and I doubt anyone around this table read it — then we can’t hold people responsible for not reading every line when they were closing their loan.’” (See: Jackson: Mortgage fine print not read, March 20, 2008)
Bargaining Over Mortgage Terms
A basic concept in the contracting process is that both parties must be able “to negotiate as equals to have a valid contract,” according to Successful real Estate Negotiation. “In situations where one party feels compelled to act because he or she believes they have no choice, or do not have a valid opportunity to understand the agreement, or finds the complex and technical language used in the contract is over his or her head, then such contracts may, in certain instances, be declared invalid by the courts because these deals lack a true ‘bargaining over terms.’ A contract in which the language cannot be understood equally by both parties is a so-called ‘contract of adhesion.’”
The mortgage system has broken down because in many places the standards and protections that any normal, rational person would expect are missing. The result is that blanket expectations of personal responsibility are not possible on a playing field which is neither fair nor level.
Regulators, for example, should be expected to protect the public interest yet did nothing to stop the widespread use of stated-income loans nor did they object to the unfettered use of option ARMs or interest-only mortgages, the toxic loans behind many of today’s foreclosures.
Not only did federal regulators fail to protect the public, they made sure that state regulators could do little if anything to defend borrower interests. As the federal Office of Thrift Supervision has said, state laws which “prohibit the financing of single premium credit life insurance or that restrict points, fees, and prepayment penalties or other forms of compensation are preempted” by federal regulations.
A Contract is a Contract — But Not Always
A mortgage is nothing more than a contract between a borrower and a lender. A lender provides cash in exchange for the borrower’s promise to repay the debt under certain terms and conditions.
But while the concept of a “contract” can be generally explained in just a few words, the actual mechanics of contract law fill large libraries. It’s not enough to just sign on the dotted line, a host of other factors potentially come into play.
“The case for personal responsibility is surely attractive,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the nation’s largest source of foreclosure data and listings. “But our legal system plainly recognizes that personal responsibility does not exist in a vacuum. To look only at personal responsibility when considering mortgage issues is to miss the larger picture.”
As an example, in California the Fourth Appellate District Court of Appeal heard a dispute between a builder and a home buyer. The issue in Baker v. Osborne Development: Was the buyer obligated to use binding arbitration in the event of a dispute with the builder?
The written agreement between the parties was clear: Buyer Baker had agreed to use an arbitration service named by Builder Osborne. But the appeals court ruled in January that the requirement could not be enforced. Why? Because the terms of the agreement were unconscionable.
It’s not enough to bury “overly harsh” and “one-sided” clauses in a complex legal document and then expect them to be enforced. Fairness and balance also count, said the court, which ruled for Baker the borrower.
There are other elements required to create a valid agreement besides a signature. First, said the court, there is the matter of oppression. “Oppression arises when the parties have unequal bargaining power, leading to no real negotiation and lack of meaningful choice.”
Element of Surprise
Also, said the judges, the agreement failed because it contained an element of “surprise.”
“Surprise may arise when challenged terms are hidden in a prolix printed form drafted by a party in a superior bargaining position.” (The term “prolix” means lengthy and complex.)
Hmm — a prolix printed form. That sure sounds like a toxic mortgage agreement
The Role of Lenders
But what about lenders? Can’t borrowers rely on them for advice? Don’t lenders universally try to get the best rates and terms for borrowers?
“Some have proposed,” Harry Dinham, a former president of the National Association of Mortgage Brokers told Congress, “that a fiduciary duty standard should be implemented and mortgage originators and their loan officers should act in the ‘best interests’ of the consumer. NAMB remains opposed to any proposed law, regulation or other measure that attempts to impose a fiduciary duty, in any fashion, upon a mortgage broker or any other originator.”
Another leader of the lender community, John Robbins, former chairman of the Mortgage Bankers Association, has said that “a lender underwrites, approves and funds the loan. The lender does not hold himself out as an agent of the borrower. While a lender must serve its customers fairly, and the industry has done much to assure high professional standards, a lender owes a duty to its shareholders and investors. A borrower knows a lender offers its own products and does not offer to shop for borrowers.”
While some lenders — such as those who belong to the UpFront Mortgage Brokers Association — feel they have a fiduciary obligation toward borrowers, much of the lending industry does not. How can borrowers tell the difference? It’s virtually impossible because no lender advertises that “we’re not here to get you the best possible rates.”
While there’s an important standard of personal responsibility which ought to be recognized, it’s obviously a standard which is not absolute. This should not be seen as a surprise: As Supreme Court Justice Antonin Scalia — a principled conservative by any measure — has explained, “you can make an exception without the sky falling.”
(Update: If passed, the Wall Street reform bill will finally assume that lenders have a baseline obligation to treat borrowers fairly. In fact, the bill actually allows borrowers to collect big damages for lender abuses. Stay tuned to see if it passes and if the consumer protections remain in place.)
Published originally by RealtyTrac.com in 2008 and posted with permission.